QAD Inc.
Q3 2015 Earnings Call Transcript

Published: 26 Nov 2014

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the QAD Fiscal 2015 Third Quarter Financial Results Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions) As a reminder, this call is being recorded. I would now like to turn the conference over to our host, Mr. John Neale from QAD. 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 2015 third quarter ended October 31, 2014. 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 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 disclosing non-GAAP net income and non-GAAP earnings per diluted share which are non-GAAP financial measures as defined by the 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’d 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 third quarter results. Pam Lopker, President; and Daniel Lender, Chief Financial Officer, join me on the call. But before I begin, I’d like to thank our investors, employees and customers for an amazing 35 years in business. During that time, we’ve witnessed major changes in technology, the rise of the multinational corporation and the ups and downs of the economic cycle. We have been able to weather all these changes and indeed find ourselves in the best shape ever to capitalize on the next wave of changes to come. For the third quarter, we’re again happy to report total revenue above our guidance, with cloud subscription revenue growing about 50% year-over-year. We also saw growth in licenses, maintenance and services and these were our best third quarter and year-to-date revenue performances ever. And combined with good expense control, our operating income was solid. Daniel will give you the numbers and I’ll discuss the details. Daniel?

[Daniel Lender:]

Thank you, Karl. We generated record quarterly revenue for the third quarter with especially strong growth in our cloud offering, as reflected in the subscription revenue line. Professional services revenue hit a third quarter record, while our licensed business grew nicely from last year even with our increased focus and success in the cloud. Comparing to the same quarter last year, total revenue increased 13% to 74 million, up from 65.7 million. License revenue grew 27% to 8.6 million, up from 6.8 million. During the third quarter we closed five license deals greater than 300,000 compared with six in last year’s third quarter. Subscription revenue was up 51% to 7.7 million compared with 5.1 million last year, primarily related to the ongoing growth of our cloud offering. We benefited from two large customer conversions and user growth within our existing customers. These conversions typically provide three to four times the annual maintenance revenue and annual recurring subscription revenue upon conversion. Maintenance and other revenue were 35 million compared with 35.6 million last year. On a constant currency basis and not including other revenue, maintenance grew approximately 100,000 over the prior year period. There was a negative currency impact of 400,000 on maintenance revenue and no other revenue in this year’s third quarter compared with 400,000 in last year’s third quarter. This solid performance of our maintenance line is worth highlighting as it is negatively impacted by conversions to the cloud such as the one I mentioned earlier. Professional services rose 25% to 22.6 million, up from 18.2 million last year. The improvement is consistent with our license and subscription revenue growth. Currency had an 800,000 adverse impact on total revenue during the 2015 third quarter and a 600,000 favorable impact on cost of revenue on total operating expenses. Overall, currency had a negative impact of 200,000 to income from operations. Looking at total revenue by vertical, high tech and industrial represented 32%, automotive 31%, consumer products and food and beverage 21% and life sciences 16%. And by geography, North America was 43%, EMEA 34%, Asia-Pacific 17% and Latin America 6%. Gross profit grew 11% to 40.9 million versus 36.8 million for the same quarter last year. As a percentage of revenue, gross margin was 55% compared with 56% for the same period last year. Sales and marketing expenses totaled 16.4 million or 22% of revenue versus 15.2 million or 23% of revenue for last year’s third quarter. The dollar increase was primarily related to increased salaries due to additional headcount, higher commissions and bonuses, some related to cloud sales and increased travel. As our cloud business continues to grow, commissions and variable compensation expense in current periods will also increase. As a reminder, our policy is to expense commissions in the period when a sale occurs. So, when the cloud sales are booked, we incur the expense with other related revenue in the period. R&D expense for the third quarter was 10.2 million or 14% of revenue compared with 9.8 million or 15% of revenue for the same quarter last year. For last year’s third quarter, R&D expense was unusually low as 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 administration expense was 8.3 million or 11% of revenue versus 7.8 million or 12% of revenue for last year’s third quarter. The increase was primarily driven by personnel expense. Total operating expenses in the quarter were 35 million or 47% of revenue compared with 33 million or 50% of revenue last year. You can see the leverage in our model as the revenue growth outpaced cost increases. Equity compensation expense was 1.2 million for both fiscal 2015 and 2014 third quarters. Operating income improved substantially to 5.9 million, up from 3.8 million from last year’s third fiscal quarter. Other income was negligible for this year’s third quarter compared with other expense of 372,000 last year. The change related to the impact of foreign exchange. Net income totaled 5.1 million or $0.31 per diluted Class A share and $0.27 per diluted Class B share. Net income for last year’s third quarter was 2 million or $0.13 per diluted Class A share and $0.11 per diluted Class B share. Our tax rate for the third quarter of fiscal 2015 was 14%. As we discussed on our last earnings call, we expected the third quarter tax rate to be substantially lower than the run rate as a result of the release of a FIN 48 provision for uncertain tax positions resulting from the expiration of open years in certain territories. We expect a tax rate of approximately 27% for the fiscal 2015 full year. This quarter we’re introducing non-GAAP net income and non-GAAP earnings per diluted share. QAD uses non-GAAP measures internally in evaluating and measuring our business results. We believe that the disclosure of these non-GAAP measures will provide additional insight to investors in evaluating our ongoing operations and comparing them with other companies in our industry. These measures should not be used in isolation or in substitution of the information prepared in accordance with GAAP. We have provided a table in our press release reconciling the GAAP to non-GAAP financial measures. Non-GAAP net income, which we define as net income excluding stock-based compensation, amortization of purchase intangible assets, gain and loss adjustments on the Company’s interest rate swaps and certain income tax adjustments, totaled 6.6 million or $0.40 per diluted Class A share and $0.34 per diluted Class B share. For last year’s third fiscal quarter, non-GAAP net income was 3.6 million or $0.23 per diluted Class A share and $0.19 per diluted Class B share. For the year-to-date period, cash flow provided by operations was 5 million compared with 11.6 million for the same period last year. The current year-to-date period was primarily impacted by the change in deferred revenues. I will now briefly review our year-to-date results. Revenue rose to a nine-month record of 215.5 million, up 12% from 192.8 million for the first nine months of fiscal 2014. Gross profit increased 11% to 117.8 million or 55% of revenue versus 106.5 million or 55% of revenue for the same period last year. Total operating expenses amounted to 109.6 million or 51% of revenue compared with 102.9 million or 53% of revenue for the first nine months of fiscal '14. Foreign exchange had a negligible impact on a year-to-date basis. Net income grew to 6 million or $0.37 per diluted Class A share and $0.31 per diluted Class B share. Net income for the first nine months of fiscal '14 was 2 million or $0.13 per diluted Class A share and $0.11 per diluted Class B share. Non-GAAP net income totaled 10.4 million or $0.64 per diluted Class A share and $0.54 per diluted Class B share for the fiscal 2015 year-to-date period compared with 6.2 million or $0.39 per diluted Class A share and $0.33 per diluted Class B share for the same period in fiscal 2014. Moving on to the balance sheet. We ended the October quarter with cash and equivalents of 71.4 million compared with 76 million at the end of fiscal '14 and 65.8 million at the end of the third quarter last year. Accounts receivable equaled 46.4 million, down from 71.3 million at the end of fiscal '14 related to the customary seasonal decline, but up slightly from 44.5 million at the end of the third quarter of last year. Days sales outstanding using the countback method was 58 days for the third quarter of fiscal 2015 compared with 57 days last year. The quality of our receivables remains healthy. Our deferred revenue balance at the end of October was 72.7 million, which was comprised of 57.7 million of deferred maintenance, 9.6 million of deferred subscriptions, 2 million of deferred license and 3.4 million of deferred professional services. Other liabilities included 2.5 million in long-term deferred subscription revenue related to a multiple year cloud deal that we closed last quarter. While we normally bill subscription revenue on a quarterly basis, this specific deal was billed and paid upfront for the full multiple year period. Our deferred revenue balance at the end of last October was 78.9 million and 104.2 million at the end of fiscal 2014. Our business outlook for fiscal '15 calls for total revenue of approximately 291 million and EPS of $0.58 per diluted Class A share and $0.49 per diluted Class B share. We also expect non-GAAP earnings per diluted share of $0.92 per Class A share and $0.78 per Class B share. And that concludes my remarks, Karl. Back to you.

[Karl Lopker:]

Okay. Well, thanks, Daniel. As we mentioned, we did quite a bit better than expected in the third quarter in all revenue lines. Our services increase of 25% was largely driven by implementation and upgrades, as in the recent past. We’ll continue to grow services with total revenue. This helps ensure a high maintenance renewal rate and future new user growth. We also like the fact that licenses and maintenance continue to steady during our transition to a greater portion of business in the cloud. But the most exciting area for QAD is still the increase in cloud subscription. This has been a major focus for QAD and we can see the results. We’ve continued to bring in cloud subscriptions growth in our target 40% to 50% range and we’ve booked seven new sites this quarter for cloud apps. Our total funnel is up over 20% from last year at this time, with cloud apps representing around one third of the opportunity, up from 25% last year. The increase in cloud funnel apps, or cloud apps funnel, is mainly driven by a few larger global deals which have longer sales cycles and are more difficult to predict, rather than a large number of smaller opportunities. Indeed, the solid increase in cloud subscriptions in the third quarter was driven by a few larger deals in the second quarter. The majority of our funnel for cloud apps remains to be for conversions from on-premise. Conversions generally produce cloud subscription revenue faster than new accounts since existing customers usually cut over to the cloud at a faster pace than new customers. Although conversions do affect maintenance revenue, we’ve been able to keep maintenance at historical levels due to higher license revenue and a solid renewal rate. Our revenue mix by region was in line with historical average, and our automotive vertical performed somewhat better than other verticals. Full time employee headcount of 16 to 20 was up around 7% from last year mostly due to increases in the cloud operations group, North American services and global sale. Now I’ll turn over the call to Pam for a closer look at the QAD productivity.

[Pam Lopker:]

Thank you, Karl. We had seven new customers in Q3. I want to mention a couple new wins to give you some color on who is going to the cloud. So on ERP deal, first of all, we had an existing on-premise customer and a leading manufacturer of kayaks, canoes and related accessories. They were at a point that their computer infrastructure was becoming a risk and it was time to upgrade. The cloud made a lot of sense as they could focus their existing IT people on business processes around implementing new functionality. The second customer was a new logo for QAD, a manufacturer of tools and imaging solutions for applications in minimally invasive [neo] (ph) surgery. They selected QAD due to the breadth and depth of our life science knowledge and experience and a large number of life science companies that are already FDA validated and satisfied cloud users with QAD. We also had a very nice cloud win coming from our precision division for transportation and logistics tracking for a very large software company in their consumer electronics division. There we will be happy to handle their return and replacement items. In addition, we closed a pilot from our CEBOS division for quality management in the cloud. It was to one of our very large automotive suppliers who is an on-premise customer. This is an important milestone for us as when we acquired CEBOS two years ago, they lacked the cloud offering. So this is a great win where we have a large on-premise customer that is now starting to use our cloud capability for certain point solutions. I also wanted to mention we had a very busy quarter with user group meetings going on around the globe. I personally attended several of them. To start with, I was in China where we had an executive conference geared at CFOs and the benefit for the cloud. I then went to the UK where we had an executive conference at the Weston Park, which is a beautiful estate on 1,000 acres originally built in the 17th century. We had over 100 customers attending that conference. Then I continued back to the U.S. and lastly we hosted the West Coast User conference in our Santa Barbara headquarters. We also had well over 100 attendees there with a [indiscernible] on the life science companies from Southern California. So incredible leading edge products from these customers. One of the customers in attendance was Second Sight Medical Products who developed a product that allows the blind to see. They had a very successful public offering last week. Congratulations to them. Thanks, Karl.

[Karl Lopker:]

Okay, Pam. As you can see, we’re excited about the prospects for QAD cloud apps and our goal is to continue to grow subscription revenue 40% to 50% while maintaining profitability. We are keeping an eye on the global manufacturing economy, which is showing some areas of weakness as measured by the country's Purchasing Managers' Indices. The U.S. is still performing well. But with flat growth in some of the other major economies and the strength of the dollar against major currencies, we’re keeping a watch on what’s happening in the Eurozone, China and Japan. As usual, now we’ll take questions. Operator, can you give the instructions?

[Operator:]

Thank you. (Operator Instructions) For our first question, we'll go to the line of Mark Schappel with Benchmark. Please go ahead.

[Mark Schappel:]

Karl, starting with you, with respect to the upcoming fiscal Q4, which is typically a big power quarter, in your view is it shaping up to be kind of a normal user loser quarter towards fiscal year end?

[Karl Lopker:]

I got a little bit of Internet interference there. Is it shaping up to become a normal what?

[Mark Schappel:]

Kind of a user loser quarter with respect to IT spending in general? I am looking for fiscal Q4 seasonality and is this shaping up to be kind of a normal quarter or do you see some hesitation there still from your buying customers?

[Karl Lopker:]

I'm thinking it's going to be a fairly normal quarter. I don't see any really major changes. Most of our revenue comes from the U.S. and the U.S. economy is actually doing pretty well.

[Mark Schappel:]

And then probably moving over to [indiscernible] again here. I mean it looked like a very good quarter with the exception that your cash flow from operations seemed much lower than I would have expected to correlate this. Maybe just review once again why cash flow for operations was all challenged this quarter?

[Daniel Lender:]

On an operating basis, actually I believe the quarter itself was a little bit better than last year. On a nine-month basis, what we have here is really the effect of the change in the deferred revenue. So basically last year we had a lot more deferred put into the books this year that's more of that revenue has been released and that really is the change between the two years.

[Mark Schappel:]

And then Karl back to you, with respect to your cloud manufacturing apps, could you just talk a little bit about -- or maybe Pam, this is more of a question for you. But just talk a little about some of the functionality we can expect or at least your customers can expect and maybe some upcoming releases in the next six to nine months?

[Pam Lopker:]

For our cloud operations?

[Mark Schappel:]

Yes, certainly your cloud products.

[Pam Lopker:]

We continue to release basically the same capability in the cloud as we do on-premise. One of the areas that I talked about in all the user conference that we attended, we're moving from a .NET user interface to HTML5 user interface and we're really modernizing the whole look and feel of our product and we will start to release that in the -- to early adopters in the March timeframe of next year that will likely do everything. All of our user interface moves in the past, it will be -- you can run it concurrently with .NET. So you won't have to take the risk of just moving to a whole new user interface. It will be rolled out in a concurrent manner so you can access the HTML5 or you can access the .NET. And that gives us really great capabilities as we move to supporting all of our application on mobile and on cell phones and tablets, because from the HTML5 user interface, we can easily move to every screen to a mobile device without having to maintain different technologies. Other than that, we will have kind of standard capabilities coming out in all of our manufacturing and finance and sales areas. There is always new functionality everywhere. Certainly CEBOS with their move to a cloud product was actually a total rewrite of their product which started a few years ago and has a much greater capability. One of the areas that we are seeing a lot of interest in the cloud for is a whole idea of purchase requisition handled over the Internet to suppliers allowing them to post bids for different product requirements and organize those and handle them all over the Internet. So that's getting a lot of interest and we like it because it's a complete cloud offering.

[Operator:]

Thank you. And next we will go to the line of [Paul Orfalea] (ph). Please go ahead.

[Unidentified Analyst:]

I want to compliment you both and all of you are doing a great job. I am a happy shareholder. But I have four questions. I didn't understand the cash flow answer about deferred revenue. It seems to me if you have less deferred revenue, your cash balances would go up, not down. The second question, are you continuing to buy back shares and are you thinking of increasing the dividend? And when I look at insider transactions, it seems like once the stock is at $22, $23 or about $330 million market cap, there seems to be a significant -- not a significant, there seems to be some insider selling. So those are my four questions.

[Daniel Lender:]

So on the cash flow, the deferred revenue affects the net cash provided by operating activities. So as the is more deferred revenue on the balance sheet, that's typically what's happening is that's not being reflected as income yet. Cash is in, but in terms of how the cash flow statement reads, as deferred revenue goes down that gets recognized as revenue but it's not bringing in any of the cash. Relating to…

[Unidentified Analyst:]

I don't get it. So if the increase -- if there is an increase in deferred revenue, that would mean the cash balances would go up, not down. I'm really confused on that subject.

[Daniel Lender:]

So our deferred revenue in the number of the categories decreased in 2014 and it increased in 2013. So therefore we had a higher cash provided by operations in 2013 versus 2014. The second question regarding buybacks, we have a -- on a regular basis, we evaluate our different options in terms of capital allocations. We have done them in the past and we don’t have any plans approved at the moment. And regarding the insider transactions, I think from time-to-time insiders buy or sell stock for their own personal reasons and there’s really not a lot I could...

[Unidentified Analyst:]

But it seems like every time the stock is at $22 or $23, there seems to be more coming out of the woodwork.

[Daniel Lender:]

Well we have a fairly broad...

[Unidentified Analyst:]

Magic price or something?

[Daniel Lender:]

Yes, and the other piece that maybe I think you are probably looking at Paul is related to RSU investing. So that probably is the increased activity. If you look at it carefully, you’ll probably see that actually, most of the activity.

[Unidentified Analyst:]

What is the RSU?

[Daniel Lender:]

Those are stock -- similar to stock option.

[Pam Lopker:]

And they have to pay taxes on them when they sell. So they have to sell [indiscernible].

[Unidentified Analyst:]

But it seems like they always can exercise when the stock is at a new high. It's just cursory, looks like that.

[Daniel Lender:]

Paul, it might have been a coincidence on that. And obviously, without any specific more details, I’m not looking specifically at the transactions right now, so I can’t. But I'd be happy...

[Unidentified Analyst:]

Look it back up on -- Google insider trading. What about...

[Daniel Lender:]

Listen Paul, I will be happy to have a call with you after. I really don’t want to take a lot more...

[Unidentified Analyst:]

I agree, I just wanted to know. Last one is the dividend increase.

[Daniel Lender:]

So we increased dividends some time ago. And again, it is something that we evaluate on a regular basis.

[Unidentified Analyst:]

What is regular? Is that like once a year?

[Daniel Lender:]

It gets evaluated on a quarterly basis at our Board meetings.

[Operator:]

(Operator Instructions) And we do have a question from the line of David [indiscernible]. Please go ahead.

[Unidentified Analyst:]

Wondered if you could just give us an update on the S-3 filed in September and any updates on that?

[Daniel Lender:]

So, the only update that’s actually out there that it became effective and we have it in place. And when the Company or if and when the Company decides to do something with it, at that point in time we’ll make the appropriate announcement.

[Operator:]

(Operator Instructions) And at this time there are no further questions. I’ll turn the call back to Mr. Karl Lopker.

[Karl Lopker:]

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

[Operator:]

Ladies and gentlemen, this conference will be available for replay after 04