QAD Inc.
Q2 2017 Earnings Call Transcript

Published: 26 Aug 2016

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the QAD Fiscal 2017 Second Quarter Financial Results Call. At this time, all lines are in a listen-only mode, later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's conference is being recorded. And now I would like to 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 might contain forward-looking statements that are based on certain expectations and analysis. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. QAD takes 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'll be discussing non-GAAP net income and non-GAAP earnings per diluted share, which are non-GAAP financial measures as defined by SEC Regulation G. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures are 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 second quarter results. Pam Lopker, President and Daniel Lender, Chief Financial Officer are joining me on the call. Our fiscal second quarter was strong in terms of cloud bookings, in fact it was our second best quarter ever. In addition to the strong performance in bookings, our prior success in both attracting new customers to our cloud and converting existing on premises customers, continues to drive our cloud subscription revenue, which showed a 37% growth rate this quarter. Given our focus and success in the cloud, our license revenue was naturally lower than historical levels and we expect this effect to continue going forward. And due to strong cloud bookings and net new business our services backlog is improved. Maintenance revenue remain strong despite the increase in subscription from the cloud. Denial will give the numbers and I will discuss the details.

[Daniel Lender:]

Well thank you Karl, total revenue for the second quarter came in above the top revenue [ph] of our guidance range and subscription revenue came in about a $100,000 higher. Cloud bookings were strong as we added 19 customers the second largest numbers of new customers in any previous quarter. We signed cloud contracts with annual recurring value greater than any prior quarter except for our last Q4, which always tends to be seasonally stronger. The quarter also include in land mark cloud deal and we have now started the initial phase of what is our largest cloud deal to date. GAAP net income was higher than anticipated as a result of higher than forecasted license revenue, a positive foreign exchange effect to other income and recording a tax benefit for the quarter. Total revenue for the second quarter was 69.8 million compared with 71.3 million last year. Currency had a 1.2 million negative impact. Comparing to prior year on a constant currency basis, total revenue was relatively flat with lower license and services revenue, offset by an increase in subscription revenue of approximately 37% in constant currency to 12.3 million. Currency had a 910,000 positive impact on expenses and an overall 335,000 negative impact to net income. Recurring revenue which we define as subscription revenues plus maintenance revenue makes up approximately 66% of total revenue, up from 60% one year ago. Customer preference to the cloud continues to increase faster than our expectations earlier in the year. And in the current quarter we closed most of our new deals in the cloud. In addition to converting several of our existing customers, as a result we continue to see lower license revenue in compares into prior years, a trend that we see increasing going forward. This trend is a result of our success of our ongoing transition to the cloud. As our business model continue to evolve we expect that it will continue to create some short term profitability challenges as we invest in support of the growth of our car business and our sales and operational expenses are recognized ahead of revenue. Subscription margins were 45%, up 1% from last year but slightly down sequentially. Given the acceleration of our cloud business we have had to make additional investments in infrastructure in order to support additional environment for our new customers. The associated revenue to these environment lags and as a result we experience margin pressure [indiscernible] of high growth. Subscription margins should improve overtime, but these types of quarterly fluctuations should be expected as we invest to support high growth. License revenue was 6.4 million which was higher than in the first quarter, but lower than the 8.6 million we reported last year. Foreign currency had a negative impact of 143,000. During the second quarter we closed one license deal greater than 300,000 compared with eight last year. License revenue in the current quarter included recognition of a transfer fee and additional user licenses of 1.9 million related to an existing customer. Maintenance and other revenue totaled 33.3 million compared with 33.8 million last year. Foreign currency had a negative impact of 576,000. On a performance basis maintenance revenue was flat year-over-year. We continue to be happy with our maintenance performance especially given the ongoing shift towards the cloud. We do expect maintenance revenue will decrease in the future as our customers convert o the cloud. Professional services revenue was 17.8 million versus 19.8 million last year. Foreign currency had a negative impact of 335,000. As we stated in the prior quarter earnings announcements services revenues continue to be affected by delayed projects starts which resulted in lower utilization. We were able to significantly improve our professional services backlog during this quarter, as we now have several projects underway that should help improve overall utilization. Total revenue by vertical for the second quarter was automotive 35%, high-tech and industrial 33%, consumer products and food and beverage 18%, and life sciences 14%. By geography North America was 47%, EMEA 29%, Asia pacific 17% and Latin America 7%. Gross profit for the fiscal 2017 second quarter amounted to 36.9 million or 53% of total revenue versus 38.7 million or 54% of total revenue in last year. The decline in gross margin resulted principally from our services business. Sales and marketing expense was 17.4 million or 25% of total revenue compared with 17 million or 24% of total revenue of last year. Currency had a 196,000 favorable impact. The increase related to a one-time marketing payment to a distributor and higher commissions related mainly to the high level of cloud bookings in the quarter. R&D expense was 11.1 million or 16% of total revenue for the second quarter of 2017, compared with 10.6 million or 15% of total revenue last year. Currency had a favorable impact of 128,000. The increase was caused by higher personnel to support our investment in our Channel Islands project. General and administrative expense was 8.5 million or 13% of total revenue versus 8.6 million or 12% of revenue a year ago. Currency had a favorable impact of a 161,000. Total operating expenses amounted to 37.2 million or 54% of total revenue compared with 36.3 million or 51% of total revenue a year ago. Currency had a favorable impact of 485,000 and equity compensation expense was 2.4 million in both periods. This brings our operating loss to 363,000 versus operating profit of 2.3 million from last year's second quarter. Net income totaled 600,000 or $0.03 per diluted Class A and Class B share from last year's second quarter net income was 1.6 million or $0.09 per diluted Class A share and $0.07 per diluted Class B share. Our year-to-date tax rate as of the end of the second quarter fiscal 2017 was 43% and for the fiscal 2017 we anticipate a tax rate of 45%. Non-GAAP net income which is described in greater detail in today's press release was 2.8 million or $0.15 per diluted Class A share and $0.12 per diluted Class B share. For last year's second quarter non-GAAP net income was 3.6 million or $0.19 per diluted Class A share and $0.16 per diluted Class B share. I would like now to provide a brief review of our year-to-date results. Total revenue was a 135.2 million compared with a 140.6 million for the first six months of fiscal 2016, in constant-currency total revenue declined by 2%. Gross margin was 52% of total revenue compared with 54% in the prior year primarily as a result of lower services margin. Subscription margin increased to 46% of subscription revenue from 45%. Total operating expenses amounted 73.5 million versus 72.7 million last year. As a percent of revenue total operating expenses were 54% in the current year compared with 52% of total revenue in the prior period. Net loss was 2.1 million or $0.12 per Class A share and $0.10 per Class B share, is compared with net income of 2.2 million or $0.12 per diluted Class A share and $0.10 per diluted Class B share. Non-GAAP net income was 1.5 million or $0.08 per diluted Class A share and $0.07 per diluted Class B share versus 5.2 million or $0.28 per diluted Class A share and $0.23 per diluted Class B share. Moving onto our balance sheet, we ended the second quarter with cash and equivalents of about 135 million which is down slightly from a 138 million at the end of fiscal 2016 primarily as a result of dividend payments. Accounts receivable equaled 45.5 million about equal to 46 million last year. Our receivables quality remains healthy. Day sales outstanding using the count back method were 54 days for the second quarter of fiscal 2017 compared with 55 days a year ago. Our deferred revenue balance at July 31, 2016 was 85.3 million which included deferred maintenance of 65.1 million, deferred subscription of 17.2 million, deferred professional services of 1.8 million and deferred licenses of 1.2 million. On constant-currency basis deferred revenues were 86.4 million at the end of fiscal 2017 second quarter. Currency negatively impacted deferred revenue by $1.1 million. A year ago, our deferred revenue balance was 82.5 million, which included 56.5 million of deferred maintenance, 12.1 million of deferred subscriptions, 2.6 million of deferred professional services and 1.3 million of deferred license. Generally maintenance contracts are billed annually while subscription contracts are billed either annually or quarterly. Cash flow provided by operations was 1.8 million for this first half of fiscal 2017 compared with 9.2 million for the first half of 2016. The decrease is due to lower net income and lower collections mainly as a result of our business model shift. Our fiscal 2017 guidance remains unchanged, we anticipate total revenue of 277 million to 283 million including 50 million to 53 million of subscription revenue. We continue to believe the subscription revenue will grow annually at a rate of approximately 30%. We expect GAAP earnings per share of approximately $0.04 to $0.14 per diluted Class A share and $0.03 to $0.13 per diluted Class B shared, and non-GAAP earnings per share of approximately $0.38 to $0.48 per diluted Class A share and $0.31 to $0.41 per diluted Class B share with stock-compensation expense of approximately $7.3 million. Our business outlook for the third quarter of fiscal 2017 includes total revenue of 68 million to 70 million including approximately 13.2 million of subscription revenue, GAAP income per share of approximately breakeven for Class A and Class B share and we’re expecting non-GAAP earnings per share of $0.09 per diluted Class A share and $0.08 per diluted Class B share. And that concludes my remarks for today. Karl, I'll turn it back to you.

[Karl Lopker:]

Okay, thanks, Daniel. We continue to be excited about our success in cloud activity. Around half of our cloud new sites have come from net new customers. That is new customers or new divisions of existing customers. The rest comes from on premise customers who converted to cloud usual while doing an upgrade. Both of these types of bookings generate services revenue and because of the strong bookings our services backlog has increased significantly for both QAD and our partners. Services utilization suffered in the first half of the year, however we believe the situation is changing for the better due to our increased backlog. Our sales funnel for cloud and licenses remains the same and total as last year, the cloud has doubled [ph] 60% of the funnel and cloud B also accounted from most of the large deals. We added 19 new cloud sites in the quarter and many of these deals have a potential from much larger roll outs overtime. Maintenance revenue was flat in constant currency despite the effect of cloud conversions and lower level of license deals. Renewal rate are consistent with past experience however conversions from on premise to the cloud and the shift of our business as a whole from a licensed vendor to a cloud vendor are putting more pressure on this revenue line going forward. On the regional basis for the quarter North America was stronger than usual while Europe was a bit weaker. Automotive was our strongest performing vertical for the quarter, however our strongest cloud performance on a year-to-date basis has come from life sciences where we feel we have a unique advantage due to our proven ability to help customers become certified by the FDA. Full time employee headcount at 1,710 was up around 3% from last year. Although personal expense was up only around 1%. The increase was mainly in cloud operations development and services. Now put it over to Pam for a closer look at our cloud activity. Pam?

[Pam Lopker:]

Great. Thanks, Karl. As Karl mentioned, we had a very good cloud quarter. The big news this quarter as 19 new deals and more than doubling of the booking revenue from last year Q2. And in fact except for one Q4 which is normally seasonally strong, the quarter was the strongest quarter we have ever had in terms of cloud business closed. We had 11 new customers and 8 conversions. All verticals and all regions contributed to the booking this quarter was North America and automotive followed by consumer products being the strongest, for a better color. One of our highlights of this quarter was a land mark deal. This was a large global automotive companies, where we were are to able reverse a SAP direction and roll out. This was a situation where we were able to secure a site two years ago as they needed something faster than they could deploy with SAP. Using this as a foothold we were able to gain internal references and then work our way up to corporate. QAD was selected because of our speed of implementation, global financials, automotive capabilities, integrated EDI and our automation solutions software capabilities and aligning [ph] it with industry 4.0 and the Internet of Things. Like we like to say simple, effective, global and automotive. The order this quarter represent a beginning of the global roll out of QAD in the cloud, to 17 countries worldwide [ph] across their enterprise. Here is what it takes to win a large global deal in automotive, you have to have global financials with embedded localizations working worldwide. You need to automate the soft floor, you need to have embedded EDI and you need to have verified security processes and a world class Cloud offering. That leads me to the next highlight I’d like to make about actually a Bank, this is an expansion of a cloud deal outside of our manufacturing vertical by Precision, our transportation management subsidiary. It’s a deal to a very large global bank, which was presently sold to their credit card replacement division and this quarter lead to the decision to implement Precision as their shipping standard for all divisions of pratfall [ph] overnight shipments. This expansion gives over 200,000 employees access to Precision’s desktop shipping presenting important documents for their customers. In order to win this accounts, our Cloud operations team has to pass through securities scrutiny of one of the world’s largest leading financial institutions and provide peak load performance of 350,000 shipments per shift. This is a great testament to the high security standards of our global cloud infrastructure and operations. This makes four total banks that Precision has as customers for their transportation [indiscernible] capability, all very large global banks, so great verticals for Precision, not necessary for QAD but really helps to show how secure and performing our Cloud environment is. I would also like to announce that QAD was named the 2016 enterprise cloud company of the year by Stratus Awards for cloud computing conducted by the business and analytics in intelligence group. The Stratus Awards identifies and acknowledges distinguished companies, products and people offering unique solutions that take advantage of cloud technologies. We were able to demonstrate our ability to offer best in class cloud services, no matter where the customer is located. Thank Karl back to you.

[Karl Lopker:]

Alright thanks Pam. On the economic side we’re seeing a slightly more positive environment. The Brexit issue doesn’t seem to have as big an effect on the overall manufacturing economy as we feared, and Europe continues to recover while the U.S. remains in growth mode. We expect to continue to keep up the pace in Cloud due to the increased interest in our cloud offerings both by ERP as well as our divisional products as Pam mentioned. As usual, we will now take questions. Operator, can you give the instructions?

[Operator:]

[Operator Instruction] Our first question comes from the line of Bhavan Suri with William Blair. Please go ahead.

[Bhavan Suri:]

Hi, thanks for taking my question and congrats on the cloud customers and just on the overall business there. It's good to hear the manufacturing businesses are picking up. When you look at the manufacturing businesses and maybe this for both Karl and Pam, and you look at how life science has been the big driver of Cloud. Are you starting to see some of the manufacturing guys become a bigger part of the pipeline for Cloud or are they still largely taking on primes?

[Pam Lopker:]

I think absolutely, the number of customers that a year ago were not considering Cloud that are now looking at it is continuing to grow. I don’t have the absolute statistics on that but certainly customers that would say, no way, we are not going to Cloud and now considering Cloud. I think the momentum is there and it's just continuing to grow quickly.

[Bhavan Suri:]

Okay. And then just help me reconcile a little bit sort of when you look at the deals and you are saying the larger deals in the pipeline are cloud. But if I look at Cloud subscriptions vis-à-vis licenses, plus maintenance, plus services, how do we reconcile those two or are the deals that are license based typically from existing customers expanding? How should we think about that from a deal size perspective in the pipeline for Cloud?

[Pam Lopker:]

I’ll let Daniel or Karl take that.

[Daniel Lender:]

Well, definitely most of license deals we are doing right now are from existing customers who either are adding new users to existing sites or maybe they are adding new sites. When they add new divisions that’s really a Cloud opportunity for us and we are going after that. So I hope that answered it.

[Bhavan Suri:]

No it did, okay good, good. And then maybe back to Pam here, because this will touch on one of your favorite subject, but how is the roll out of the newest phase of Channel Island going especially with the embedded analytics. What sort of traction, I know it's early, are you seeing with that product? A - Pam Lopker Yes, we are getting a lot of -- quite a list of earlier adaptors waiting for that, that’s going to be out in September, the better the analytics. So we are really setting up to push that out to early adaptors and certainly across our verticals that’s very-very interested to them and we are very happy to see the interest from the CFO level, because anytime we can be in front of the CFO and give them something that they are looking for is great for us.

[Bhavan Suri:]

Got it. And then just one last one from me, as you look at the subscription business and it continues to grow, and maybe this one is for Daniel, just sort of some sense of where subscription gross margin might end up at the end of the year and sort of how we should think about that trajectories in next couple of quarters?

[Daniel Lender:]

Yes, so as I mentioned in remarks Bhavan, we do see continued improvement in that area overtime. We are making or having to make some greater investments giving the higher level of activity in that area. So we -- it's too early to say, but we may not get as much of an improvement this year as we did last year. But that’s mainly a result of the investment to support those particular large Cloud customers ahead of the revenue being recognized.

[Operator:]

Our next question comes from the line of Brad Reback with Stifel. Please go ahead.

[Brad Reback:]

Daniel could you review this transition fee that you talked about, the $1.9 million?

[Daniel Lender:]

So, that's actually a combination of a fee that, when our customers divest a particular entity they typically need to pay for the ability to transfer the license to another entity. So, that $1.9 million actually relates to a couple of deals, part of it was a transfer of a license and the other part was actually additional users. So, it's -- that number is a combination of both.

[Brad Reback:]

And can you remind us on the sales force side, how you're comping your quota carriers between license and subscription and those are that are -- does there remain a heavy incentive on the subscription side?

[Daniel Lender:]

From a sales comp standpoint our reps get compensated about 1.6 to 2 times the rate that they would get compensated for a similarly sized license deal. And the reason for the variance between 1.6 and 2 is dependence on the level of discounting. So, the greater the discount, the less rate that they get. So there're not only incented to sell the cloud, but there're also incented to sell it at not a high discounts, because sometimes we're doing that in the license business given the importance of margins in that particular area.

[Brad Reback:]

And do you see that persisting given how much success you're having in the Cloud and the deals getting bigger and the pipeline getting bigger?

[Daniel Lender:]

Yes, it's not something that we would intend on changing, we see that working, it's working to -- you have to both incent to your sale force and provide the right sort of value and incentive to your customers to move that way. So, we think both areas are important.

[Operator:]

Our next question comes from the line of Mark Schappel with Benchmark. Please go ahead.

[Mark Schappel:]

Karl starting with you, given the success you're having in your manufacturing ERP cloud business, what are sort of the plans you have for adding more sales headcount this year or do you have plans to add sales headcounts?

[Karl Lopker:]

We’re adding sales headcount, we'll add some sales headcount, but I'd like to see more of the funnel being closed before we get really aggressive there. I'd also like to see a little more positive sign from the economy that I think I'm a little more positive on it than I was last quarter, but we do have an election coming up and we still have the full effect of the Brexit to still be felt.

[Mark Schappel:]

And then Daniel, given that you're half way through your fiscal year here and given the good 2Q numbers, why not raise your full year range here? I mean what are some of the variables out there that are giving some pause?

[Daniel Lender:]

Well there's a few things that we're taking into consideration Mark, one area is part of the beat [ph] in performance in Q2, likely deals on the license side that we would have otherwise probably have seen in Q3. So on the license front it is -- we see that more of a just shift between quarters and then with the success that we've had on the -- on bringing in the number of cloud deals, as I mentioned we do have to make investments both in terms of time and money in order to ensure that those customers get up and running as quickly as possible.

[Mark Schappel:]

Okay, great and then operating cash flow appears to be running well behind last year's numbers according to my model anyways. I believe you touched on this a little bit in your prepared remarks and maybe you could expand on that a little bit more and also give us an idea of what we can expect for the balance of the year.

[Daniel Lender:]

Yes, so I think the operating cash flow difference between this year and last year, a lot of it related to the change of business model which is not only effecting the timing of when we are billing customers, but also the pace at which revenue gets recognize for those particular deals which in term is effecting our bottom line. So, I would expect that effect both of those effects to continue as we continue to make this transition.

[Operator:]

And our last question will come from the line of Michael Morosi with Avondale Partners. Please go ahead.

[Michael Morosi:]

I guess just building on the back that the last question. As these cloud deals continue to get bigger, which is great. How should we think about the timing of that rev rack [ph] and as they approve to be bigger multi geography kind of longer roll outs, how should we expect those deals to rolls with the P&L?

[Daniel Lender:]

Yes, so typically with cloud deals obviously when -- in the quarter about we close and we don’t get to recognize any of that revenue. Revenue then starts either the following quarter or sometimes even the little bit further after and with very -- with largely deals with a multi country roll out what typically happens is there is they are done over ways that typically the revenue is built to a run rate over in 18 to 24 months period.

[Michael Morosi:]

Okay, and then with respect to service utilization it was good to see that services gross margins were back negative -- were back positive, but on the year they are fairly flat. How should we expect services gross margins to track on the back half and going forward?

[Daniel Lender:]

Services margins should slowly continue to improve and probably by next year or so we should be running at a pace more similar to historical standards.

[Karl Lopker:]

Operator do we have any more questions?

[Operator:]

We have no further questions.

[Karl Lopker:]

Okay. Well, thank you everyone for your attendance and your questions. We’ll update you again in November with our third quarter results. Good-bye for now.

[Operator:]

And ladies and gentlemen that does conclude today’s conference. Thank you for your participation and for using the AT&T executive teleconference. You may now disconnect.