QAD Inc.
Q4 2017 Earnings Call Transcript

Published: 10 Mar 2017

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the QAD Fiscal 2017 Fourth Quarter Financial Results Conference Call. At this time, all phone lines are in a listen-only mode. Later there will be an opportunity for your questions and instructions will be given at that time. [Operator Instructions] And as a reminder, this conference is being recorded. I will 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, 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:]

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. As we saw last quarter, our cloud subscription revenue maintained a healthy 40% growth rate for the quarter and then 34% for the full-year. Our license revenue was strong mostly due to new users from existing customers. These two factors have driven our services backlog to historical highest a dramatic change from the first half of the year. Daniel will give you the numbers and I will discuss the details. Daniel?

[Daniel Lender:]

Thank you, Karl. Our cloud business remain strong with subscriptions revenue improving 39% this quarter or 41% in constant currency as we added 22 new customers and grew our existing customer base. At the same time, maintenance and services revenue remained relatively steady while license revenue came in strong. We are pleased to report that total revenue, subscription revenue and non-GAAP earnings per share met guidance. During the quarter, we placed a one-time non-cash valuation allowance on our U.S. deferred tax assets, which impacted GAAP EPS. I will discuss this in more detail later. Total revenue for the fourth quarter was $73.3 million up from $69.3 million last year, again, driven by gains and subscription and license revenue. Currency had a $1.4 million negative impact on total revenue. Comparing the result to last year's fourth quarter on a constant currency basis, total revenue increased more than $5 million driven by higher subscription, license, and services revenue. On a constant currency basis, maintenance revenue was flat year-over-year. Recurring revenue which is a combination of subscription and maintenance revenue will now accounts for 63% of total revenue. License revenue amounted to $8.9 million up from $8.1 million last year. This is noteworthy given the strong cloud growth we saw during the quarter and it's attributed to the expansion within our existing customer base. While we are pleased to see these gains in on-premise deals, we continue to believe that the level of license revenue will decline over the long-term as more of our customers transition to the cloud. As I mentioned during the last quarters call, there will be short-term challenges to the bottom line resulting from investments in support of our cloud business growth as well as sales and operational expenses that are recognized ahead of cloud revenue. This is typical for companies making similar transitions. We are managing the transition well by maintaining overall revenue levels while having grown our cloud business in the 30% to 40% range. For the full-year, subscription revenue contributed almost 20% to our total revenue marking an important milestone for QAD. Subscription margins improved nicely, growing to 53% in the fourth quarter up from 50% last year and 48% for the fiscal 2017 third quarter. The improvement was attributed mainly to revenue catching up with previously added capacity. While our long-term target of 60% remains intact our aggressive investment in cloud growth will result in quarterly fluctuations. Maintenance and other revenues totaled $31.8 million versus $32.4 million a year-ago. On a constant currency basis maintenance remained flat, which given our shift to the cloud is noteworthy. As our customers continue to embrace cloud based solutions we believe that maintenance revenue will likely decrease. Professional services revenue totaled $17.9 million compared with $18.2 million last year. On a constant currency basis, services revenue grew by 100,000. Our services organization remains very engaged with our customers and are putting plans in place to add capacity via new hires and to our partner at work to satisfy demand. Our professional services hiring plans could put some pressure on margins during FY2018. Contributions of total revenue by vertical for the fourth quarter was automotive 37%, high tech and industrial 32%, consumer products in food and beverage 15% and life sciences 16%. By geography, North America was 46%, EMEA 31%, Asia Pacific 16%, and Latin America 7%. FY2017 fourth quarter gross profit was $40.4 million versus $38.4 million last year. As a percentage of total gross was 55% for both periods. Sales and marketing expenses was $17.7 million compare with $16.9 million a year-ago. The increase related to higher commissions and bonuses, to measure it with our cloud growth. As a percentage of total revenue sales and marketing expense was 24% for both periods. R&D expense was $10.6 million for the fourth quarter of 2017 compared with $9.8 million last year. The increase resulted from personnel expense related to the hiring of 30 additional people to continue to invest heavily in our product most notably Channel Islands, which is being well received by our customers as a percentage of total revenue R&D expense was 14% for both period. General and administrative expenses was $7.9 million versus $8 million a year-ago. G&A expenses as a percentage of revenue to 11% versus 12% last year. This brings total operating expenses to $36.3 million compared with $34.8 million a year ago at 49% and 50% of total revenue for the current quarter compared to last year. Equity compensation expense was $1.8 million for both periods. Operating profit came to $4.1 million an increase from $3.6 million from last year’s fourth quarter. Income tax expense of $19.8 million included a one-time non-cash accounting adjustment of $16.3 million that I mentioned earlier. The adjustment was attributed to the placement of valuation allowance under U.S. deferred tax assets. Recent losses generated in our U.S. entity primarily in connection with our continued transition too an investment in a cloud model to acquire us to place a valuation allowance on these tax asset for accounting purposes. As cloud revenue continues to grow, we believe profitability will increase over the long-term and we will be able to utilize our deferred tax assets. GAAP net loss resulting from the valuation allowance was $15.2 million or $0.82 per Class A share and $0.68 pre Class B share for the last year's fourth quarter net income was $4.1 million or $0.22 per diluted Class A share and $0.18 per diluted Class B share. Non-GAAP net income which we described in today's press release was $3 million or $0.16 per Class A share and $0.13 per Class B share. For last year's fourth quarter, non-GAAP net income was $8.5 million or $0.45 per Class A share and $0.38 for Class B share. Moving now to our full-year results. Total revenue was $278 million the same for fiscal 2016. The reduction in licenses and professional services as well as the negative impact of foreign exchange was fully offset by the growth of our cloud revenue. It's worthwhile to note that on a constant currency basis total revenue grew by $4.7 million. Gross margin was 53% of total revenue, compared with 54% for FY2016 primarily reflecting lower services margin and the shift in a revenue mix from license to cloud. We improved our subscription margin to 48% for FY2017, up 1% from 47% last year. Total operating expenses came to $143.8 million versus $141.1 million last year. As a percent of total revenue, total operating expenses were 52% for FY2017, compared with 50% of total revenue for the prior year. Net loss of $15.5 million was as for the quarter mainly related to the valuation allowance compared with net income of $8.9 million last year. Non-GAAP net income was $7.6 million versus $18.1 million last year. We ended FY2017 with about $145 million in cash and equivalent, up from $138 million at the end of FY2016. And during the year, we paid over $5 million in cash dividends for our shareholders. Accounts receivable increased to $69.4 million from $65.5 million last year. Our days sales outstanding using the count back method was 50 days for the fourth quarter versus 49 days one-year ago. The quality of our receivables remains healthy. Our deferred revenue balance at January 31 was just over $104 million, including $78.9 million of deferred maintenance, $20.4 million of deferred subscriptions, $2.6 million of deferred professional services and $2.2 million of deferred licenses. On a constant currency basis, deferred revenue was $105.2 million at the end of FY2017 including a $1.2 million negatively impact from currency. A year ago, our deferred revenue balance was $97.9 million including $79.5 million of deferred maintenance, $14.2 million of deferred subscriptions, $2.3 million of deferred professional services and $1.9 million of deferred license. As you know, maintenance contracts are typically billed annually, while subscription contracts are billed either annually or quarterly. Our cash flow provided by operations was $18.7 million for fiscal 2017, compared to $24.1 million for fiscal 2016, mainly as a result of lower net income, resulting from the shift from license to the cloud. Starting in FY2018, we will provide guidance for total revenue, subscription revenue, GAAP pre-tax income, and non-GAAP pre-tax income. Our guidance will no longer include GAAP earnings per diluted share and non-GAAP earnings per diluted share. We are making this change in order to improve alignment with recent interpretations of the SEC’s complains and disclosure interpretations on the use of non-GAAP financial measures. For fiscal 2018, we expect total revenue of $288 million to $292 million, including $68 million to $70 million of subscription revenue, GAAP pre-tax loss of $1 million to pre-tax income of $1 million, and non-GAAP pre-tax income of $8 million to $11 million. And for the first quarter of fiscal 2018, we expect total revenue of $68 million to $70 million, including $15.5 million of subscription revenue, GAAP pre-tax loss of $2.5 million to $2 million, and non-GAAP pre-tax loss of $450,000 to pre-tax income of $250,000. With that, back to you Karl.

[Karl Lopker:]

Well, thanks Daniel. Our cloud activity continues to perform well with half of our revenue coming from conversions from on-premise costumers as we have traditionally experienced. Since these conversions are usually associated with an upgrade, our services backlog is strong and we are hiring to fill demand and expanding our partner network. Our license revenue is mainly from new users and it has been generating less of the demand for services. As I mentioned, our services backlog is at an all time high. Services utilization continues to improve in the quarter, but may suffer a bit in the coming year due to hiring and training to meet the backlog. Our sale funnel for cloud and licenses is up around 5% from last year at this time with all the increase coming from cloud and cloud now accounts for 60% of the fund. We added 22 new cloud customers in the quarter including two customers who purchased our divisional products in the cloud. Maintenance revenue was flat in constant currency, despite the effect of cloud conversions in the lower level of license revenue. We continue to see renewal rates consistent with past experience however conversions from on-premise to the cloud will continue to affect overall maintenance revenue. On a regional basis for the quarter, overall revenue was consistent with past experience, and we are happy to see cloud bookings picking up in regions outside North America. They are now 50% of our cloud business and we believe that the global nature of our cloud business is a real strength for QAD. Automotive was again our strongest performing vertical for the quarter and year overall as it has been for some time. Full time employee headcount at 1,710 was up around 3% from last year. The increase was mainly in cloud operations, development and services. Now I’ll turn the call over to Pam for closer look at our cloud activity. Pam? Pam Lopker Great. Thanks, Karl. We have very strong quarter for our cloud business closing out the best quarter and the best year ever in cloud both in terms of closing business as well as recognized revenue. We had 22 new cloud customers, 14 of which were conversion, six net new, and two who purchase cloud modules for their on premise environment. So historically it was a little high on the number of conversions, but overall through the year we’re still looking at that 50/50. All verticals and all regions contributed to the booking this quarter with industrial followed by automotive being the strongest in counts of customers and strong new business from all four regions. This quarter nearly a third of our bookings were new users as existing cloud customers continued their rollout of our ERP product across different areas of their enterprise and as they increase their use due to their own business cloud. This is a great testament to the success of our customers are having with our cloud offerings. Also quite a bit different than other cloud companies who tend to sell by the number of employees or the total number of users all upfront because the nature of our global customers they will buy for a division, for a country and based on the success of that continue our rollout. So we are glad to see that nice recurring revenue through their growth and of course is in the testament of our ability to get them implemented and have been continuing to rollout. We also signed number of cloud deals coming from India this quarter with a new goods and service tax regulation going to affect in July of this year in India and changes still being discussed, cloud makes a lot of sense in India, even though India typically is very pressured on cost, this was a good situation for them to consider our cloud offering. Also coming up in this year is changes to the U.S. and Euro revenue recognition standards of ASC 606 and IRF15 and possibly with a new taxes on imports particularly into the U.S. Changes are easier to implement for companies that are working in the cloud and we're able to support our customers on a global basis which really provides a win-win situation. I also wanted to mention that we our Explore Conference coming up. This year we will be holding our QAD Explore User Conference May 8 through 11 in Downtown Detroit. Explore is QAD’s largest annual event for customers, partners, sponsors and QAD experts come together for a week of formative sessions and fund training manufacturing industries specific presentations and of course networking. The agenda provides updates on our key trends in manufacturing such as Industry 4.0 and Internet of Things, strategic developments in the industry that call QAD services and information on new solution developments including Channel Islands. Attendees will hear from over 75 speakers consisting of QAD executives, customers and manufacturing authorities. This year we will be highlighting the unique agility that QAD Solution provides to our customers allowing them to meet the needs of their changing business environment. To the highlight the accelerating pace of change in manufacturing, we are excited to have the [indiscernible] as its speaker this year. If you like please join us in the [Big D]. Thanks Karl, back to you.

[Karl Lopker:]

Okay, Pam. The manufacturing economy seems to be rolling along nicely with the JP Morgan Purchasing Managers Index at six-year high. Europe seems to be doing well after an extended period of slow growth. We are following the U.S. tariff proposal and talking with our customers about what the reaction might be, especially looking for the effects on our automotive customers, but very global supply chains. The automotive vertical in fact is also heading into a tremendous amount of change over the next decade from electric and autonomous vehicles as well as ride-sharing services. In India case, we expect to keep up the pace in cloud due to the increase interest in our cloud offerings both for ERP as well as our divisional products. And finally as shown in our press release, Anton Chilton who has been running our global services organization will also be responsible for sales and marketing. Anton has been with QAD for over 12 years in various sales and services positions and QADs Asia Pacific region, and our Global Strategic Accounts Group. Prior to the QAD, he had roles with Atos Origin and Cap Gemini and he holds an MBA from INSEAD. Now as usual, we’ll take questions. Operator, can you give the instructions.

[Operator:]

[Operator Instructions] Our first question will come from Bhavan Suri with William Blair. Please go ahead.

[Bhavan Suri:]

Hey guys. Thanks for taking my question and congrats. It was a very solid quarter. Just to start off first, it feels like you're seeing more of the existing customers. I know its one quarter, but start to shift to cloud. Do you think it's normally? Do you think we're at some sort of inflection point given education, given acceptance of cloud, so we could see that start to be more a part of that pipeline as opposed to 50/50 maybe 60/40 of existing versus net new?

[Karl Lopker:]

Well, I’ll take that. I think it's going to continue at about 50/50, especially since we're putting, starting to put a little bit more focus on our net new business as we need that to grow because eventually we'll run out of people to convert to the cloud.

[Bhavan Suri:]

Got it. Okay, we'll go and see how it plays out. I guess when we turn to next parts, you've also seen sort of a very solid growth in Asia, you talked about India, you talked about China in the past. Is there something there that's driving the cloud interest or is it just – are they net new customers there? What's driving that acceleration in that part of the world that typically has been a license based model more than a cloud based?

[Karl Lopker:]

Well, that part of the worlds been quite hesitant to go to the cloud, and they don't necessarily – they don't trust where all their data is. However, the combination of them starting to feel a little more comfortable, the 50% of our business there is actually multinationals doing business. So they're less [indiscernible] go to the cloud. And then you have things like the tax situation changing all the time. So that's a good reason to go to the cloud.

[Kara Bellamy:]

And also the larger Asia companies, so Japanese companies, Chinese companies, it make a lot of sense when they're running these international organization, going to the cloud because they themselves don’t have the support staff to support all the different languages around the world and requirement. So it’s not a little company so much that we see going to the cloud in Asia-Pacific to some larger global company.

[Bhavan Suri:]

Got it. And then one for me both of you guys that you've mentioned Karl, there is a little bit of this call and typically you've done a lot of implementation work yourselves. Are you seeing third-parties? Are you pushing for third-parties to do implementation because historic I mean it feels like QAD has done a lot of their own implementation? Is there a shift there and some sort of strategic change or are you seeing guys like Accenture or other consulting company start doing implementation. How should we think – just a little more color in your comments?

[Karl Lopker:]

Well, we are pushing a little bit more for partners to do services mainly because of our backlog and also because of the upgrade that people are starting to get more and more interested in as we get closer to pushing out all of the Channel Islands. So we're looking forward there. So yes we are looking at other partners. Those partners are not necessarily the big guys because they love to do the SAP and Oracle implementation, which gets them about three to five times much money. But we are looking for the smaller partners and the big guys may come along when the new product is out.

[Bhavan Suri:]

Got it. That’s really helpful. Guys that was great. Thanks for taking my questions and congrats again.

[Operator:]

Thank you. Our next question will come from Richard Davis with Canaccord. Go ahead please.

[Richard Davis:]

Hey, thanks very much. So one kind of technology question and one kind of multi-question, so the technology question is you guys highlighted the Channel Islands kind of rest API initiatives, does that come with a kind of control console that kind of help manage and monitor the security in the API? And then the more important question is, it seems to me that if you've pushed in that direction isn’t that going to make a very least upgrades easier and maybe even transition of an ERP system to cloud easier because you have less customization and things like that, so that's my first question?

[Pam Lopker:]

First of all there is no customization, so all the – what we’ve worked on for the – probably even in the last 10 years is to eliminate the need to customization and that isn’t by trying to put a 1,000 million control files of all the different options and blab, blab, blab anybody might ever want, but instead putting the ability to make changes that are in data as opposed to encode and once that upgrade easily So whether it’s a report, whether it’s a screen been able to add field, take fields off, add new fields that’s logic and all that stored in data and works with the software to move forward. So that is part of our strategy. We expect that – we’ve had a lot of experience with this. We’ve done it first of all from our services organization to a something that called non-intrusive customizations and then taking those concepts and embedding them with a very nice easy to use way into the software. And of course, the whole API structure of the software is imperative to support that kind of technology change and capability. And then from a security that extremely important, people are more and more concerned about security, I think we all are and I think there's good reason for that. So making sure that our software particularly in the cloud is secure. We hire outside firms to penetration test that all the time on a continuous basis and make sure that no one can get into our software and that’s I think a huge plus to go to the cloud as well because we are on that 7/24.

[Richard Davis:]

Got it. And then real quickly, you mentioned and I agree with you, likely big changes in the composition of cloud ownership is going to occur and stuff like that. I mean we may hear about this more when we go to Detroit, but is there anything in particular that you guys are doing to try to get ahead of the curve to help you? These guys out because for it clears is going to be some degree of change for them or how do you think about that? Thanks.

[Pam Lopker:]

Well certainly a lot of that rest on the whole Internet of Thing capabilities, so being able to those API’s and hocking into big data and databases in order to keep track of not only demand that changes needed for maintenance, defects when things are going wrong and being able to isolate them and fix them. It's all part of the whole Internet of Things platform and certainly needed to support all kinds of systems not just Kara is going into the future, but it could very well be in the future that our larger customers, the OEMs and the automotive business for instance are going to own that equipment and that's just not card business that had everything from printers to medical devices and they need to be able to maintain it and remotely and be able to determine when defects are happening before they actually happen. So I think that's going to be a big part of our systems and products in the future.

[Richard Davis:]

Perfect. Thank you so much.

[Pam Lopker:]

Thanks.

[Operator:]

Thank you. We'll go next to Adam Borg with Stifel. Please go ahead.

[Adam Borg:]

Great. Thanks so much for taking the question. I believe that quarter you talked about there being about 70 sales reps and when thinking about fiscal 2018 I was just curious what your plans are for growing headcount and kind of what would the focus be if any? Thanks.

[Karl Lopker:]

Well we have about 70 sales reps right now and we intend to keep it about 70 sales reps, we would like them to do a little bigger deals and I'd like to see a bigger funnel before we start hiring a lot more. Although as soon as we see that happening, we will definitely be aggressive in that area.

[Adam Borg:]

Great. And just a follow-up, is there any plans for the sales compensation structure with respect to cloud to change for this year?

[Karl Lopker:]

We have tweaked it a little bit for this next year, but not huge changes, we see a lot of business coming in through our divisional products and so we actually indented those a little bit more for this coming year and especially if those are in the cloud, so that should help the sales reps to penetrate our existing accounts a little bit more, but no we haven't done any major changes.

[Adam Borg:]

Great. Thanks so much.

[Operator:]

Thank you. Our next question is from Mark Chappell with Benchmark. Go ahead please.

[Mark Chappell:]

Hi good evening. Most of my questions have been answered. Just one though Karl for you. The automotive business had a particularly stronger performance this quarter and I was wondering if you expect this trend to continue or whether just one or two things in the quarter that drove that business?

[Karl Lopker:]

I think the automotive business is going to continue to be strong. I don't know it's going to be any stronger than it has been. We don't want to have too many eggs in one basket in any case, but when you have a number of activities going on in the automotive business do that that should drive a lot more revenue. So I don't expect it to be getting weaker either.

[Mark Chappell:]

Okay. Thank you.

[Operator:]

And we have time for one last question that will come from Michael Morosi with Avondale Partners. Go ahead please.

[Michael Morosi:]

Hi, guys. Thanks for taking the question. First for Daniel, what are the FX assumptions in the fiscal 2018 revenue outlook?

[Daniel Lender:]

So for in terms of our modeling going forward what we typically do Mike is we take current rate. So we try not to predict where – for an exchange movements are going to go up or down. So you can reasonably take the average over the last month or two and that will be close to what we're using.

[Michael Morosi:]

All right, very good. And with respect to subscription margins, you continue to show good leverage there. Where do we stand in terms of the cloud infrastructure investments and where are those break points where we'll have to see another round of investment in capacity to support continue growth?

[Karl Lopker:]

Yes, so the investments that we do from a capacity standpoint are stepped investment because easier for us to deploy, a number of servers versus doing them one at a time. So we typically invest as I said in step, we're not necessarily going to see one big investment or – so it's going to be as we have done in the past there's some investment done in a particular quarter as we see the future demand getting close to what we have in terms of capacity. But we have become through the use of different technologies. We've become more flexible in terms of how we are utilizing some of the hardware. So as a result of that we’re also will continue to improve the efficiency of the equipment that we have. So we have a number of different initiatives that are going to help us to get to that 60%, which is where we're aiming. As we've said it's going to be a gradual journey.

[Michael Morosi:]

That's very good, and Pam, you referred to the land and expand approach that that are driving, you follow on sales, could you quantify a little bit the up-sell opportunity for those accounts as they are in new users over time?

[Pam Lopker:]

Well, typically a larger company that has five plus countries and they’ll gives us a starter country, saying okay, let’s gives this a try in the U.S. or in China and based on that success we will buy more. So they're not giving us a contract upfront, they're giving us a country, they’re giving us a division and based on that they're buying more. So there's no – typically no commitment upfront, but this is the opportunity and that is working well for us obviously this quarter with one third of our revenue, our new bookings coming from that type of activity. So no new customer, it’s not a new customer, we have the logo, but now we’re just expanding.

[Michael Morosi:]

Very good and if I would might looking one last one, the big deal activity in the quarter seemed to step up pretty appreciably just based on over 500,000 and over a million wins in the quarter. What is driving that? Is it fairly broad based or there are a few factors that have increased those larger deal wins?

[Daniel Lender:]

Yes, some of that actually relates to the Q4 where we have some maintenance renewals and some larger license deals in that typically happen in our Q4. But generally speaking we are certainly engaged in and looking to do more larger deals obviously there's a little bit more [bank for a buck] when it comes to sales effort there.

[Michael Morosi:]

Very good, thanks. End of Q&A

[Operator:]

Thank you. I’ll now turn the call back to Mr. Lopker for closing remarks.

[Karl Lopker:]

Okay. Thanks everyone for your attendance and questions. We’ll update you again in May. Goodbye for now.

[Operator:]

Thank you, again ladies and gentlemen. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.