QAD Inc.
Q4 2018 Earnings Call Transcript

Published: 22 Mar 2018

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the QAD Fiscal 2018 Fourth Quarter Financial Results Conference. [Operator Instructions] And as a reminder, this conference is being recorded. I'd now like to turn the conference over to our host, Kara Bellamy, Chief Accounting Officer. Please go ahead, ma’am.

[Kara Bellamy:]

Hello, everybody 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 fourth quarter and full year results. Pam Lopker, President; and Daniel Lender, Chief Financial Officer, join me on the call. We are excited to report that cloud bookings for the quarter and the year came in over our expectations; however, due to our policy of expensing commissions and bonuses when we incur them, operating profit suffered a bit. The strong cloud bookings also helped us drive up our services backlog and maintenance again held steady. Daniel will give the numbers and I'll discuss the details. Daniel?

[Daniel Lender:]

Well, thank you, Karl. Our fourth quarter results were strong with revenue of 80.8 million, exceeding the top end of our original guidance range, driven by good performance in all revenue categories. Currency had a negligible impact from the prior quarter. For the full fiscal year, subscription revenue grew 33% to almost 70 million and total revenue grew 10% to 305 million. Subscription margins improved to 56% from 48% in the prior year. For the quarter, subscription revenue of 19.7 million was near the top end of our original forecast and grew 34% from the prior year. Subscription margins were 60% for the quarter, up from 53% a year ago as a result of our ability to leverage ongoing economies of scale and operational efficiencies. We expect to achieve our annual target margins of 60% in fiscal 2019. Given the high level of cloud business as we close the year, we anticipate additional investments in our data centers and cloud operations, so, we continue to expect quarterly fluctuations in subscription margin as our strategic investments in cloud growth may not match the timing of revenue increases. Maintenance and other revenue was 31.9 million, approximately the same as last year. On a performance basis, maintenance revenue decreased 1.6 million, offset by positive currency impact of 1.4 million. We continue to expect maintenance revenue to decline as existing customers convert to the cloud. Recurring revenue which equals subscription plus maintenance revenue was 63% of total revenue for the quarter and 65% for the full-year. License revenue was 7.2 million versus 8.9 million last year. We continue to generate license revenue from our existing customers, adding users’ modules, which we believe is a result of the strong global manufacturing environment. Professional services revenue was up 23% to 22.1 million from 17.9 million last year. On a constant currency basis, services grew 18%. We continue to see significant activity in this category due to cloud implementations and existing customer upgrade projects. Fourth quarter services margins remained negative due to increased headcount and ongoing training in our professional services organization over the last several quarters. We expect margins will improve to at least break even in the first quarter and throughout fiscal 2019. Our tour revenue by vertical for the fourth quarter was

[Karl Lopker:]

Okay. Well, thanks, Daniel. Our cloud bookings continue to be strong and are up considerably year-over-year. Conversions from on premise to the cloud continue to be more than half of our cloud bookings. We added 10 new cloud customers in the quarter. Our license revenue continues to be steady. While services continued to grow, we need to improve our billable utilization. The fourth quarter is always a challenge due to the holiday and year-end periods. We do expect to improve our services margin this next year. Our focus has been and will be to be able to meet our customers’ requirements for new implementations and upgrades. Our sales funnel is up 5% from last year, even after the strong sales performance in the fourth quarter, however, this results in many of the open deals still being in their initial stages. Cloud remains over 60% of our funnel. On a regional basis for the quarter, all regions performed well, similar to previous years. Automotive continues to be our strongest performing vertical, although, we are seeing a pickup in industrial products. Full time employee headcount at 1860 was up around 9% from last year, but only slightly up from last quarter. 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. Pam?

[Pam Lopker:]

Great. Thanks, Karl. Q4 was a great booking quarter to top off a great cloud year. In Q4, we had 19 new cloud bookings, including 9 conversions and 10 new customers, representing all verticals and all regions. This quarter, the North American region and automotive vertical followed closely by electronics and industrial has the largest bookings in dollars. I'd like to highlight one of my favorite deals in Q4, a 1.5 billion global manufacturer of commercial food service equipment. From a QAD product perspective, they're very interested in using our Channel Islands architecture and we expect them to be an enthusiastic reference. Their equipment is very innovative, everything from pizza ovens to commercial refrigerators, deep fryers and steam ovens, all are saving metrics on a daily basis and have Internet connectivity. We are excited to work with them going forward to showcase Internet of Things and machine learning connected to our service and support module. While it is early days for Internet of Things and machine learning, we are selecting a handful of customers to work with a specific task. Afterwards, we will standardize these capabilities and provide them a standard offering to our customer base. I’d also like to point out our rollout success of a large global automotive company who went live with 15 locations on our QAD cloud. We have another 31 additional locations with planned go-lives this year. But that’s just a few of the many. In fact, our last fiscal year, we had 124 cloud go-lives versus 78 the prior year. Also, I’d like to mention that we're hosting our Annual Explore Conference in Dallas, May 7 to 10. We will be showcasing our progress on developing the next generation of ERP applications based on our QAD enterprise platform. We have an exciting lineup of 75 speakers and are looking forward to welcoming our global customers. Thank you, Karl.

[Karl Lopker:]

Okay. Thanks, Pam. 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. That is of course unless the proposed trade tariffs cause a hiccup. Now, as usual, we’ll take your questions live. Operator, can you give the instructions?

[Operator:]

[Operator Instructions] We have one question from the line of Bhavan Suri with William Blair.

[Bhavan Suri:]

Congratulations. Just a stellar quarter out there. Maybe one for -- maybe Karl and Pam together a little bit. So obviously, macro in the manufacturing economy is a nice tailwind, but Pam’s pet project of Channel Islands and cloud is also a tailwind, right? It's a great sort of way of giving people the ability, especially in biotech and other areas to get ERP up and running without sort of the implementation challenges of a traditional ERP. If you were to look at the drivers of growth and I know it's a tough question, but how much of it could you say is macro driven and how much is product driven, because it is a really good macro, but it’s also a differentiator product, just trying to understand sort of if the macro turn the sustainability of growth just on the product side?

[Pam Lopker:]

Well, Bhavan, of course, you're asking a product person. So my – it’s 90% product with 10% tailwind. But I think, in general, if you go back and look at really bad times like the 2008 period, people just buckle up and do nothing. So I think as long as the economy is stable, the cloud will be the big momentum and as things improve, as things grow faster, that will only help more and certainly the mindset of the customers have changed a lot in the last two years from being on premise thinking to being cloud thinking and that’s going throughout our customer base, the small customers as well as the large customers.

[Karl Lopker:]

Yeah. And I think the customers are comfortable in both investing in the cloud, knowing we're doing this transition to a few whole new ERP technology and so I think they're both kind of working together and I think the technology over the next few years will certainly help drive the cloud business.

[Pam Lopker:]

Certainly helped with the customer I highlighted, which was a Q4 win, the Channel Islands technology was just a huge motivator and driver for their decision.

[Bhavan Suri:]

I guess as you look at this and you sort of had some nice cloud wins. With the, you guys had sort of acceptance of cloud, you have now got referenceability and we all know customers’ referenceability is huge. Are the cloud – initial cloud deals for new customers, is the ASP ticking up? Is the size of the deal ticking up or is it still pretty small? And then when people are moving to cloud from existing products, they used to do it by module or things like that as opposed to a huge forklift. Are any of those trends changing?

[Karl Lopker:]

Yeah. So I don't think -- we have not seen a very significant change on that one, Bhavan. I mean, over the last few quarters, I think over the year, we have seen a few larger deals, so the number of larger deals that we're seeing are there and customers are also planning and in some cases, having some commitment to longer term global rollout of the product set. And so that’s particularly true with regards to the conversions where they will convert a particular region or a particular country initially and then they're going through that. Pam mentioned one automotive company, that was the case, that started a while back, but we have a few kind of -- we have a whole number of projects currently right now in the pipe where we are working with customers to bring more and more sites live.

[Pam Lopker:]

And I think the one holdout for that is China. We still see resistance in kind of local Chinese companies to move to the cloud and also some global companies of having their data inside of China, but now, with the new Chinese regulations, it’s kind of at [indiscernible] on whether their data needs to be in China or whether it can be outside of China, so that's going to be a developing area.

[Bhavan Suri:]

Got it. And then one last one for me for Daniel, I didn’t know you were going to jump on the previous question, Daniel. So I have one prepared for you. I missed what you said about gross margin, but you sort of 50% [ph] subscription gross margin target, and I think I caught -- sorry I was jumping between calls, but I caught something about sort of investment data. So just to clarify that a little bit and I guess you’ve hit 60%, when you look at what enabled you to reach that a little faster, I think maybe you had guided all of us, what can we do to go beyond that level? I guess, that's what I'm thinking and you and I have just agreed and agreed about parts of this. So -- but let's just get your thoughts about sort of where you think that heads? I know you may not want to give guidance, but sort of like what are the drivers to get it higher? Thank you.

[Daniel Lender:]

Yeah. I think there's a number of drivers that are there, clearly plane economies of scale, it's certainly a driver. Also, our organization has been developing quite a number of automation procedures that allows for a lot of processes that otherwise would have to be manual to be done that way. So that’s helped us well. We are looking at potentially additional data centers as the adoption of cloud continues to become more and more global. So that would have a bit -- a little bit of an impact. We think that we can probably -- for the short to medium term, we think we can probably continue to improve, maybe 1% to 2% per year. We haven't yet set the next goal and our focus right now is more on the growth side, but we will continue to look at improving the margin as well.

[Bhavan Suri:]

I think you just set the goal then.

[Pam Lopker:]

So we want to make sure that we’re not doing anything that shortens their satisfaction.

[Operator:]

The next question comes from the line of Richard Davis with Canaccord.

[Richard Davis:]

So, look, in the past, you guys have had a good mix of kind of internally developed functionality and you’ve also done acquisitions, and I’m not going to ask you, oh, yeah, what’s the next company you’ll buy. But just maybe you can remind people a little bit how you think about M&A in terms of kind of financial guardrails in terms of, like their maximum number you pay, because everything seems to be ten times revenues now, are there earnings dilution or how do you kind of think about that beyond kind of mom and apple pie? Thanks.

[Karl Lopker:]

Sure. We're not a 10 times revenue yet, but let me cover the acquisition piece. So from an acquisition standpoint, typically, what we look at is we will look at companies that will either provide us with specific set of functionality that it's critical and strategic to our customer base or in some cases typically either if we're looking for deeper penetration in geography or having a set of consulting capabilities, those are the other types of acquisitions that we would consider. And as you know, we haven't done in the past and it's anything very large, we typically look for companies that are nice tuck-in type of products or capabilities. And, we are fairly conservative in terms of what we pay for these companies typically and they have been in the 1.5 to 2 times revenue. And then, a lot of times, there is a little bit of investment that needs to go on after the acquisition is made, but that’s typically what we’ve looked at. Obviously, as you're looking at smaller companies and if you're buying a particular technology, that metric may not always hold, but generally speaking, that's been our guide going back.

[Richard Davis:]

And then I'm sure the answer is no, but I'll ask anyway. So do you want to pre-sell any QAD Explore announcements, whether product wise, whether Jay-Z or Timberlake will be there. Anything you want to talk about there.

[Karl Lopker:]

I think Richard Davis is going to be there, but we have -- I think, we’ll let our marketing department come up with the right messaging and timing on that one.

[Operator:]

The next question comes from the line of Brad Reback with Stifel.

[Brad Reback:]

Daniel, just real quickly, what type of FX tailwinds are you getting in fiscal ’19 from a high level?

[Daniel Lender:]

So at a high level, in terms of fiscal ’19, I think rates have been fairly steady the last couple of quarters. I mean I think if you were to compare rates at the year – year-over-year, we definitely got quite a bit of tailwind. I think in terms of next year, when we're thinking about our forecast, our forecast is using rates where currently now the US dollars declined about 6% or so from Q3, which does have -- give us a little bit of a tailwind there, but it’s probably on a full-year basis not going to be as much.

[Operator:]

And we’ll take our last question from the line of Matthew Galinko with Sidoti.

[Matthew Galinko:]

I think you mentioned that you're targeting a Q1 services -- professional services gross margin of around breakeven. Did I hear that right and can you kind of walk me through how you get from the 4Q number to the 1Q number?

[Daniel Lender:]

Yes. You did hear that right. At the moment, we are expecting at about breakeven in Q1 and that is mainly through higher utilization of our existing personnel. There's also a few other items that affect the profitability that relate to fixed price projects and depending on when you can actually recognize the revenue. And then finally, as we have gotten more and more of our, you know, the people that we've hired, trained, the reliance on subcontractors should also decline somewhat in Q1, but more throughout the year.

[Matthew Galinko:]

Okay. So is it reasonable to think that by the exit of the year, you could sort of be back at a more historical professional services gross margin or not really thinking about that at this point?

[Daniel Lender:]

Yeah. Our goal is currently through -- towards the end of the year, yes, to be -- to start to get closer to where our historical numbers are. So, we would probably be a bit disappointed if by then we're not -- we haven't made some good progress.

[Matthew Galinko:]

And then you talked about 60% of the funnel being cloud. I'm curious of the remaining 40% that's not cloud, what's the pushback and do you think that of the sort of pipeline that does close, do you think greater than 60% ends up being on the cloud side.

[Daniel Lender:]

So, the first -- let me answer one of your points and I’ll let Karl add on to it. With regards to the piece that it’s not cloud, most of that relates to existing customers that have current implementations where they may be adding users or adding modules and in some cases maybe adding some sites as well, but they haven't quite made a mental change to go to the cloud. The other aspect as well relates to some customers that are located in places where cloud adoption is not fully there yet. Pam mentioned China, but there's other places around the world where that’s the case.

[Karl Lopker:]

That is the answer. In fact, a lot of the new modules that we're selling to existing on premise customers are actually modules that we only provide in the cloud. So, our existing on premise customers don't only buy on premise modules.

[Matthew Galinko:]

And then last question for you just on kind of the order flow, it sounds like, it looks like Q4 was really strong. I'm just curious if that’s just kind of a fact of life or if you can push more kind of into the earlier parts of the year, so it's just sort of out of your control.

[Pam Lopker:]

Last year, we had a very strong Q1. So, I guess.

[Karl Lopker:]

Yeah. I think part of it is the conditioning of the sales force and conditioning of the client base of ERP in general for many years that leads to that. But, in fact, this year, given where we are and how strong Q4 was, we have a strong funnel, buy many of the deals in the funnel are in earlier stages. So, we do have some work to do in terms of trying to achieve that.

[Daniel Lender:]

The bigger deals are actually harder to bring in. The smaller deals like new modules or new users are definitely things that we’ll be pushing for to try to keep up the pace in Q1.

[Pam Lopker:]

And that's what’s great about having the installed base that we have in the cloud. We're always getting new modules and users, so kind of that ebb and flow of just continual growth through the customers growing and expanding.

[Matthew Galinko:]

All right. Well, last one for you, just to clean up. Did you provide any sort of updated tax rate or cash tax rate guidance under the new tax plan.

[Daniel Lender:]

Yes. So with regards to the new tax reform that’s been passed, we're still evaluating the impact for FY19 as most companies are. Our overall tax position is really a result of our global tax position across multiple jurisdictions. We are anticipating a close to breakeven result next year, a bit of profit maybe, but it's not that much. So we don't really expect significant short term benefits of the lower tax rate, but it's really too early to tell at this moment to what that rate is going to be.

[Operator:]

All right. Thank you. That was the last question. I will turn it back over to Mr. Lopker please.

[Karl Lopker:]

Okay. Well, thanks everyone for your attendance and questions. We’ll update you again in May with our first quarter results. Good bye for now.

[Operator:]

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