QAD Inc.
Q3 2019 Earnings Call Transcript

Published: 21 Nov 2018

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the QAD Fiscal 2019 Third Quarter Financial Results Call. At this time, all participants are in a listen-only mode and later, we will conduct a question-and-answer session, instructions will be given at that time. [Operator Instructions] As a reminder, the conference is being recorded. And I’ll now turn the meeting over to our host, Chief Accounting Officer, Kara Bellamy. Please go ahead.

[Kara Bellamy:]

Hello, everybody, and welcome to today’s call. Before we begin, I would like to ensure that everybody understands that our discussion may contain forward-looking statements that are based on certain expectations and analyses. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. QAD undertakes no obligation to revise or update these forward-looking statements to reflect events or circumstances after the date of this call. For a complete description of these risks and uncertainties, please refer to QAD’s 10-K and 10-Q filings with the Securities and Exchange Commission. Please also note that during this call we will be discussing non-GAAP pretax income, which is a non-GAAP financial measure as defined by SEC Regulation G. A reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measure is included in today’s press release, which is posted on the Company’s website. Now, I would like to turn the call over to Daniel Lender, QAD’s Chief Financial Officer.

[Daniel Lender:]

Well, thank you very much, Kara. Good afternoon, everyone. Thank you for joining us to discuss QAD’s third quarter results. Pam Lopker, President is joining me on the call. Before we begin, I want to acknowledge, as most of you know, that we recently lost Karl, our CEO, a great friend, colleague and co-founder of QAD. He helped build the great Company and an outstanding team that will continue a legacy of helping global manufacturers to better manage their operations. While we are back to business as usual here at QAD, Karl is and will be sorely missed. I would like to thank all of you for your heartfelt thoughts and sympathy during this time. Let’s now review our results. While total revenue was slightly below guidance due to our services business, subscription revenue on profit exceeded our expectations. Currency had a negative $1.4 million impact to revenue, compared with last year, but no impact to our bottom line. My comments about revenue growth are given on a performance basis, unless otherwise noted. Compared to the same quarter last year, third quarter revenue increased by 5%. Subscription revenue grew 40% and is now approaching 30% of our business. Subscription margins rose to 64%, up from 56% a year ago, and 63% for the second quarter. We expect margin of about 63% for the full year and just a reminder, our goal is to grow margins by 1 to 2 percentage points annually after fiscal ‘19. Maintenance and other revenues was roughly equal to last quarter at $30.4 million but was down about 4.5% year-over-year, primarily related to continued customer conversions to the cloud and historical attrition. As car conversions increase, maintenance revenue is expected to decline. Recurring revenue which equaled subscription plus maintenance revenue grew 11% from the prior year and accounted for 68% of total revenue for the third quarter, up 4 percentage points from last year’s third quarter. Our professional services revenue was $20.7 million, the same as in last year’s third quarter. Services margins remained positive for the quarter. During the quarter, the multisite global implementation we discussed on our last earnings call, temporality paused in order to finalize processes of the 59 sites already live. This fourth month pause and lower services activity in EMEA impacted our third quarter services revenue and will also have an impact to our fourth quarter. The implementation is anticipated to resume right after the New Year, once the customer finishes their end of year activity. Despite the lower revenues, we were able to achieve profitability due to effective management of utilization and subcontractors. For the full year, we anticipate achieving a small profit in our professional services business. License revenue was $4.6 million versus $6.6 million last year. We closed two deals greater than $200,000 with none greater than $1 million. We continued to generate a majority of our license revenue from existing customers. Total revenue by vertical for the third quarter was automotive 39%, high-tech and industrial 30%, consumer products, and food and beverage 16%, and life-sciences 15%. By geography, total revenue was North America 50%, EMEA 28%, Asia-Pacific 16% and Latin America 6%. Gross margin was $42.2 million for the 2019 third quarter, compared with $38.9 million last year and gross margin was 63% for the fiscal 2019 period and 51% for the fiscal 2018 period. Our sales and marketing expense totaled $18.4 million versus $17.7 million last year and was 23% of total revenue for both periods. The increase was due to additional headcount as we discussed last year. R&D expense was 13.2 million for the 2019 third quarter versus $12.1 million last year. The increase was primarily driven by additional headcount, and third-party developers. R&D expense was 17% revenue of total revenue for the fiscal ‘19 third quarter and 16% last year. General and administrative expense amounted to $8.1 million or 10% of total revenue, compared with 8.6 million or 11% of total revenue last year. The decrease was attributable to lower personnel costs and reduced stock compensation expense. This brings total operating expenses to $39.7 million for the fiscal ‘19 third quarter compared with $38.4 million last year. As a percentage of total revenue, operating expenses were 50% in both periods. Stock compensation expense was $2.1 million for the fiscal 2019 third quarter and $2.3 million last year. Operating income was $2.5 million versus $430,000 last year. Our GAAP pre-tax income was $3.6 million versus a GAAP pre-tax loss of $1.1 million for the last year’s third quarter. Non-GAAP pre-tax income was $5.7 million versus $3.5 million a year ago. Our GAAP net income totaled $3 million or $0.14 per diluted A share and $0.12 per diluted B share comparing to a GAAP net loss of $161,000 or $0.01 per Class A and B share last year. Income tax expense was $587,000 for the third quarter; our annual effective rate is expected to be approximately 40%. Now, I’ll briefly review our year-to-date results. For the year-to-date period, total revenue grew 12% to $250 million, up from $224 million, driven primarily by increases in subscription and services revenue. Subscription revenue grew 35% to $67.8 million compared with $50 million in the year ago period. Our gross margin was 53% of total revenue compared with 51% in the prior nine-month period. And subscription margin totaled 63% for the fiscal ‘19 period and 54% for the fiscal ‘18 period. Our total operating expenses came to $125.4 million or 50% of total revenue versus $115 million or 51% of total revenue last year. Our pretax income was $8.7 million versus a pretax loss of $1.2 million a year ago and non-GAAP pretax income was $16.2 million for the fiscal 2019 year-to-date period compared with $6.1 million last year. Our GAAP net income was $5.5 million or $0.26 per diluted A share and $0.23 per diluted B share versus a net loss of $3.9 million or $0.21 per class A and $0.17 per class B in the same period last year. We ended October with $138 million in cash and equivalents compared with $147 million at the end of fiscal 2018. Our accounts receivable was $46.4 million, compared with $83.5 million at the end of the fiscal ‘18 and $50.8 million a year ago. Our day sales outstanding using the comeback method was 48 days for fiscal 2019 third quarter versus 53 days for the same period of last year. And the quality of our receivables remains healthy. Our short-term deferred revenue balance on October 31 was $80.5 million versus $83.1 million a year ago. And it includes $50.7 million of deferred maintenance versus $52.7 million, $27.8 million of deferred subscription versus $25.5 million, $1.8 million of deferred professional fees versus $3.6 million and $200,000 of deferred licenses versus $1.3 million. As a reminder, our maintenance contracts are billed annually and subscription contracts can be billed either annually or quarterly. Our cash flow from operations was $15.1 million for the first nine months of fiscal ‘19 comparing to $2.8 million last year, reflecting continued subscription revenue and margin growth. I’ll finish up our financial review with guidance. We have tightened our revenue guidance and increased our pretax guidance for the full year and are now expecting total revenue in the range of previous guidance of approximately 332 million including approximately $92 million of subscription revenue; increased GAAP pretax income to approximately $9 million to $10 million from previous guidance of $5 million to $7 million; and increased non-GAAP pretax income to approximately $19 million to $20.5 million from previous guidance of $16 million to $19 million. Looking a bit ahead into FY20. As we discussed during last year end, we closed a significant number of deals that would have naturally closed in the first half of this year. This resulted in quite strong subscription revenue that we’ve enjoyed during the year, but also meant that we entered FY19, with a cloud funnel where the majority of deals were in early stages. We expected that it would result in those deals closing later in the year. Due to the stronger subscription revenue in FY19 and the back end weight of our funnel at the beginning of the year, we anticipate the subscription revenue growth for the first half of next year will be below the FY19 growth rates. However, we’re very pleased that our weighted cloud funnel today is almost 40% stronger than it was last year. So, we expect the subscription revenue growth will we accelerate towards the second half of the year and into the years following. We’ll be providing more detailed guidance for fiscal ‘20 during our fourth quarter financial results call, currently scheduled for the middle of March. Now, I’d like to turn the call over to Pam for deeper look at our cloud business and product area. Pam?

[Pam Lopker:]

Great. Thanks, Daniel. In Q3, we had 15 new cloud deals including 10 new cloud customers and 5 conversions. On a regional basis, North America was once again the strongest, with the industrial electronics closely followed by life science, the strongest verticals this quarter. DynaSys continues to go well in the cloud. They were able to close the net new customer of furniture and interior décor with a relatively short cycle time of under 90 days. We believe this is due to references from similar companies already using DynaSys. Our largest deal for the Q was the conversion for our manufacturing and distributor of money handling and vending equipment. They were recently bought by a private equity company and were on a very old release of QAD. To support their planned growth moving to the currently release and the cloud made a lot of sense. Now for an update on the product. In early November, QAD entered the QAD Enterprise Platform to our partner community at the Annual Partner Conference in Budapest that we call Teamwork. Over 30 of the developer attendees stayed for the QAD Enterprise Platform training class that was concluded with a 24-hour task packathon. [Ph] Developers worked together as actual teams to roughly deliver a business application, built using the QAD Enterprise Platform. Such apps can be new functionality or extensions of the current functionality in QAD. The event was a great success with 19 successfully built in applications ranging from a company car employee assignment app which of course is very big in Europe but no longer what we do here in the U.S., as far as giving employees cars -- company cars. We also had a quality system training record app and an employee loan tracking app. Many of the platform features were exploited by the teams to handle -- to include creation of a rich user interface, web user interface, dynamic embedded images, email notifications, analytics and integration of external systems, all apps are packaged into a deployable app that can be moved to other environment. The winning app was an issue tracking solutions that could be used for service and support management for manufacturing companies, and it was done by Hungarian partner. This was deemed to offer the most business value and utilize a breadth of QAD Enterprise Platform features. While we expected the teams to work 8 to 10 hours and return the next day to serve their projects. And to developer reputation, it appeared some teams worked through the night and were still energized to show their apps off the next morning. We are excited to see how easily it was -- easy it was for developers with minimal training on the platform to quickly develop business related applications, leveraging the QAD platform. It was a real life showcase of the value it will bring to our partners and customers. We believe this will translate to a competitive advantage and our ability to run this new business. Thanks and back to you Daniel.

[Daniel Lender:]

Well, thanks very much, Pam. That’s very exciting about the platform. Looking at our business on a regional basis for the quarter. Asia Pacific and the Americas performed as expected while professional services affected EMEA in particular. Pam highlighted a cloud from DynaSys. I would add both DynaSys and Precision posted another set of good quarters with increasing portion of their deals coming in the cloud. Our full-time employee headcount was similar to last quarter, around 1,900 employees. The manufacturing economy continues to show strength. And as I mentioned, our weighted funnel is up almost 40% from prior year, putting us in a good position for strong execution over the next few quarters. And as usual, we will now take your questions live. Operator, can you please give the instructions?

[Operator:]

[Operator Instructions] And our first question will come from the line Bhavan Suri with William Blair. Please go ahead.

[Bhavan Suri:]

I guess, just to start off at a macro level maybe for Pam and for you Daniel, both, just at a high level. Are you seeing any impact from sort of geopolitical issues, any business impact from the tariffs on sort of the core manufacturing base you have?

[Pam Lopker:]

Certainly, here are customers talking about it, but so far there is no slowdown in purchasing, and we really don’t expect to see that. Change is always good for you, as at the end of the day, they’ve got moved manufacturing from one country to another. That’s always good for us too.

[Bhavan Suri:]

Got it. And then, just one quick follow up on Channel Islands, obviously GA in September. There is one of nuances to that, the variability of upgrades of piecemeal modular nature of upgrades, the better function on the cloud. So, as you think about those moving pieces, are you seeing any one of those particularly driving acceleration of cloud business? And then, the balancing pieces, right? Asia was going well and then slowdown especially in China, so just some sense of how those pieces you think are and will drive cloud growth over the next three years?

[Pam Lopker:]

I do think that Channel Islands, we are releasing that first in the cloud but even more than that it’s got some different technology pieces that IT on-premise would have to learn. So, it really makes a lot of sense for customers to go to the cloud and take advantage of our knowledge, hosting and providing those capabilities without them having to learn. And I just get the general sense that most companies believe that sooner or later, they’re going to go to the cloud and might as well go now, so hopefully that continues I think as well.

[Bhavan Suri:]

And one quick last one for me, on the competitive environment, one of the advantage you’ve had by standardizing on progress and things like that is sort of templatizing the product, so implementation is faster. When you look at SAP HANA and their ability to templatize now with standardized database, are you seeing any change in that environment there, specifically from them more than anyone else, or is it still pretty much status quo?

[Pam Lopker:]

We’re certainly hoping that this whole move for S/4 HANA, and they’re providing no upgrade, that’s a complete reimplementation, even the data stores are different, everywhere, certainly hoping that that’s going to give their customers pause, and at least looking at other product. So, we’re feeling that that’s a good thing for us.

[Daniel Lender:]

And just to add something to what Pam said, Bhavan, I mentioned the implementation that paused for a few months for this customer. They were able to implement QAD in -- 59 times in about 20 months, which is unheard of in a global ERP environment. They still have about another 20 to go, but it’s just -- again, it’s a proven point of showing our ability to actually implement go-live and get the customer to using the application and get value of it very, very rapidly.

[Pam Lopker:]

And if you look at what we converted them from, it was a wide variety of ERP systems that they had installed, many were SAPs, some were older releases of ours. So, we were able to take all kinds of different ERP systems, and convert them in that 20-month period, we can’t -- we don’t believe anybody could do that.

[Operator:]

Our next question is from the line of Zach Cummins with B. Riley FBR. Please go ahead.

[Zach Cummins:]

So, first question for me is just around the multisite professional services project that you had going on. Can you provide a little more detail on what was really causing the temporary pause there? And is there really any concern that this potential project could be put on hold for multiple quarters or potentially be lost or anything along those lines?

[Daniel Lender:]

No. I mean, as I mentioned this project has been on for a while. The customer is already live in 59 different facilities all over the world. So, it’s really more about them catching their breadth, to be -- and then be able to handle all of their year-end activity that happens between now and the end of December and the plans are really for them to start up the project again early January.

[Pam Lopker:]

And that 59, there’s only about 20 more to go. So, we’re well on the home stretch.

[Zach Cummins:]

And then, in terms of the implied growth in the subscription line in Q4 of this year, it’s decelerating down to about 23% year-over-year. Is that just related more so to timing of the deals and being the timing of the close or anything along those lines, or can you just provide a little more color around that deceleration in that line?

[Daniel Lender:]

The overall revenue -- subscription revenue for the year is -- it’s right in the middle of what we have been guiding for sometime already. When we look at the growth numbers, we like to look at it on a fourth quarter basis, because any one quarter has a revenue that either up or down that will impact just one quarter-over-quarter comparison to prior year. So, there isn’t anything in particular to the fourth-quarter number. Again, we look at it more on a four-quarter basis.

[Zach Cummins:]

And then, final question for me. It sounds like hiring with your cloud services team is still a little bit slower than expected. Do you expect this to really start picking up here in Q4 in the coming quarters as you really start to scale on the subscription side of the business?

[Daniel Lender:]

Yes. So, on the hiring side, we have been -- on the subscription side, we have been maybe a little bit slower than what we would have planned, but not significantly. We are still planning in the not-too-distant future to open up a new data center in Asia. But, I do anticipate that most of the hiring for us, given the strength of funnel and so forth, it’s going to be more on the sales and marketing side. And obviously, you got to make sure that there’s enough people on the cloud operations piece to support the new customers, but that will come naturally.

[Operator:]

Our last question comes from Jeff Captain with Stifel. Please go ahead.

[Jeff Captain:]

I’m trying to follow-up real quick on the data center you just mentioned, Daniel, because you guys raised the guidance for the cloud subscription margin to 63% for this year. I’m just curious, if opening up that data center I guess, I don’t know, it sounds like early next year, one half next year that impacts your ability to improve margins by 100 and 200 basis points per year that you are talking about?

[Daniel Lender:]

Yes. So, the opening of the data center is important for us in terms of driving revenue growth in Asia Pacific, China in particular. The actual opening of the data center will initially actually be a detractor for margins over -- as we acquire more customers there, it will -- that will change and it will go back to more of a normal range. Our overall margin there, we are still -- our aim is to still try to improve it next year 1% to 2%. And that comes through a lot of automation and another efficiencies that we are gaining as the business continues to gain scale.

[Operator:]

Thank you. And I’ll now turn the meeting back over to Daniel Lender for closing remarks.

[Daniel Lender:]

Well, thank you very much. Thank you all very much for your questions. And we look forward to updating you with our fourth quarter and full year results in March.

[Pam Lopker:]

Thanks, everyone.

[Operator:]

Thank you. Ladies and gentlemen, this will conclude our teleconference for today. Thank you for participation and for using AT&T Executive Teleconference. You may now disconnect.