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Q2 2015 Earnings Conference Call

August 26, 2014 05:00 PM ET


Karl Lopker - CEO

Daniel Lender - CFO

Pamela Lopker - Chairman and President

John Neale - SVP, Finance and Treasurer


Ryan Vardeman - Palogic Capital

Mark Schappel - The Benchmark Company


Ladies and gentlemen, thank you for standing by and welcome to the QAD Fiscal 2015 Second Quarter Financial Results Call. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions) And as a reminder, this conference is being recorded.

I’ll now turn the conference over to John Neale, QAD’s Senior Vice President of Finance and Treasurer. Go ahead please.

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 second quarter ended July 31, 2014. The press release and associated financial statements are available through the Investor Relations section on our Web site at Additionally, please be advised that this call is being Webcast live on our Web site.

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 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’d 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 second quarter results. Pam Lopker, President; and Daniel Lender, Chief Financial Officer, joining me on the call.

For the second quarter, we’re happy to report total revenue above our guidance with cloud subscription revenue growing above 45% year-over-year. We also showed growth in licenses, maintenance and services. And these were our best second quarter and first half revenue performances ever. Daniel will give you the numbers then I will discuss the details. Daniel?

Daniel Lender

Thank you, Karl. Our second quarter capped a record revenue first half for QAD with growth across all of our business lines versus last year. Revenue from our cloud-based services grew substantially and we realize solid gains to Professional Services.

Comparing to the same quarter last year, total revenue rose 12% to $73.1 million, up from $65.2 million. License revenue grew 4% to $9 million, up from $8.6 million. During the second quarter, we closed five license deals greater than $300,000 compared with six in last year’s second quarter.

Subscription revenue was up 45% to $6.4 million, compared with $4.5 million last year due primarily to the continued growth and success of our cloud offering. Bookings for the QAD Enterprise Cloud remains solid. Both our European and North American regions cloud businesses performed well in the quarter.

Maintenance and other revenue improved 5% to $36.1 million, up from $34.3 million last year. The increase in maintenance was related to new users, new customers, new modules and price increases in excess of cancellations and customers transitioning to the cloud.

Professional services grew 20% to $21.5 million, up from $17.8 million last year. The improvement is consistent with our license and subscription revenue growth; we expect to continue to see high demand for our professional services.

Looking at total revenue by vertical, high-tech and industrial represented 32%, automotive 29%, consumer products and food and beverage 21% and life sciences 18%. And by geography, North America was 42%, EMEA 35%, Asia Pacific 16% and Latin America 7%.

Gross profit grew to $39.8 million compared with $36.4 million for the same quarter last year. As a percentage of revenue, gross margin was 55% versus 56% for the same period last year. Sales and marketing expenses totaled $17.4 million or 24% of revenue versus $15.9 or 25% of revenue in last year’s second quarter. The dollar increase is primarily due to increased commissions some related to cloud sales, increased salaries due to additional headcount and related travel.

As our Cloud business grows, it continues to add commission and variable compensation expense in current period. Our policy is to expense commissions in the period where the sale occurs. So when Cloud sales are booked, we incur the expense without the related revenue in the period.

R&D expense for the second quarter was $10.8 million or 15% of revenue compared with $10.5 million or 16% of revenue for the same quarter last year. The prior year included $300,000 joint development benefit.

General and administrative expense was $9.3 million versus $8.4 million last year. As a percent of revenue, G&A expense was 13% for both periods. The increase was primarily driven by professional fees, personnel, and stock compensation expense.

All of our operating expense lines were negatively affected by increased variable compensation related to our cloud business without the benefit of the related cloud revenue in the current quarter.

Total operating expenses in the quarter were $37.8 million or 52% of revenue compared with $34.9 million or 54% of revenue last year. Equity compensation expense was $1.7 million for the fiscal 2015 second quarter versus $1.6 million a year-ago.

Operating income improved to $2.1 million, up from $1.5 million from last year’s second fiscal quarter. Other expense was $58,000 for this year’s second quarter compared with other income of $673,000 last year. The prior year period included a positive impact related to the interest rate swap associated within mortgage of our Santa Barbara headquarters.

Net income was approximately $1 million, or $0.06 per diluted Class A share and $0.05 per diluted Class B share. Net income for last year’s second quarter was $1.3 million or $0.08 per diluted Class A share and $0.07 per diluted Class B share.

Our tax rate for the second quarter fiscal ’15 was approximately 51%. This was higher than expected primarily as a result of significant stock compensation exercises in the quarter where the tax deduction amount was lower than the accounting expense.

For our third quarter, we expect the tax rate to be significantly lower than that of Q2 and for the full fiscal year, we expect a tax rate of approximately 37%. For the year-to-date period, cash flow provided by operations was $5.5 million compared with $13 million for the same period of last year. The decline relates primarily to the net effect of higher billings in excess of collections.

I’d now like to very briefly review our year-to-date results. Revenue rose to a first half record of $141.5 million, up from $127.1 million for the first six months of fiscal 2014. Gross margin was 54% of revenue versus 55% for the same period last year.

Total operating expenses amounted to $74.5 million or 52% of revenue compared with $70 million or 55% of revenue for the first six months of fiscal ’14. Net income grew to approximately $900,000 or $0.06 per diluted Class A share and $0.05 per diluted Class B share. We had breakeven performance for the first half of fiscal ’14.

Moving on to the balance sheet, we ended the second quarter with cash and equivalents of $75.3 million, compared with $76 million at the end of fiscal ’14 and $59.4 million in the second quarter of last year.

Accounts receivable equaled $52.7 million, down from $71.3 million at the end of fiscal ’14 related to the customary seasonal decline, but up from $42.7 million in the second quarter of last year.

Days sales outstanding using the countback method was 58 days for the second quarter of fiscal ’15, compared with 53 days last year. Quality of our receivables remains good.

Our current deferred revenue balance was $88.8 million which was comprised of $72.6 million of deferred maintenance, $9.7 million of deferred subscriptions, $2.7 million of deferred license and $3.8 million of deferred professional services.

In addition, other liabilities included $2.8 million in long-term deferred revenue related to a multiple year cloud deal that we closed in the quarter. Our current deferred revenue balance was $86 million at this time last year and $104.2 million at the end of fiscal ’14.

Our business outlook for the third quarter of fiscal ’15 calls for total revenue of approximately $71 million and $0.12 per diluted Class A share and $0.10 per diluted Class B share. For the full-year, we’re raising our guidance for revenue growth rate from prior year to 8% and maintaining our earnings guidance roughly equal that to fiscal ’14 levels.

That concludes my remarks. So, I’ll turn things back to you Karl.

Karl Lopker

Okay, well thanks Daniel. As we mentioned, we did a bit better than expected in the second quarter in all our revenue lines. Our services increase of 20% was largely driven by implementations and upgrades as in the recent past. We will continue to concentrate on growing services, so that we can ensure the maintenance renewals 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. 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 continue to bring in cloud subscriptions growth in our target 40% to 50% range and we booked 10 new sites this quarter for QAD cloud apps. Our total funnel is up around 15% from last year at this time with cloud apps representing around one-third of the opportunity, up from 25% last year. The increase in cloud apps funnel is mainly driven by a few larger global deals rather than a large number of smaller opportunities.

The majority of our funnel for cloud apps remains for conversions from our 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.

Europe continued to show good strength in the quarter, which reflects a more positive economic situation for manufacturing in that region. We continue to see more interest from Europe in the Cloud Apps which is very extremely encouraging.

Total revenue breakdown by vertical was maintained at historical averages, although we did take a few larger license and cloud orders for life sciences which is performing very well. Full time employee headcount was up around 4% from last year at 1,595, mostly due to increases in our cloud operations group, services, and sales and marketing.

Now let me turn the call over to Pam for a closer look at the QAD cloud activity. Pam?

Pamela Lopker

Okay. Thank you, Karl. A little bit about the cloud in Q2. In Q2, QAD like the rest of the industry has been Western Europe join the cloud bandwagon. It was as if Western Europe was waiting for the U.S to gain further traction to stay at the cloud bandwidth for real.

Gartner predicts 12% growth in ERP cloud for North America and FY15 and 24% for Europe with France leading the way for growth in Europe. Perhaps the cloud is a way to deal with high labor costs and regulations in France and the rest of the world, we believe our global operating and delivery structure positions us well to gain from this trend. We are also happy to see our growth being more than double that of the global growth that Gartner see.

As Karl mentioned, we had two new -- 10 new customer sites in Q2. I would like to just give you a little color by talking a bit about two different deals of Q2. The first new cloud customer I would like to mention is our largest deal in the quarter, which is a Scandinavian life science company that manufacturers life saving emergency response educational products with global sales at manufacturing sites in Scandinavia, Japan, U.S., and China. The company is now long-term QAD customer and decided to make that move to the cloud in conjunction with an upgrade to our enterprise edition.

Our ability to (inaudible) cloud across three continents with the functionality that enables them to simplify and standardize complex manufacturing operations was a driving focus and factor in this deal.

The next customer I want to mention is a Tier 1 global automotive buyer headquartered in Michigan, that produce a range of metal automotive components such as oil pans, engine mount brackets, reinforcement, stampings and support. This customer was also a long-term QAD customer, looking to upgrade to enterprise edition.

The cloud created a compelling offering that frees up their IT resources to focus on projects for improving business operations. I think it’s also worth noting that in Q2 we had 13 (indiscernible), our largest number yet in the cloud in one quarter and it was certainly influenced by a large number of deals in Q4.

Okay Karl, back to you.

Karl Lopker

Okay, Pam. As you can see we’re excited about the prospects for QAD cloud apps and our goal is to continue to grow subscription revenue 40% to 50% while maintaining profitability. On the balance sheet cash continues to increase which is important as our growth in QAD cloud apps continues to accelerate and puts additional demands on that part of our business.

As usual, we will now take the questions from the analysts. Operator, can you please give the instructions for the questions?

Question-and-Answer Session


Certainly. (Operator Instructions) And we do have a question from Ryan Vardeman with Palogic. Go ahead please.

Ryan Vardeman - Palogic Capital

Hey, guys great quarter and thanks for taking my question. Are the CEBOS and DynaSys acquisitions fully integrated and what are the long-term opportunities in each of those products?

Karl Lopker

The CEBOS -- both of those acquisitions are fully integrated right now. And we’re happy to say that both of those divisions are actually growing faster than QAD as a whole so, and the opportunities look extremely great for those.

Ryan Vardeman - Palogic Capital

Okay. And now that your revenues is high as its ever been, what are you long-term visions for revenues, where did they go and where do you see profit margins going over time and how long or how do we get there?

Karl Lopker

Well, certainly I think we can continue to grow the cloud business at 45% or 50%. So we don’t see any reason that would stop. I mean, we’re -- we’ve been able to demonstrate that now for probably what three, four years. So, we don’t say any reasons that is going to end even probably in the three to five year range.

Ryan Vardeman - Palogic Capital

Okay, great. And what about margins, I mean, the cloud revenue is digested in the enterprise, how -- when do you think that margins are going to start coming back our way, I guess, when -- yes …?

Karl Lopker

Well our margins have a couple of elements to them. One is the cost and we’re working on the costs and we’re being able to drive down the costs somewhat and we’re focusing on that. But you also have then the competitive pressures as more and more companies get into the cloud ERP business. So hopefully we will be able to maintain margins at least where they’re, maybe improve those as we get more efficient infrastructure as they get to higher and higher volumes. But we will have to see where that goes. I -- its hard to say right now.

Ryan Vardeman - Palogic Capital

Okay, wonderful. Well, thank you very much. We are still huge fans and big cheerleaders for you guys and appreciate all your hard work. Thank you so much and thanks for taking my call -- question.

Karl Lopker


Daniel Lender

Thanks, Ryan.

Karl Lopker

Keep (indiscernible).


Thank you. (Operator Instructions) And next we have Mark Schappel with Benchmark. Go ahead please.

Mark Schappel - The Benchmark Company

Hi, good evening. Thanks for taking my call and nice half in the quarter. Karl starting with you, in your prepared remarks you mentioned that your deal funnel was up about 15%. Thus far it’s been a little bit lower than what I remember in the past, any concern with that there or is there anything going on that we should be mindful of?

Karl Lopker

No, actually 15% is pretty good. The Company is growing at 10% to 12%, so having the deal funnel up 15% is -- shows that we have some more gas in the tank. So now that’s -- I don’t think that’s a problem, I think it’s a good thing. In fact, the funnel had been running about flat for the last couple of years and we’re still able to (indiscernible) increases in revenue. So I think the funnel going up is a good thing.

Mark Schappel - The Benchmark Company

Okay. Thanks for clarifying that. And then, Daniel could you just review the issue with the tax rate in the quarter?

Daniel Lender

Sure, Mark. So during the quarter we had a large amount of stock activities from employees. And that the benefit that the employees realize is different than it was for accounting purposes that had been accumulated by the company. As a result of that, we end up with one of the discrete items that is related to stock compensation that ends up affecting the rate for the quarter. We don’t believe we’re going to get those levels going forward this year. So, we do believe that the rate is going to come down significantly next quarter and then the year at about 37% on a blended basis.

Mark Schappel - The Benchmark Company

Okay, great. And then, Daniel the outlook implies some leverage in the model. I was just wondering if you could help us on the line items that we are likely to see some of that leverage.

Daniel Lender

Sure. I mean, in terms of we -- in terms of the cost of revenue we expect the cost of revenue to as a percentage of revenues to remain fairly consistent. We have improved our services margins over the last couple of quarters and we think there are still potentially a little bit more room there for those to go up. And then, on below the line on the operating margin area, I think on the areas where with growth in revenue that we can see some leverage I think will be particularly the R&D and G&A line, sales and marketing tends to be a little bit more sensitive to the -- to all commissions and other sales driven expenses.

Mark Schappel - The Benchmark Company

Okay. Thank you. That’s all from me.

Daniel Lender



Okay, thank you. (Operator Instructions) Okay. We have no one else and to you Mr. Lopker. Please go ahead with any closing remarks.

Karl Lopker

Okay, well thanks everyone for you attendance and questions. We will update you again in November with our third quarter results. Good bye for now.


Thank you. Ladies and gentlemen this conference will be available for replay after 4:00 PM today through midnight September 3rd. You may access the AT&T executive playback service at any time by dialing 1800-475-6701 and entering the access code 332-168. International callers dial 320-365-3844, using the same access code 332168. And that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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