QAD Inc.
Q4 2016 Earnings Call Transcript

Published: 11 Mar 2016

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the QAD Fiscal 2016 Fourth Quarter Financial Results Call. At this time, all participants are in a listen-only mode, Later there will be an opportunity for question. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Kara Bellamy, Chief Accounting Officer. Please go ahead.

[Kara Bellamy:]

Hello, everybody, and welcome to today’s call. Before I begin, I need to ensure that everybody on the call understands that our discussion might contain forward-looking statements that are based on certain expectations and analyses. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. QAD 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. Please also note that during this call, we'll be discussing non-GAAP net income and non-GAAP earnings per diluted share, which are non-GAAP financial measures as defined by SEC Regulation G. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures are included in today’s press release, which is posted on the company’s website. Now I would like to turn the call over to Karl Lopker, QAD’s Chief Executive Officer.

[Karl Lopker:]

Well, good afternoon and thank you for joining us to discuss our fourth quarter results. Pam Lopker, President; and Daniel Lender, Chief Financial Officer, join me on the call. While we finished our fiscal 2016 year with a strong performance in our cloud business, closing 24 new deals in the fourth quarter across all regions and all product lines, we've now grown our user count in the cloud from last year by almost 50% and have made important improvements to our margins. We are well on our way transitioning our business and while this dose represents some short term challenges to the timing of revenue we continue to manage well through the transition and we're maintaining our profitability and our competitive position. Daniel will give you the numbers and I’ll discuss the details.

[Daniel Lender:]

Well thank you, Karl. Our review of first our fourth quarter results followed by a full year results. Total revenue for the fourth quarter was $69.3 million compared to $79.6 million last year and our forecast of $70 million. The variance of forecast is explained by negative impact from currency of $900,000 from last quarter. And in addition, we experienced about $1 million higher than expected license deferrals. At the same time, we surpassed our subscription guidance, improved our subscription margin and met our EPS guidance. Compared to the same quarter last year, currency had a $4.1 million negative impact on total revenue this quarter. On a constant currency basis, total revenue declined 8%, currency also had a $3.1 million positive impact on expenses, which resulted in an overall $800,000 negative impact to net income. On a constant currency basis, subscription revenue of $10.6 million grew approximately 37% versus prior year. Foreign currency had an approximate $200,000 negative impact on subscription revenue. Recurring revenue, which we define us subscription revenue and maintenance revenue now makes up approximately 52% of total revenue. We continue to make excellent progress in QAD’s cloud operations where subscription margins improved by three percentage points on a sequential basis and 14 percentage points compared with last year. We plan and continue to improve our margins over time, but we do anticipate fluctuations as we make investments in this area in order to support our growth. License revenue was $8.1 million versus $15.7 million last year. Foreign currency had a negative impact of approximately $600,000. As mentioned a higher level of deferrals impacted license revenue for the quarter. During the fourth quarter we closed five license deals greater than $300,000 with non-greater than $1 million compared with nine last year including five greater than a million. Maintenance and other revenue totaled $32.4 million compared with $34.1 million last year. Foreign currency had a negative impact of $1.8 million. On a performance basis, maintenance revenue increased 1%. Professional services revenue was $18.2 million versus $20.9 million last year. Foreign currency had a negative impact of $1.4 million. Professional service performed as expected. It is important to note that we're making additional investments related to growing several QAD offering such as our cloud EDI, automated solutions and the services groups that our support our divisional product. In particular see both in DynaSys. Total revenue by vertical for the quarter was high-tech and industrial 35%, automotive 31%, consumer product and food beverage 19% and life sciences 15% and by geography North America 46%, EMEA 30%, Asia Pacific 17% and Latin America 7%. Gross profit for the fiscal 2016 fourth quarter was $38.4 million or 55% of total revenue versus $45.7 million or 57% of total revenue last year. Sales and marketing expense was $16.9 million compared with $19.5 million or 24% of total revenue for both periods. Currency had a $900,000 favorable impact. The decline resulted from lower commissions and bonuses due to lower license revenue. R&D expense was $9.8 million or 14% of total revenue for the fourth quarter of '16 compared with $10.1 million or 13% of total revenue for last year's fourth quarter. Currency had a favorable impact of $400,000. On a performance basis, R&D expense was flat quarter-over-quarter. General and administrative expense was $8 million or 12% of total revenue versus $8.2 million or 10% of total revenue last year. Currency had a favorable impact of $200,000. On a performance basis, G&A expense was flat versus last year. Total operating expenses gained to $34.8 million or 50% of total revenue compared with $37.9 million or 47% of total revenue a year ago. Currency had a favorable impact of $1.5 million. Equity compensation expense was $1.8 million for the fiscal 2016 fourth quarter versus $1.2 million from the prior year, the increase mainly related to the rise in stock price over time. This brings operating income to $3.6 million versus $7.7 million for last year’s fourth fiscal quarter. Net income totaled $4.1 million or $0.22 per diluted Class A share and $0.18 per diluted Class B share compared with $6.9 million or $0.42 per Class A share, $0.36 Class B share last year. Note that the EPS calculation includes an 18% increase in the number of weighted average Class A shares outstanding. Our tax rate for the fourth quarter of fiscal 2016 was negative 8%. This was mainly due to our ability to utilize net operating losses as a result of the liquidation of an inactive entity. For fiscal 2016, sorry for fiscal 2017, we anticipate a tax rate of 34%. Non-GAAP net income, which is described in greater detail in the press release issued earlier today, was $5.9 million or $0.31 per diluted Class A share and $0.26 per diluted Class B share. For last year's fourth quarter, non-GAAP net income was $8.5 million or $0.51 per diluted Class A share and $0.45 per diluted Class B share. Let me now move on to our full year results. Total revenue was $280 million compared to $295 million last year. In constant currency, total revenue improved $2.7 million or 1%. Gross margin was 54% of total revenue for fiscal '16 versus 55% for fiscal '15. Total operating expenses amounted to $141 million versus $148 million last year. As a percent of total revenue, operating expenses were 50% for both periods. Net income was $8.9 million or $0.47 per diluted Class A share and $0.40 per diluted Class B share compared with $12.9 million or $0.79 per diluted Class A share and $0.68 per diluted Class B share. Non-GAAP net income was $15.6 million or $0.82 per diluted Class A share and $0.69 per diluted Class B share versus $18.5 million or $1.13 per diluted Class A share and $0.96 per diluted Class B share. Again note the 20% increase in diluted Class A share count. We ended the year with cash and equivalents of $138 million, up from $121 million at the end of last year. Accounts receivable equaled $66 million compared with $79 million at the end of fiscal '15 mainly due to lower fourth quarter billings. As a reminder, we typically built subscriptions one quarter at a time. Day sales outstanding using the count back method was 49 days for the fourth quarter of fiscal '16 compared with 48 days a year ago. The quality of our receivables remains healthy. Our deferred revenue balance at January 31, 2016, was $97.9 million versus $102.7 million last year, which included deferred maintenance of $79.5 million versus $86.4 million, deferred subscription of $14.6 million versus $11.6 million, deferred professional services of $2.3 million versus $2.8 million and deferred licenses of $4.5 million versus $1.9 million. On a constant currency basis, deferred revenues were $101.4 million compared with $102.7 million last year. There was a $3.5 million total adverse impact to deferred revenues from foreign currency of which $2.9 million related to deferred maintenance. Cash flow provided by operations was $23.7 million for both fiscal 2016 and fiscal 2015. For the full fiscal 2017 year, we anticipate total revenue of $279 million to $285 million, including $48 million to $52 million of subscription revenue. We expect subscription revenue to grow approximately 30% on a yearly basis. GAAP earnings per share of approximately $0.30 to $0.38 per diluted Class A share and $0.24 to $0.32 per diluted Class B shares, non-GAAP earnings per share of approximately $0.65 to $0.73 per diluted Class A share and $0.53 to $0.61 per diluted Class B share, stock compensation expense of approximately $7.5 million. Our business outlook for the first quarter fiscal '17 includes total revenue of $64 million to $66 million, including approximately $11 million of subscription revenue. Capital loss per share of $0.08 to $0.06 per diluted Class A share and $0.07 to $0.05 per diluted Class B share. Non-GAAP earnings per share of $0.00 to $0.02 per diluted Class A and B shares and as a reminder in calculating the tax effects including our non-GAAP business outlook, we have adopted a use of long-term planning rate of 25% in order to better provide consistency across reporting periods by renovating the effect of non-recurring and period specific items. Stock compensation expense of approximately $1.7 million. That concludes my remarks for today. Now I’ll turn the call back to you Karl.

[Karl Lopker:]

Okay. Thanks Daniel. While we had an exciting quarter in terms of cloud activity, which did impact our license revenue, we have a focus on increasing cloud subscriptions even at the expense of licenses and maintenance and license activity was also impacted by the typical slowdown in the rate of growth in the manufacturing business. As I mentioned we added 24 new cloud sites in the quarter. Importantly two thirds of our cloud subscription bookings came from new customers and new divisions of existing customers. We expect to receive additional new users from these customers as they use more and more of our cloud offerings. In fact, our largest cloud deal in the quarter was a continued expansion of an existing cloud customer to additional sites and users. Our total sales funnel is up 5% from last year at this time and cloud remains more than 50% of the deals. We are pursuing a number of larger deals over one million in annual contract value, which take time to close. And for new customer deals, the rollout can take months before we recognize significant revenue as subscription. However, half of our cloud deals are convergence from on-premise to cloud which do produce revenue and subscription revenue much faster than new customer deals. Our services revenue has continued to decline due both to currency and the hesitance from customers to take on large upgrades in the midst of a manufacturing slowdown. Fortunately we have flexibility to manage these fluctuations in demand through the use of subcontractors. We’re also continuing to invest in our services practices around Cloud EDI, automation solutions, quality management and supply chain. Maintenance revenue grew in constant currency despite the effect of cloud convergence. Renewal rates are consistent with past experience. However, convergence from on-premise to the cloud are putting more pressure on this revenue line going forward. On a regional basis North America was stronger than usual, which is good since more than half of our business comes from North American base multinationals. In sum, the third quarter automotive was our best performing vertical due to the continued strength of the automotive industry. In fact looking at it by contract value, about two-thirds of our cloud deals came from automotive. Full time employee headcount at 1,650 was up around 2% from last year, spread fairly evenly across regions and corporate and we are still confident in our cloud momentum and have a large number of opportunities ready to close. So now I’ll turn the call over to Pam for a closer look at the cloud activity.

[Pam Lopker:]

Great, thanks, Karl. We had a very busy cloud quarter in Q4. As was mentioned we had 24 cloud wins in Q4, that’s more than double any historical quarter and great momentum bringing the total to 61 new wins for the year. The 24 deals in Q4 account for -- come from -- composed of 16 new customers and eight conversions. Our deals in Q4 represented all of our verticals with considerable strength in auto, which represented six deals and 40% of the contracted value. Life science also continues to be strong in deal count with six in Q4, but are typically smaller customers and smaller revenue so only represented 16% of the contracted value. We also had cloud sales in each of our three divisions, precision for transportation management, synopsis for supply chain planning and CEBOS for quality management. In fact they're really gaining momentum with the divisional sales into the cloud. In addition we saw three EE deals that included subscription for our automation solution product for which I’ll give some color later. As Daniel mentioned, we are continuing to improve our cloud margins. At the same time we've continued to improve our overall SLA and now are above the 99.9% up time. In fact we’ve experienced less than 20 minutes on average of downtime per month, compared to our normal contractual commitment of 99.5%, which allows three hours and 39 minutes downtime per month. Our assistance behind our SLA for up time are quite robust where we monitor 20 different potential points of failure in hardware and application and looking for indication of something that might go wrong so we can investigate and fix well before the time that it does stay off. One large net new auto customer is a leading e-manufacture auto part plant. They are struggling, implementing overall and decided to take another look at alternative. We then followed an in-depth operational review that we were contracted for. We called these operational reviews Q-STAND Assessments of course in QAD everything starts with a Q. During this engagement we visited manufacturing sites in both U.S. and Mexico to review their processes and pain points. We presented our finding, which included solutions to the key operational pain points. Afterwards we presented how the QAD EE Cloud application will meet their requirements. Our robust references and automotive, which included site business to other automotive cloud customers were key in sealing the deal. And in addition to contracting for our full enterprise addition suite, they will also be implementing in our demand planning capabilities and guidance division. I also like to take a moment to mention our Life Science vertical. We've been very successful in attracting many small startup life science companies. Several of them were launched by Alfred E. Mann. Alfred started his career in aerospace and semiconductors. Upon retiring he funded a foundation to launch companies that develop medical devices with a mission to help sublime to see the depth to hear and the paralyze to control their limbs. Alfred died last month at age 90. QAD is proud to have several startups as customers and we're honored to play a role in his mission. I’d like to mention something about our automated solutions offerings. It’s just going to be made general availability this month and has been a big catalyst early adopter to customers. They appreciate the data collection and label printing capabilities that help them streamline their business processes, reduce errors and improve efficiency, but they recognize its benefits are going to be far beyond that. With this well documented APIs automation solutions enables our customers to easily connect with applications like MES and provide a gateway to the internet of things. As customers begin to look at ways to connect machine to machine and collect detailed information about the manufacturing processes, automation solutions becomes a perfect connector to make the transition to internet of things faster, simpler and less costly. I'm also happy to say we had a large truck trailer manufacture go live over the weekend with EE and Automated solutions. So far all is quiet and faces are happy. Finally I’d like to mention that Explore is coming up in Chicago in May and we’re really excited about it. First of all we will unveil what we’ve been doing in the Channel Island project for our new architecture and an industry-leading user experience. We're in the early adopter phase and have done a few sneak previews with other customers and judging from the reactions we’re pretty sure it will be well loved. We will also be featuring automated solutions and what the future looks like as the internet of things evolve. We have some powerful outside speakers including manufacturing features Jim Carol, Cyber Security Expert, Doug White and [Jim Wallack, the leading Guru] [ph] backed by popular demand. And I'm sure that Karl you’ll be attending the conference too, won’t you?

[Karl Lopker:]

I hope so. I'm only keynote speaker list.

[Pam Lopker:]

Okay. Back to you.

[Karl Lopker:]

Thanks Pam. For this coming year we’re anticipating a more difficult economic environment. The last half of last year showed a tightening of spending on elective projects that we expect will continue into 2016. Indeed the Global Purchasing Managers Index is showing a stagnating manufacturing economy although North America and Europe are relatively stronger than the rest of the world. However we expect to continue to keep up the pace in cloud because of the increased interest in our cloud offerings, both for ERP as well as our divisional products. As usual now, I’ll take questions. Operator, can you give the instructions.

[Operator:]

[Operator Instructions] First question comes from the line of Bhavan Suri of William Blair. Please go ahead.

[Bhavan Suri:]

Hey guys. Hey Pam. Hey Karl. Hey Daniel. Can you hear me okay.

[Karl Lopker:]

Yes Bhavan. How are you?

[Bhavan Suri:]

And I apologize for the background noise, as you know obviously, but anyway lets dive in Karl, just touching on your comment about the economic environment maybe a little bit more color there because obviously your subscription numbers are growing nicely. The business is actually performing okay despite the issues in manufacturing and when you got life sciences and automotive offsetting that. How should we think about those two verticals growth versus the core broader manufacturing space for the coming fiscal year, just some color on how those might grow and then could you see some upside especially in the life sciences space that could offset any weakness, just any color would be great to start off with.

[Karl Lopker:]

Okay. Well it’s a complex environment. It's more complex than Europe and North America versus the rest of the world. Automotive is doing well. There is still a lot of mergers and acquisitions going on there and that actually works for us because there is spin offs we can sometimes get some cloud business, we definitely get some new customers that are expanding on their own. So automotive looks pretty good. One of the problems with the industrial side is the price of oil. So most of our larger industrial companies have something to do with oil, they sell seals or valves or something of that nature. So their business is negatively affected. They are usually at zero growth or may be on negative growth. So they're really worried about cutting cost. The automotive people are happy because the price of oil is better. So people are buying more automobiles. So that’s good. Life science seem to be affected either way. So keep growing along pretty well in life sciences and people keep eating food. So that’s been about steady for us.

[Bhavan Suri:]

Got it. And then if I switch a little bit here, when you look at the ROI obviously offered by subscription versus the existing on-premise solutions SAP or Oracle and then obviously the fact that your stuff tends to work faster out of the box apart from limitations. Why in a cost constraint environment, I understand people are risk averse, but in a cost constrain environment, wouldn't that be more appealing especially the shift to paying on subscription basis, which is more aligned with their business as opposed to an upfront cost.

[Pam Lopker:]

We actually think that that’s a really good plus for us and we're starting to see some momentum in that area. Customers that had picked SAP for corporate rollout now looking at these for the next five, 10 years maybe we should look at QAD and the cloud. So that has actually been working quite well for us and I think particularly in automotive where we have very large successful cloud implementations, the fear of having thousands of users in the cloud isn’t such a big deal, because we have good proof points.

[Karl Lopker:]

Yeah, I would say also that there is a difference between the conversions and selling new customers. I’d say most new customers right now are really looking at the cloud. They may go on premise, but I’m seeing most of them go to the cloud. When I look at our conversions from on-premise for our current customers, a lot of times those come along with an upgrade and the upgrade is more what they’re giving some thought to because the cost more take some time out of the people to reorganize. So, I think that’s why we're seeing relatively stronger business coming from new customers than we are from conversions, although conversions are still a good one third of our business now.

[Bhavan Suri:]

All right. Got it. And then one last one for me before I turn it over. Pam at the last user conference Channel Island was talked about a lot and there were some early releases. Obviously that UI and from the iPad capabilities, which SAP and Oracle don’t really provide and interactive functionality not just for sales, but for other modules on the core supply chain. Just some sense of how that rollout and development path is coming along and an update of when we might expect to see some more core functionality released as part of the Channel Island releases?

[Pam Lopker:]

Well we continue to add more functionality to that release. So our primary focus has been on the external phasing world. So sales orders, sales close and now purchase acquisitions, we’re working on purchase orders, the dashboards what we call action centers. So everything that we believe approvals everything that people would normally want to do on the road and we’re continuing that down that road and then we’ll start next year moving on to the more core inside functions like manufacturing and financials. So it is a multiyear rollout at that we’re making good progress on it and it’s hanging together quite well. So we’re happy.

[Bhavan Suri:]

Sure. I guess what I was asking more specifically is was there a piece of that, that will get rolled out from a product cycle capitals perspective of course, some of the upgrade decisions that we made say in the next let’s say six to 12 months or is there still a next year type of feature functionality when you'll see a big step function release in the product?

[Pam Lopker:]

Well that is certainly happening at the early adapters. They had to upgrade and they've committed to do that and so that's been good and I think we are starting to give people more preview speaks of the applications and I do believe that there is a lot of excitement, so that it should drive upgrades and hopefully to the cloud upgrades since we’re only providing it in the cloud at this point. So we’ll see and we have a big nut to keeping our cloud growth over 30%. So we meet everything we can to keep moving that way.

[Bhavan Suri:]

Great. Thanks for taking my questions guys. I appreciate it.

[Pam Lopker:]

Thanks.

[Karl Lopker:]

Thanks Bhavan.

[Operator:]

Okay. Thank you. [Operator Instructions] You've a question from the line of Richard Davis of Canaccord. Please go ahead.

[Richard Davis:]

Okay. Thanks. What extent do you hit your numbers, are you going to hire more sales people and pay right back and then could you talk about the hiring environment? And then the second question is on the development side, analytics is a big thing and I know you have a degree of that, but to what degree do you want to make that a bigger push or more push it harder and things like that, thanks.

[Karl Lopker:]

Well, on the hiring side Richard, we’re going to be fairly cautious. So I don’t think that we’re going to increase our sales rep force just yet, although we do have plans, but we need to see little more positive reactions from the market.

[Richard Davis:]

Got it. And then the analytics side?

[Pam Lopker:]

So on analytics, we actually -- can we mention that now, okay. So on the analytics side our whole focus in on embedded analytics. So I think that the customer base is more interested or we see much more interest in real time embedded analytics than separate BI test type separate database. So that’s been where our focus is and we’re happy with that direction.

[Richard Davis:]

Great. That makes sense. Thank you very much.

[Operator:]

Okay. Thank you. And the next question is from the line of Jeff Captain of Stifel. Please go ahead.

[Jeff Captain:]

Hey guys. Thanks for taking the question. Just a couple of quick ones on the cloud. First Daniel you guys -- just curious, you mentioned it a little bit in your prepared remarks, just curious what you think the cloud subscription might come in next year given the nice expansion you showed this year I think like you said 800 basis points and 400 basis points of expansion a year before that.

[Daniel Lender:]

Yes, so we continue to make good inroads there Jeff and we think we can continue to slowly expand the margin there. I think we’re quite happy with our ability to expand as much as we did last year. As margins should get better and better, it becomes harder to get that next percentage point. So we are aiming to continue to expand next year maybe a couple of percentage points, but it’s going to be on a -- we could see some fluctuations on a quarter-to-quarter basis as I mentioned because of investments that we continue to make in order to support some heavy on-boarding of new customers.

[Jeff Captain:]

Got it. Okay. And then a quick one just on the cloud pipeline, I think you guys mentioned last quarter that it was up 15% over the prior year, just curious what that looks like going into next year?

[Daniel Lender:]

Our total pipeline right now is 5% over where it was last year at this time. So the difference in cloud is a little stronger than it was last year. So I would say it was probably up 7% to 10%.

[Jeff Captain:]

Okay. Great. Thanks a lot guys.

[Karl Lopker:]

Sure. Thanks Jeff.

[Operator:]

Okay. Thank you. And now back to Mr. Lopker.

[Karl Lopker:]

Okay. Well, thanks everyone for your attendance and questions. We’ll update you again in May with our first quarter results. Bye for now.

[Operator:]

Okay. Thank you. And ladies and gentlemen, this conference will be made available for replay after 4’o clock PM today through March 17, 2016, at midnight. You may access AT&T Executive Replay System at any time by dialing 1800-475-6701, entering the access code 383789. International participants dial 320-365-3844 and again that access is 383789. And that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.