QAD Inc.
Q3 2018 Earnings Call Transcript

Published: 22 Nov 2017

[Operator:]

Welcome to QAD's Fiscal 2018 Third Quarter Financial Results Call. [Operator Instructions] As a reminder, today's conference is being recorded. I'd now like to turn the conference over to Chief Accounting Officer, Ms. Kara Bellamy. Please go ahead.

[Kara Bellamy:]

Hello, and welcome to today's call. Before we begin, I need 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 Karl Lopker, QAD's Chief Executive Officer.

[Karl Lopker:]

Well, good afternoon, and thank you for joining us to discuss our third quarter results. Pam Lopker, President; and Daniel Lender, Chief Financial Officer, joined me on the call. Overall, we had another solid second quarter, cloud bookings continue to grow and license revenue again did well. In addition, services revenue grew, although services margin is still under pressure due to aggressive hiring and subcontracting to meet demand. And maintenance held steady. Daniel will give the numbers, and I'll discuss the details. Daniel?

[Daniel Lender:]

Thank you, Karl. We continue to post solid results in the third quarter, revenue of $76.9 million exceeded the top end of our guidance range by approximately $2 million and increased 9% in constant currency from $69.5 million last year. Revenue exceeded guidance due to higher-than-expected licenses and services revenue and the positive currency impact on maintenance revenue. Compared to the prior quarter, the U.S. dollar devalued against many currencies in the quarter resulting in a favorable impact to total revenue of $1.1 million. This was offset by a negative impact to expenses of nearly $1 million. As a result, on a net basis, the impact to profitability was negligible. Subscription revenue at $17.2 million was just shy of our forecast of $17.4 million, and rose 26% from $13.7 million in the prior year. We've closed some large deal in the middle of the quarter where we were unable to recognize revenue due to certain issues in the contract. We expect to meet these milestones in Q4 and begin recognizing revenue. Subscription margins improved to 56% from 48% a year ago, resulting from ongoing economies of scale and operational efficiencies. Even as we continue to invest strategically in future cloud growth, we expect 55% subscription margins for the year which remains ahead of plan. We are confident in our ability to reach our 60% long-term target but we continue to expect quarterly fluctuations as continued investment in this area may not match the timing of revenue increase. Maintenance and other revenue were $32.4 million versus $32.6 million last year. Maintenance decreases on a performance basis was -- were primarily due to conversions to the cloud, and were offset by positive currency fluctuations of $0.6 million. We expect maintenance revenue will continue to decline as existing customers convert to the cloud. Recurring revenue, which is subscription plus maintenance revenue, was 64% of total revenue for the quarter. License revenue grew to $6.6 million, up from $4.3 million last year. License revenue continues to be driven by expansion of our existing perpetual customer base. As we mentioned before, when the manufacturing economy is healthy, our existing customers need to purchase additional licenses to support higher production. Professional services revenue grew to $20.7 million, up 9% from $19 million last year. We continue to see significant activity in professional services resulting from cloud implementations and existing customer upgrades. Professional services revenue should remain strong throughout the remainder of the year. Third quarter services margins did not improve as we expected due to additional hiring and training of 75 employees in our professional services organization over the last several quarters. These new hires were not utilized to the level we expected and sub-contractor expense was higher than the prior quarter to meet ongoing customer projects. We are focused on improving margins next quarter and next year through improving utilization and using our sub-contractors more efficiently. Our total revenue by vertical for the third quarter was; automotive, 38%; high tech and industrial, 33%; consumer products and food and beverage, 15%; and life sciences, 14%. Total revenue by geography was; North America, 49%; EMEA, 28%; Asia Pacific, 16%; and Latin America, 7%. Gross margin in the third quarter amounted to $38.9 million or 51% of total revenue versus $36.5 million or 52% of total revenue than last year. The decrease in margin was mainly attributed to professional services. Sales and marketing expense totaled $17.7 million or 23% of total revenue compared with $15.3 million or 22% of total revenue a year ago. The increase was mainly due to higher salaries, as a result of additional headcount, as well as higher bonuses and commissions. R&D expense was $12.1 million for the 2018 third quarter versus $10.8 million last year. The increase resulted from higher personnel expense, mainly due to additional headcount to support our Channel Islands initiative. As a percentage of total revenue, R&D expense was 16% for both periods. General and administrative expenses were totaled $8.6 million compared to $7.9 million last year, the increase was primarily related to higher stock compensation and bonuses. As a percentage of total revenue, G&A expense was 11% for both periods. Total operating expenses were $38.4 million or 50% of total revenue compared with $34.2 million or 49% of total revenue last year. Equity compensation expense was $2.3 million for the fiscal 2018 third quarter and $1.8 million last year. Operating income was $430,000, versus $2.3 million a year ago; and we recognized $658,000 in other income during the quarter resulting from interest income and positive foreign currency fluctuations. This brings pretax income to $1.1 million compared to $2.7 million last year, a non-GAAP pretax income worth $3.5 million versus $4.6 million last year. Income tax expense equaled $1.2 million for the fiscal third quarter and reflects actual results in the quarter. Last year's tax expense was $1.2 million which applied an estimated annual tax rate. A quick reminder, because we expect our results to be close to breakeven for the year, we are recognizing taxes each quarter on the actual quarterly results. GAAP net loss was $151,000 or $0.01 per Class A and Class B share; and for last year's third quarter, GAAP net income was $1.5 million or $0.08 per diluted Class A and $0.07 per diluted Class B share. For the year-to-date period, total revenue grew 10% to $224.3 million, up from $204.7 million, driven by gains in subscription, services, and license revenue. Subscription revenue grew 33% to $50 million compared with $37.5 million in the year-ago period. Gross margin was 51% of total revenue compared with 52% in the prior year 9-month period. And subscription margin was 54% for the fiscal '18 period and 46% last year. Total operating expenses came to $115 million versus $107.5 million. As a percent of total revenue, total operating expenses were 51% for the current year-to-date period compared to 52% last year. Our pretax loss was $1.2 million versus $784,000 a year ago. Non-GAAP pretax income was $6.1 million compared with $5.7 million for the first 9-months of last year. Our GAAP net loss was $3.9 million or $0.21 per Class A share and $0.17 per Class B share compared with a net loss of $291,000 or $0.02 per Class A and $0.01 per Class B share last year. And we ended the third quarter with over $140 million in cash and equivalents, compared with $145 million at the end of fiscal 2017. And our accounts receivable was $50.8 million, compared with $39.1 million a year ago. Our day sales outstanding using the count back method was 53 days for the fiscal third quarter versus 50 days a year ago, and the quality of our receivables remains healthy. Our deferred revenue balance at October 31 was $83.1 million versus $74 million a year ago which includes $52.7 million of deferred maintenance versus $58.8 million, $25.5 million of deferred subscription versus $17.9 million, $3.6 million of deferred professional services versus $2.3 million, and $1.3 million of deferred licenses versus $1 million. My quarterly reminder, our maintenance contracts are billed annually, while subscription contracts can be billed either annually or quarterly. Cash flow provided by operations was $2.8 million for the first 9-months of fiscal 2018 compared with $5.5 million for the same period last year, primarily as a result of lower net income. For fiscal '18, we're adjusting our guidance as follows; total revenue of $300 million to $302 million, including $69 million to $70 million of subscription revenue. GAAP pretax income near breakeven and non-GAAP pretax income of $9 million to $10 million. Before I turn the call back to you Karl, let me cover some highlights. Our total revenue has grown over 10% from prior year and we're now on-track to exceed the $300 million mark for the year. Although we do experience quarterly fluctuations, our subscription revenue has grown 34% over the last 12 months, is on-track to exceed 30% growth for the financial year and to be approaching the $80 million run rate by year end. We have continued to make significant progress in improving our subscription margin, in fact on a trailing 12-month basis, subscription margins have improved from 47% to 54% which is well ahead of our plan. In summary, we have so far executed on our strategy and remain on-track to finish the year on plan. Over to you, Karl.

[Karl Lopker:]

Okay. Well, thanks, Daniel. Our cloud bookings continue to be strong, and are up considerably on a year-to-date basis. This gives us confidence on our subscription outlook for the year. Conversions from on-premise to the cloud were again more than half of our cloud bookings and we added 18 new cloud customers in the quarter. Our license revenue continues to be strong which we attribute to the strong global manufacturing economy. And as Daniel pointed out, while services continue to grow, we need to improve your billable utilization which we expect to do in the fourth quarter. The good news is that we've been better able to meet our customers' requirements for new implementations and upgrades. Our sales funnel is down from last year but this is due more to strong cloud bookings and license revenue than to weakness in the market. Cloud still remains over 60% of our funnel. On regional basis for the quarter, all regions performed well. However, licenses were strong in North America due to a couple of large order from existing customers. Automotive continues to be our strongest performing vertical for the quarter although we did pick up a large cloud booking in consumer products in Europe. Full-time employee headcount at 1,840 was up around 7% 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 and development activity. Pam?

[Pamela Lopker:]

Great. Thanks, Karl. [Indiscernible] I try to talk through my call today. So Q3 was a great booking quarter for cloud, we had 18 new cloud bookings which comprised of 9 conversions and 9 net new customers, representing all verticals and all regions. This quarter the European regions and a consumer product vertical had the largest booking. I'd like to highlight one particular deal; while many consultants believe that ERP in the cloud is only for small companies, we continue to see very large companies with thousands of users move to the cloud. This quarter we received a cloud order from a $25 billion-plus consumer product company that has been a QAD customer for over a decade. Even though their IT operations were very efficient, they liked the flexibility of cloud with the ability to add and reduce users as their global business changes. I'd also like to mention our success in life science. While overall I believe life science is only about 14% of our business, and the cloud, it represents 23% of our cloud revenue; this quarter we had five net new cloud customers coming from life science. These companies are truly leading edge technology company creating everything from literally a basic surgery devices to MRI guided radiation therapy to cell-based therapeutics. QAD cloud offerings provides both the functionalities these companies need to run their businesses while also confirming to FDA regulations and assisting in their audits. Those are September releases of Channel Islands on the QAD enterprise platform, we move into limited availability base of our product introductions process. This opens Channel Islands in the QAD enterprise platform for all customers. In addition, in the September release we released our first release of supplier portal in the Channel Islands environment, this provides our customers with the important multi-enterprise capability. In closing, I'd like to mention that QAD recently celebrated our 20 years as a public company with ringing the bell at the NASDAQ. We had a very large crowd of QAD that had joined us from our New Jersey office which primarily helds our support and ever-growing cloud team. Back to you Karl, thanks.

[Karl Lopker:]

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

[Operator:]

[Operator Instructions] Our first question comes from the line of Matthew Galinko with Sidoti. Please go ahead.

[Matthew Galinko:]

My first question is around just getting kind of your professional services hires upto speed and well utilized, is -- do you have any leverage you could pull to accelerate that process or is this just kind of the speed that will have to happen and can you just call it a little bit more about how you see getting to better utilization in the fourth quarter?

[Karl Lopker:]

Well, there is a lot of training involved for our large ERP package like we have. And when we hire people, we have a mix of people that we hire that are newbies, that are -- just graduated from college and a mix of people that pretty much hit the ground running that might have experienced with other ERP packages. Or we hire people maybe that have worked for QAD before so they can get going fairly rapidly but it does take time to train. In fact, the college hires takes us -- we have a 9-month program that they go through. So we do need to balance it with more experienced people and sub-contractors. But we've been doing reasonably well in meeting our customers' demands for the services which is probably the most important thing that we have going right now.

[Operator:]

Next question comes from the line of Bhavanmit Suri with William Blair. Please go ahead.

[Bhavanmit Suri:]

I guess maybe just turning over first to license beats [ph]; that surprised me a little bit. Just -- as you're looking at the pipeline, just letting it a little color on sort of the mix there. Was that an existing set of customers? And when you look at the pipeline, is it still sort of 50-50 split and I know quarterly it changes but just some color on sort of how that's looking and how that might look going forward over the next year or so?

[Karl Lopker:]

Well, most of our licenses definitely come from existing customers who are expanding the use of our product, maybe going into factories and other parts of the world where they haven't been in. And we expect -- as the manufacturing economy is strong, we expect that to pretty much continue, although 60% of our funnel is cloud, so we expect to continue to have strong bookings on the cloud. Next year, as we look forward, we can't see anything that's necessarily going to slowdown the manufacturing economy. Having said that though, something happens at the stock market, that could definitely start affecting our customers' customers and then our customers; so we're always on the watch for that.

[Bhavanmit Suri:]

Then one for Daniel, you know, the issue with the large cloud during the quarter, is that a one-off issue or you have -- could that happen again? Just a little more color on what exactly happened, that would be helpful. Thank you.

[Daniel Lender:]

It's really -- it's a one-off issue with large deal that has certain contractual provisions in there that basically requires to have some environment slides before we get to start recognizing revenue, I mean those projects are ongoing and we expect to meet those milestones during Q4, so we're counting on that revenue for Q4. So Q4 will include a little bit of a catch-up relating to Q3 for that particular customer.

[Bhavanmit Suri:]

Got it. Pam, as you look at Channel Islands, I think Daniel mentioned more investments in Channel Islands, and I think we had talked maybe in the past about the R&D there sort of reaching a certain maturity level and some of those investments shifting to literally sales and marketing. Just A) some understanding what those investments are, the incremental ones? And then, B) again, not near-term but over the next 12 to 24 months, is that shift from R&D in Channel Islands and spend there, so maybe sales and marketing is still part of the plan?

[Pamela Lopker:]

We have about another year and a half of intense development to [indiscernible] where we want to be on the complete platform. So I do think that we will have heavier R&D investments over the next period and half, but I do think that maybe before them, there will be more investments in sales area. But Daniel, you might have more of a forecast on that.

[Daniel Lender:]

Yes, on the sales side we typically -- we do those investments in lock [ph] to where we see the deals. The main investments right now are really going on around building the pipeline and building a lot of the marketing in supporting sales. As we've talked about it before, we are making some changes to the sales force in terms of their focus to net new, so those are not radical changes, they are changes that we are doing on a progressive fashion; so as we convert more and more over customer base over to the cloud, we do need to continue shifting the focus of the company to new customers as well.

[Bhavanmit Suri:]

One more last, any large SAP displacements in the quarter?

[Karl Lopker:]

There were no specific large displacements. There were a number of the elsewhere SAP was in the mix but there wasn't anything to point to.

[Operator:]

And the last question in queue comes from the line of Brad [ph] with Stifel. Please go ahead.

[Unidentified Analyst:]

Karl, on your comment about the sales funnel being down; is that just truly a function of the size of deals per cloud being smaller than a license deal where the volume is either flat to up?

[Karl Lopker:]

The funnel being down a bit is due to two reasons; one is that we closed a lot of cloud deals in the quarter. Q3 maybe more than we have expected but also a year ago, we did not have a very strong Q3 so the funnel was larger a year ago just because of the weakness of the previous Q3; so I think there is -- those two factors involved made the sales funnel down a bit although we're not concerned about it because the activity is as higher than it was a year ago for sure.

[Unidentified Analyst:]

And Daniel, maybe just some quick high levels thoughts if you can around subscription as we think about fiscal '19 and sort of the sustainability of 30% plus growth?

[Daniel Lender:]

At a high level, we're still are targeting to maintain growth at the 30% plus level. We are -- this quarter is the time where we have little bit of planning in terms of how we're going to achieve those but we are -- we feel that there is definitely room to continue that growth rate.

[Operator:]

And we have no further questions in queue. So I'll to turn it back to you, Mr. Lopker.

[Karl Lopker:]

Okay. Well, thanks everyone for your attention and being on the call. We'll talk to you again in the March with our full year results. Bye now.

[Operator:]

Ladies and gentlemen, this concludes today's conference. Thank you for using participation and for using AT&T Executive Teleconference. You may now disconnect.