QAD Inc.
Q3 2016 Earnings Call Transcript

Published: 24 Nov 2015

Executives:

Kara Bellamy - Chief Accounting Officer Karl Lopker - Chief Executive Officer Pam Lopker - President Daniel Lender - Chief Financial Officer
Analysts:

Bhavan Suri - William Blair Richard Davis - Canaccord Mark Schappel - Benchmark Brad Reback - Stifel
Operator:

Ladies and gentlemen, thank you for standing by. Welcome to the QAD Fiscal 2016 Third Quarter Financial Results Conference Call. At this time, all participants will be in a listen-only or muted mode, and later we’ll conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions]. As a reminder, the conference is being recorded. And I will now turn the conference over to our host, Chief Accounting Officer, Kara Bellamy. Please go ahead.
Kara Bellamy:

Hello, everybody, and welcome to today’s call. 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 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. Now, I would like to turn the call over to Karl Lopker, QAD’s Chief Executive Officer.
Karl Lopker:

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. For the third quarter, we achieved our guidance for earning but not for revenue that’s mostly due to a lower average deal size and lower services. Deal activity and our win/loss statistics were in line with previous experience but we have fewer large deals. However, we were able to reduce expenses, in line with our actual revenue in order to achieve our profitability. And currency negatively affected our revenue compared to last quarter and also when looked out on a year-to-year basis. Daniel will give you the numbers and I will discuss the details. Daniel.
Daniel Lender:

Thank you, Karl. Total revenue was $68 million compared with $74 million last year and to guidance of $72 million. We missed the revenue guidance due to lower than expected license sales and services revenue. However, we met our subscription guidance and remain on track to meet our full year subscription revenue goals. We also met our EPS guidance, since the lower revenue led to lower bonus and commission expenses. And in addition, we preserved our services margins through a subcontractor management. Currency had a $4.9 million negative impact on total revenue this quarter. On a constant currency basis, total revenue declined less than 2%. Currency had a $3.7 million positive impact on expenses, which resulted in an overall $1.2 million negative impact on net income. On a constant currency basis, subscription revenue of $9.7 million grew approximately 30% versus prior year. Foreign currency had an approximate $300,000 negative impact on subscription revenue. On a year-to-date basis our subscription revenue of $28.2 million grew over 40% over the prior year period. We continue to make good progress in our cloud operations where subscription margins improved on a run rate basis by 4 percentage points so far this year. License revenue was $6.4 million compared with $8.6 million last year. Foreign currency had a negative impact of approximately $500,000. While the volume of deals was comparable to the prior year, the number of large deals we were expecting was lower, in particular in the EMEA and Latin America region. During the fiscal 2016 third quarter, we closed no license deals greater than $300,000. This compares with five license deals greater than $300,000 including one greater than $500,000 last year. Maintenance and other revenue totaled $33.4 million compared with $35 million last year. Foreign currency translation adversely affected maintenance revenue by approximately $2.4 million. The maintenance business continued to perform solidly. It is important to note that there was a $400,000 negative impact from foreign currency fluctuations from the prior sequential quarter. Professional services was $18.6 million versus $22.6 million last year. Foreign currency had a negative impact of approximately $1.7 million. Professional services performed lower than expected by approximately $2 million due to several factors. Some of our customers had earlier than expected go-lives that went very smoothly and did not acquire much post go-live services. Delayed starts to projects in the Latin America and the EMEA regions also contributed to the lower revenue. Despite this lower revenue, we were able to produce margins consistent with our historical trends, as we’ve reduced subcontractor views and benefited from the effect of lower incentive compensation. We do not expect our professional services revenue to increase from current run rate in the near-term. Moving next to total revenue by vertical, high-tech and industrial represented 32%; automotive 33%; consumer products and food and beverage 20%; and life sciences 15%. By geography, North America represented 46%; EMEA 30%; Asia-Pacific 17%; and Latin America 7%. Gross profit for the fiscal 2016 third quarter equaled $37 million or 54% of total revenue versus $40.9 million or 55% of total revenue last year. Overall expenses were lower over the prior year period and the prior quarter due in part to lower bonus achievement and commissions as management’s compensation is aligned to the performance of the Company. Sales and marketing expenses were $15.5 million or 23% of total revenue compared with $16.4 million or 22% of total revenue for the third quarter of fiscal 2015. Currency had a $1 million favorable impact. Salaries and travel increases were offset by lower commissions and bonuses. R&D expense was $10.2 million for both 2016 and 2015 third quarters or 15% of total revenue this year compared with 14% of total revenue last year. And currency had a favorable impact of approximately $500,000. General and administrative expense was $7.7 million or 11% of total revenue versus $8.3 million or 11% of total revenue for last year’s third quarter. Currency had a favorable impact of approximately $300,000 and lower bonuses contributed to the remaining decrease. Total operating expenses were $33.6 million or 49% of revenue compared with $35 million or 47% of revenue one year ago. Currency had a favorable impact of $1.7 million. Equity compensation expense was $1.9 million for the fiscal 2016 third quarter versus $1.2 million for the prior year. The increase mainly related to the higher stock price. Operating income totaled $3.5 million versus $5.9 million for last year’s third fiscal quarter. This brings net income to $2.6 million or $0.14 per diluted Class A share and $0.12 per diluted Class B share compared with $5.1 million or $0.31 per Class A share and $0.27 per Class B share last year. Please note that EPS includes a 21% increase in the number of diluted weighted average Class A shares outstanding. Our tax rate for the third quarter of fiscal 2016 was 22% and we anticipate a tax rate of approximately 31% for the full year. Non-GAAP net income, which is described in greater detail in the press release we issued earlier today, was $4.4 million or $0.24 per diluted Class A share and $0.20 per diluted Class B share. For last year’s third quarter, non-GAAP net income was $6.4 million or $0.40 per diluted Class A share and $0.34 per diluted Class B share. Now, I’ll provide a very brief review of our year-to-date results. Total revenue was $208.6 million compared with $215.5 million for the first nine months of fiscal 2015. In constant currency, total revenue grew by 4%. Gross margin was 54% of total revenue for the fiscal 2016 year-to-date period versus 55% for the same period last year. Total operating expenses amounted to $106.3 million versus $109.6 million last year. As a percent of revenue total, operating expenses were 51% for both periods. Net income was $4.8 million or $0.25 per diluted Class A share and $0.21 per diluted Class B share compared with $6 million or $0.37 per diluted Class A share and $0.31 per diluted Class B share. Non-GAAP net income was $9.6 million or $0.51 per diluted Class A share and $0.43 per diluted Class B share versus $9.9 million or $0.61 per diluted Class A share and $0.52 per diluted Class Believe share. Please again note the increase in share count. We ended the quarter with cash and equivalents of $126.6 million, up from a $120.5 million at January 31, and $71.4 million at the same time last year. Accounts receivable equaled $41.2 million compared with $46.4 million in the prior year third quarter. Days sales outstanding using the count back method was 60 days for the third quarter of fiscal 2016 compared with 58 days one year ago. The quality of our receivables remains healthy. Our deferred revenue balance at October 31, 2015 was $69.6 million versus $72.7 million last year, including deferred maintenance of $54.7 million versus $57.7 million, deferred subscription of $12.3 million versus $9.6 million, deferred professional services of $2.1 million versus $3.4 million and deferred licenses of $500,000 versus $2 million. On a constant currency basis, deferred revenues would have been $73.7 million compared with $72.7 million last year. Of the $4.1 million total adverse impact of foreign currency, $3.5 million related to deferred maintenance. As a reminder, our maintenance contracts are typically billed annually while subscription contracts are typically billed quarterly. Our cash flow provided by operations was $9.2 million for the fiscal 2016 year-to-date period compared with $5 million for the same period last year. Our business outlook for fiscal 2016 now reflects lower professional services and an increased effect of the transition to the cloud from the traditional license business and includes total revenue of approximately $279 million including approximately $38 million of subscription revenue; GAAP earnings per share of approximately $0.36 per diluted Class A share and $0.30 per diluted Class B share; non-GAAP earnings per share of approximately $0.68 per Class A share and $0.57 per diluted Class B share; and stock compensation expense is expected to be around $7.6 million. As a reminder, in calculating the tax effect 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 eliminating the effect of non-recurring and period specific items. That concludes my remarks. I’ll turn the call back to Karl.
Karl Lopker:

Thanks Daniel. Our license revenue was impacted this quarter by the cyclical downturn in manufacturing, and geopolitical uncertainty in Europe and Latin America that slowed decisions for a number of our customers. I can tell you though that our cloud activity is extremely high. We have a larger sales funnel than ever, and on a recent trip to Europe we’re seeing much more interesting cloud applications there. Our total sales funnel is up 8% from last year at this time and cloud is more than 50% of the deals. And although we have a large number of deals over 100, the deals over 1 million ACD [ph] take time to pursue and close, especially indicators in some regions are not that strong and there is political uncertainty. Our services activity has slowed down, as we had a number of successfully early go-lives in the quarter and we did not get enough engagements to make up for that void. However, we adjusted our cost to be in line with this level of activity. We are on track to meet our subscription revenue forecast and we’ve worked hard to improve our margin on cloud apps, more improvement is planned to the next year. We had 10 new clouds sites in the quarter, half from industrial companies. The drop in maintenance revenue was due almost exclusively to the strength of the dollar with some of that from previous cloud conversions. Renewal rates are consistent with past experience. And on a constant currency basis, our deferred maintenance is higher than at this time last year. On a regional basis, Asia Pacific was relatively stronger due to activity in Australia and China. Europe and Latin America were a bit weaker. Overall, similar to the second quarter, automotive was our best performing vertical due to the strength of the automotive industry and the desire to upgrade and expand systems after a long period of low investment. Looking forward, we see a number of things that will drive activity, the first is our long standing process of customer engagement where we annually dive into a customer’s business and make recommendations on how they could improve whether through something as simple as user training or showing them to how to use what they already have for large projects such as new modules or upgrades. We’ve been recognized for this customer oriented activity this year in Forbes, Forrester and [indiscernible] articles and have led to significant benefits to many of our customers. We’re also on the rollout phase of our new user experience which has been very well received by our customers. And cloud activity is picking up with Europe getting more and more interesting. Overall, we’re not deterred by our third quarter results, although we do need to watch the expense line until we convert our sales funnel. Full time employee headcount is up at 1,670, about 1% higher than last year, mostly due to increases in our cloud operations and services groups. Now, I’ll turn the call over to Pam for a closer look at our cloud activity and our new user experience. Pam?
Pam Lopker:

Thanks Karl. I am glad to say that cloud growth is going per plan. We had two new cloud -- 10 new cloud customers in Q3 of which three were conversions from on premise. It’s interesting to note that our cloud customers in Q3 were mainly industrial companies which in general are having a tough time in this economics. While it’s premature to say perhaps the variable cost of cloud is appealing in different difficult economic times, at least two customers have mentioned that to me in the last month. This quarter, I will give you some color one of our division’s recent cloud wins, but first let me highlight QAD, Inc. itself as a cloud customer. QAD, Inc. recently finished their conversion to QAD Cloud. Unfortunately they didn’t pay us any revenue for that but we still like them as a customer, with our last country Brazil rolling into the cloud in Q3. QAD, Inc. is now running in a single database for all 20 countries where we have entities. I believe QAD’s ERP is the only cloud and most likely the only on-premise software product that can support all countries worldwide in a stable environment including the very difficult local Brazilian requirements. Supporting local requirements on a global basis in a single base line is a huge accomplishment by our R&D team over the last few years and is also very important in our cloud offering for our international companies. QAD, Inc. also upgraded to the current financial release this weekend. For the last few years, our customers have been able to upgrade the financial modules independently of the rest for the court system. As part of our Channel Island release, we are providing the capability to upgrade the module areas of sale, manufacturing, supply chain, finance and base independent of each other. This is a big advantage where its’ having to do all assumptions at the same time, particularly for large multinational companies that are in the single data base environment. It’s great to have QAD, Inc. as a QAD cloud customer, we particularly like try our new capabilities in-house. Now on to CEBOS. So, our CEBOS division who provides quality management solution that we sell, both to traditional QAD customers and companies outside our customer base and verticals. One of our wins last quarters was a French arm of the U.S. life sciences company. We engaged with the customer in mid of the quarter as they were in urgent need of a solution for document and training management in order to meet regulatory compliance issues. QAD’s cloud quality management solutions hit the bell [ph] perfectly. It not only addressed all the requirements but a cloud deployment allowed them for a swift effective implementation. While the company is still an on-premise ERP company, having the quality management capabilities of cloud was a huge advantage for them. Our development team and our CEBOS division have done a great job in transforming their on- premise solution to the cloud since the acquisition. It is great to see our customers now starting to embrace the strategy. On a different topic, the user interface and architecture for Channel Islands continues to be well received by our customers. I was recently at the UK User Group meeting where Channel Island was presented. It’s wonderful to see such excitement and positive comments from our customers. The web user interface and intuitive design is getting a lot of buzz and excitement with both our customers and our partner networks. We are continuing to work with our early adaptors and look forward to having some customers in production early next year. Thanks Karl, back to you.
Karl Lopker:

Okay, Pam. The global manufacturing economy continues to grow although a bit more slowly as defined by the Global Purchasing Managers Index. The relative growth in U.S. manufacturing has continued to slow a bit and Eurozone seems to be picking up, although the recent political development could have a significant effect on this growth. China is still a concern due to negative growth, although our strong market position and effective sales execution has produced strong results there. Overall, the environment looks positive for QAD to continue to keep up the pace we have seen so far this year, and we are encouraged by the increased interest in our cloud offerings, both of the ERP as well as our divisional products. That’s all I have. And as usual, we will now take the questions. Operator, can you give the instruction?
Operator:

Yes. [Operator Instructions] And our first question from Bhavan Suri with William Blair. Please go ahead.
Bhavan Suri:

Hey, guys thanks for taking my questions. Just to dive in quickly on the license and support numbers that were slightly lighter, could you give us some color -- if we were to take out that miss there, how much of it was the project ended earlier, [audio gap] the weaker manufacturing environment.
Karl Lopker:

Sorry. We missed a little bit of what you said there, Bhavan.
Bhavan Suri:

Just if you could split out, how much of the lower revenue was due to the fact -- you mentioned obviously, you just said you ended projects earlier, so less on services. What’s the delta between those two numbers, license versus the earlier professional services or less professional services?
Karl Lopker:

Do you mean what’s the connection are you talking about?
Bhavan Suri:

No, what was the split?
Karl Lopker:

So, the project ending earlier and those both factors that you talk about, Bhavan, relate to our professional services business. The license being down relates mainly to the number -- not having a number of deals that were large enough at the end of the quarter.
Bhavan Suri:

Okay. But I guess I thought you mentioned that also the deal size was small and I was wondering if that had impact or did that not have an impact results, primarily to professional services?
Karl Lopker:

Yes, that did not have an impact on professional services. That comment is related to our license business.
Bhavan Suri:

Got it, okay. And then when you look at the overall environment and it’s sort of been deteriorating for a little while, certainly in North America. And you look out to sort of maybe not just the next three months but the next year to year and a half, do you guys expect that to sort of stay where it is; do you think it gets a little worse? It’s a big prediction, but I guess we’re trying to figure out sort of how to think about that part of the business?
Karl Lopker:

Well, I’m thinking there’s some positives and some negatives. Our funnel is bigger than it’s ever been, and our cloud funnel’s up about 15% from the previous year. So, I’d like that a lot. However, manufacturing companies are risk averse and so they tend to delay things at the drop of a hat. So, they tend to push a lot out. So, I think the environment -- I’m hoping the environment will at least stay steady for the next year or so. That’s why I see that -- we can continue to perform as we have in the past.
Bhavan Suri:

And when you look at sales cycles, just some sense of sort of the elongation [ph] of your seeing vis-à-vis where they were?
Karl Lopker:

We lost you again. You were talking about sales cycles and where are they now versus before -- or go ahead?
Bhavan Suri:

Yes, exactly, exactly.
Karl Lopker:

I don’t see much change in the sales cycles. It’s maybe they are elongated for the cloud deals for sure, but we have a number of deals that also close very quickly for new users and new modules.
Bhavan Suri:

And then, one last one from me, when you look at the subscription pipeline growth, you touched on sort of healthier interest and subscription in Europe. If I look at the mix of that pipeline, it used to be pretty much -- I mean subscription is usually a North American phenomenon, but when you look at the pipeline, how does that split look between North America and Europe?
Karl Lopker:

I don’t know. That’s tough to tell right now because of a lot of the North American deals are global deals. So, less than half of our users are actually located outside of the U.S. I could probably find that out but it would be a more difficult number to have.
Pam Lopker:

And certainly changing from activity, we’re seeing more and more activity in Europe where we haven’t seen that before.
Karl Lopker:

Yes, most people that we talk to actually in Europe with large implementations will talk to us about the cloud where they wouldn’t have a year or two ago.
Bhavan Suri:

And Asia seems to be a place where they were much more open talking about cloud implementations where maybe two years ago they weren’t, does that phenomenon continue?
Karl Lopker:

Yes. Actually, Asia was almost in the same position as Europe, when we got together with our management team, we talked about it. The Asia RVP and also the European RVP, we’re seeing about the same thing. Asia however is certainly a lot of different economies and a lot of different cultures. So, we’re seeing a lot more activity in Australia right now, the exchange rate is a lot more positive; I think it’s what at $0.72 for the Australian dollar right where it was a $1.06. So, they’re becoming more competitive; they’re feeling better; things are looking up there. So, we’re seeing a lot more activity there. And China continues to juggle on for us. They’re doing -- we’re doing pretty well. Also Japan is starting to feel a lot better because they’re good for more competitive demand on a world-wide basis. So, yes, I think Asia is picking up and there -- anytime any anybody talks to us about an upgrade or a new deal, we talk to them first about cloud.
Bhavan Suri:

And one last one, I’ll turn back to queue, but any change in the competitive environment, Karl, Pam; are you seeing in core or at the core or even SAP lowering price or offering some kind of discounted program to get there, customers to shift to whatever -- to get customers shift that cloud offering; anything and any change like competitive environment from a pricing perspective or just even from an operating perspective?
Pam Lopker:

Well, towards the cloud, it’s still the field is pretty wide open, there isn’t a lot of a cloud competition. We really do not see Oracle for instance with ERP for manufacturing cloud offering. SAP, no, always just kind of point solutions. So, they -- from what we’ve seen in our segments, we have not seen them with a cloud offering, maybe a hosted offering.
Operator:

And we’ll go to Richard Davis with Canaccord. Please go ahead.
Richard Davis:

Bhavan and I would like to just help cell tower companies give us better reception but that’s probably not part of your step. [Ph] Have you -- from a sales, and with you guys I can as a general rule, make more money with greater velocity of selling cloud and stuff like that. Is there a point that in time and just maybe a year or two or three years, I don’t know, would you actually start to A, [indiscernible] to move faster or B, pay your sales people more for a closing cloud deals and/or C, make the two products relatively different in terms of feature, functionality, the kind of pull the customers towards cloud, because in the end that’s kind of where we’re aiming towards that’s the goal at the of the end rainbow?
Karl Lopker:

Well, Richard, we do both of those things already. So, our commissions on the cloud are quite a bit better than on on-premise. It’s not -- I mean we haven’t cut out commissions on-premise, we could maybe eventually but they’re such that everybody always leads with the cloud offering. So that’s not a problem. We do have a bit different cloud offerings, includes more products and when you buy on-premise, so cloud. you get pretty much access to everything, so that we can get people add more users all the time; where on premise, we ask them to buy module by module usually.
Richard Davis:

And I imagine the cloud is a lot more mobile friendly and specifically on this track, is that right?
Pam Lopker:

Actually they’re the same right now but that will become more as we see over the next few years, our cloud will have every application available, mobile and available within the cloud for us. So, we will have more connectivity to other -- immediate connectivity to other cloud services as well as more mobile.
Operator:

And we’ll go next to Mark Schappel with Benchmark. Please go ahead.
Mark Schappel:

So Karl, starting with you, last year at this time, the deal funnel was up I believe 20% over the prior year. And in your prepared remarks, I believe you said it was up only 8% this quarter. The smaller growth you’re seeing in the funnel, what would you attribute that to; would that be to the smaller deal sizes that you referenced?
Karl Lopker:

Well, actually last quarter, I said that the sales funnel was flat with the previous year, so being up 8% feels good to us. Of course, you’d expect that since we didn’t close as many deals in Q3 as we would have liked or the value of those was not as large as we would have liked.
Mark Schappel:

And then also in your prepared remarks, I believe you mentioned that the service agreements you noted that some of them finished earlier than expected. Is it fair to assume that those were cloud projects?
Karl Lopker:

I couldn’t tell you right…
Daniel Lender:

Because I assume they were very much…
Pam Lopker:

Cloud tested…
Daniel Lender:

No, I think they were a mix of different projects that had been -- they were fairly significant and have been going on for some time. So, they were not only cloud projects.
Mark Schappel:

And along those lines, Daniel, I mean you guys have been implementing ERP solutions, both cloud and on-premise for some time now; you guys have a good idea of how long it takes. Why did some of these projects end sooner than expected; were there some cancellations in there; did companies decide not to do phase two of projects?
Daniel Lender:

I think in essence, we had some fairly smooth implementations. And a lot of times, it was significant implementations or significant upgrades and per the actual SOW what ends up happening is after the customers go live. There is some amount of post go-live services because there is a number of things that will typically still need to need addressing after the customer has gone live. In these cases, the go-lives were smooth and we didn’t get a lot of those additional services as we sometimes do.
Mark Schappel:

And then, just one last question here, given that the Company was able to lower the expense base in the quarter on a lower revenue number, is it fair to assume that you saw some problems in the revenue front fairly early in the quarter?
Daniel Lender:

We saw times that some services revenue may not be as strong but sometimes the billings in early months don’t quite catch up. So that wasn’t entirely clear on a global basis. And we also were not so concerned about the services side of the business because that tends to adapt fairly quickly to changes in demand and we are able to keep up these fluctuations on a quarterly basis and hold up margins fairly well. And from a sales activity standpoint, we were pretty much seeing on the license side what we typically expect in terms of volumes, so we were expecting from a volume deal standpoint to materialize to the forecast almost to the end of the quarter. So no, I mean it was a bit of a surprise to us at the end that we weren’t able to get to high enough number that we did. So, I think the fact that some of the customer base were unable to pull the trigger at the end and led us to come up short on the license side.
Operator:

Thank you. And we have time for one more question. We’ll go to Brad Reback with Stifel. Please go ahead.
Brad Reback:

Daniel, I just wanted to ask you a quick question on the services commentary about it being flat going forward, that’s flat sequentially as well?
Daniel Lender:

Yes, it’s flat from Q3 Brad. Correct. There could be a slight additional pressure from foreign exchange, but we wouldn’t expect that to be too big.
Brad Reback:

And I know you haven’t given guidance for ‘17 yet, but how should we think about the subscription growth rate going forward? Obviously, it’s getting to be a bigger numbers, so that natural deceleration. Can you sustain something in the 30s or should we think about it continuing to compress? Thanks.
Daniel Lender:

Our goal is to try to sustain it to that level. Obviously, for next year, a lot of the growth will depend on how strong of a cloud quarter, so to speak, we have in Q4, as that quarter does tend to be as license quarter, used to be a bit heavier from a deal standpoint. So, I think we will have a little bit better visibility after that. But given the size of the funnel being 15% higher than it was last year on the cloud side, there is certainly enough raw material to keep the growth going.
Operator:

And I will turn it back to Karl Lopker.
Karl Lopker:

Well, thanks everybody for your questions and your attendance. And we will talk to you again in March with our full year results.
Operator:

Thank you. And ladies and gentlemen, this conference call is being made available for replay. The replay begins today November 24th at 4

QAD Inc. Q3 2016 Earnings Call Transcript

Other QAD Inc. earnings call transcripts:

QAD Inc.
Q3 2016 Earnings Call Transcript