Kinaxis'(KXSCF) CEO John Sicard on Q2 2019 Results - Earnings Call Transcript

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About: Kinaxis Inc. (KXSCF)
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Earning Call Audio

Kinaxis, Inc. (OTCPK:KXSCF) Q2 2019 Earnings Conference Call August 2, 2019 8:30 AM ET

Company Participants

Rick Wadsworth – Vice President-Investor Relations

John Sicard – President and Chief Executive Officer

Richard Monkman – Chief Financial Officer

Conference Call Participants

Richard Tse – National Bank

Thanos Moschopoulos – BMO Capital Markets

Robert Young – Canaccord Genuity

Paul Treiber – RBC Capital Markets

Stephanie Price – CIBC

Paul Steep – Scotia

Daniel Chan – TD Securities

Deepak Kaushal – GMP Securities

Kevin Krishnaratne – Paradigm Capital

Suthan Sukumar – Eight Capital

Operator

Good morning Ladies and gentlemen. Welcome to the Kinaxis Inc. Fiscal 2019 Second Quarter Conference Call. [Operator Instructions] I’d like to remind everyone this call is being recorded today, Friday, August 2, 2019. I will now turn the call over to Rick Wadsworth, Vice President of Investor Relations at Kinaxis. Please go ahead Mr. Wadsworth.

Rick Wadsworth

Thanks, operator. Good morning, and welcome to the Kinaxis earnings call. Today, we will be discussing our second quarter results, which we issued after close of the market yesterday. With me on the call are John Sicard, our President and Chief Executive Officer; and Richard Monkman, our Chief Financial Officer.

Before we get started, I want to emphasize that some of the information discussed on this call is based on information as of today, August 2, 2019, and contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the forward-looking statements disclosure in the earnings press release as well as in Kinaxis' SEDAR filings.

During this call, we will discuss IFRS results and non-IFRS financial measures. A reconciliation between IFRS results and non-IFRS financial measures is available in our earnings press release and in our MD&A, both of which can be found in the Investor Relations section of our website, kinaxis.com, and on SEDAR.

Participants are advised that the webcast is live and is also being recorded for playback purposes. An archive of the webcast will be made available on the IR section of our website. Neither this call nor the webcast archived may be rerecorded or otherwise reproduced or distributed without prior written permission from Kinaxis.

To begin our call, John will discuss the highlights of our quarter as well as recent business developments, followed by Richard, who will review our financial results. Finally, John will make some closing statements before opening up the line for questions.

I'll now turn the call over to John.

John Sicard

Thank you Rick. Good morning and thank you for joining us today. I'm pleased to report second quarter results that continue to support our strong growth outlook for the year. On a comparative basis, during Q2 we grew SaaS revenue by 18% to $28.3 million. We grew total revenue by 9% at $42.4 million and we delivered adjusted EBITDA up 27% of revenue.

We closed a number of large marketing customers in the quarter and also expanded upon existing deployments. This new business has driven a record setting backlog for Kinaxis and continues to fuel my confidence in hitting our full year growth outlook. We are thrilled to have earned the trust and confidence of companies in every geographic region during the quarter, including recent announced the Johnson Electric and Yamaha.

Today, I'm happy to share that Guardian Glass was also included in the group of new customers that we added in Q2. These successes demonstrate that the importance of digital supply chain transformation in the market continues to gain momentum and that Kinaxis is uniquely positioned to address this need using our powerful concurrent planning engine.

During the second quarter, we also signed another major strategic partnership. We have teamed with global consulting and digital services leader Infosys, who operates in 45 countries and have a strong supply chain practice serving our core verticals. Infosys compliments our growing group of strategic partners including Accenture, Deloitte, EY and Genpact. Together, our partners help scale our implementation capabilities to support our growth and continue to be key influencers in helping us win new business.

As in previous quarters, partners continue to influence the majority of our new customer wins in every theatre. In addition to having growing customers recognize our differentiated value, we are pleased to see that Gartner continues to distinguish Kinaxis as a leader in their latest report on sales and operations planning systems of differentiation. We have been named a leader by Gartner in six consecutive reports related to supply chain planning, which is a testament to the distinctive value we provide to the market.

In short, our successes in Q2 are the result of executing on our sales strategy, our partner strategy, and our ability to delight our growing customer base with proven value. Our pipeline remains very strong and our confidence remains very strong. As always, we are razor focused on the long-term sustained success of Kinaxis.

With that, I'll turn the call over to Richard Monkman for an overview of the financials for the quarter.

Richard Monkman

Thank you, John and good morning. As a reminder, unless otherwise noted, all figures reported on today's call are in U.S dollars under IFRS. On a comparative basis, total revenue in the second quarter increased 9% to $42.4 million driven primarily by SaaS revenue, which grew 18% to $28.3 million. This growth was due to contracts secured with new customers as well as the expansion of existing customer subscriptions. We recorded 2.4 million of subscription term license revenue in Q2 which was consistent with our previous commentary on the expected cadence of customer-hosted subscription renewals throughout 2019.

As we've previously noted, given these customer renewal cycles, description, term license revenue will vary quarter-to-quarter. Our professional services revenue was 13% lower compared to 2018 at 8.4 million. Professional service revenue varies quarterly based upon a number of factors, including the number, size and timing of customer projects, as well as the level of deployment engagements supported by our partners.

Overall, we remain very pleased with the diversity of our revenue base. For the year-to-date, our 10 largest customers accounted for 37% of total revenues with no individual customer accounting for greater than 10% of total revenues. Geographically for the year-to-date, we are seeing an increased percentage of our revenue coming from both Europe and Asia, which is consistent with our recent investment in these regions.

Gross profit grew 11% to $29.4 million or 69% of revenue, compared to 68% in Q2 2018. This increased resulted from growth in SaaS revenue, partially offset by an increase in cost of revenue such as related headcount, partner and third-party cost, and higher depreciation costs associated with the expansion of our data center capacity. The profit decreased 6% during the quarter to $4 million or $0.15 per diluted share, compared to $0.16 per share in Q2 2018. This change reflects the results in higher operating costs, given our accelerated level of investments in sales, product and global operations.

These investments were primarily additional headcount and higher expenses related to sales commission and marketing activity. Adjusted EBITDA for the second quarter grew 5% to $11.6 million or 27% of revenue compared to 28% in the same quarter of 2018. The increase in adjusted EBITDA is due to an increase in revenue and gross profit, partially offset by the increases in operating expenses, excluding stock-based compensation and appreciation.

Cash from operating activities decreased 4% to $8.8 million, largely due to recognition of the deferred revenue balances and payment of income taxes during the quarter. For the six months ended June 30th, 2019, cash, cash equivalents and short-term investments grew by $19.4 million to $200.9 million. Our minimum contracted revenue backlog as of June 30th, 2019 was a record $247.3 as detailed in Note 12 to our financials. This amount includes future contracted SaaS, maintenance and support and subscription term license revenue. The vast majority of this backlog was the $229.3 million related to future SaaS revenue.

The total backlog amount will be recognized over a number of periods as follows: $64.3 million will be recognized in the second half of 2019 of which $57.7 million relates to SaaS. Backlog for fiscal 2020 is $87.9 million, of which $81.7 million relates to SaaS business, and the remaining $95 million will be recognized in fiscal 2020 and thereafter of which $89.9 million relates to SaaS. I'm pleased to note that our six months SaaS backlog together with our year-to-date SaaS revenue of $55.6 million totals approximately $113 million and forms the bases for continued confidence in our 2019 SaaS revenue guidance of 20% to 22% growth.

Total bookings in Q2 were $46.8 million of which SaaS bookings were $45 million. We were very pleased with this performance, as you know bookings will remain variable between periods as they depend upon the timing of customer decisions. Our backlog metric is based upon the minimum revenue contracted at the end of the quarter. As such is clearly related to the timing of the signing of the customer contract. Trade receivables and deferred revenue balances, our accounting cycle metrics which are driven by the timing of invoice. As customer purchase orders are not always issued concurrent with contract signing, the issuance of customer invoices, especially for late quarter deals may not be fully reflected in trade receivable and deferred revenue balances as at the end of the quarter. This was the case in the second quarter.

Regarding our current year investment plans, and particularly our accelerated investment in sales and marketing, we continue to expect that sales and marketing will be in the 24% to 26% range of total revenue. With our product team expansion and new product innovation investments, we continue to expect that research and development will be in the range of 18% to 20% of total revenue. Based on these results and our business outlook, we are pleased to reaffirm our guidance for fiscal 2019 which includes, total revenue of $183 million to $188 million, SaaS revenue growth with 20% to 22% over the 2018 amount of $97.2 million, subscription term license revenue of $22 million to $24 million for the full year, approximately 40% to 45% of that full year amount will be recognized in Q4.

Full Year adjusted EBITDA margin of 25% to 27% of revenue and our aggressive hiring plans for both sales and marketing and research and development remained underway. Capital expenditures of $11 million to $13 million range, the majority of which were invested in Q2 on planned data center expansion in R&D investments.

Thank you for your continued support of Kinaxis. And with that, I turn the call back over to John.

John Sicard

Thank you, Richard. In summary, we are pleased with our progress in the first half of the year and believe we are well, very well positioned to deliver on our full year targets. I'm encouraged by ongoing sales activity, the growth of our stable of top tier partners and their level of engagement, our ongoing product innovations and the results in growth and awareness of Kinaxis. Most of all, I am humbled and encouraged by the top quality brands who continue to trust Kinaxis with their supply chain transformation initiatives.

On behalf of Kinaxis, I would like to thank you for your support, as always for taking time to join us on the call today. With that, I'll turn the line over to the operator for Q&A.

Question-and-Answer Session

Operator

Thank you, gentlemen. [Operator Instructions] Our first question comes from the line of Richard Tse of National Bank. Your line is open.

Richard Tse

Yes. Thank you. It was great to see the backlog. I'm just kind of curious, as you're bidding on these deals, have you seen any change in the macro environment? Certainly, that backdrop has been a bit volatile of late, kind of curious to see what your thoughts are on that.

John Sicard

Yes. Richard, we’re definitely seeing, I'd say more focus on digital transformation and more focus on looking at supply chain improvements. And we're seeing that in every theatre that we focus on, and frankly, in every vertical. When we look at our current pipeline, it remains very strong and very evenly balanced across the six verticals that we're in, so we're definitely seeing the market heating up.

Richard Tse

Okay. And in regards to that – the pipeline, is there any way you can maybe help us sort of quantify the coverage of that pipeline perhaps what it is today versus what it was relative to last year? Just trying to, I guess get some comfort around this reacceleration here notwithstanding your comments on the backlog.

John Sicard

Yes. Well, certainly what I – if I compare our pipeline today versus 12 months ago, it is much more evenly distributed between North America, Asia and Europe. And a year ago, I might've seen the Europe as a slightly depressed in comparison. And part of that was our focus, if you recall a year ago, we made a very definitive decision to invest in Europe as a primary geography. And the results has been a strengthening of the pipeline. I would say, today we're seeing more strength in aerospace and defense than we were for example a year ago, these are what I call macro level differences. And overall the pipeline remains as strong today as it was, certainly as it was a quarter ago.

Richard Tse

Okay. And just one last one for me. I think you said the majority of your wins are influenced by partners. Could you maybe give us a sense of what that would compare to, again, relative to last year? And I guess related, how many partners do you think you need to sort of be at the point where you can sort of just mine that base without having to add more? That's it. Thank you.

John Sicard

Yes, great question. And so, when I compare partner influence today versus a year ago, it's higher. It has continuously – every quarter seems to be gaining some momentum there, which is very healthy. Our opinion about partnership is, these aren't, what I would call marketing relationships. The partners that we signed are ones that have a very specific desire to grow or practice around rapid response and practice around concurrent planning. And so these are very serious engagements for us. In many cases these are partners that have existing customers or prospects that are looking at supply chain transformation.

And so this is what's fueling the relationships that we've formed. I don't know that I would say there's some specific number, we always have partners that I would call on the incubation period where we're talking to them, there is a relationship brewing, when we make an announcement such as Infosys, it's because of we've signed an agreement. It's not just a verbal agreement, we've signed an agreement with them and it’s a serious activity and serious collaboration occurring between us. So I can’t honestly say that, we're at the pinnacle point and we're no longer accepting partnerships, that is not the case because there are always interesting, not only large, but I'd say interesting boutique firms that have very specific areas of expertise and those we're always interested in.

Richard Tse

That's great. Thank you.

John Sicard

Thank you.

Operator

And your next question comes from the line of Thanos Moschopoulos of BMO Capital Markets. Your line is open.

Thanos Moschopoulos

Hi, good morning. John, you're achieving a high 20% EBITDA margin, which on the one hand is obviously fantastic, but on the other hand, it makes me wonder if you're reinvesting enough back into the business, given the huge market opportunity ahead of you. And I realize it might be too early to talk about 2020 and beyond. But maybe in more general terms, how are you thinking about the right level of spending and the careful balance between investment and margins?

John Sicard

Yes. So we're always going to be focused on growth first, always. And as I stated last – in the last quarter, we are accelerating our spent in sales and marketing and on the products team quite frankly. And so we continue to focus on that, we have opened head count in every theatre and our expectations, as Richard pointed out on the sales and marketing, our expectations is that we'll hit that level of investment of 24% to 26%.

Thanos Moschopoulos

Okay. And John, given that some clients are looking at broader transformation initiatives, as you alluded to that are probably extending beyond just the planning piece. I imagine deals are getting more complex and is that leading to a change in sales cycles at all?

John Sicard

We're not seeing a change in sales cycles frankly, we – it is one of those measures I look at somewhat as a leading indicator to get a sense for the market maturity. But these are quite important decisions when someone is looking at a supply chain transformation or a digital transformation, they're making a decision that'll affect the next 20 years or longer. And so, we're still sort of seeing that an average kind of an 18 month window as they go through the interest and intrigue phase, the trust and confidence phase and ultimately the deployment, selection and deployment phase.

So we're not necessarily seeing a shift, we are seeing, I'd say some degree of more breadth in some of the deployments, the notion of concurrency expanding beyond sort of demand and scheduling and moving more into capacity and production scheduling and things of that nature. So we continue to see a broader footprint, not only with existing prospects, but also with our current customers and current deployments.

Thanos Moschopoulos

Great. And then finally, how do you feel about your deployment capacity? I mean, obviously you've brought on a lot of new partners, but in terms of where you are with respect to onboarding them, relative to the geographies where you're closing some new deals. Has that deployment capacity been able to scale to support the growth or has there been any bottlenecks that you need to address?

John Sicard

Yes. There is – it's a great question. And some of this I would say is a region specific. In Asia Pacific, we are hyper focused on growing that particular area, we're seeing a lot of activity and, so we're very focused on maturing and growing the talent pool available for deployments, as it relates to partners. We have 100s of people with certifications now outside of Kinaxis, there are 100s of people, that have gone through certifications, there is certifications that we have given out now are measured at well over a 1,000, I don't know the exact number off hand here, but I know there are 100s of – there is 100s of consultants out there already across our customer base.

And there is never a month that we're not doing training, all the training is done digitally. certifications are done digitally. So we've prepared for scale and if anything it's region specific, as deals crop up in certain theatres, making sure that we have enough coverage from the partner ecosystem to do the deployments. We're also involved in our own deployments, there are occasions where we have customers who prefer to use us as prime and certainly we have projects today, we're the prime deployment agent and we'll continue to grow professional services to make sure that our customers are receiving the service levels that they're looking for.

Thanos Moschopoulos

Great. I'll pass the line. Thanks.

Operator

And our next question comes from the line of Robert Young of Canaccord Genuity. Your line is open.

Robert Young

Hi, good morning. In the comments earlier on the funnel, I think you said it was as strong today as it was a quarter ago. Of course this quarter you converted a bunch the funnel into backlog. So were you making that comment specifically to say that there is activity in the funnel in the near-term that could continue this kind of growth in backlog we've seen?

John Sicard

Well, we're continuously monitoring, what I would call unsolicited inbound leads, which continues to be strong, we're involved in a lot of events in supporting a lot of events today. And we're also building the AE team and building the sales – our sales capacity and those have a direct impact on the number of prospects that we have to work. We still have well over 2,000 in our TAM. And we haven't tapped the mid market for example yet. So we continue to look at opportunities to grow the TAM as we grow the sales team. And so, I would say I'm very happy with the pipeline today. I'm happy with the diversity in geography and the spread across all of the – all the market verticals, it's just plain, very healthy.

Robert Young

Okay. I think a lot of people will try and understand how the timing of the investments in the channel and the expansion in sales, how that's going to benefit the financials. And so if I think about the strategy, you added a channel over the last several years to take pressure off of pro services to get in front of more deals, to expand your capacity. And then now you've expanded sales to improve Europe, specifically, but to convert more of that activity that you're seeing out of the channel. Then – so what’s the next step? Like, when do some of the activity or the sales force, when does that start to fall into actionable deals? Is there any kind of timing you can help walk investors?

John Sicard

Yes. Obvious, when we hire an AE and I think about AE coverage, right, I look at the pipeline, I look at the maturity of the pipeline and where they are in the funnel and we've been at this a very, very long time. So we feel like we have some science behind how, what I would call, deal flow and velocity, deal velocity. So when we – we stated last quarter that we were investing – accelerating our investment in sales and marketing ahead of even where we were on January 1, okay. So we were not far into the year and we realized that we were seeing, what I would call, forward momentum in the market and making those investments in sales and marketing.

Now, again I go back to what is the average deal cycle and we still see it at the 18 months kind of a range, some are a little sooner and some – I mean some are measured in years, quite frankly. Some are just staggeringly long, but some are fast. But in any case the reason for us making those accelerated investments is noted measurement of momentum that causes us to say, we – if we don't make these investments now, we'll have a coverage problem 18 months from now, think of it that way. So we're making the investments now knowing the need for coverage and we continue to monitor those, what I would call, forward looking measurements, as it relates to making our – placing our investments.

Robert Young

Okay, that's helpful. And you said that you had activity in every major theatre, every major geo, I assume that's the same as that. Should I assume that it's like North America, Europe and in Asia? Or would there be something more granular? And then it seems as though that North America seems to be lagging a little bit now, it may be that Europe and Asia have been accelerating it, so North America just doesn't look as good. But is there investment in these happened in North American in the sales force? And then I'll pass the line.

John Sicard

Yes. So Rob, we're making investments in every theatre, North America, Europe and Asia in sales. And as you can appreciate not every customer would allow us to make a selection announcement, we’re obviously please to have Johnson Electric, please to have Yamaha and today announcing Guardian Glass and there's others and some will allow us to make an announcement and as press releases are approved we ship them out, the moment press release is approved, you'll hear about it. And in some cases we have customers who won't do a press release and tell they are alive, and in some cases they won't do a press release at all. They don't want any of their competitors to know that they are transforming their supply chain with Kinaxis. So just to answer your question, every theatre is active, every theatre is seeing a very healthy pipeline, in every theatre we're investing in sales and marketing.

Robert Young

Okay. Thank you.

Operator

And your next question comes from the line of Paul Treiber of RBC Capital Markets. Please go ahead, your line is open.

Paul Treiber

Thanks very much, and good morning. Just I'm wanted to focus on product innovation for a second and the impact that's having on your customer wins or pipeline. In the past, couple of the announcements you made is on the machine learning, like self-healing supply chain and then the next generation platform that allows apps on top of rapid response. Are you seeing – is that having an impact on your funnel? Are you're seeing customers interested specifically in those new innovations?

John Sicard

Absolutely, we're getting a lot of interest in these areas. And as it relates to our platform initiatives, the ability to extend rapid response without the need of Kinaxis R&D provides our customers the ability to extend rapid response with unique, what they would consider unique to their business capabilities. More importantly, it'll allow partners to engage in producing extensions to rapid response for their customers. So it's – we're heavily engaged in that area. We're certainly, and I made this point in the last earnings call as well, we're making significant investments around the CPG space. And every time we enter a new market, we have exactly one product and that one product serves all markets.

And it's a great leverage point, as we expand into CPG, we continue to make investments in R&D, as it relates to that specific market segment. They have specific analytics needs, specific math needs and we continue to make investments there. And certainly, those investments are paying off in a strengthening pipeline.

Paul Treiber

In regards to the platform and the ability for customers and partners to build applications, are you at the point now where the customers and partners are building the applications and investing in the capabilities to do that?

John Sicard

Well, it's early days. I – we have not made any formal announcements on the platform product – on the platform readiness, it is at a mature state today, we are engaged with partners in that initiative, it's not just a lab exercise today, we have existing partners that are engaged working alongside R&D. And I'm anticipating some rather exciting news by at least the connections conference, which I know you may be attending, so, stay tuned.

Paul Treiber

Okay. We'll wait for that. Just one last one, just trying to bridge between backlog and then guidance specifically on SaaS, if you take a look at the first half revenue combined with the backlog it looks like you only need about $4 million in new bookings for the year to reach the midpoint of your SaaS guidance, what's some of the parts that we should think about, as you progress through the year?

Richard Monkman

Well Paul, thank you for noticing that, and that really is one of the key strengths of our business is that visibility and the ongoing base of subscription revenue. But keep in mind that, while we will close a three year deal, we look at the timing that revenue is in the current year. So you're right, we are in a extremely strong position and it's not unusual though to have deals close later in the quarter. And so therefore, we're factoring that into our revenue guidance. But – and by the way, that backlog is just the minimum committed backlog, so part of the remaining 4% or so to hit the midpoint of our guidance is not only new named customers and expansions, but is also those customers that are scheduled for renewal in the remainder of the year.

Paul Treiber

Okay. Thank you. That's helpful.

Operator

And our next question comes from the line of Stephanie Price of CIBC. Your line is open.

Stephanie Price

Good morning. I think you can talk a little bit more about the reinvestments in 2019 and where we are in the process and how we should think about those investments kind of scaling in the back half of the year?

Richard Monkman

Thank you, Stephanie. So the focus is first on sales and the sales and marketing. And as we noted earlier, we're in the process of accelerating beyond our original growth plans. And so those primarily are an increase in not only the account executive, the selling representative, but then also the team that supports the AE. And so, these are industry of principle people that understand the specific verticals that we're in, as well as increased technical people. So that whole team is scaling in tandem. We've also – with the recruitment of Andrew and team, we are accelerating our product innovation. And so we have made significant new hires on the product team and in fact are accelerating and bringing in some of the planned growth from 2020 and product into 2019.

So those are the two key areas. We made significant investments in the data center infrastructure last year in the early part of this year, and so we're very comfortable with that capacity. And – but we will be also expanding our global support team into the theatres further. So it's really investments across the board, but primarily focused on the selling and on the product side of things.

Now, one thing that's very exciting is that – and we just announced that with the growth in particularly in our Ottawa headquarters, we have come to an agreement on a new facility. And so, we will be moving into that facility in 2021, so we're in the early stages, that’s not going to have an impact on the – material impact on the financials this year, however, it has demonstrated our commitment to Ottawa, as well as the rest of the other theatres and is creating quite a bit of excitement in the community.

Stephanie Price

Great. Thank you very much. And then in terms of the Infosys partnership, wonder if you could expand on that a bit more about the regions and verticals that the partnership is going to be initially focused on?

John Sicard

Yes, so there – I mean this is, Infosys is a tremendously mature firm as it relates to supply chain. And as I mention, they operate at 45 countries. And frankly, they operate in every market segment that we do. So there'll be no restriction in terms of what theatre we will work with them on, and there’ll be no restriction whatsoever on which market vertical they wish to engage. And they're quite strong in every one of them.

Stephanie Price

Perfect. Thank you very much.

Richard Monkman

Thank you.

Operator

And our next question comes from the line of Paul Steep of Scotia. Your line is open.

Paul Steep

Great. Can you talk a little bit about – you talked about up sell into existing accounts, maybe talk about what you've seen in terms of one module adoption in further up taking those clients? And then maybe secondly, the trend in net revenue retention, how that's trending in terms of both, not just expansion of the client but also maybe price uptake? Thanks.

Richard Monkman

Sure, Paul. Thanks for the questions. So let's – I'll start with the net revenue retention, again it remains over 100%. That's one of the depths that we have and the stickiness if you will with our customers. And yes, it is generally the case, that there is an increase on renewals in terms of the pricing. But the primary growth vectors, if you will for expansion, it's still about one-third of our incremental revenue comes from customer expansions. It’s just a deeper penetration within the customers.

So that includes everything from additional users or seats if you will, to recall, one of the key elements of support that we provide is ability to model sites, manufacturing center, distribution center, so customer is securing additional sites as well as on the application. So we're fortunate that we have a number of those drivers for the expansion. So absolutely it's focus. In fact, we now have dedicated salespeople just on – focused on the customer base and we expect that stickiness and expansion to continue.

Paul Steep

Thank you.

Operator

And our next question comes from the line of Daniel Chan of TD Securities. Your line is open.

Daniel Chan

Alright, good morning guys. I just want to do expand on Paul's question a little bit on the guidance here. Richard, I was hoping if you can give us a little bit of color of how you build it up, obviously with the number of marquee closures that you had in the quarter, guidance remains the same. So when should we expect some of these announcements and these marquee or these big deal announcements to kind of make you drive some of that guidance up higher for the year?

Richard Monkman

Well as I noted in my prepared comments and I think in one of the sort of indirectly, one of the questions earlier is that, Dan, it's not uncommon to see deals later in the quarter, which really means that their contribution even announced deals was not significant in the quarter and therefore what we’ve seen in the outdoors, but this is a trend that continues. So for instance, Q1 closer deals really started tracking revenue, often would start tracking revenue in Q2 and so on.

I think if we go back to the mechanics, so one of the things we've been known for a ever since as a public – being a public company, is that when we do provide subscription guidance, we have the order of 80% of that in backlog at beginning of the year, so in other words in the four or 12 months. And then the three elements to close the remaining 20% of the guidance, our new name wins, expansions and those renewals. So in our minds it's very logical that as you move through the year, you're going to see a tightening of that percentage moving into the end of the 90% range.

Now being at essentially sort of a 96% or so of the full year number, mid-year is a strong basis for our confidence I'll say. But, we know that deals can be lumpy and so therefore we believe that this is the appropriate guidance at this juncture. And of course we will revisit it at our next conference call.

Daniel Chan

Okay. Thank you. That's helpful. I also want to drive it onto your margin guidance. The first half margins have been really strong. Are there a number of investments that you expect to ramp significantly in the second half? If my math is correct, second half EBITDA margins would have to come in at around 21% for you to get to the midpoint of your margin guidance. And we haven't seen that kind of level in H2 since you've been a public company. So are you expecting outsize investments in the second half coming in to drive that margin guidance that we see?

Richard Monkman

Yes, Dan there are few factors there so, yes as a public company, but remember it was 2018 that we were required to adopt IFRS 15 which changes the timing of the revenue for the customer-hosted arrangements, that is primarily driven by the subscription term license. And we've noted that the subscription term license will be considerably stronger in Q4, in fact that's 40% to 45% of that total $20 million to $24 million number that we guided to will be in Q4. As such mathematically, now when you have the first two quarters and you've heard this guidance on the fourth quarter, you will see that our expectation for subscription term license in Q3 is at a lower level.

And as such, that is one of the key drivers for EBITDA performance, gross profit as well as EBITDA performance. So that is a factor that you're going to see a lower EBITDA performance in Q3. But the other key driver is obviously our investment and our spent. And we've talked about the increases across the board, but in particular in sales and marketing, and product. And so these are actually well underway and given that they're heavily focused on people, are going to be sustained through the next two quarters. So yes, we are signaling that we are accelerating our – we'll continue to accelerate our investment in the sales and marketing and you'll see that uptick in the next two quarters.

Daniel Chan

Great, thank you.

Operator

And our next question comes from the line of Deepak Kaushal of GMP Securities. Your line is open.

Deepak Kaushal

Hey guys. Good morning. Thanks for taking my questions. John, Richard, I wanted to just go back to a question from Rob earlier on revenue by geography. So when I look at the U.S. market in particular, the last three years seems like you guys have been stuck for lack of a better word between $100 million and $120 million in revenue. What does it take to unstuck in this market, like does that require a refocus like you did in Europe or a sales and marketing spend about 25% of revenue? How should we think about that?

Richard Monkman

Yes, I can appreciate from the information that you have – that you may come to that conclusion, but that's not really the characterization least certainly that we would see, because first-off this is total revenue, so it's not just subscription revenue, its professional services revenue. The second element is, at least prior to 2018 it included the rate of a level for the subscription term license. In fact you may recall that when on our adoption to IFRS, there was approximately 20 million of revenue related to subscription revenue that we had to retroactively put into our books. And so that is revenue that would have – you would have seen in the future periods. And given our legacy, that was significantly weighted to the North American market.

So it's a combination of factors, but that professional services revenue is down. It is down for the North American customers, particularly given the strength of our partner network and our encouragement of the partners to pick that up. So – but we are also increasing our investment in North America in the sales team, from a relative basis that it was significantly higher in Europe and you could see the results of that already and in Asia.

Deepak Kaushal

Okay. So, so thank you for that. That's helpful. So if we think about 20% or plus overall corporate growth rate going forward, is that going to be equally balanced between North America, Europe and Asia-Pac or do you expect a more outsized contribution from international markets?

Richard Monkman

Well, we do believe it's going to be across all theatres, but given, just from a mathematical base, given the current level of Europe and Asia, one would expect a higher relative contribution in terms of percentage there. As John narrated and we've discussed before, our long-term goal is to see essentially equal contributions across the three core theatres. And so, yes, at least for the midterm, I would anticipate that we will see this higher level of sustained growth in Europe and Asia.

Deepak Kaushal

Got it. Thanks. And then for John more of a conceptual question, we're seeing some fallout in the supply chain from 737 MAX grounding with Boeing. Just conceptually, how does an event like this impact your business? As a business, as usual your existing customers raise a crop of a bunch of new customers or new product opportunities? How does it impact your business? How are you taking advantage of this to expand your opportunities?

John Sicard

Well, frankly our business is always impacted by volatility in the market place, whether its supply shortage or demand spikes or tariff wars, all of these types of things lead to either margin erosion or revenue erosion in both affect our customers. They care deeply about both of those sides of the equation.

So, I would say – as a general statement I can't say that the Max 8 or tariffs or any of those things, we don't necessarily track the pipeline growth associated with specific events like that. I can say that we are seeing a general uptick in market interest in digital transformation that I would say is undeniable based on the measurements that we have in place monitoring the market and monitoring, the pipeline.

So, I guess that's the best way I can answer that question. I don't know that there's a specific correlation between a singular event like MAX 8 or change in tariffs with the growth of the pipeline.

Deepak Kaushal

Okay. Okay. That's helpful. Thank you for taking my question. So I'll pass the line.

John Sicard

Thanks, Deepak.

Operator

Our next question comes from the line Kevin Krishnaratne of Paradigm Capital, your line is open. Please go ahead.

Kevin Krishnaratne

Hey there. Good morning, kind of another question again on the sales cycle. Again, I can appreciate the complexity of these transformations in 18 months window, it’s still there, but I'm just wondering what more on the front-end can talk about maybe the proof of concept stage or as you're getting more mature as you're bringing more partners on, are you seeing any change in how quickly you're able to do the POC, the initial conversation with the customer. How's that going?

John Sicard

Yes, I'd say we're not – haven't seen sort of a remarkable acceleration in the sales cycle, as you can appreciate, our customers tend to be very large, global, complex manufacturers and so their environments are equally large, complex and global. And so running through proof of concepts, often involves, testing environments and testing concurrency across different geographies. It's not just testing one product line in one geography often we'll have customers who wanting us to ensure that our philosophy will span their entire ecosystem.

So I'm not necessarily seeing an acceleration in that process. What we are seeing is, more interest in concurrency. I mean, there was a time people didn't believe, it was possible frankly and now we are seeing a lot more interest in the merits of that technique versus what I would call the legacy technique where you study one supply chain function at a time. In our world we deal with concurrency right at the base and we're pioneers in that field and that's always been our philosophy. So if anything, we're seeing a lot more interest in this technique and our prospects are asking us to expose them to it and to educate them on what life is like for them, once they transform and move into that philosophy.

Kevin Krishnaratne

Okay, great. Thanks for that John. Second one, moving over to partners, can you remind us or just confirming where you are with partner led engagements more on the initiation. Is it mainly the case that a new customer, potential new customer’s first exposure to RapidResponse from a partner they're already engaged with and the partner is suggesting that were or are there still cases where a customer is coming to you and then depending on the vertical or complexity, I know you mentioned your desire for more boutique type of shops where you might direct them to an appropriate partner. And just how do we think about the sort of initiation stage of these eventual partnerships?

John Sicard

Yes, the answer is quite frankly both. There are definitely cases where we'll have a customer engaged with us, either its unsolicited inbound interest or a meeting a large supply chain events, where we initiate the engagement, but rest assured, one of the first questions we ask is, who do you work with from an SSI partner perspective. And so it's quite common for us to engage collaboratively with our partners as we go through a sales cycle and frankly, there are cases where we'll sign a partner and they already have engagements. They have interest from an existing customer of theirs as they are pulling us down.

I'd say – just about uniformly the deal – the progression of a sales cycle happens collaboratively and that is pretty uniform.

Kevin Krishnaratne

Okay, great. And then just last one again on partners, just if you can remind us how we should think about pricing. Like I completely understand that on pricing, I kind you're very firm on that given the great value that you provide, but do you see any instances where say a partner might in a way sort of eat some of the costs as a way to win that end customer as part of a much bigger supply chain mandate. I'm just trying to think about how you think about pricing on a customer’s point of view with a partner?

Richard Monkman

Yes. So thanks Kevin. It's not a model whereby it's seldom a resell. It's a partner influence deal. And, and in most instances the partners are really focused on the long-term professional services level of engagement, they may be the ones already leading that digital transformation. And so see us as the key factor in effecting that change. And in some cases, partners are prohibited for instance, the accounting related from taking any type of a contingency fee. So it's not really a factor and quite frankly our pricing is really driven more on the ROI. And so what we work with the partners is to demonstrate that return on investment. And so it hasn't really – we haven't really seen erosion from that perspective. So we can be extremely competitive and drive that ROI. And so it's not something we buy, we just sell on a resell it's done, but it's not done on a large scale basis.

Kevin Krishnaratne

Got it. Understood. Thanks guys. Pass the line.

Operator

Thank you. And our next question comes from line of Suthan Sukumar, Eight Capital, please go ahead. Your line is open.

Suthan Sukumar

Good morning guys. You've been quite active in adding new channel partners, some of these current partnerships are already positioning you for the mid-market or would you be looking to expand your partner ecosystem further when you do make a push down market?

John Sicard

Yes that's a very interesting observation and question. I would say yes, we are engaged in certain theatres in certain verticals where the prospect's you might consider them to be more of the upper-end of mid-market. I wouldn't say there are any partners specifically that are focused or directed to focus on mid-market. I made that statement a little bit earlier that, when we talk about our current TAM of just over 2,000, that tends to be the elephants needs extremely large complex global in theatre in the six verticals that we publish that's what the current TAM.

But I would say, we have existing customers that I would consider to be mid-market and in some cases we have partners that are, I would say working on opportunities that are both in them, let’s say elephant category, the global enterprise category and in the mid-to-upper, mid-market category. But again, I wouldn't say that we have any partnerships that we have signed, where they are neither directed nor individually focused on midmarket.

Richard Monkman

Yes. And just to give a bit of a bounce. So typically when we focus on customers, they generally need to have sufficient, as John would say pain to really use RapidResponse. So that’s typically not unusual to be sort of a $1.5 billion or large in many cases multiple billions of dollars in revenue. So for us mid-market is really sort of $0.5 billion to $1.5 billion. And there are significantly more, I mean by a factor of three to four accounts in that total addressable market.

Suthan Sukumar

Okay. Great, thanks. That's helpful. And I also just want to follow up on your upcoming next gen engine launch and RapidResponse platform strategy. I'm curious to know what are you guys seeing, if any, from an industry and competitive response to these product and tech enhancements and more broadly, what are you guys seeing overall from the competitive environment?

John Sicard

Well, we continue to see primarily, SAP as a competitive landscape, they're typically the incumbent, which is why we typically see them, now they belong – I believe anyway, I would say, follow a different philosophy in how to solve supply chain planning problems. And this is why I said we often lead with technique first, not technology. We lead with technique and we bond on technique first. And when we get to the point where our prospect says you need to tell me how to do that, well then that's where the technology comes in.

The notion of RapidResponse as a platform and we have been working on this for many years, this is not some new initiative we started last year and this is the next gen engine that has been three to four years in the making. So as you can appreciate quite, this will be a very major release for us and a major technology boost.

It's going to allow us to more rapidly enter new markets. So partners will obviously be very interested in getting us beyond the six core verticals. This allows for what I'd call mass runtime configurability that we've just never seen before. And this allows us to break into new market verticals through partner leverage much, much faster than it was ever capable.

And we're also seeing a lot of pull from customers. So it's a response to what customers tell us, they're looking for and being able to apply unique capabilities to RapidResponse, what they consider to be company differentiators for them and looking to apply that directly to RapidResponse. So we're pretty excited about it. We're right around the corner. I think I mentioned this at our Connections event will be a very interesting event for us as it relates to a RapidResponse as a platform. So stay tuned.

Suthan Sukumar

Thank you. Great. Thank you for the color. John, I'll pass the line.

John Sicard

Thank you.

Operator

There are no further questions in the queue. I’d turn the call back to our presenters for closing remarks.

Rick Wadsworth

Thanks, operator. Thank you everyone for participating on today's call. We appreciate your questions as always and your ongoing interest in support of Kinaxis. We look forward to speaking with you again when we report our Q3 results. Bye for now.

Operator

And this concludes today's conference call. You may now disconnect.