QAD Inc.
Q3 2014 Earnings Call Transcript

Published: 27 Nov 2013

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the QAD Fiscal 2014 Third 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 your host, John Neale. Please go ahead.

[John Neale:]

Hello, everybody, and welcome to today's call. I'm John Neale, QAD's Senior Vice President and Treasurer. Earlier today, we issued a press release announcing QAD's financial results for the fiscal 2014 third quarter ended October 31, 2013. The press release and associated financial statements are available through the Investor Relations section on our website at qad.com. Additionally, please be advised that this call is being webcast live on our website. Before I begin, I need to ensure that everybody on today's 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. 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 third quarter results. Pam Lopker, President; and Daniel Lender, Chief Financial Officer, join me on the call. We had a solid quarter in our core business, and our On Demand business continues to grow. In fact, subscription revenue was up 34% over the previous year quarter. On Demand is still a small part of our business, but it's growing steadily and, certainly, On Demand is a fast-growing trend in ERP. Services bookings were again strong due to upgrades and On Demand conversions and rollouts. So Daniel will give you the numbers, and I'll discuss the details.

[Daniel Lender:]

Thank you, Karl. Total revenue grew to $65.7 million for the third quarter of fiscal 2014, up 6% from $61.7 million a year ago. CEBOS, which we acquired fiscal 2013, contributed $700,000 to the top line. Foreign currency had a $300,000 negative impact on revenue. License revenue was $6.8 million, compared with $7 million last year. From license deals above $100,000, approximately $3 million in license orders was deferred and not recognized during the third fiscal quarter for accounting purposes, but we did recognized approximately $1.7 million of prior license deferrals. This quarter, deferrals were primarily due to lack of VSOE of fair value for those multi-element deals or when expected services work was still being negotiated. We expect to recognize some of this revenue starting next quarter and the rest over the next year. This quarter, we closed 6 license deals with greater than $300,000, compared with 5 last year. Maintenance and other revenue rose to $35.6 million, up from $34.8 million last year. The majority of the increase related to the timing of one customer's renewal, where support had been provided in prior period but the renewal documentation was not received until this quarter, as well as additional revenue recognized from our acquisitions of CEBOS and DynaSys. Professional services revenue grew 13% to $18.2 million from $16.1 million last year. Due to the nature of large, multi-element transactions, services revenue and margins tend to fluctuate from quarter-to-quarter due to the effect of ratable recognition and the achievement of milestones, while costs related to these engagements are expensed as incurred. As a result, we expect to continue to experience some variations in our services margin on a quarterly basis. Subscription revenue, which includes QAD On Demand, grew 34% to $5.1 million, up from $3.8 million last year. On Demand bookings remained strong for the quarter, with the majority coming from North America, which is consistent with historical patterns. Looking at total revenue by vertical, high tech and industrial represented 35%; automotive, 27%; consumer products and food and beverage, 23%; and life sciences, 15%. By geography, North America, 44%; EMEA, 33%; Asia Pacific, 17%; and Latin America, 6%. Gross profit grew to $36.8 million or 56% of revenue for the third quarter of fiscal '14, compared with $35.2 million or 57% of revenue for the same quarter last year. Sales and marketing expenses were $15.2 million versus $14.7 million during the third quarter of last year. The increase primarily reflected sales commissions, including commissions for orders where revenue was deferred and On Demand orders where revenue will not be recognized until future periods, and $300,000 of costs related to the CEBOS that were not in last year's third quarter. As a percentage of revenue, sales and marketing expense totaled 23% and 24%, respectively, for the third quarter of fiscal 2014 and 2013. R&D expense for the fiscal 2014 third quarter was $9.8 million or 15% of revenue, compared with $9.7 million or 16% of revenue for the same quarter last year. R&D expense in the current third fiscal quarter included $50,000 of joint development income versus $400,000 for the same quarter last year. CEBOS added $400,000 to this expense category during fiscal '14 third quarter. In addition, during the most recent third quarter, we realized a $600,000 benefit related to receiving an exemption that allowed us to reverse business and value-added taxes we had accrued over prior periods. General and administrative expense was $7.8 million versus $7.6 million last year. As a percent of revenue, G&A expense was 12% for both quarters. This brings total operating expenses to $33 million or 50% of revenue for the fiscal 2014 third quarter versus $32.1 million or 52% of revenue for the same period 1 year ago. Total expense related to CEBOS was $1.1 million for the third quarter of fiscal '14. Equity compensation expense totaled $1.2 million for the third quarter of fiscal '14 versus $1.1 million a year ago. Operating income increased to $3.8 million, up from $3.1 million for last year's third fiscal quarter. Net income grew to $2 million, or $0.13 per diluted Class A share and $0.11 per diluted Class B share, from $1.8 million, or $0.12 per diluted Class A share and $0.10 per diluted Class B share, last year. Our tax rate for the third quarter fiscal '14 was 40%. For the full year, we expect a tax rate of approximately 42%. For the first 9 months of fiscal '14, cash provided by operations increased to $11.6 million from $10.7 million. Now I would like to briefly review additional year-to-date results. Revenue rose to $192.8 million, up from $186.4 million for the first 9 months of fiscal '13. The acquisitions of CEBOS and DynaSys contributed $6.4 million in revenue for the FY '14 year-to-date period versus $2 million last year. Gross margin was 55% of revenue versus 57% of revenue for the first 9 months of fiscal 2013. Total operating expenses were $102.9 million or 53% of revenue, compared with $97.6 million or 52% of revenue for the same period last year. The acquisitions contributed $8.3 million to total expenses, compared with $2.6 million last year. Net income totaled $2 million, or $0.13 per diluted Class A share and $0.11 per diluted Class B share, for the first 9 months of fiscal 2014. For the same period last year, net income was $4.6 million, or $0.29 per diluted Class A share and $0.25 per diluted Class B share. Moving on to the balance sheet. We ended the fiscal 2014 third quarter with cash and equivalents of $65.8 million compared with $65 million at the end of fiscal 2013 and $69.7 million at the end of last year's third quarter. Accounts receivable equaled $44.5 million, down from $72.6 million at the end of fiscal 2013 and up from $40.3 million at the end of last year's third quarter. DSO, using our countback method, was 57 days for the third quarter of fiscal 2014 versus 52 days for the third quarter of fiscal 2013. The quality of our receivables remains good. Our deferred revenue balance was $78.9 million, comprised of $61.8 million of deferred maintenance, $6.1 million of deferred subscription, $7.2 million of deferred license and $3.8 million of deferred professional services. Our deferred revenue balance was $71 million and $101.2 million at the end of last year's third quarter and at the end of fiscal 2013, respectively. Our business outlook for the fiscal '14 fourth quarter calls for total revenue of approximately $69 million and earnings of approximately $0.16 per diluted Class A share and $0.13 per diluted Class B share. That concludes my remarks. I'll turn the call back to you, Karl.

[Karl F. Lopker:]

Okay, thanks, Daniel. Licenses, maintenance, services and subscription revenue came in roughly on target. And On Demand bookings continue to come in not quite as strong as last quarter, but still meeting our goals. One difference in our On Demand bookings for the quarter was that most of the activity was in new divisions of existing customers as opposed to our usual 50% in conversions from On Premise customers. Since new customers in new divisions usually do not commit upfront to all the users they'll eventually need, there remains significant opportunity for additional users in the future. The funnel for On Demand continues to be around 25% of our total funnel. However, the total funnel is down around 5% from last year, reflecting the choppy first half of the year for most businesses. We do expect that the funnel will increase as the U.S., China and, recently, the Eurozone are showing a positive PMI, as reported by market economics. In the services area, upgrades continue to be the fastest-growing part of the business. This is important because most On Demand conversions also include an upgrade. And if the customer doesn't decide to move to On Demand, an upgrade usually indicates a renewed commitment to our QAD solutions for the foreseeable future. Regional and vertical results were generally in line with the recent history, and full-time employee headcount was flat from last year at 1,540, reflecting our constant control on cost. Now I'll turn the call over to Pam for a closer look at our On Demand activity.

[Pamela M. Lopker:]

Sure, Karl. Today, I want to give a bit of color to the types of deals we are seeing for On Demand. I'm going to give you 3 examples of deals that closed in Q3, and I think this is a good representation of the opportunities that we won. So first of all, we had a new U.S.-based startup company in the med device area building a product for heart rhythm disorder. Last quarter, I mentioned a large U.K. plastics packaging company purchasing for their initial first site for an 11-site global rollout. This quarter, they purchased for an additional site. The third customer is a large Japanese Tier 1 automotive supplier in the safety area. After several On Demand implementations in Asia Pacific, they now move to the Americas, with this quarter bringing a deal for Brazil. As you can see that we continue to get new deals, but we also get significant revenue from rollouts of deals that we previously sold. I've also like to mention our China user conference that took place in Kunming, China, earlier this month. The user conference was in the southwestern city of Kunming and had 220 attendees, and some highlights were we announced the rollout of our new On Demand center in Suzhou, which is outside of Shanghai. This On Demand center will be used for the local Chinese market. There was a great presentation that I particularly enjoyed by Paul Allen [ph] of Linear. They're a manufacturer of home and commercial entry access control devices. Their successful rollout of OD was actually a surprise and a delight to both him and their corporate entity as, to date, they've had no system outages. So that was just a great presentation to show how well On Demand can work in the Asia Pacific area. We also provide 20 track sessions, with the highest attendance in the On Demand and in the CEBOS Quality Management sessions. I'd also like to mention a few things about our product. We had an enterprise release for EE 2013.1 this September, and some of the highlights, we released 20 standard dashboards for different roles in the company. A role could be an accounts payable clerk versus a marketing manager versus a manufacturing manager, and we've pre-populated these dashboards with KPIs and drill-downs right to the source records. That's really enjoyed by our customers. They love having that dashboard right at their fingertips and be able to drill down to the detail. We also released collections, a set of collections, also -- for 20, the 20 standard roles. So a collection could be all the screens, all the menu items needed for an accounts payable clerk or a sales order CSR, or it could also be a production manager. Whatever it might be, there's 20 standard roles in our software, and we released collections for all of those. We also announced early adopter availability for our new trade commercial management, and that works to track all your promotions and rebates and integrates into finance, and also for our serialization and lot tracking, which is used by all verticals but is a major foundation for our ePedigree capability in life science. We also released support for a few more countries for our localization requirements in the base module, and now our countries total 47 that we handle in standard product, and we'll shortly be heading to 53 that are ready to be released. Thanks, Karl. Back to you.

[Karl F. Lopker:]

Okay. Well, thanks, Pam. We're excited about the prospects for On Demand, and we see activity picking up from increased attention on this segment in the press. Our challenge is still to balance revenue and profitability during the transition to On Demand. On the balance sheet, cash continues to look good, which is important as our growth in On Demand continues to accelerate. Now as usual, we'll take questions from the analysts. Operator, can you give the instructions?

[Operator:]

[Operator Instructions] Your first question comes from the line of Mark Schappel from Benchmark.

[Mark W. Schappel:]

Karl, I had just a question for you on the deferred license orders. I was wondering if there's anything that the company is doing, particularly in the sales force, process-wise or procedural-wise to just improve the close rates there so that the license deals don't get deferred at the end of the quarter?

[Karl F. Lopker:]

I'll let Daniel actually take that question because it's multi-dimensional.

[Daniel Lender:]

Yes. Sure, Mark. I mean, I think our philosophy has always been to bring in a good commercial deal into the company. And if the revenue recognition doesn't necessarily follow, we're willing to live with that. I think that, over time, as the deals get -- as we do -- with bigger deals in multi-element transactions and so forth, we've -- we just ended up with -- in the last few quarters, we've ended up with more deferrals. The flip side of that, as I mentioned during my speech, is that this quarter, we did get to recognize -- even though we did defer $3 million, we did get to recognize about $1.7 million of deals that had been prior -- that had prior deferrals. So we do get a little bit more of a smooth effect to the license deals.

[Mark W. Schappel:]

And Daniel, while I have you on the phone here, cash flow from operations. I think you gave it for the total year-to-date. Do you have it for the quarter?

[Daniel Lender:]

Yes, so cash flow from operations for the quarter was negative of about -- hold on a second. So for the quarter, our cash flow from -- used by operations was about $1.5 million.

[Mark W. Schappel:]

$1.5 million, great. And then maybe turn this one over to Pam. I was just wondering what the -- excuse me, the On Demand count was this quarter with respect to On Demand deals?

[Pamela M. Lopker:]

Boy, I don't have that in front of me. Total deals or new customers?

[Mark W. Schappel:]

Yes, actually, I mean, both would be helpful. I think we're just looking for trends here. I mean, are we above where we were last year at this time, flat?

[Pamela M. Lopker:]

Certainly -- in revenue, certainly, above. I think on new-new deals, there were 3 new deals. The total deals must be -- do we have an answer there?

[Unknown Executive:]

Total customer?

[Pamela M. Lopker:]

Total On Demand deals for the quarter. Must have been 20 or 30, but I'm just guessing. Let's see what -- it was in the 20, 30 range.

[Operator:]

Your next question comes from the line of Joe del Callar from Cowen and Company.

[Joe del Callar:]

Joe for Peter here. Congrats on the quarter and specifically on the On Demand business. So just a follow-on to Mark's question. How should we think about the revenue trajectory of the model going forward for On Demand as we saw acceleration, obviously, in the year-over-year growth this quarter, and obviously a strong quarter, but is this just a preview of what we can expect going forward? And if these were license deals, how many -- how much in license did these deals displace?

[Daniel Lender:]

Joe, this is Daniel. Yes, so -- I mean, if you actually look at our On Demand business, so far, this year has been strong, in particular, compared to last year. So we've had good growth in our bookings, which has held positive momentum throughout the year. You are seeing, as you point out, the effect on the subscription revenue, as the deals that we have done earlier on in the year are starting to add to that line. Looking ahead, obviously, we are doing everything we can from -- in terms of our -- the execution of our strategy to continue that trend. And from a growth standpoint in the company, we'd like to continue to see the growth be driven by that revenue line. In terms of the comparison for -- to licenses, it was close to the $2 million range. But it's always hard to compare because, a lot of times, when you do licenses, customers will buy more users upfront than they would do on an On Demand deal.

[Karl F. Lopker:]

Yes. It also demands upon our mix of conversions versus new customers in new divisions. Conversions are conversions from just maintenance revenue into On Demand revenue, which is almost immediate. So we get a good bump there. But there was no license revenue usually attached to that. If we do a new customer, yes, they don't buy all of the licenses -- or they don't buy all the seats upfront. They usually buy maybe anywhere between 20% and 50% of the seats upfront to get started on their implementation. So it's tough to tell because we don't know exactly what the mix is going to be every quarter.

[Daniel Lender:]

Yes.

[Joe del Callar:]

And so switching gears a little bit. So you have -- you now apparently had -- obviously, had a good conference in China. So some of what we're hearing just sort of around the macro is that the developing countries are slowing down a little bit. Is that a characteristic that you're seeing? Or are you immune from it so far?

[Karl F. Lopker:]

Well, let me talk first because I was also at our partner conference in Budapest, and they had a slow first 3 quarters of the year, but everybody was extremely positive about the last quarter and moving forward. So I would say that they're feeling a lot better about it. We haven't seen necessarily the revenue kick from that, but they're feeling a lot better about it. How did you feel about the customers from China, Pam?

[Pamela M. Lopker:]

Yes, I saw a lot of enthusiasm from China. I think the attendance was slightly down. We might have had 220 people instead of, like, 260 or something the last year, but we're also quite a ways away. So it was a good flight for anybody going. There's not too many people living in the Kunming area. But definitely, a lot of excitement, a lot of people looking to buy, very -- so I can't -- I don't feel -- nobody was saying, "Our business is down, we can't invest." There was none of that. But certainly, it's hard to tell with China how much of their growth is manipulated and...

[Karl F. Lopker:]

Yes. But also, the people that go to our China user conference are usually customers with some money to spend, or they have projects going on. When we talk about the Teamwork conference of our partners in Budapest, those people are -- come no matter what, if the economy is up or down, so I think it might actually be a little bit better indication.

[Pamela M. Lopker:]

What we do with our China user conference, always, we have it in a 5-star-type hotel, but we always make sure that there's like a Chinese working person hotel right by, and a lot of our Chinese customers stay in those kind of hotels as not to -- as to cut costs on the travel and expense.

[Operator:]

Your next question comes from the line of Matthew Paul from Sidoti & Company.

[Matthew Paul:]

Could you provide some color on the health of employment growth within your customer base and if it's generated any sizable growth to your existing licenses?

[Karl F. Lopker:]

Well, I can tell you, in the automotive area, there really hasn't been any growth in employees. In fact, in most of the -- our businesses, except maybe life sciences, they're trying to keep employee growth down because everybody still remembers the recession area. So -- no, because we sell named users, yes, employee growth is very important to us, but that's not really happening right now.

[Matthew Paul:]

Okay. And second question, could you give -- I know you reviewed some from your Asian conferences, but could you give a quick high-level review of -- on any feedback you have from international customers regarding the On Demand option versus license? Maybe we could talk, more specifically, about Europe or Latin America?

[Karl F. Lopker:]

Yes. Well, mostly On Demand is interesting to the North American customers, many of which have sites all over the world. About 50% of our users are actually not located within the United States, although many of them are purchased within the United States. We're seeing second best area is Asia Pacific, especially Japan. So we're talking to a lot of Japanese multinationals who want to have a standardized system outside of Japan and that maybe already have us installed in 2 or 3 sites and they want to expand that to 20, 30, 50 sites. So that's really good business for us. Australia, also, is pretty accepting of On Demand. China is getting there, so they're still a little bit leery, especially after this NSA thing. It really spooked a lot of people. So they're a little leery about having a U.S. company -- having their data stored on a U.S. company machine. But it's not having as bad an effect as I actually would have worried about. Europe is the kind of the last one, they're kind of laggards in the On Demand area for us. We're really trying to pump that up, but getting them to On Demand has been more difficult than the other areas of the world.

[Matthew Paul:]

And you're confident that in 2014, maybe 2015, international growth -- or acceptance, rather, will drive your SaaS business?

[Karl F. Lopker:]

Definitely international needs to kick in. When Europe starts to kick in, that will be very big. And one of the things that we have is our new financials. Well, they're not that new. They've been out for like 5, 6 years. But they were designed and built for European companies for the IFRS requirement. So we're getting a lot of upgrades in Europe. We're just not getting as much On Demand business as we would like to see. But once that kicks in, I think it'll be definitely a driver of our On Demand revenue.

[Operator:]

And at this and, there are no further questions.

[Karl F. Lopker:]

Okay. Well, thanks for your attendance and your questions, and we will update you again in March with our fourth quarter and full year results. Bye for now.

[Pamela M. Lopker:]

Thank you.

[Operator:]

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