QAD Inc.
Q4 2009 Earnings Call Transcript

Published: 13 Mar 2009

[Operator:]

Ladies and gentlemen thank you for standing by. Welcome to the QAD fiscal 2009 fourth quarter financial results conference call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. John Neale. Please go ahead sir.

[John Neale:]

Hello and welcome everyone. I’m John Neale, QAD’s Vice President and Treasurer. Earlier this afternoon we issued a press release announcing QAD’s results for fiscal 2009, fourth quarter and full year ended January 31, 2009. The press release and associated financial statements are available through the Investor Relations section of our website at www.qad.com. Additionally, please be advised that this call is being webcast live on our website. Before we begin I need to insure that everyone on today’s call understands that our discussions might contain forward-looking statements that are based on certain expectations and analysis as of March 12, 2009. 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 forward-looking statements to reflect events or circumstances after the date of this call. For a complete description of risks and uncertainties please refer to QAD’s 10-K and 10-Q filings with the Securities and Exchange Commission. Now I’d like to turn the call over to Karl Lopker, QAD’s Chief Executive Officer.

[Karl F. Lopker:]

Well good afternoon and thank you for joining us to discuss our fourth quarter results. With me today is Daniel Lender, Chief Financial Officer and Pam Lopker, President. Our fourth quarter was even more difficult than we expected. The economic crisis spread from the U.S. to include manufacturing firms worldwide, especially those in the automotive supply area. Daniel will give you the numbers for the quarter and then I’ll discuss the details. Daniel.

[Daniel Lender:]

Thank you Karl. As Karl mentioned our financial results this quarter were negatively impacted by the continuing effects of a global economic slowdown which resulted in pullbacks or delays in spending among our customer base. Total revenue was $59.3 million in the fiscal ’09 fourth quarter, representing primarily a significant decline in license revenue and to a lesser extent services revenue. During the last quarter of fiscal 2009 we received orders from 27 customers representing more than $500 thousand each in combined license, maintenance and services billing, including seven exceeding $1 million and three exceeding $2 million. License revenue was $10.2 million in the fourth quarter, versus $22.4 million in the same period of last year. Significant declines in demand for our customers’ products generally resulted in a move to preserve capital, as well as delays in licensing purchasing decisions. This was especially true in the automotive sector, which represents about a third of our business. Maintenance and other revenue was $32.4 million in the fourth quarter of fiscal ’09, which includes a negative foreign currency impact of approximately $1.5 million compared to last year at $33.1 million. While customer renewal rates continue to be north of 90% and most customers are renewing at similar or higher rates, we have recently seen some extended negotiations during the renewal process, posing an increased risk. Services revenue was $16.7 million compared with $19.8 million last year, reflecting customer shutdowns and vacations and service engagement delays or cancellations driven by the tough economy. Gross margin was 53% of total revenue in the fiscal ’09 fourth quarter versus 59% in the similar period last year. The change reflects the mix of revenue as well as lower margins in our services business, due in part to lower revenue from severance related to the reduction in force in our services organization. Total operating expenses in the fiscal ’09 fourth quarter amounted to $50.2 million or 85% of total revenue compared with $39.5 million or 52% of total revenue in the fiscal ’08 fourth quarter. As we discussed in our press release issued earlier today, total operating expenses included a non-cash goodwill impairment charge, severance costs and bad debt expense that altogether totaled $18.4 million. Excluding these items, expenses would have been down 19% year-over-year and we would have been very close to achieving breakeven during the quarter, despite experiencing a significant decline in our planned revenues. During the company’s annual test for impairment during the fourth quarter of fiscal ’09, it was determined that a write-down of goodwill related to the company’s EMEA business segment was necessary. As such, we incurred a non-cash goodwill impairment charge of $14.4 million which brings our total goodwill balance as of year end to $6.2 million. Next, in connection with the previously announced 125 person workforce reduction, which amounted to about 8% of our global workforce, we incurred severance costs of $3.3 million in the fourth quarter of fiscal ’09 and expect to record approximately $1 million of additional severance expense in the first quarter of fiscal 2010. As a result of this initiative, we expect to reduce operating expenses by approximately $14 million on an annualized basis beginning in the current fiscal year. We also recognized bad debt expense of approximately $700 thousand this quarter, mainly related to a customer project we completed some time ago. Finally, we incurred approximately $400 thousand in costs related to canceling this year’s Explore User Conference. We canceled this event after many conversations with our customers who are generally reducing travel budgets. In response to this, we are engaging in a variety of new initiatives to meet our customers needs while providing increasing value, including hosting a virtual User Conference this year. We will continue to proactively align our cost structure with current revenue level and are working to best position QAD for the expected economic recovery. In addition to the reduction in workforce, we continue to review overall spending throughout the entire organization, including travel and entertainment; marketing and events; and property and facilities. At the same time, however, we will continue to make strategic investments in our business where we can achieve a good return on that investment and position QAD for future success. Operating loss in fiscal 2009 fourth quarter was $18.8 million, which includes $1 million in stock compensation expense. Compare it with operating income of $4.7 million which includes $1.8 million of stock compensation expense in the same period last year. Other income was about $600 thousand for the most current quarter versus other expense of about $100 thousand for the fiscal ’08 fourth quarter. The change primarily relates to foreign exchange gains offset by lower interest income. Our net loss for the fiscal 2009 fourth quarter was $17.4 million or $0.57 a share versus net income of $5.2 million or $0.16 per diluted share in the same period last year. Now for full year results. Total revenue in fiscal ’09 was up slightly to $263.4 million compared with $262.7 million in fiscal ’08. Operating loss of fiscal ’09 included the items I discussed earlier and was $23.2 million including $5.5 million in stock compensation expense. This compares with fiscal ’08 operating income of $5.6 million including $6.2 million in stock compensation expense. Net loss for fiscal ’09 was $21.4 million or $0.70 a share, compared with net income of $5.4 million or $0.17 per diluted share. Cash flow provided by operations for fiscal ’09 was $7.2 million compared with $15.9 million last year. Cash and equivalents at January 31, 2009 were $31.5 million versus $36.2 million at October 31 and $45.6 million at the end of fiscal 2008. The change in our cash balance over the last 12 months reflects our positions related payments of $7.1 million and $5.3 million in dividend payments and stock repurchases. Days sales outstanding using the Countback Method was 75 days in the fourth quarter of fiscal ’09 versus 58 days in last year’s fourth quarter. Given the economic situation, we are monitoring our receivables closely, particularly in the auto industry where the situation is especially grim. Given continued uncertainty in global marketplace, we’re not providing our normal outlook for the 2010 full fiscal year. First, from a financial perspective our number one focus in fiscal 2010 is profitability and we’re continuing to take the necessary steps to streamline our business and allow it to achieve profitability at lower revenue levels than in the past. For the first quarter of fiscal 2010 we’re currently expecting revenues about 10% lower than our most recent quarter and given the timing of some of our cost saving initiatives, we’re currently forecasting a small operating loss in the first quarter. With that review, I’ll turn the call over to Karl.

[Karl F. Lopker:]

Okay. Thanks Daniel. Well, the selling environment has been very difficult for both new business and even current projects. It’s no surprise that there are few new projects coming up for bid in manufacturing companies, but also some projects that are already started are being delayed or canceled. Our license deal win ratios have been similar to the past, but the number and size of deals has been down. In other words, we’re winning our fair share but overall spending is being reduced as expected. Our license pipeline is only down 15% from a year ago, but many projects have been pushed out. I don’t need to tell you that especially hard hit has been the automotive sector. Automotive is generally a third of our business and through the first three quarters of the year was our best performing vertical market. However, in the fourth quarter automotive manufacturing really fell off a cliff. Even merger and acquisition activity did not make up for the license shortfall as automotive suppliers reduced their staff by 30 to 40%. Strength in the automotive segment has an effect on other manufacturing, since so many companies have at least a portion of their business related to automotive production. Our services revenue was down due mainly to delayed or canceled projects. We offset some of the effect of the delays through vacation accruals. And although large services engagement in the automotive sector was scaled back significantly, creating an impact on our services results, our overall services business is well diversified across regions and verticals. However, we do expect a decline in services revenue during the coming year. Maintenance held up reasonably well, even though some customers have been cutting expenses aggressively. We are working with our customers to keep them on maintenance, and our maintenance renewal rate was still above 90% for the quarter. On a geographical basis, all regions experienced a similar reduction in revenue. During the quarter we saw the same issues in North America spread to Europe and Asia-Pacific, causing the overall decline. If you discount the fourth quarter expenses for goodwill, bad debt and severance, we produced a small operating loss for the quarter and for the year. Despite the severe drop in license revenue, our operating losses curtailed by the cost reduction actions we implemented early in the quarter, such as travel expense reductions; use of video teleconferencing; and vacations during the low activity periods. Despite our growth throughout the first three quarters, our overall head count is currently about even with the end of last fiscal year due to attrition and workforce reductions. We expect that headcount will continue to decrease due to our aggressive performance management process and some attrition in the remainder of the year. We have been polling our customers to see how the economic situation is affecting them and what we can do to help them get through this crisis. So where do we see the opportunity? Life sciences and food are not as affected by the economic crisis as other types of manufacturing. We expect these verticals to grow a bit. We’re looking at our financial stronger manufacturing customers to make acquisitions and the weaker companies to divest. Both situations create opportunities for QAD. We are also seeing stalled implementations involving competing software, where customers are coming to us for more rapid deployment and return on investment. And since companies have been reducing their workforces and will be slow to rehire them, we see more demand for training, especially self-service and web-based training. And also this reduction to headcount at our customer creates demand for application management services where we manage the applications. We can provide services from help desk to infrastructure management. And in other cases companies want to reduce capital expenditures and IT costs, and are considering going to an on-demand environment, where we take care of their application needs and leverage our global infrastructure. In the product area, QAD 2008 Enterprise Edition is being rolled out, although some customers are delaying their upgrades in order to delay expenses and to focus on their financial situations. Just earlier this week we held a newsgroup conference and I’ll let Pam tell you about what she heard. Pam.

[Pamela M. Lopker:]

Great Karl. As you said earlier this week we hosted the QAD West Coast User Group meeting here at our Santa Barbara headquarters. We had 110 attendees representing most of our verticals including food, medical device, [ATT] and electronics. We did not have any automotive companies as they are not located on the West Coast. Overall we’re seeing medical devices companies are still in growth mode; food companies are pretty stable; but [CPG] and electronics seeing declines in business. Softwares of service or on-demand is a very interesting topic that many customers are considering as a way to reduce operating costs and mitigate their risk. A focus on getting the most out of their current investment and needing to do all the work with fewer people is one of the major topics. This is the first of four North American Regional Spring User Conference led by our customers themselves. QAD will be playing a major role in all of these conferences over the next couple months. Many companies have travel restrictions in place, but the attendees are committed to attend these Regional User Group events because they learn the best practices that they feel are vital to help them during this time of economic uncertainty. We also saw many of our customers traveling by car, you know, for a five, seven hour trip and carpooling with each other in order to save travel costs, and I think that’s probably true with all companies because of travel restrictions and trying to reduce costs. Many expressed optimism in their – as their companies are addressing the challenges from the economic crisis. There was a noticeable effort to focus on the positive and to emphasize the value of partnership and teamwork to overcome the difficulties they are facing. Overall, it was a very good and upbeat conference. On the R&D side, QAD is still investing in R&D with particular emphasis on differentiating ourself through usability, softwares and service offerings, and Best In Class business processes and metrics. We have already seen some of these R&D initiatives deliver benefits. For example, our improved usability throughout the product has led to some increase in module sales, particularly for a product area such as field service and enterprise asset management. I will highlight a couple customers mentioned in our press release. FEI Company is a $600 million maker of imaging equipment, primarily used in nanotechnology research. Customer service is paramount to their overall strategy and field service is a major part of their revenue and key to customer satisfaction. They have chosen to upgrade to our latest release of field service and deploy our handheld technologies to their field service people in order to meet their goals. Ball Corporation is a $7.5 billion provider of packaging, primarily for food and beverage industries. Ball has been growing through acquisitions and has been consolidating plants. As part of this plant consolidation effort, Ball has the goal of improving their plant utilization by 25%. Ball chose in their process to implement our enterprise asset management product to enable them to make these operational efficiencies and permit them to reduce their future capital requirements. Two very successful module type upgrades and we’re seeing many of these in our customer base today. Thank you Karl.

[Karl F. Lopker:]

Okay. Pam just talked about the Regional User Conferences, but as many software company vendors have done we’ll be replacing our annual live Global User Conference with a virtual conference held over the web. We’re actually excited about the opportunity this is going to give us to touch many more customers than we have in the past. Well, overall the business climate for manufacturing is tough and as a result we’ve seen our business fall along with our customers. Although we’re not quite as affected due to our maintenance revenue stream, we are working to make sure this source of revenue is solid and customers continue to realize the value they have been receiving. We’re also focused on maintaining our financial health as the economy finishes its cycle and shows improvement. Well, that finishes our prepared report for the quarter. Operator, can you give the instructions for questions?

[Operator:]

Certainly. (Operator Instructions) Your first question comes from Mark Schappel - The Benchmark Company.

[Mark Schappel:]

Karl, in the past you’ve stated that on-demand revenue is becoming or you’re seeing it become a larger part of your sales funnel and I guess my first question is was there any meaningful on-demand revenue in the quarter?

[Pamela M. Lopker:]

Can I?

[Karl F. Lopker:]

Yes, go ahead Pam.

[Pamela M. Lopker:]

Last quarter I think we got four new sales of on-demand and we are definitely seeing that funnel increasing, not just from new business but from existing customers. Actually one of the deals was from an existing customer in the home building area that decided to go to on-demand instead of on premise because of their need to reduce operating costs quite a bit. And we actually are seeing many deals in our on-demand funnel now and I think it’s this economic time is giving them the impetus to change from their internal premise to on-demand application.

[Mark Schappel:]

The on-demand deals that you did receive, were they for those supply chain visualization product or were they for the core manufacturing –

[Pamela M. Lopker:]

I’m sorry. All four of those were for the core [subtle] ERP. We also did have supply visualization sales as well, but I don’t know those numbers off the top of my head. But you’re asking for total ERP so that’s what I –

[Mark Schappel:]

Okay. Thank you. And Karl if I heard you correctly during your prepared remarks, it was either you or Daniel mentioned that automotive was about a third of total sales in the quarter, and this would be a normal percent – if this is so, this would be a normal percentage for the sector. That would appear that the downturn you saw was pretty broad-based across all your sectors. Is that a – am I capturing this correctly?

[Karl F. Lopker:]

[Inaudible] no, usually automotive is about a third of our total revenue, you know, year-in and year-out [inaudible] it had been increasing. No, in the fourth quarter it was down quite a bit relative to the other verticals. Life sciences was up relative to the other verticals. And no, but automotive definitely was down in the fourth quarter.

[Mark Schappel:]

Do you have the percentage of sales handy?

[Karl F. Lopker:]

We do.

[Daniel Lender:]

I don’t have the percentage of overall sales, Mark, we actually – probably the biggest decline in from a revenue perspective in automotive actually were around the ongoing services projects that we had with our customers. On the licensing side we did see a decline to about 26, 27% of that license revenue where we saw an increase in life sciences by a couple of percentage points.

[Operator:]

Your next question comes from [Jason Nelson – Rommel Asset Management].

[Jason Nelson:]

Just wanted to touch on the new cost structure that you guys have in place now. Any revenue run rate you could discuss that would kind of target a 10% operating margin? In looking at the quarterly release I know some of the severance is still in the sales and marketing and R&D numbers. Any details you could provide in those lines as well would be appreciated.

[Daniel Lender:]

There’s no specific total revenue number because a lot of our – a good portion of the profitability for a company is based on the gross margin provided by the different revenue lines, so it really depends on revenue mix. And you know from our comments on our gross margin that most of the changes to the gross margin were relating to the mix in revenue. So from a revenue perspective it really depends on where that revenue is coming from, whether it was licenses or services, etc. From an overall perspective, as we mentioned, the actions that we took we expect to gain approximately $14 million or so of savings on an annualized basis. Also from a personnel perspective, you know, roughly 10% of our costs on a personnel side are what I would call variable costs. They’re depending on the company’s ability to achieve revenue and margin costs. So in addition to that, we do have some amount of natural adjustment that happens if revenue targets are not met or if revenue targets and profit targets are exceeded and those costs automatically go up as well.

[Jason Nelson:]

So the $14 million of expected cost savings, can you just for my edification – I mean, I know this was disclosed in December as well, I believe, where exactly is that coming from? Because, you know, I kind of have a rough picture of even – I personally can’t imagine things turning up in the next year or so too much and you guys obviously have to have some internal targets where you’re hoping to at least maybe get to a 10% operating margin business, so if you could just help me on the cost side with where the $14 is coming from then maybe I can back into where you guys need to be to get to say a 10% operating margin business.

[Daniel Lender:]

The main areas where one was on the service side in order to align our services costs to the different level of services revenue. And then the – there was really no impact on the support side as our maintenance business which is a pretty stable business, it drives that piece. And then there were costs below the gross margin line on all three areas such as marketing, R&D and G&A where at this point in time we’re not providing any further breakdown of that.

[Jason Nelson:]

Is this a competitive reason why you’re not looking to do so? I’m just curious.

[Daniel Lender:]

Yes.

[Operator:]

Your next question comes from Jason Nelson – Rommel Asset Management.

[Jason Nelson:]

On the maintenance line, I know you guys indicated that you’re still seeing greater than 90% renewal rate. I think in the past either in discussions maybe with Jim or [Mel] you’ve indicated this has been somewhere around a 95% number. You still seeing declines in – I’m just curious, as the quarter progressed was there a material decline in renewal rate that you can talk about?

[Daniel Lender:]

We have not so far seen declines in our renewal rates. Our renewal rates have as we’ve said they’ve held from our past historical numbers. The one area as we mentioned where we have seen – there’s some, in certain cases, in some elongation of the negotiation cycle around certain of our customers which, you know, of course brings some additional risk to those particular contracts.

[Jason Nelson:]

So how successful have you guys been at passing along price increases? I know that was going to be a goal I guess several quarters back for the year, and I’m sure in this economic environment that’s easier said than done. If you are experiencing low 90’s renewals and you had $1.5 million of currency against you in the quarter versus last year, then you must be having some success there. Am I incorrect in this assumption?

[Daniel Lender:]

No, I mean, we are having some success there. I mean we’re clearly – we work with our customers and there’s differences between the structure of the contracts that are being renewed. But as we said earlier, we’ve been typically renewing either at previous prices or higher.

[Jason Nelson:]

And just to be clear it was $1.5 million against you in currency for this quarter, correct? In maintenance?

[Daniel Lender:]

Right.

[Operator:]

There are no further questions. Please continue.

[Karl F. Lopker:]

Okay. Well let me summarize what you’ve heard today. While we are well aware of the economic conditions, we’re taking the actions required to maintain our financial health and we’re looking for ways to benefit our customers as they work through the crisis. Thank you for your attendance. We’ll give you another update in May with the results of our first quarter of FY ’10. Good-bye.

[Pamela M. Lopker:]

Thank you.

[Operator:]

Ladies and gentlemen this conference will be made available for replay after 4