QAD's (QADA) CEO Karl Lopker on Q1 2017 Results - Earnings Call Transcript

| About: QAD Inc (QADA)

QAD Inc. (NASDAQ:QADA)

Q1 2017 Earnings Conference Call

May 19, 2016 05:00 PM ET

Executives

Kara Bellamy - CAO and Corporate Controller

Karl Lopker - CEO

Pam Lopker - President

Daniel Lender - CFO

Analysts

Bhavan Suri - William Blair

Mark Schappel - Benchmark

Jeff Captain - Stifel

Michael Morosi - Avondale Partners

Operator

Ladies and gentlemen, thank you for standing by and welcome to the QAD Fiscal 2017 First Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode, later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's conference is being recorded.

And I would now like to turn the conference over to your first speaker, Ms. 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 the 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.

Please also note that during this call, we'll be discussing non-GAAP net income and non-GAAP earnings per diluted share, which are non-GAAP financial measures as defined by SEC Regulation G. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures are included in today’s press release, which is posted on the Company’s website.

Now I would like to turn the call over to Karl Lopker, QAD’s Chief Executive Officer.

Karl Lopker

Well, good afternoon and thank you for joining us to discuss our first quarter results. Pam Lopker, President and Daniel Lender, Chief Financial Officer joined me on the call. We began our fiscal 2017 year with a slow quarter in terms of licenses and services but maintenance revenue remains strong even given the increase in subscriptions in the cloud. And the first quarter was our strongest first quarter ever in terms of cloud bookings. We added six new customers in the cloud and our sales funnel for cloud is only getting stronger. We began the second quarter with our largest Explore Customer Conference since the great recession and were about a third of the attendees are cloud customers and another third of the attendees are considering moving to the cloud. While we’re neutral on the manufacturing economy, we are optimistic about our cloud business.

Daniel will give you some numbers and I'll discuss the details.

Daniel Lender

Well thank you Karl, first quarter total revenue met guidance and subscription revenue came in about $500,000 higher. Cloud bookings were the highest first quarter bookings to-date with life sciences showing strong results. At the same time, GAAP net income fell short due to a faster than expected shift from licenses to the cloud, lower than expected services utilization, and foreign exchange revaluations reported through other income and expense. Total revenue for the first quarter was $65.4 million compared with $69.3 million last year. Currency had a $1.4 million negative impact. On a constant currency basis, total revenue decreased 4% due to lower license and services revenue. Currency also had a $1 million positive impact on expenses which resulted in a overall $400,000 negative impact to net income. On a constant currency basis, subscription revenue of $11.5 million increased approximately 25% versus prior year. Currency had a $300,000 negative impact on subscription revenue. Prior year included a one-time recognition of $900,000 related to a cloud implementation in Latin America where we had previously deferred revenue as previously disclosed. Excluding the one-time recognition, growth would be 35%.

Recurring revenue which we define as subscription revenue plus maintenance revenue now makes up approximately 68% of total revenue compared to 62% a year ago. Our cloud business is growing ahead of our initial expectations with a revenue mix shifting significantly in favor of subscriptions over licenses. Subscription margins were similar to last year's first quarter at 46%. As we said on our last call, we expect margins to grow over time but we anticipate quarterly fluctuations as we continue to make investments in this area to support our growth. With a high level of activity in both signed customers and prospects, we increased capacity in our cloud operation centers during the quarter which caused a quarterly margin to come down slightly from the fourth quarter. License revenue came in less than planned at $3.9 million versus $6.9 million last year. Foreign currency had a negative impact of $200,000. And last year's first quarter included a benefit of $900,000 from prior period deferrals versus only $150,000 this quarter. During the first quarter, we closed no license deals greater than $300,000 compared with five last year.

Maintenance and other revenue totaled $32.8 million compared with $33.4 million last year. Foreign currency had a negative impact of $500,000. On a performance basis, maintenance revenue was relatively flat year over year. We are pleased with our maintenance performance especially given the ongoing shift towards the cloud. Professionals services revenue was $17.1 million versus $19.6 million last year. Foreign currency had a negative impact of $400,000. Services revenues was lower than expected due to delayed project starts which resulted in lower utilization. Total revenue by vertical for the quarter was high-tech and industrial 34%, automotive 32%, consumer product and food and beverage 19%, and life sciences 15%. By geography, North America was 45%, EMEA 30%, Asia Pacific 18% and Latin America 7%.

Gross profit for fiscal 2017 first quarter was $33 million or 51% of total revenue versus $37.2 million or 54% of total revenue last year. The decrease in gross margin was attributed to the lower utilization in services business as well as license revenue contributing a smaller percentage of our total revenue. Sales and marketing expense was $16.9 million or 26% of total revenue compared with $17.1 million or 25% of total revenue last year. Currency had a $200,000 favorable impact. R&D expense was $11.1 million or 17% of total revenue for the first quarter of 2017 compared with $10.7 million or 16% of total revenue for last year's first quarter. Currency had a favorable impact of $100,000. R&D headcount additions contributed to the increase in expense. General and administrative expense was $8.0 million versus $8.4 million last year. As a percent of revenue, G&A expense was 12% in both periods. Currency had a favorable impact of $100,000.

Total operating expenses amounted to $36.2 million or 55% of total revenue compared with $36.4 million or 53% of total revenue a year ago. Currency had a favorable impact of $400,000. Equity compensation expense was $1.6 million for the fiscal 2017 first quarter versus $1.3 million for the prior-year quarter. This bring our operating loss to $2.9 million versus operating profit of $760,000 for the last year's first quarter. Other expense was $900,000 compared with zero in the prior-year period. Foreign exchange from the revaluation of US dollar short-term balances held in foreign entities had an unfavorable impact of $700,000 due to the dollar declining against all of the currencies in these foreign entities. Net loss totaled $2.7 million or $0.15 per Class A share and $0.13 per Class B share compared with net income of $549,000 or $0.03 per diluted Class A share and $0.02 per diluted Class B share last year.

Our tax rate for the first quarter of fiscal 2017 was 28.1%. For fiscal 2017, we anticipate a tax rate of 40%. Non-GAAP net loss which is described in greater detail in the press release we issued earlier today was $1.3 million or a loss of $0.07 per Class A share and $0.06 per Class B share. For the last year's first quarter, non-GAAP net income was $1.6 million or $0.09 per diluted Class A share and $0.07 per diluted Class B share. We ended the first quarter with cash and equivalents of almost $140 million, up from almost $138 million at the end of fiscal 2016. Accounts receivable equaled $44.8 million versus $51.2 million last year. Our days sales outstanding using the count back method were 65 days for the first quarter of fiscal 2017 compared with 73 days one-year ago. Our receivables quality remains healthy.

Our deferred revenue balance at April 30, 2016 was $92.6 million which included deferred maintenance of $73.6 million, deferred subscription of $15.8 million, deferred professional services of $2 million and deferred licenses of $1.2 million. Our deferred revenue balance was $91.4 million at this time last year which included $75.7 million of deferred maintenance, $12.1 million of deferred subscriptions, $1 million of deferred license and $2.6 million of deferred professional services. Generally maintenance contracts are billed annually and subscription contracts are billed quarterly. On a constant currency basis, deferred revenues were $93.6 million at the end of fiscal 2017 first quarter. Currency negatively impacted deferred revenue by $1 million. Cash flow provided by operations was $1.1 million for the first quarter of fiscal 2017 compared with $4.3 million a year ago.

Moving to guidance, we are updating our full year guidance to reflect both our first quarter results and the increased velocity of the shift to the cloud. This shift effects both our top line, as cloud agreements do not generate revenue immediately and our bottom line, as commissions are expensed in the current period and our variable compensation structure is weighted toward cloud achievement. In addition, as mentioned before, our services business has been experiencing lower than historical utilization. While we expect this to normalize over time, we expect services profitability will be challenged in the near term.

For the full fiscal 2017 year we now anticipate total revenue of $277 million to $283 million including $50 million to $53 million of subscription revenue. We expect subscription revenue to grow approximately 30% on a yearly basis, GAAP earnings per share of approximately $0.04 to $0.14 per diluted Class A share and $0.03 to $0.13 per diluted Class B shared, non-GAAP earnings per share of approximately $0.38 to $0.48 per diluted Class A share and $0.31 to $0.41 per diluted Class B share and stock-compensation expense of approximately $7.3 million.

Our business outlook for the second quarter of fiscal 2017 includes total revenue of $67 million to $69 million including approximately $12.2 million of subscription revenue, a GAAP loss per share of $0.08 to $0.06 per Class A share and $0.07 to $0.05 per Class B share. Non-GAAP earnings per share of $0.03 to $0.05 per diluted Class A share and $0.02 to $0.04 per diluted Class B share.

As a reminder, in calculating the tax effects included our non-GAAP business outlook. We have adopted the use of a 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, stock compensation of approximately $2.4 million.

And that concludes my remarks, Karl. Back to you.

Karl Lopker

Okay, thanks, Daniel. While we had another exciting quarter in terms of cloud activity and it continues to impact our license revenue, we have a focus on increasing cloud subscriptions even at the expense of licenses and maintenance. In addition, license activity was also impacted by the cyclical slowdown in the growth and manufacturing. Our services revenue declined due both to currency and delays in the start based to the few larger engagements and mainly in North America and also resulted in a loss of utilization.

In particular, one large deal was approved and planned to start on the day it was delayed due to reorganization by the customer. Our services funnel is strong and we believe we will have better results in this area in the second half of the year. We added six new cloud sites in the quarter, more significantly as a fact that half the value of our cloud bookings came from life sciences, an area where we traditionally receive a number of smaller deals.

While our total sales funnel is flat with last year at this time, cloud increased to more than 55% of the deal. A number of those deals are over $1 million in annual contract value and take time to close and roll-out, although we also see a good mix of medium sized opportunities also. Maintenance revenue was flat in constant currency, despite the effect of cloud conversions and renewal rates are consistent with past experience. However, conversions from on-premise to the cloud are putting more pressure on this revenue line going forward.

On a regional basis, North America was weaker than usual, mainly due to large cloud deal had slipped and is since closed. While our life sciences was our best performing vertical this quarter, over the last year automotive was our top vertical due to the continued strength of the automotive industry while industries that rely on the price of oil have stagnated or declined. Full-time employee headcount was up at 1,715, up around 2% from last year although the personnel expense was only up around 1%. The increase was mainly on our cloud operations development and services.

Now I'll turn the call over to Pam for a closer look at our QAD cloud activity. Pam?

Pam Lopker

Great. Thank you, Karl. As Karl mentioned, we had a very good cloud quarter. The big news this quarter was the larger number of deals from existing cloud customers buying based on successful pilots and rollouts. In addition to that, we have six new cloud customer wins, three net new customers and three conversions. New customers were distributed across all verticals, auto, life science, consumer products and industrial.

We are also pleased to see our life sciences wins were of significant value from large established companies versus the typical smaller startups that makes the bigger of deals that we normally get. So for a better color, our net new customer in life sciences came from a very competitive sales cycle including the long list of virtually all of our competitors both on the cloud and on-premise. QAD was chosen based on substantial references in life science, our validation capabilities in the cloud and our global footprint and products capabilities. We expect to see sizable growth in this new customer as their business develops.

[indiscernible] this quarter was from a $100 million consumer product company, manufacturing kitchen and bakeware products. They have been a customer for 15 years and due to the expansion plans, they have determined moving to the cloud would make good business sense in order to help and manage their growth and reduce risk.

I’d also like to mention a couple of highlights from our Explore conference. At Explore we highlighted our new embedded analytics that will be part of our Channel Islands initiative. Almost 70% of our Explore customers indicated that they have potential projects that were on analytics. They also voted with their feet [indiscernible] insight session on embedded analytics, the most attended QAD breakout session.

Showing similar strong customer interest, both our demand and supply chain planning solution, second only to analytics and potential projects reported by the customers and attendees. QAD automation solution was a key area of focus at the event helping our customers reduce time, effort and errors associated with manual processes, but also serves as the backbone for the Internet of Things. Over 60% of our explore customer attendees indicated potential projects around automation solution.

It was also interesting to note that 30% of the Explore attendees were cloud customers which compared to 15% from last year. In addition, another 30% of attendees expressed interest in going to the cloud, so really a tremendous amount of cloud happening in our customer base as well as net new customers who are really seeing a lot of momentum there. Next year Explore will be held in the heart of customer base, Detroit, Michigan on May 8 through 11. I hope many of you can join us there.

Thanks, Karl. Back to you.

Karl Lopker

Okay. Well, thanks, Pam. For this year, we're still seeing a more difficult economic environment as indicated by the low US GDP number in the first quarter. The last half of last year showed a tightening of spending on elected projects that we expect will continue through 2016. Indeed the Global Purchasing Managers Index is showing a stagnating manufacturing economy and is pretty much consistent around the world in both developed and emerging economy. However, we expect to continue to keep up the pace in cloud due to the increased interest in our cloud offering both for ERP as well as our divisional products.

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

Question-and-Answer Session

Operator

Our first question comes from the line of Bhavan Suri with William Blair. Please go ahead.

Bhavan Suri

Hey, guys, thanks for my questions, and it’s good to see the cloud revenue beat and the race. I guess as I look at the commentary or listen to the commentary and think about the business, the bookings number for cloud sounds great, but let me reconcile a couple of things here. You signed six customers in the quarter and last year it was 12 and last quarter was 24, are deal sizes bigger now or how should we think about that given the dynamics of the big bookings number but sort of few customer base?

Karl Lopker

The deal sizes vary all over the board. In the life sciences, generally there are a lot of smaller deals sizes from startup or companies within the first 10 years, but we are also talking about some large automotive companies and the industrial companies that are considering moving to the cloud. So overall I think the deal sizes will increase, but it really varies quite a bit.

Pam Lopker

But I think this quarter probably had over half of our cloud revenue which we did have an excellent first quarter more than several and the other first quarter in revenue, but of course a lower number of net new deals, but over half - approximately half of our revenue this quarter was from existing cloud customers extending their cloud footprint, so we don’t count those and is net new because they are just existing customers buying for another site, buying for another function. So I think we are going to see more of that in the future as we have such a large customer base. As the customer base of cloud grows, we are going to see a lot of emphasis on getting new business or more business from existing customers and that’s going to be somewhat of a trend that those numbers are really up and down depending on the size of the deals.

Bhavan Suri

Yeah, I mean, I guess, so - and we will get to the new versus existing in a second, if we take revenue audit for a second, because the revenue we are seeing is from customers who were sold quarters ago, right, many, many quarters ago because of implementation and the forklift over existing or otherwise, I guess when I look at the bookings number which was high, but you only added 6 net new customers, but those are all sort of forward-looking metrics, because you haven’t deployed them yet, I’m now looking at the 24 last quarter, I’m just trying to reconcile those two pieces?

Daniel Lender

Yeah. Let me answer that. So when Pam was talking about, she used the word revenue, she was really discussing bookings. So, to summarize, I would say that on average, the 60 odd that we got this quarter were higher in value and one of the things that Karl talked about was the fact that our life sciences deals that we got this quarter, which was very strong, were generally bigger in size than what we typically see in life sciences. So that was probably one of the big differences there.

And on top of that, what Pam was talking about is, we did get a number of deals, so we don’t necessarily consider new customers, but they’re existing implementations where customers have been rolling out and furthering their cloud deployment, which added to bookings for the quarter as the billings for those and the revenue for those will come in, in later quarters. I hope that makes it a little bit more clear, Bhavan.

Bhavan Suri

No. It does. And so just a follow-up, thanks, Daniel. And so a follow-up from that is, obviously, the commentary of the mix, new versus existing, it feels like certainly this quarter, you guys see a lot more existing customers and if I have it right, the metric is one-times maintenance gets you 3.5 times the maintenance number as subscription revenue, so bookings were stronger, but that should mean we should see a nice uptick, I’m sorry about the background noise, but we should see a nice uptick in subscription revenue over the next, let’s say, 6 to 18 months because of the shift that we’re seeing to more existing customers, obviously that’s the higher revenue mix, does that sort of logically flow through?

Daniel Lender

Yeah. No. It does and we have -- and I think part of the reason why you’re seeing some of the strength in our maintenance business is the fact that some of the growth in our cloud business is actually coming from customers that have already converted.

Bhavan Suri

Right. I guess I’m looking for, if I look forward though, given that conversion and given sort of that metric, I’m not going to recognize the revenue right away, but if I’m taking maintenance and moving it and get to 3.5 times the amount of revenue at subscription, it feels like maybe you’ve been a little conservative on the growth rates of the subscription line over the next 12 to 18 months?

Daniel Lender

Yes. I mean we’re giving the best vision that we currently have, but obviously there is -- we certainly feel that there is upside going forward.

Bhavan Suri

Okay. And then when I turn to just the overall manufacturing sector, I mean, it’s been under pressure, Asia and then the US and even Europe a little bit, not a little bit, it’s been under pressure for a while, have you seen any pricing pushback at existing customers either on renewal of maintenance or renewal of subscription at all, Karl or Pam, as you talk to customers.

Karl Lopker

We always see pushback on pricing. So I can’t say that’s anything new or anything the result of the current situation. That’s normal I would say.

Bhavan Suri

Okay. And then one last one from me, as you look at life sciences and you look at sort of some of the concerns specifically in the US around drug pricing concerns around the election the one that might happen, how do you guys think about sort of that broader macro and I ask this for all of my companies that sell into the pharmaceutical life sciences space, biotech space, where people might cap pricing or things like that, do you think that’s holding back anyone’s space despite your strong quarter or is that something that we feel like won’t be as regulated as people might be concerned about?

Karl Lopker

Are you talking mainly about life sciences there?

Bhavan Suri

Yeah. Exactly.

Karl Lopker

We don’t really consider that. Life sciences is about 15% of our business, it’s probably about 25% of our cloud business, but either way it works out and I don’t think it’s going to affect us for that reason.

Bhavan Suri

Okay. That’s great guys. Thanks for taking my questions and nice job on the subscription bookings.

Karl Lopker

Thanks, Bhavan.

Operator

And we do have a question from the line of Mark Schappel with Benchmark. Please go ahead.

Mark Schappel

Hi, good evening and thanks for taking my question. Daniel, starting with you and your prepared remarks, you mentioned that the license revenue came in lower than planned and I was just wondering if it came to lower than planned simply because customers decided to switch over to do some cloud deals or did it come in lower than planned, just to maybe some execution mishaps?

Daniel Lender

I think probably the main reason was that the customers are switching more towards the cloud and we have, we didn’t -- not only saw that in the results of Q1, but we’re seeing that as well in the makeup of our funnel and that’s what’s kind of leading to some of our longer-term view in terms of the guidance.

Karl Lopker

Yeah. The other item, non-licenses, I think that weak industrial environment to manufacturing economy is contributing because most of the people that are buying licenses now, they’re adding to their current, either adding to their current licenses or adding new divisions and don’t really want to move to the cloud. So -- and many of those customers are industrial depending on oil. So they’re not really expanding, in fact, they’re just trying to hold on at keeping their revenue flat. So I think that has a lot to do with the -- any growth at all on licenses.

Mark Schappel

Okay, thank you. And then Daniel, from an earnings perspective, it appears that you’re expecting a bit of a hockey stick with respect to your operating margins as the year goes on, and or the fiscal year goes on, where do you expect to see that operating margin leverage as we get into say Q3 and Q4.

Daniel Lender

Yes. So on the earnings side, Mark, a significant factor this quarter, as we mentioned earlier, was the services utilization and as we said, it’s a short-term problem, which we expect it will correct itself certainly into the second half of the year. So we expect to see further benefit there and also as some of the cloud deals that we’ve closed and we’re currently working on close, that revenue obviously will contribute as well in addition to the normal hockey stick that we see on the license business as well. Also, Q1 and Q2 for us in terms of sales and marketing spend that we do carry our two big events in Q1 and Q2, so those have a bit of an additional expense as well.

Mark Schappel

Okay, great. And then Karl one for you here, looking at the cash balance, it’s still up there almost $140 million here, talk to just about your plans to put it to work. Initially, acquisitions were in your intentions, but maybe you can talk a little bit about what you’re seeing on the M&A front and just maybe keeping you from pulling the trigger?

Karl Lopker

Where I want to spend the money is increasing our infrastructure for the cloud because of huge demand, that’s where I want to spend it. We also look at acquisitions occasionally but haven’t found anything that’s really got us to move. But in this environment, you do need a good safety cushion. We like to have that part too.

Mark Schappel

Okay, thank you.

Operator

And we do have a question from the line of Jeff Captain from Stifel. Please go ahead.

Jeff Captain

Hey, guys. Thanks for taking the question. Just wanted to touch on the professional services business, if you could give any more color on, Karl, the deal deferrals in the Americans that you mentioned during your prepared commentary and when do you guys think that will kind of normalize and makes it get back for the year that would be great?

Karl Lopker

Well, we’ll definitely fix the margin problem in the second half of the year, bit of it will trail over into the second quarter, I’m sure. We’ve already closed a couple of the deals that we thought we’re going to close in the first quarter from a services standpoint, so that’s all relieved some of the pressure, but it’s not like we haven’t been doing anything. We’ve been spending a lot more time in training, so we’re getting more ready for the larger deals when they do close.

Jeff Captain

Got it. Great. Thanks a lot.

Operator

And we do have a question from the line of Richard Davis from Canaccord. Please go ahead.

Unidentified Analyst

Hi, guys. It’s Mark on for Richard, two quick questions from me. First, you called out strength in life sciences in terms of cloud bookings, I was just wondering if there are any verticals that are really underperforming your expectations in terms of either bookings or activity in the pipeline for cloud. And then second on gross margins, is this quarter going to be the bottom for you, do you expect it to march upwards throughout the year? Thanks.

Daniel Lender

Well, on the verticals underperforming our expectation, I know the industrial vertical, because it’s so dependent on oil, is not doing well, I’m not sure it’s underperforming our expectations, because we’ve known about the oil problem for what nine months or so, so we can see it coming, we’re happy that our motivations are strong.

Pam Lopker

I was saying that where we see the most interest in cloud is driven by automotive and life sciences and I think it has to do with the global and regulatory requirements and so people that are on premise, lot of small CP customers or industrial customers, they don’t have the reason to go to cloud the way that automotive and life sciences. Certainly, we have a good showing for our whole customer base that whereas life science is only 15% of our customer base on-premise, so it’s 15 – I mean, 25 to 30 in the cloud and automotive does also represent a higher proportion, it might be – please don’t quote me on those numbers, but it maybe 30% on-premise and 40% in the cloud. So we do have higher representations of two verticals.

Karl Lopker

As you far as your question on the margin, I do believe this is a low-point. We invested ahead of some larger cloud deals, and we have sold some, so that margin should be able to increase, if I am not correct Daniel will let me know.

Unidentified Analyst

Okay. Thanks guys.

Operator

And our last question comes from the line of Michael Morosi from Avondale Partners. Please go ahead.

Michael Morosi

Hi, guys. Thanks for taking the questions. First for Daniel, did I hear you correctly in saying that the assumed tax rate for this year will be 40%? And I believe that’s higher than previously, and so can you maybe just talk about some of the factors there?

Daniel Lender

Yes, you did here correctly, Michael. Our tax rate is affected by a number of items like withholding taxes between a number of foreign jurisdictions and so forth that are not related to our income level in those jurisdictions or elsewhere. So given the fact, when we have an overall lower operating profit, what is happening is that those particular items end up being a higher percentage of the overall bill and as a result of that, the tax rate goes up. If we do perform better than expected, then you would expect the tax rate to come back down.

Michael Morosi

All right. Thanks for that. And then with respect to subscription margin, I was wondering if you could just walk me through some of the levers for continued upside. I know you have been investing a lot in the business, but when should we expect some of that leverage to show through? And also just a little bit longer term, if you can talk about the trajectory and the ultimate ability to meet or exceed corporate average gross margins.

Daniel Lender

Yes, we made significant progress on that front last year and as we’ve talked before, we are continuing our focus in making gradual improvements there. We do have some ups and downs that we have talked before. In this quarter, we opened another data center for some of our backup capabilities in addition to making a number of investments for some upcoming cloud business that we saw in the pipeline. There is some lead time in order to be able to get the hardware and everything else in there. So we do see some ups and downs. We are – the areas, some of it is technical around the utilization of resources and so forth where we are making – we have done a lot of automation and we’ll continue to do that in order to optimize those areas. Also our cloud operation centers that support that business, they are becoming more and more efficient, both as a result of the overall size of the business, but also our ability to utilize efficiently offshore resources. So those are kind of the main drivers that are going to be helping in driving those costs to more normalized levels. As we have mentioned before, our longer term target in that area is around 60% mark.

Michael Morosi

Thanks for that. And then finally with respect to growth in the cloud side, it seems like you continue to get some nice uplift from existing cloud customers. So how would you expect the typical cloud contract to evolve overtime? And to the extent that there is upside to the initial contract value, if you could just across that customer base maybe quantify the potential for upside overtime.

Karl Lopker

Everybody wants to talk. Pam, you first.

Pam Lopker

Okay. I will take it. Well, typically we see an increase in new users that corresponds to growth in global manufacturing, and as Karl mentioned, that’s been slow due to the economy. So given a steady state, you should expect to see that 3% to 4%, 5% increase based of a growth of the economy. But depending on what we sell, for selling a small startup life science and that kind of a risky adventure [indiscernible] and then again they make a lot of business. But many of our customers that we have sold or just use an example, we sold early on Nexteer. Nexteer was a several billion dollar automotive steering company, a spin-off of Delphi and when we first sold them we sold them for a pilot in Poland and a so couple hundred users in Poland. And based of the success of that, they rolled out on a global basis and now there maybe 1,200 to 2,000 users. So that type of sale, that growth that drives that large growth and so depending on our balance customers, if we can sell many more large customers doing pilots, which they do, it’s not like a work they are -- salesforce where they make you buy for your whole company all at one time and you’re not going to buy for a particular division or particular plant or a business, it’s a bit different than that because they can buy for a division or particular plant and based on the success of that rolling that out. So we do believe overtime that those rollouts will be a big part of our business that’s getting the exact balance of that, really depends on the mix of customers that we sell in the quarter. I guess that was long-winded, but there you go. Thanks.

Michael Morosi

No, that was comprehensive. I would appreciate that. And then if I could just one more, how has the customer reception been coming out of the Explore Conference, there is obviously a lot of excitement around cloud and some of the new applications. What has the feedback been since?

Pam Lopker

Well, I got to say, I do these platinum meetings every conference, which I spent like an hour with various customers over two days, so I don’t know how many I deal with, ten [indiscernible]. I get all the softballs, everybody is happy, they are going to the cloud, I go why didn’t I get any tough problems, but maybe they went to somebody else. But I did, it was very exciting, the momentum and the excitement around going to cloud and really seeing that turn with some very large customers that we never thought would consider the cloud now, they are saying, yes, we are interested. So I think that momentum has moved dramatically towards the cloud in the last few months. Karl, Daniel, I don’t know what you have to say about your interaction with customers.

Karl Lopker

Well, I got a couple of customers that had the tough questions for me, but now most people surprise me at their acceptance of the cloud this time. I mean, it did happen that some customers said we never considered, but all of a sudden send me a proposal and we have to justify it, but they are giving us a chance to go in there and get them on the cloud.

Michael Morosi

It’s great. Thank you.

Karl Lopker

Operator, any more questions?

Operator

There are no further questions in queue, sir. Please continue.

Karl Lopker

Okay. Well, thank you everyone for your attendance and many questions. We’ll update you again in August with our second quarter results. Good-bye for now.

Operator

And ladies and gentlemen, this conference will be available for replay after 4:00 pm Pacific today through May 26. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 entering the access code 389838. International participants may dial 320-365-3844. And those numbers once again are 1-800-475-6701 and 320-365-3844, again entering the access code 389838. That does conclude your conference for today. Thank you for your participation and for using the AT&T executive teleconference service. You may now disconnect.

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