QAD Inc.
Q3 2014 Earnings Call Transcript

Published: 26 Nov 2014

[Operator:]

Welcome to the QAD fiscal 2015 third quarter financial results call. [Operator Instructions]. 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 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 third quarter results. Pam Lopker, President and Daniel Lender, Chief Financial Officer joins 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 above 50% year-over-year. We also showed 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 will 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 license business grew nicely from last year even with our increased focus on 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 was $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. The solid performance of our maintenance line is worth highlighting as it is negatively impacted by conversions to the cloud such as the ones 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 cloud sales are booked we incur the expense without the 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 administrative 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 for 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’ve 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 purchased intangible assets, gain-loss adjustments on the company's interest-rate swap 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 revenue. 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 2014. 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 count back 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 build subscription revenue on a quarterly basis, this specific deal was built 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, 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 will 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 be 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 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 1/3rd 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 averages and our automotive vertical performed somewhat better than other verticals. Full-time employee headcount at 16 and 20 was up around 7% from last year mostly due to increases in the cloud operations group, North American services and global sales. Now I'll turn over the call to Pam for a closer look at the QAD cloud activity.

[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 deals, 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. A second customer was a new logo for QAD and a manufacturer of tools and imaging solutions for applications in minimally invasive neo-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 helping 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 a 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 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 benefits of the cloud. I then went to the UK where we had an executive conference at the Westin Park which is a beautiful estate on 1000 acres originally built in the 17th century. We had over 100 customers attending that conference. Then I continued back to the U.S. and last week we hosted the West Coast user conference in our Santa Barbara headquarters. We also had well over a 100 attendees there with a large consortium of life science companies from Southern California. So incredible leading edge products from these customers, one of the customers in attendance was Second Site 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 are 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’re keeping an eye on the global manufacturing economy which is showing some areas of weakness as measured by the country 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 watch on what is happening in the Eurozone, China and Japan. As usual now we will take questions. Operator, can you give the instructions?

[Operator:]

[Operator Instructions]. Our first question will go to 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 kind of a big power quarter, in your view is it shaping up to be kind of a normal use it or lose it quarter for 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 use it or lose it quarter with respect to just IT spending in general? I guess I'm looking for fiscal Q4 seasonality, is it shaping up to be kind of a normal quarter or do you see some hesitation there still with your buying customers?

[Karl Lopker:]

I'm thinking it is 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:]

Okay. And then probably moving over to you, Daniel here. I mean it looked like a very good quarter with the exception of maybe cash flow from operations seemed much lower than I would have expected in a quarter like this. Can you maybe just review once again why cash flow from operations was a little challenged this quarter?

[Daniel Lender:]

Yes, sure, Mark. 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 revenue put into the books and this year there is -- more of that revenue has been released and that really is the change in the -- between the two years.

[Mark Schappel:]

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

[Pam Lopker:]

For cloud operations?

[Mark Schappel:]

Yes, concerning your cloud products.

[Pam Lopker:]

Yes, 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 conferences that we attended, we’re moving from a dot.net user interface to an HTML5 user interface which -- and we are 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. But like we do everything, all of our user interface moves in the past, it will be -- you can run it concurrently with dot.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 HTML or you can access the dot.net. And that gives us really great capabilities as we move to supporting all of our application on mobile and on both phones and tablets because from the HTML 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 much greater capability. One of the areas that we are seeing a lot of interest in the cloud for is the whole idea of purchase requisitions 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 is getting a lot of interest and we like it because it is a complete cloud offering.

[Operator:]

Thank you. And next you will go to [indiscernible]. Please go ahead.

[Unidentified Analyst:]

I want to complement you both and all of you are doing a great job, I'm 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 the 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 there is more deferred revenue on the balance sheet that’s typically what is happening is that is not being reflected in -- as income. Yes, cash is in, but it's 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.

[Unidentified Analyst:]

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

[Daniel Lender:]

Yes. So our deferred revenue in a number of the categories has 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 on a regular basis we evaluate our different options in terms of capital allocations. We’ve 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 is 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 of them coming out of the woodwork.

[Karl Lopker:]

Well, we have a very broad [multiple speakers].

[Unidentified Analyst:]

Is that a magic price or something?

[Daniel Lender:]

Yes, the other piece that maybe you are probably looking at Paul, is related to RSUs investing. So that's probably the increased activity. If you look at it carefully you will probably see that actually being most of the activity.

[Unidentified Analyst:]

What is the RSU?

[Daniel Lender:]

Those are similar to stock options.

[Pam Lopker:]

And they vest, they have to pay taxes on them when they vest so they have to sell--

[Unidentified Analyst:]

But it seems like they always get exercised when the stock is at a new high, just cursory looks at that.

[Daniel Lender:]

Paul, it might have been a coincidence on that. And obviously I would -- so 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:]

Maybe you could look it back up on the Google insider trading. What about--

[Daniel Lender:]

Yes, so, Paul, I will be happy to have a call with you after. I really don't want to take up 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's 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 meeting.

[Operator:]

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

[Unidentified Analyst:]

Wondered if you could just give us an update on the S3 you filed in September and any update on that.

[Daniel Lender:]

So, the only update that's actually out there, 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 we will -- at that point in time we'll make the appropriate announcements.

[Operator:]

[Operator Instructions]. At this time there are no further questions. I'll turn the call back over to Mr. Karl Lopker.

[Karl Lopker:]

Okay, well thanks everyone for your attendance and questions. We will update you again in March with our fourth quarter results. Goodbye for now.

[Operator:]

[Operator Instructions]. That does conclude our conference for today. Thank you for your participation and for using AT&T's teleconference service. You may now disconnect.