QAD Inc.
Q1 2018 Earnings Call Transcript

Published: 26 May 2017

[Operator:]

Welcome to the QAD Fiscal 2018 First Quarter Financial Results Call. [Operator Instructions]. I'll now turn the conference over to Chief Accounting Officer, Kara Bellamy. Please go ahead.

[Kara Bellamy:]

Hello and welcome to today's call. Before I begin, I need to ensure that everybody on the call 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 Karl Lopker, QAD's Chief Executive Officer.

[Karl Lopker:]

Well, good afternoon and thank you for joining us to discuss our first quarter results. Pam Lopker, President; and Daniel Lender, Chief Financial Officer, join me on the call. Overall, we had a good solid first quarter. While our subscription revenue growth rate was slightly down from previous quarters, our cloud bookings were significantly over budget and license revenue did well. In addition, services revenue and backlog continue to grow and maintenance held steady despite the effect of cloud conversions. So Daniel will give the numbers and I'll discuss the details. Daniel?

[Daniel Lender:]

Well, thank you, Karl. Our cloud business continues to grow with revenue increasing 34% this quarter or 35% on a constant currency basis. Bookings were also strong as we added 17 new cloud customers and significantly exceeded budget. Maintenance revenue remained steady while services revenue continues to grow as a result of new cloud customer implementations and upgrades from existing customers. License revenue grew as a result of additional users and module purchases from our existing customer base. Total revenue and pretax income came in higher than our guidance and non-GAAP pretax income met guidance. Subscription revenue was slightly below guidance due to some customers not achieving connectivity early enough in the quarter. We do not recognize subscription revenue until connectivity is established. Total revenue for the first quarter was $71.4 million, up from $65.4 million last year driven by subscription, license and services increases. Currency had a $1.2 million negative impact on total revenue. On a constant currency basis, total revenue increased more than $7 million from last year's first quarter. Subscription revenue grew to $15.3 million, up from $11.5 million last year. This line continues to grow as a percentage of total revenue and now represents 21%. Subscription margins improved to 50% from 46% a year ago and declined as expected from 53% in the fourth quarter. The year-over-year improvement is attributed mainly to economies of scale and operational efficiencies. As we've mentioned in the past, our continued aggressive investment in cloud growth will result in quarterly fluctuations, but our 60% long term target remains intact. Maintenance and other revenue was $31.9 million versus $32.8 million last year as a result of continued migration to the cloud. But on a constant currency basis, maintenance revenue was down 1% year-over-year. As we discussed last quarter, we expect maintenance revenue to decline over time as our customers continue to adopt cloud-based solutions. We're pleased with the maintenance revenue results given the number of customer conversions to the cloud. Recurring revenue which is the combination of subscription and maintenance revenue, now accounts for 66% of total revenue. License revenue was $5.3 million, up from $3.9 million last year. Given our continued strong cloud growth, this improvement is notable and demonstrates growth within our existing perpetual customer base. Over the long term, we continue to believe that license revenue will decline as more of our customers transition to the cloud. Professional services revenue totaled $18.9 million compared with $17.1 million last year. We continue to see strength in services revenue as supported by cloud implementations and existing customer upgrades. We expect services revenue to continue to be strong for the rest of the year. We did start some hiring programs for our services organizations during Q1 and we'll continue to add resources in this area throughout the rest of the year. As a result, we do expect to see professional services margin pressure despite the strong performance for the top line. We need to ensure that our customers -- as our customers expand their footprint in the cloud, we can fully support them. Contributions to total revenue by vertical for the first quarter was automotive, 37%; high tech and industrial, 32%; consumer products and food and beverage, 16%; and life sciences, 15%. By geography, North America represented 47%; EMEA, 29%; Asia Pacific, 17%; and Latin America, 7%. Our strong performance in cloud bookings and license sales led to our commissions and bonus expense to be significantly higher than budget this quarter. You can see this effect reflected across both our cost of revenue and our operating expense lines. Fiscal 2018 first quarter gross profit was $36.5 million versus $33.3 million last year. As a percentage of total revenue, gross margin was 51% for both periods. Sales and marketing expense totaled $17.6 million compared with $16.9 million a year ago. The increase is related to higher commissions and bonuses. As a percentage of total revenue, sales and marketing expense was 25% for the 2018 period and 26% last year. R&D expense amounted to $11.5 million for the 2018 first quarter compared to $11.1 million last year. The slight increase resulted from higher personnel expense associated with additional headcount of 20 as we invest in our product functionality and in our Channel Islands project. As a percentage of total revenue, R&D expense was 16% for the 2018 first quarter and 17% last year. General and administrative expenses were $8.6 million versus $8 million 1 year ago, with the increase primarily relating to higher bonus expense. As a percentage of total revenue, G&A expense was 12% this year which is consistent with last year. This brings total operating expenses to $37.9 million compared with $36.3 million in fiscal '17 and 53% and 55% of total revenue, respectively, for the current quarter compared with last year. Equity compensation expense was $1.8 million for the fiscal 2018 period and $1.6 million last year. Our operating loss was $1.4 million which improved from last year's first quarter operating loss of $3 million. Our pretax net loss totaled $2 million compared with $3.9 million in fiscal 2017. Non-GAAP pretax income was $146,000 versus non-GAAP pretax loss of $1.9 million last year. Income tax expense was $620,000 for the quarter and reflects actual tax expense versus a benefit of $1.1 million last year which applied an estimated annual tax rate. Because we expect our results to be close to breakeven for the year, we will be recording taxes each quarter based on actual tax expense. GAAP net loss was $2.6 million or $0.14 per Class A share and $0.12 per Class B share. For last year's first quarter, our net loss was $2.8 million or $0.15 per Class A share and $0.13 per Class B share. We ended the first quarter with over $153 million in cash and equivalents, up from $145 million at the end of fiscal 2017; accounts receivable of $46.4 million, up from $44.8 million a year ago. Days sales outstanding using the countback method was 55 days for the first quarter versus 65 days a year ago and the quality of our receivables remains healthy. Our deferred revenue balance at April 30 was just over $97 million, including $70.7 million of deferred maintenance, $23.3 million of deferred subscriptions, $1.7 million of deferred professional services and $1.5 million of deferred licenses. On a constant currency basis, deferred revenue was $99.5 million at the end of fiscal 2018 first quarter, including a $2.2 million negative impact from currency. A year ago, our deferred revenue balance was $92.6 million, including $73.6 million of deferred maintenance, $15.4 million of deferred subscriptions, $2.2 million of deferred professional services and $1.6 million of deferred licenses. As a reminder, maintenance contracts are billed annually while subscription contracts are billed either annually or quarterly. The growth of over 50% in deferred subscription from the prior year is a combination of the growth in our cloud business and our shift to more annual billing cycles versus quarterly billing. Our cash flow provided by operations was $7.9 million for Q1 of 2018 compared with $1.4 million for the same period last year, mainly resulting from strong cash collections. Finishing off with guidance. For fiscal 2018, we continue to expect total revenue of $288 million to $292 million, including $68 million to $70 million of subscription revenue; a GAAP pretax loss of $1 million to pretax income of $1 million; and non-GAAP pretax income of $8 million to $11 million. For the second quarter fiscal '18, we expect total revenue of $71 million to $73 million, including $16.5 million of subscription revenue; a GAAP pretax loss of $1.5 million to $1 million; and non-GAAP pretax income of $1 million to $1.7 million. I'll turn things back to you, Karl.

[Karl Lopker:]

Okay. Well, thanks, Daniel. Our cloud bookings continue to come in steadily, with half due to conversions from on-premise and half from new customers or new users. We had an exceptionally strong quarter in services bookings from cloud conversions which caused us to increase our hiring in this area. Our license revenue has come mainly from new users and new modules to existing customers. New customers are generally choosing cloud apps. While services utilization continued to improve in the quarter, our strong overall performance led to higher bonuses. So the higher utilization did not show up in margin improvement. Services margin will continue to be affected by hiring and training to meet our increased backlog. Our sales funnel for cloud and licenses is down slightly from last year at this time which we expected given the strong bookings in the first quarter. However, cloud still accounts for 60% of the funnel. We added 17 new cloud customers in the quarter, including 2 customers who purchased our divisional products in the cloud. As I mentioned before, maintenance revenue was down slightly in constant currency despite the effect of cloud conversions. We continue to see renewal rates consistent with past experience. However, cloud conversions from on-premise to the cloud will continue to impact overall maintenance revenue. On a regional basis for the quarter, overall revenue is consistent with past experience. However, cloud bookings were strong in North America due to a large cloud conversion order. Automotive companies continued to be our strongest performing vertical for the quarter. Full-time employee headcount at 1,775 was up around 4% from last year. The increase was mainly in development and services. Now I'll turn the call over to Pam for a closer look at our QAD cloud activity and a recap of our recent customer conference.

[Pamela Lopker:]

Thanks, Karl. Q1 was certainly a great cloud quarter with 17 deals, including 7 conversions and 2 perpetual customers purchasing our divisional products in the cloud, representing all verticals and all regions. I'd like to highlight one particular deal, a large industrial, multinational company. We were told, several years ago, the company had made a strategic decision to move to SAP wall-to-wall. After several years and considerable expense of implementing SAP in Europe, they decided to stop the SAP rollout. This quarter, we received a large order for an upgrade to the cloud for their North American site. I believe the value of QAD's cloud is easy to see when compared to large, costly implementations. During the first week of May, we held our annual user conference in Detroit. Total attendance was up over last year with more than 830 attendees. 54% of the customers surveyed at the event reported potential upgrade projects over the next year. We also saw significant interest in moving to the cloud, with approximately 25% of the customers at the conference already in the cloud. A key focus of the event was the increasing pace of change in our customer's industries. Detroit was the perfect location given our large automotive customer base and the enormous change facing the automotive industry with the perfect storm of electrification, autonomous vehicles and ridesharing. To help our customer adopt with a rapid response to change in their industries, we introduced the QAD enterprise platform. I'd like to talk a bit about the QAD enterprise platform. No matter how much companies want a standard software out of the box, with ERP software, there's nearly always customizations that are required due to the customer's own personality and their competitive landscape. With cloud, it's imperative to have an ERP system that can be extended in such a way that the company-specific functionality looks and feels like the standard part of the application, but can be maintained and upgraded independently from the standard application. For years, QAD has tackled these customization issues in 2 ways, one, by getting rid of the hardcoded reports and queries by providing tools that allow the ability to configure reports and queries in data that provide seamless upgrades; and two, we included the ability to extend and modify existing screens with new logic and new fields, allowing users to personalize their experience while also allowing for seamless upgrades. With the QAD enterprise platform, we're leveraging what we provided in previous environments and adding the ability to create entirely new applications, all in a very easy-to-use, no-programming-necessary environment. And best of all, the new application can leverage the enterprise data available in the QAD standard ERP product and the capabilities provided in the platform. The resulting application uses our Channel Island web-user interface, automatically providing the ability to run on different devices, both desktop and mobile, but leverages the inherent security of the application and across the Internet and takes advantage of key features such as attachments, activity feeds, KPI and dashboards, all with no version lock-in and the ability to continually be able to take new standard product releases and upgrades. The QAD enterprise platform is an accumulation of our long history of innovation and we're very proud to provide this to our customers. Thanks. Karl, back to you.

[Karl Lopker:]

Okay. Thanks, Pam. The manufacturing economy continues to roll on nicely and we expect to continue to keep up the pace in cloud that we experienced this last year. As usual, we'll now take your questions live. Operator, can you give the instructions?

[Operator:]

[Operator Instructions]. And our first question will come from Bhavan Suri with William Blair.

[Bhavanmit Suri:]

Congrats on the big cloud win. I guess, I'll touch first just on that win, I think, Pam, you mentioned with the industrial company in North America. Can you just give us a little more color sort of what size that was? And sort of how many sites, maybe not in dollars, but how many sites? And how soon you could actually capture the global opportunity with that customer? Or are you just limited to North America for right now?

[Pamela Lopker:]

Well, off the top of my head, I'm thinking it's 20-ish-plus sites and that'll be interesting. Obviously, we'd like to go after Europe, but they had a huge investment there. I don't know what their appetite would be for that. But right now it is North America only and probably Asia Pacific is up for grabs, I would say. But yes, definitely a large customer in the industrial segment.

[Bhavanmit Suri:]

Got it, got it. And just as you look at the pipeline, you've obviously added Channel Islands that has future functionality that's only cloud available. Outside of that, are you seeing any other catalyst either sort of external, meaning companies starting to think and be more open about cloud or something that you're doing other than sort of Channel Islands, maybe that's just it, that are accelerating the move to cloud? Because the cloud pipeline now is 60-40, but the pipeline is 60% cloud. Sort of just some sense of what the drivers are as we think of sort of this continued sort of strength in the cloud.

[Pamela Lopker:]

I would go back to the baseline. If you're a new company today, would you implement an ERP system in the 4 walls, I don't think so. You would get cloud. There's no way you want to invest in the people, the hardware and the software and do that in-house. And so I do believe as people look at doing an upgrade which we have the large -- I think 54% of the customers looking at upgrades, certainly look at the cloud. And I think, obviously, if going to the cloud is the same price that you're paying for maintenance, they'd all be going there tomorrow. So a little bit of that gap is educating them on the difference in the cloud versus on-premise and what costs really are in on-premise. But I do believe, over time, over the next decade, everyone will move to the cloud. And having said that, there are some real catalysts to move to the cloud and a lot of that has to do with security. We have extremely advanced security and we're doing implementation testing on a continuous basis, very difficult for every on-premise customer to do that themselves. And then connectivity, we use the Dell Boomi platform for connectivity not only to on-premise applications, but also to other cloud applications. And as we build that network of cloud applications that we're connected to in our cloud, it's very, very difficult and expensive for customers to reproduce that on, on-premise.

[Bhavanmit Suri:]

That's helpful. Maybe one for Karl, too, here. You guys had sort of started shifting a little bit, both in sales and marketing, towards this challenger model, so there's some comp structure adjustment. Just some color on how that's playing out. And sort of is it meeting your expectations? Or is there still time for that fully to be rolled out across those organizations?

[Karl Lopker:]

Well, every year, we kind of tweak the comp model a little bit. And I'd say this year, it's a little bit too early to see what the effect of this year's tweaking is. But there's not huge changes. We like to have the sales force be able to depend on our policies and so it's not that large. But it does help over a long period of time. It was probably about 5 or 6 years ago that we made the big change to really compensate cloud over on-premise.

[Bhavanmit Suri:]

Got it. Maybe I'll squeeze one last in for Pam. Pam, what is the next focus of Channel Islands? You've spent a lot of time sort of improving the UX. You have the ability for customer's partners to build applications for the platform. What are you sort of seeing the next sort of couple pieces rolling out on the Channel Islands?

[Pamela Lopker:]

Well, our initial focus on Channel Islands is to roll out the things that are customer-facing, that really benefit from being in the web environment. So we started with sales, the sales orders, sales quotes, allowing customers the ability to use mobile and have a seamless sales experience across the company. We then moved to purchase requisitions and purchase orders. And now we're tackling the FSM environment, the field service environment. And once we do that, we'll continue rolling out the rest of the product over the next couple years, but getting it all to Channel Islands. We're starting now to move up in the size of early adopters. We wanted to start with smaller companies, $200 million, $300 million, $400 million companies that we could make sure that we're performing and it was handling their volumes. And now we're moving up to midsize and larger companies as early adopter customers.

[Karl Lopker:]

One thing I might point out is -- excuse me, one thing I might also point out is the QAD enterprise platform is being built to be cloud independent. So people eventually, not right now, will be able to choose which cloud they go on depending upon which cloud favors their type of business. So you might choose Amazon cloud if you're more in the retail area or you might choose Google Cloud if you're more into machine learning and artificial intelligence. So I think that's going to be a big change a little bit further out.

[Operator:]

[Operator Instructions]. And we'll go next to Richard Davis with Canaccord.

[Richard Davis:]

Two quick questions. So like in the past year, we saw NetSuite acquired by its rich uncle, saw Plex kind of go up for sale, Epicor announced a few products, Microsoft kind of announced some stuff with Great Plains and Navision. So what impact, if any, do you expect to see from these dynamics? And I have a quick follow-up.

[Pamela Lopker:]

We never really competed with NetSuite at all. So I don't see really any competitive change in that area. And that's pretty much true for Microsoft on the low end. We don't see them often, particularly because they don't handle international global capabilities in a centralized manner and it's more focused towards low end. Plex, we do see at the lower end of automotive, particularly in machining, stamping-type companies, but nothing really new there. I haven't heard that they've been sold. I haven't heard any news in that area, maybe you have. So I think our main competitor still is at SAP at the high end. And I think that we're doing quite well competing with them as they struggle to enhance their product to be lightweight, easy to use and really cloud enabled.

[Richard Davis:]

And then the quick follow-up is when I talk to companies and even kind of adjacent point-solution vendors, it seems to me that you can't really do IoT without cloud. I mean, it's like super hard otherwise. And so to what extent do you expect to see demand driven by this dynamic?

[Pamela Lopker:]

Yes. I think that's another -- we're just starting now to look at how to articulate the functional advantages of cloud. And certainly, the couple that I mentioned before are key. Security, security, security is huge in today's environment. And then what I said was hooking into other clouds, easily being able to network into other clouds and that really follows the IoT requirement. So I have to be able to hook into other clouds, whether they're a private cloud, like at a customer site that I want to look at their machines that we provided or our customers have provided to them and to be able to gather information of how they're working and be proactive and preventative maintenance or whether I am like watching a product out in the field by a customer, used by a customer. So that is all required, this Internet network that needs to be well developed. And I think it would be prohibitive to develop for most customers in an on-premise environment.

[Operator:]

Thank you. We have no further questions. Mr. Lopker, please go ahead with any closing remarks.

[Karl Lopker:]

Okay. Well, thanks, everyone, for your attendance and questions and we'll update you again in August with our second quarter results. Goodbye for now.

[Operator:]

Thank you. And ladies and gentlemen, this conference will be available for replay after 4