QAD Inc.
Q2 2016 Earnings Call Transcript

Published: 26 Aug 2015

[Operator:]

Ladies and gentlemen thank you for standing by and welcome to QAD Fiscal 2016 Second Quarter Financial Results Call. At this time all 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’ll now turn the conference over to Senior Vice President of Finance and Treasurer, John Neale. Please go ahead sir.

[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 fiscal 2016 second quarter ended July 31, 2015. The press release and associated financial statements are available through the Investor Relation 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 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 SEC Regulation G. Reconciliations of those non-GAAP financial measures to the most directly comparable GAAP measures are included in today’s press release which is posted on the company’s website. Now I would like to turn the call over to Karl Lopker, QAD’s Chief Executive Officer.

[Karl Lopker:]

Well good afternoon and thank you for joining us to discuss our second quarter results. Pam Lopker, President; and Daniel Lender, Chief Financial Officer, join me on the call. For the second quarter, we were able to exceed our guidance for revenue and earnings by focusing on our strategy of growth in cloud applications. However, currency continues to muddy our results when looked at on a year-to-year basis. Daniel will give you the numbers and I'll discuss the details, Daniel.

[Daniel Lender:]

Well thank you, Karl. Total revenue came in above our guidance at $71.3 million versus $73.1 million last year. On a constant currency basis total revenue grew 5%. Currency had a $5.6 million adverse impact on total revenue offset by a $4.4 million positive impact to expenses resulting in an overall $1.2 million negative impact on operating income. Despite this we improved operating income by almost 13% from last year. Subscription revenue improved 42% to $9.1 million, which were slightly above our guidance compared with $6.4 million last year as our cloud offering continues to grow. On a constant currency basis subscription revenue growth year-over-year was 46%. Foreign currency had a negative impact of approximately $200,000 to subscription revenue. You will recall that the first quarter included a one-time recognition of approximately $900,000 related to a Latin American implementation where we had previously deferred revenue adversely impacting our sequential comparisons. Excluding this one-time recognition subscription revenue would have grown about 7% sequentially. License revenue was $8.6 million compared to $9 million last year. On a constant currency basis license revenue would have been approximately 4% higher than the prior year quarter. The negative impact from foreign currency was approximately $700,000. During the fiscal 2016 second quarter we closed eight license deals greater than $300,000 including five greater than $500,000 compared with five license deals greater than $300,000 including two greater than $500,000 last year. Maintenance and other revenue totaled $33.8 million compared with $36.1 million a year ago. On a constant currency basis maintenance revenue grew 1%. Foreign currency translation adversely affected maintenance revenue by approximately $2.8 million versus the prior year. Professional services revenue was $19.8 million versus $21.5 million last year. The decrease is all related to foreign currency impact. Moving to total revenue by vertical, high tech and industrial represented 34%, automotive 33%, consumer products and food and beverage 20% and life sciences 13%. And by geography, North America represented 45%, EMEA 31%, Asia-Pacific 17% and Latin America 7%. Gross profit for the fiscal 2016 second quarter was $38.7 million or 54% of total revenue compared with $39.8 million or 55% of total revenue for the fiscal 2015 second quarter. Sales and marketing expenses were $17 million versus $17.4 million for last year’s second quarter or 24% of total revenue for both periods. Higher personnel in part due to increased head count and higher costs associated with QAD Explore 2015 were offset by favorable exchange rate impact of $1.2 million. R&D expense for the 2016 second quarter was $10.6 million compared with $10.9 million or 15% of total revenue for both periods and currency had a favorable impact of $600,000. General and administrative expense was $8.6 million or 12% of total revenue versus $9.3 million or 13% of total revenue for last year’s second quarter. Currency had a favorable impact of approximately $400,000 compared to the prior year. The prior year quarter also included higher professional fees related to our secondary offering which we completed earlier this year. Total operating expenses were $36.3 million or 51% of revenue, compared with $37.8 million or 52% of revenue last year. Total operating expenses benefited $2.1 million from currency fluctuations. Equity compensation expense was $2.4 million for the fiscal 2016 second quarter, versus $1.7 million for the prior year. The increase related to higher stock price for the current year grants. Operating income improved to $2.3 million, up from $2.1 million from the last year’s second fiscal quarter. Other income was $310,000 for the second quarter compared with $58,000 of expense last year. The increase primarily resulted from the change in fair value of the interest rate swaps associated with the mortgage of our corporate headquarters and a government incentive funding received by one of our subsidiaries. This brings net income to $1.6 million or $0.09 per diluted Class A share and $0.07 per diluted Class B share, compared with about $1 million or $0.06 per diluted Class A share and $0.05 per diluted Class B share last year. This improvement in EPS includes a 20% increase in the number of weighted average A shares outstanding. Our tax rate for the second quarter of fiscal 2016 was 38%. We now anticipate a tax rate of approximately 30% for fiscal 2016. Non-GAAP net income which is described in greater detail in the press release we issued earlier today was $3.6 million or $0.19 per diluted class A share and $0.16 per diluted Class B share. For last year's second quarter non-GAAP net income was $2.6 million or $0.16 per diluted Class A share and $0.13 per diluted Class B share. Please note again the increase in share count. I would like now to provide a brief review of the year-to-date results. Total revenue was $140.6 million compared with $141.5 million for the six months of fiscal 2015. In constant currency, total revenue grew by 7%. Gross margin was 54% of total revenue for both periods. Subscription margin increased to 45% of subscription revenue from 37% as we are beginning to achieve economies of scale, a greater proportion of customers are maturing past the service intense stage of moving to cloud as well as efficiencies we are building in our cloud operation centers. While we expect to see continued improvement in subscription margin over the long-term we do expect to see some volatility in this percentage as step up investments may be required as this business grows. Total operating expenses amounted to $72.7 million versus $74.5 million last year. As a percent of revenue total operating expenses were 52% of total revenue in both periods. Net income grew to $2.2 million or $0.12 per diluted Class A share and $0.10 per diluted Class B share. This compared with the about $900,000 or $0.06 per diluted Class A share and $0.05 per diluted Class B share. And non-GAAP net income was $5.2 million or $0.28 per class A share and $0.23 per Class B share versus $3.5 million or $0.21 per Class A and $0.18 per Class B. Onto our balance sheet, we ended the quarter with cash and equivalents of $130.1 million, up from $120.5 million at January 31. Accounts receivable equaled $46 million or $50.1 million in constant currency compared with $52.7 million last year. Day sales outstanding using the count back method was 55 days for the second quarter of fiscal 2016 compared with 58 days a year ago. The quality of our receivables remains healthy. Our deferred revenue balance at July 31 was $82.5 million including $66.5 million of deferred maintenance, $12.1 million of deferred subscription, $1.3 million of deferred license and $2.6 million of deferred professional services. Our deferred revenue balance was $88.8 million at this time last year, including [$2.6] [ph] million of deferred maintenance, $9.7 million of deferred subscriptions, $2.7 million of deferred license and $3.8 million of deferred professional services. On a constant currency basis, deferred revenue would have been $89.2 million compared with $88.8 million last year. Of this $6.7 million total adverse impact of foreign currency, $5.7 million related to deferred maintenance. As a reminder typically our maintenance contracts are billed annually and subscription contracts are billed quarterly. Cash flow provided by operations was $9.2 million for the 2016 fiscal year-to-date period, compared with $5.5 million for the same period last year. The increase related to higher collections. Today, we're providing third quarter guidance on a regular rating [ph] our full year guidance. Our business outlook for the third quarter of fiscal '16 includes total revenue of approximately $72 million and subscription revenue of approximately $9.5 million. We anticipate GAAP earnings of $0.13 per diluted Class A share and $0.11 per diluted Class B share and non-GAAP earnings per diluted share of approximately $0.21 for Class A and $0.18 for Class B. As a reminder, in calculating the tax effect included in our non-GAAP business outlook we've adopted the use of a long-term planning rate of 25% in order to better provide consistency across interim reporting periods by eliminating the effect of non-recurring and period specific items. For the full year we expect our revenue of approximately $295 million including approximately $38 million of subscription revenue. GAAP earnings per share of approximately $0.49 per diluted and Class A share and $0.41 per diluted Class B shares and non-GAAP earnings per share of approximately $0.84 per diluted Class A share and $0.70 per diluted Class B share. Stock compensation expense is expected to be $7.6 million for the full year. With that I'll turn things back to you Karl.

[Karl Lopker:]

Okay, thanks Daniel. License revenue was slightly above last year's quarter after taking to account the strength of the U.S. dollar and it was led by automotive where we have a significant presence in larger multinationals who traditionally prefer to run their own data centers rather than move to the cloud. However we are seeing interest in moving to the cloud as these multinationals upgrade their systems. Cloud application bookings continue to grow, composed largely of conversions from on-premise. We added 15 new cloud sites in the quarter, half from life sciences companies. We believe that the strong cloud bookings from life sciences companies in the quarter was largely due to our qualified environment, where we feel we have a competitive advantage. Our qualified environment allows life sciences companies to get up and running in the cloud more quickly than competing cloud applications. And life sciences customers have the freedom to control the timing of upgrades and manage their re-validation processes. One interesting development in the quarter is that we are starting to real interest in the cloud coming from Asia and Europe who have been hesitant in the past. We believe we are well positioned to take advantage of this trend due to our strategy of focusing on multinational manufacturing companies. In fact close to 50% of our cloud sites are already currently from outside the U.S. To compete on the international stage software company must not only provide a robust financial package, but also must be able to satisfy local requirements, a promise that only a couple of our competitors can offer. The drop in maintenance revenue was due almost exclusively to the strength of the dollar with some effect from previous cloud conversions. Renewal rates are consistent with past experience. Our services revenue decreased from the previous second quarter due to currency. Our focus in services is to support our customer in getting up and running quickly and to convert to the cloud. We expect to grow our services revenue only as fast as we need to in order to accomplish this strategy. Our total sales funnel is even with last year at this time with cloud apps representing around 50% of the opportunity. The majority of our funnel for cloud apps is still for conversion from on-premise. Our revenue mix by region was inline with historical averages and overall automotive was our best performing vertical due to the strength of the automotive economy and the desire to upgrade and expand systems after a long period of low investment. I also want to mention that two of our divisions, precision and transportation management and CBOs [ph] and quality manager performed particularly well in the first half of this year and our DynaSys closed their first cloud deal. We now have cloud customers in all three of these divisions. We find that many companies are more willing to commit to point solutions rather than complete ERP replacements or upgrades. Full time employee head count was 1,640 and up about 4% from last year mostly due to increases in our cloud operations group. So let me turn the call over to Pam for a closer look at our QAD cloud activity.

[Pamela Lopker:]

Great, thanks, Karl. As Karl mentioned, we had 15 new cloud wins in Q2, seven conversions and eight new customers, with seven of those in life science. Here is some color. In the U.S. we had a division of a large global pharmaceutical companies that provides a broad spectrum of contract services to support quality pharmaceutical formulation development, analytical testing services and commercial and clinical trial manufacturing. Also in the U.S. we had a small medical device company that makes products, including endoscopic suturing and gastric banding systems. And as Karl mentioned cloud is catching on, on the global basis. This quarter we saw four conversions from the Asia-Pacific region including one from Singapore, Japan, New Zealand and India. So a pick every country. These companies represented CPG and life science verticals in the areas of food cosmetics and health products. Back to your Karl.

[Karl Lopker:]

Okay, thanks Pam. The global manufacturing economy continues to grow, as defined by the global purchasing managers index. Growth in the U.S. has slowed somewhat, but the Eurozone seems to be picking up. China is a concern due to negative growth. Overall the environment looks positive for QAD to continue to keep up the pace we’ve seen in the past, although currency will continue to create difficult year-over-year comparisons during this fiscal year. As usual, now we’ll take questions. Operator, can you give the instructions please?

[Operator:]

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

[Bhavan Suri:]

Hey guys. Can you hear me okay?

[Karl Lopker:]

Yes Bhavan, thanks.

[Bhavan Suri:]

Hey thanks for taking my calls -- questions, nice job on the subscription growth and on the win, Pam. I guess just to touch on that a little bit I know you provided some color but you had a pretty big win in the life sciences healthcare space last quarter. Any update on how that’s rolling out, so one division, sort of are there expansion plans there, is it too early to think about other divisions, how is that going given sort of the strength you saw again in the second quarter in that vertical?

[Pamela Lopker:]

Bhavan, I was wondering that, the same thing myself. I need to research that. I have heard it’s going well. I think it is early days but I did want to ping those sales reps and says hey when is the next one going to come. But I think as you mentioned it is a little bit early but so far so good and I do expect that we will see more from that company.

[Bhavan Suri:]

Okay, and then it’s been an interesting mix sometimes you got sort of stronger new wins but for a few quarters now you had sort of some volatility between the conversion mix and the win mix. When you look at that sort of on a longer-term basis you have alluded to a 50-50 kind of ratio. Is that trend still true or is it leaning more towards existing customers converting?

[Pamela Lopker:]

No, I think it’s still 50-50. What’s good about the existing customers converting is they tend to be larger deals because you get them all at one time whereas the new customer, particularly a multi divisional company will tend to do one division and then the next and then the next. So you get a smaller new customer and then you get more new users quarter after quarter. So they are both good. We like them both. You would think and in some ways it would be easier to convert our existing on-premise customers to the cloud but it maintains in that 50-50 ratio.

[Bhavan Suri:]

And then in the back to the pharma life sciences healthcare space, you guys do the core manufacturing stuff but when you look at sort of CRM, would you end up seeing sort of the leader there and is there any risk if they move into the supply chain side of the house at all specifically maybe Viva or even IMS Health?

[Pamela Lopker:]

Certainly you do see the sales force tied CRM areas, you do see Microsoft, sometimes for CRM. We actually do have our own embedded CRM product maybe not as strong as some of the standalone ones and I would say maybe a third of the customers pick our own embedded CRM. So, so far I think there has been Salesforce manufacturing products, a couple of them I can think of on the force platform but we really have never seen them in a deal either one of them. So that’s possible, I just don’t see that, oh gosh I have - we don’t say, oh we have Salesforce CRM so we should look at HR for from the Salesforce platform, you would look at maybe Workday but there is no -- I don’t see the advantage of sticking to a single platform like that.

[Bhavan Suri:]

No, yeah. And then two more quick ones; one, you touched on Workday, given sort of they are starting to see a little bit more traction in the financial space, are you starting [indiscernible] with them anymore or is it still sort of very, very sort of sporadic situations?

[Pamela Lopker:]

We have never seen them selling standalone finance. So I would think that their better market would be in the service area where people don’t need it to be integrated with purchasing and supply chain and manufacturing. I can’t see that today that a company would go after an un-integrated ERP product.

[Bhavan Suri:]

And then one quick one for Daniel and then I will hop back into queue. On the gross margins I mean Daniel those have ticked up nicely even on the cloud business. Last quarter was -- the first quarter was an anomaly partially but sort of you see those pick up I think probably a little ahead of our expectation certainly, given we had expected a slightly slow ramp to those margins picking up nicely overtime but certainly not as quickly and then you obviously said there might be more investment. Just give us a little color there on how we should think about the year for that business just so we understand sort of the investment versus sort of the scale that you guys are starting to achieve there?

[Daniel Lender:]

Yeah sure. In terms of the year going forward, I don't expect that the cost are going to necessarily outpace growth in revenue. However, as we get closer towards the end of the year we may potentially step up some hiring or open up maybe an additional data center or two that could increase those costs. So I think it should be fairly steady for the remainder of this year.

[Bhavan Suri:]

Hey great. Thanks for taking my questions guys.

[Daniel Lender:]

Sure, thanks.

[Operator:]

Thank you. Our next question is from Brad Reback with Stifel. Please go ahead.

[Brad Reback:]

Great, thanks very much. Karl, can you maybe talk to your comment around the sales pipeline being flat year-over-year. I think this is the first time in five quarters that it has been up sort of 15% to 20%.

[Karl Lopker:]

Yeah, what happened last year we were getting a lot of the very large deals into the funnel and we haven't seen that many of the very large deals that we put in. What we are seeing is more shorter term deals that are smaller. So that's good. We do obviously look very closely at that because we would like to see to growing at least 10% a year. But it doesn't concern us when we look at the mix inside of there. There is also some currency effects in there, so we're getting less dollars for some of the international deals than we were getting before.

[Brad Reback:]

Great, thanks very much.

[Operator:]

Thank you. We'll go next to Richard Davis with Canaccord. Please go ahead.

[Richard Davis:]

Hey thanks. Two quick questions. So one, are there industry verticals that you would consider entering that are adjacent to kind of your cornerstone efforts in manufacturing and MedTech. And then how do you think about that process if that were to happen kind of organic versus M&A. And I have a follow up.

[Pamela Lopker:]

I guess that would be maybe me. So we are doing a lot of work of moving more towards the MES layer. So not necessarily an adjacent vertical but in an area that we haven't been before. So we have just come out with a new what we called automation system that does a lot of the barcoding hookup to device IP addresses and things. And we will be -- we will continue to push more in that direction so we can really do from the shop floor to the top [indiscernible] that people use. So in that area there could be at some point room for an acquisition, although it's a very, very disjointed market with a huge number of very small players.

[Richard Davis:]

Got it. And speaking of barcoding, I was thinking about this. So I've been here long enough to remember RFID how kind of spooked some ERP firms because they're worried about data ingestion. So we've kind of fast forward whatever 15 years now we have kind of this Internet of Things sensors. Now you and I both realize that, I don't know, 99% of these companies are on the drawing board in terms of ingestion. But will your software be able to handle that data flow if and when IoT kicks off.

[Pamela Lopker:]

Well certainly that's the whole part of the shop floor too is that you end up getting tons of data from every machine, typically quality type data, the actual dimensions of a pole -- hole, how that was punched and you are storing tons and tons of data. So we've already been working on that and integrating some other database technologies that are good at big data. So I do think that's a part of it might be things that we will finally see RFID starting to catch on now that they're much cheaper. I think it was the expense of the actual tag that was holding people back for years.

[Richard Davis:]

Yeah, fine, great. Super, thank you so much.

[Pamela Lopker:]

Thank you.

[Operator:]

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

[Mark Schappel:]

Hi, good evening. Karl starting with you, could -- given the upside in the quarter, what is that that you're seeing out there that's giving you hesitation about raising your full year outlook? Is it mostly a currency issue?

[Karl Lopker:]

It's definitely somewhat of a currency issue. But the choppiness of the market is something we really have to watch. Most of our indicators are good, but this last week has -- it's been a little scary. We do noticed that some capital investments going up and we know that automotive is getting a little bit stronger but I am a little concerned that some of the buyers are just going to freeze up. I know that happened back in 2009 so they could freeze up and that could just delay things for a while. Manufacturing companies are really risk adverse. So I think we’re definitely taking a cautious attitude.

[Daniel Lender:]

Mark, if I can add to that, this is Daniel. We basically, in last quarter we went above our forecast and that mainly came on the license side. So I mean we’re looking at that -- those deals would have come in later in the year we were able to close them faster. So it’s more of a timing thing, our overall view of the year is therefore the same.

[Mark Schappel:]

Okay great. And then one final question Karl I was wondering if you just clarify your comments around your business in China, if I recall correctly you guys have a development center over there and probably have a good read of what’s going on?

[Karl Lopker:]

Well we have a good business in China, we have about 400 sites over there and just because of the recent activity we are doing, our business review we took a look at China and our China business is actually well ahead of budget for the year. So they are doing pretty well. Of course we do kind of expect a slowdown maybe even in automotive but they are still doing pretty well and we do have a number of people there that are actually getting a little cheaper because of the one but not that much cheaper.

[Mark Schappel:]

Thank you.

[Operator:]

Thank you. And we have no further questions Mr. Lopker do you have any closing remarks.

[Karl Lopker:]

Let’s wait a second and see if there is any other questions. Okay well thanks for your attendance and questions and we’ll update you again in November with our third quarter results. Good bye everyone.

[Pamela Lopker:]

Thank you, bye-bye.

[Operator:]

Thank you. And ladies and gentlemen this conference will be available for replay after 3