QAD (QADA) Q3 2019 Earnings Conference Call Transcript

QAD (QADA)
Q3 2019 Earnings Conference Call
Nov. 20, 2018 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the QAD fiscal 2019 third-quarter financial results call. [Operator instructions] As a reminder, the conference is being recorded. And I'll now turn the meeting over to our host, Chief Accounting Officer Kara Bellamy.

Please go ahead.

Kara Bellamy -- Chief Accounting Officer

Hello, everybody, and welcome to today's call. Before we begin, I'd like to ensure that everybody understands that our discussion may 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 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 discussing non-GAAP pre-tax income, which is a non-GAAP financial measure as defined by SEC Regulation G. A reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measure is included in today's press release, which is posted on the company's website. Now, I would like to turn the call over to Daniel Lender, QAD's chief financial officer.

Daniel Lender -- Chief Financial Officer

Well, thank you very much, Kara. Good afternoon, everyone. Thank you for joining us to discuss QAD's third-quarter results. Pam Lopker, president, is joining me on the call.

Before we begin, I want to acknowledge, as most of you know, that we recently lost Karl, our CEO, a great friend, colleague and co-founder of QAD. He helped build a great company and an outstanding team that will continue a legacy of helping global manufacturers better manage their operations. While we're back to business as usual here at QAD, Karl is and will be sorely missed. I'd like to thank all of you for your heartfelt thoughts and sympathy during this time.

Let's now review our results. While total revenue was slightly below guidance due to our services business, subscription revenue on profit exceeded our expectations. Currency had a negative $1.4 million to revenue compared with last year but no impact to our bottom line. My comments about revenue growth are given on a performance basis unless otherwise noted.

Compared to the same quarter last year, third-quarter revenue increased by 5%. Subscription revenue grew 40% and is now approaching 30% of our business. Subscription margins rose to 64%, up from 56% a year ago and 63% for the second quarter. We expect margin of about 63% for the full year and as a reminder, our goal is to grow margins by 1 to 2 percentage points annually after fiscal '19.

Maintenance and other revenues was roughly equal to last quarter at $30.4 million but was down about 4.5% year over year, primarily related to continued customer conversions to the cloud and historical attrition. As car conversions increase, maintenance revenue is expected to decline. Recurring revenue, which equals subscription plus maintenance revenue, grew 11% from the prior year and accounted for 68% of total revenue for the third quarter, up 4 percentage points from last year's third quarter. Our professional services revenue was $20.7 million, the same as in last year's third quarter.

Services margins remained positive for the quarter. During the quarter, the multi-site global implementation we discussed on our last earnings call temporality paused in order to finalize processes of the 59 sites already live. This fourth month pause and lower services activity in EMEA impacted our third-quarter services revenue and will also have an impact to our fourth quarter. The implementation is anticipated to resume right after the New Year, once the customer finishes their end-of-year activity.

Despite the lower revenues, we were able to achieve profitability due to effective management of utilization and subcontractors. For the full year, we anticipate achieving a small profit in our professional services business. License revenue was $4.6 million versus $6.6 million last year. We closed two deals greater than $200,000 with none greater than $1 million.

We continued to generate the majority of our license revenue from existing customers. Total revenue by vertical for the third quarter was automotive 39%, high-tech and industrial 30%, consumer products and food and beverage 16%, and life-sciences 15%. By geography, total revenue was North America 50%, EMEA 28%, Asia Pacific 16%, and Latin America 6%. Gross margin was $42.2 million for the 2019 third quarter, compared with $38.9 million last year, and gross margin was 63% for the fiscal 2019 period and 51% for the fiscal 2018 period.

Our sales and marketing expense totaled $18.4 million versus $17.7 million last year and was 23% of total revenue for both periods. The increase was due to additional headcount as we discussed last year. R&D expense was $13.2 million for the 2019 third quarter versus $12.1 million last year. The increase was primarily driven by additional headcount and third-party developers.

R&D expense was 17% revenue of total revenue for the fiscal '19 third quarter and 16% last year. General and administrative expense amounted to $8.1 million or 10% of total revenue compared with $8.6 million or 11% of total revenue last year. The decrease was attributable to lower personnel costs and reduced stock compensation expense. This brings total operating expenses to $39.7 million for the fiscal '19 third quarter ,compared with $38.4 million last year.

As a percentage of total revenue, operating expenses were 50% in both periods. Stock compensation expense was $2.1 million for the fiscal 2019 third quarter and $2.3 million last year. Operating income was $2.5 million versus $430,000 last year. Our GAAP pre-tax income was $3.6 million versus a GAAP pre-tax loss of $1.1 million for last year's third quarter.

Non-GAAP pre-tax income was $5.7 million versus $3.5 million a year ago. Our GAAP net income totaled $3 million or $0.14 per diluted A share and $0.12 per diluted B share comparing to a GAAP net loss of $161,000 or $0.01 per Class A and B share last year. Income tax expense was $597,000 for the third quarter. Our annual effective rate is expected to be approximately 40%.

Now I'll briefly review our year-to-date results. For the year-to-date period, total revenue grew 12% to $250 million, up from $224 million, driven primarily by increases in subscription and services revenue. Subscription revenue grew 35% to $67.8 million compared with $50 million in the year-ago period. Our gross margin was 53% of total revenue compared with 51% in the prior nine-month period.

And subscription margin totaled 63% for the fiscal '19 period and 54% for the fiscal '18 period. Our total operating expenses came to $125.4 million or 50% of total revenue versus 150 -- $115 million or 51% of total revenue last year. Our pre-tax income was $8.7 million versus a pre-tax loss of $1.2 million a year ago. And non-GAAP pre-tax income was $16.2 million for the fiscal 2019 year-to-date period compared with $6.1 million last year.

Our GAAP net income was $5.5 million or $0.26 per diluted A share and $0.23 per diluted B share versus a net loss of $3.9 million or $0.21 per class A and $0.17 per class B in the same period last year. We ended October with $138 million in cash and equivalents compared with $147 million at the end of fiscal 2018. Our accounts receivable was $46.4 million compared with $83.5 million at the end of the fiscal '18 and $50.8 million a year ago. Our day sales outstanding using the [Inaudible] method was 48 days for fiscal 2019 third quarter versus 53 days for the same period of last year, and the quality of our receivables remains healthy.

Our short-term deferred revenue balance on October 31 was $80.5 million versus $83.1 million a year ago. And it includes $50.7 million of deferred maintenance versus $52.7 million, $27.8 million of deferred subscription versus $25.5 million, $1.8 million of deferred professional fees versus $3.6 million, and $200,000 of deferred licenses versus $1.3 million. As a reminder, our maintenance contracts are billed annually and subscription contracts can be billed either annually or quarterly. Our cash flow from operations was $15.1 million for the first nine months of fiscal '19 compared to $2.8 million last year, reflecting continued subscription revenue and margin growth.

I'll finish up our financial review with guidance. We have tightened our revenue guidance and increased our pre-tax guidance for the full year and are now expecting total revenue in the range of previous guidance of approximately $332 million, including approximately $92 million of subscription revenue; increased GAAP pre-tax income to approximately $9 million to $10 million from previous guidance of $5 million to $7 million; and increased non-GAAP pre-tax income to approximately $19 million to $20.5 million from previous guidance of $16 million to $19 million. Looking a bit ahead into FY '20. As we discussed during last year end, we closed a significant number of deals that would have naturally closed in the first half of this year.

This resulted in quite strong subscription revenue that we've enjoyed during this year, but also meant that we entered FY '19, with a cloud funnel where the majority of deals were in early stages. We expected that it would result in those deals closing later in the year. Due to the stronger subscription revenue in FY '19 and the back-end weight of our funnel at the beginning of the year, we anticipate the subscription revenue growth of the first half of next year will be below the FY '19 growth rates. However, we're very pleased that our weighted cloud funnel today is almost 40% stronger than it was last year.

So we expect the subscription revenue growth will reaccelerate toward the second half of the year and into the years following. We will be providing more detailed guidance for fiscal '20 during our fourth-quarter financial results call currently scheduled for the middle of March. Now, I'd like to turn the call over to Pam for a deeper look at our cloud business and product area. Pam?

Pam Lopker -- President

Great. Thanks, Daniel. In Q3, we had 15 new cloud deals, including 10 new cloud customers and five conversions. On a regional basis, North America was once again the strongest with the industrial electronics closely followed by life science, the strongest verticals this quarter.

DynaSys continues to form well in the cloud. They were able to close a net new customer of furniture and interior decor with a relatively short cycle time of under 90 days. We believe this is due to references from similar companies already using DynaSys. Our largest deal for the Q was a conversion for our manufacturing and distributor of money handling and vending equipment.

They were recently bought by a private equity company and were on a very old release of QAD. To support their planned growth moving to the current release in the cloud made a lot of sense. Now for an update on the product. In early November, QAD introduced the QAD Enterprise Platform to our partner community at the Annual Partner Conference in Budapest that we call Teamwork.

Over 30 of the developer attendees stayed for the QAD Enterprise Platform training class that was -- that concluded with a 24-hour [Inaudible]. Developers worked together as actual teams to roughly deliver a business application, built using the QAD Enterprise Platform. Such apps can be new functionality or extensions of the current functionality in QAD. The event was a great success with 19 successfully built-in applications ranging from a company car employee assignment app, which, of course, is very big in Europe but no longer what we do here in the U.S.

as far as giving employees cars -- company cars. We also had a quality system training record app and an employee loan tracking app. Many of the platform features were exploited by the teams to handle -- to include creation of a rich user interface -- web user interface, dynamic embedded images, email notifications, analytics, and integration of external systems. All apps are packaged into a deployable app that can be moved to other environment.

The winning app was an issue tracking solution that could be used for service and support management for manufacturing companies, and it was done by our Hungarian partner. This was deemed to offer the most business value and utilize a breadth of QAD Enterprise Platform features. While we expected the teams to work eight or 10 hours and return the next day to show their projects. And through developer reputation, it appeared some teams worked through the night and were still energized to show their apps off the next morning.

We're excited to see how easily it was -- easy it was for developers with minimal training on the platform to quickly develop business-related applications leveraging the QAD platform. It was a real life showcase of the value it will bring to our partners and customers. We believe this will translate to a competitive advantage and our ability to win with new business. Thanks and back to you, Daniel.

Daniel Lender -- Chief Financial Officer

Well, thanks very much, Pam. That's very exciting about the platform. Looking at our business on a regional basis for the quarter, Asia Pacific and the Americas performed as expected while professional services affected the EMEA in particular. Pam highlighted a cloud win from DynaSys.

I would add both DynaSys and Precision posted another set of good quarters with an increasing portion of their deals coming in the cloud. Our full-time employee headcount was similar to last quarter, around 1,900 employees. The manufacturing economy continues to show strength. And as I mentioned, our weighted funnel is up almost 40% from prior year, putting us in a good position for strong execution over the next few quarters.And as usual, we will now take your questions live.

Operator, can you please give the instructions? 

Questions and Answers:

Operator

[Operator instructions] And our first question will come from the line of Bhavan Suri with William Blair. Please go ahead.

Bhavan Suri -- William Blair & Company -- Analyst

Hey, guys. Thanks for taking my questions. Can you hear me OK?

Daniel Lender -- Chief Financial Officer

Yes, Bhavan. Thanks. Hi.

Bhavan Suri -- William Blair & Company -- Analyst

Hey. Just -- I guess, just to start off at a macro level maybe for Pam and for you Daniel or both, just at a high level sort of are you seeing any impact from sort of geopolitical issues? Any business impact from the tariffs on sort of the core manufacturing base you have?

Pam Lopker -- President

That's interesting. We certainly hear our customers talking about it, but so far there has been no slowdown in purchasing, and we really don't expect to see that. Change is always good for us. And at the end of the day, they've got moved manufacturing from one country to another.

That's always good for us too.

Bhavan Suri -- William Blair & Company -- Analyst

Got it. Got it. And then just one quick follow up at Channel Islands, on your GA in September, there is one of nuances to that -- the variability upgrade of piecemeal modular engine upgrades, the better function on the cloud. So, as you think about those moving pieces, are you seeing any one of those particularly driving acceleration of cloud business? And then, the balancing pieces, right, so Asia was going well and then a slowdown especially in China, so just some sense of sort of how those pieces you think are and will drive sort of cloud growth over the next three years?

Pam Lopker -- President

I do think that Channel Islands, we're releasing that first in the cloud but even more than that it's got some different technology pieces that IT on-premise would have to learn. So, it really makes a lot of sense for customers to go to the cloud and take advantage of our knowledge, posting, and providing those capabilities without them having to learn it. And I just get the general sense that most companies believe that sooner or later, they're going to go to the cloud and might as well go now, so hopefully that continues. I think it will.

Bhavan Suri -- William Blair & Company -- Analyst

Thanks, Pam. And one quick -- last one for me. On the competitive environment, one of the advantages you have by standardizing on progress and things like that is sort of templatizing the product so implementation is faster. When you look at SAP HANA and their ability to templatize now with standard [Inaudible] are you seeing any change in the said environment there, specifically from them more than anyone else, or is it still pretty much status quo?

Pam Lopker -- President

We're certainly hoping that this whole move to -- for HANA, and they're providing no upgrade, that's a complete reimplementation, even the data stores are different, everywhere, certainly hoping that that's going to give their customers pause and at least start looking at other products. So, we're feeling that that's a good thing for us.

Daniel Lender -- Chief Financial Officer

And just to add something to what Pam said, Bhavan, I mentioned the implementation that paused for a few months for this customer. They were able to implement QAD in -- 59 times in about 20 months, which is unheard of in a global ERP environment. They still have about another 20 to go, but it's just -- again, it's a proven point of showing our ability to actually implement go-live and get the customer to using the application and get value out of it very, very rapidly.

Pam Lopker -- President

And I -- if you look at what we converted them from, it was a wide variety of ERP systems that they had installed, many were SAPs, some were older releases of ours but we were able to take all kinds of different ERP systems and convert them in that 20-month period, which I'd just -- we can't -- we don't believe anybody could do that.

Bhavan Suri -- William Blair & Company -- Analyst

Got it. Helpful, guys. Thank you so much.

Daniel Lender -- Chief Financial Officer

Thanks, Bhavan.

Operator

Our next question is from the line of Zach Cummins with B. Riley FBR. Please go ahead.

Zach Cummins -- B. Riley FBR, Inc. -- Analyst

Hi. Thanks for taking my questions. So, first question for me is just around the multi-site professional services project that you had going on. Can you provide a little more detail on what was really causing the temporary pause there? And is there really any concern that this potential project could be put on hold for multiple quarters or potentially be lost or anything along those lines? Thanks.

Daniel Lender -- Chief Financial Officer

No. I mean, as I mentioned, this project has been going on for a while. The customer is already live in 59 different facilities all over the world. So, it's really more about them catching their breath to be -- and then be able to handle all of their year-end activity that happens between now and the end of December and the plans are really for them to start up the project again early January.

Pam Lopker -- President

And that 59, there's only about 20 more to go so we're well on the home stretch.

Zach Cummins -- B. Riley FBR, Inc. -- Analyst

Understood. That's really helpful. And then in terms of the implied growth in the subscription line in Q4 of this year, it's decelerating down to about 23% year over year. Is that just related more so to timing of the deals and being the timing of the close or anything along those lines, or can you just provide a little more color around that deceleration in that line?

Daniel Lender -- Chief Financial Officer

Yes, sure. No -- the overall revenue -- subscription revenue for the year is -- it's right in the middle of what we have been guiding for sometime already. When we look at the growth numbers, we like to look at it on a fourth quarter basis because any one quarter has a revenue that either up or down that will impact just one quarter-over-quarter comparison to prior year. So there isn't anything in particular to the fourth quarter number.

Again, we look at it more on a four-quarter basis.

Zach Cummins -- B. Riley FBR, Inc. -- Analyst

Understood. That's helpful. And then final question for me, it sounds like hiring with your cloud services team is still a little bit slower than expected. Do you expect this to really start picking up here in Q4 in the coming quarters as you really start to scale on the subscription side of the business?

Daniel Lender -- Chief Financial Officer

Yes. So, on the hiring side, we have been -- on the subscription side, we have been maybe a little bit slower than what we would have planned, but not significantly. We are still planning in the not-too-distant future to open up a new data center in Asia. I -- but I do anticipate that most of the hiring for us, given the strength of funnel and so forth, is going to be more on the sales and marketing side and obviously, you got to make sure that there's enough people on the cloud operations piece to support the new customers, but that will come naturally.

Zach Cummins -- B. Riley FBR, Inc. -- Analyst

Great. Appreciate the color. Well, thanks again for taking my questions and best of luck with the rest of the year.

Daniel Lender -- Chief Financial Officer

Great. Thanks, Zach.

Pam Lopker -- President

Thanks.

Operator

Our last question comes from Jeff Captain with Stifel. Please go ahead.

Jeff Captain -- Stifel Financial Corp. -- Analyst

Hey, guys. Thanks for taking the question. I'll try to follow up real quick on the data center you just mentioned. Daniel, you -- because you guys raised the guidance for the cloud subscription margin to 63% for this year, I'm just curious if opening up that data center -- I guess, I don't know, it sounds like early next year, one half next year, that impacts your ability to improve margins by 100 and 200 basis points per year that you are talking about?

Daniel Lender -- Chief Financial Officer

Yes. So, actually the opening of the data center is important for us in terms of driving revenue growth in Asia Pacific, China in particular. The actual opening of the data center will initially actually be a detractor for margins over -- as we acquire more customers there, it will -- that will change and it will go back to more of a normal range. Our overall margin there, we're still -- our aim is to still try to improve it next year 1% to 2%.

And that comes through a lot of automation and another efficiencies that we're gaining as the business continues to gain scale.

Jeff Captain -- Stifel Financial Corp. -- Analyst

Got it. Thanks a lot.

Daniel Lender -- Chief Financial Officer

Great.

Operator

Thank you. And I'll now turn the meeting back over to Daniel Lender for closing remarks.

Daniel Lender -- Chief Financial Officer

Well, thank you very much. Thank you all very much for your questions, and we look forward to updating you with our fourth quarter and full-year results in March.

Pam Lopker -- President

Thanks, everyone.

Operator

[Operator signoff]

Duration: 28 minutes

Call Participants:

Kara Bellamy -- Chief Accounting Officer

Daniel Lender -- Chief Financial Officer

Pam Lopker -- President

Bhavan Suri -- William Blair & Company -- Analyst

Zach Cummins -- B. Riley FBR, Inc. -- Analyst

Jeff Captain -- Stifel Financial Corp. -- Analyst

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