Kara Bellamy - Chief Accounting Officer Daniel Lender - Chief Financial Officer Pam Lopker - President

Brad Reback - Stifel Bhavan Suri - William Blair Kevin Liu - B. Riley

Hello, everybody, and welcome to today's call. Before we begin, I need to ensure that everybody understands our discussion may contain forward-looking statements that are based on certain expectations and analyses.

Such forward-looking statements are subjects to risks and uncertainties that could actual results to differ materially from those anticipated. QAD undertakes no obligation to revise or update these forward-looking statements to reflect events or circumstances after the date of this call.

For a complete description of these risks and uncertainties, please refer to QAD's 10-K and 10-Q filings with the Securities and Exchange Commission. Please also note that, during this call, we will be discussing non-GAAP pretax income, which is a non-GAAP financial measure as defined by SEC Regulation G.

A reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measure is included in today's press release, which is posted on the company's Web site. Now, I would like to turn the call over to Daniel Lender, QAD's Chief Financial Officer.

Well, thank you, Kara. Good afternoon and thank you for joining us to discuss our second quarter results.

Pam Lopker, President is joining me on the call. Our results for the quarter exceeded our guidance both on revenue and profit, strong performance across our subscription, license and services revenue categories contributed to the results.

On the cost side, subscription and services margin exceeded expectations. Compared to the same quarter last year, second quarter revenue increased 11% and subscription revenue grew 29% and now accounts for more than a quarter of our business.

Subscription margins grew to 63% up from 57% a year ago and 62% last quarter. Higher than expected revenue and slower than expected hiring for our client operations resulted in the improved margin.

We do anticipate increased spending as we add resources in our cloud operations group and as we add capacity to our data centers. We remain on target to achieve and possibly exceed annual subscription margins of 60% for fiscal '19.

Our objective is to increase margins by 1 to 2 percentage points annually after fiscal '19. Maintenance and other revenues was $30.6 million which was down 5% on a performance basis primarily related to continued customer conversions to the cloud as well as historical attrition rate.

Sequentially maintenance and other revenue was relative flat on a performance basis. As cloud conversions increased, maintenance revenue should continue to decline.

Recurring revenue which equaled subscription plus maintenance revenue grew 7% from the prior year and contributed 63% to total revenue for the second quarter compared with 65% year a ago. The decline as a percent of total revenue was due to the 31% increase in professional services year-over-year.

Professional services revenue was $26 million up from $19.8 million last year as new cloud implementations and existing customer upgrade projects continued to generate demand. Services margins remain positive for the quarter at 9%.

In addition to a regular ongoing professional services business, we have also been providing some personnel augmentation services to one of our cloud customers mainly through subcontractors where margins are minimal. These services relate to an ongoing multi-site global implementation that has run on-time, been very successful so far and it's approaching its conclusion.

As a result, we expect the services will start to wind down in the third quarter, which will result in lower forecasted services revenue that will be offset by lower subcontractor costs. For the remainder of the year, we continue to expect a small profit in our professional services business.

License revenue was $5.6 million versus $6.7 million last year. We closed seven deals greater than 200,000 with no deals greater than a million.

We continue to generate license revenue mainly from existing QAD customers as they add new users as they grow into current strong globally manufacturing environment. Currency fluctuations did not have a significant impact on our financial results, when compared with the prior year, but did have a negative revenue and positive expense impact to the prior quarter.

Total revenue by vertical for the second quarter was automotive at 41%, hi-tech and industrial 30%, consumer products and food and beverage 16% and life sciences 13%. And by geography, total revenue was North America 47%, EMEA 32%, Asia Pacific 15% and Latin America 6%.

Our gross margin was $44.1 million compared with $39.3 million for last year's second quarter and gross margin was 52% of total revenue for both periods. Sales and marketing expense, totaled $19.5 million compared with $17.7 million last year and was 23% of total revenue for the fiscal 2019 second quarter and 24% last year, the increase related to additional headcount.

You'll remember that we made some changes to our sales force that resulted in a reduction of traditional commissioned salespeople and the creation of an inside sales organization which increased the size of the total group by about 10%. R&D expense was $13.5 million for the 2019 second quarter versus $11.7 million last year.

The increase was primarily driven by additional headcount and third-party developers. R&D expense was 16% of total revenue for fiscal 2019 second quarter and 15% last year.

General and administrative expense was $9.4 million or 11% of total revenue compared with $9.2 million or 12% of total revenue last year. This brings total operating expense to $42.4 million or 50% of total revenue for the second quarter compared with $38.7 million or 51% of total revenue last year.

Stock compensation expense was $3.4 million for the fiscal 2019 second quarter and $2.6 million last year. The increase was primarily due to the higher stock price.

Operating income was $1.7 million versus $0.5 million last year. GAAP pre-tax income was $2.6 million versus GAAP pre-tax loss of $329,000 for last year second quarter.

Non-GAAP pre-tax income was $5.9 million versus $2.5 million a year ago. GAAP net income totaled $1.1 million or $0.05 per diluted plus A and B share versus GAAP net loss of $1.2 million or $0.06 per Class A and $0.05 per Class B share last year.

Income tax expense was $1.5 million for the fiscal second quarter versus $132,000 for the prior year quarter with increase due to higher profits. For the prior year and last quarter, quarterly tax expense was recorded based on actual tax incurred.

Given the higher amount of profit, we now expect, tax expense is being calculated based on applying an estimated annual effective tax rate to our results. Next, I will briefly review our year-to-date results.

For the year-to-date period, total revenue grew 16% to $170.7 million up from $147.3 million driven by increases in subscription and services revenue. Subscription revenue grew 34% to $44 million compared with $32.8 million in the year ago period.

Gross margin was 52% of total revenue compared with 51% in the prior six month period. Subscription margin was 62% for the fiscal '19 period and 54% percent last year.

Total operating expenses came to $85.7 million versus $76.6 million. As a percent of total revenue, total operating expenses were 50% for the current year-to-date period compared with 52% last year.

Our pre-tax income was $5.2 million versus a pre-tax loss of $2.3 million a year ago. Non-GAAP pre-tax income was $10.5 million for the fiscal 2019 year-to-date period compared with $2.7 million last year.

Our GAAP net income was $2.5 million or $0.12 per diluted plus A and $0.11 per diluted plus B share compared with a net loss of $3.7 million or $0.20 per Class A and $0.17 cents for Class B last year. We ended July with $139.5 million in cash and equivalents compared with a $147 million at the end of fiscal 2018.

Accounts receivable was $54.3 million compared with $83.5 million at the end of fiscal '18 and $42.4 million a year ago. Our day sales outstanding using the comeback method was 53 days for fiscal 2019 second quarter versus 51 days for the same period last year and the quality of our receivables remains healthy.

Our short-term deferred revenue balance at July 31 was $91.2 million versus $89.7 million a year ago and it includes $61.7 million of deferred maintenance versus $63 million, $27.8 million of deferred subscription versus $22.8 million, $1.6 million of deferred professional fees versus $2.7 million and $100,000 of deferred licenses versus $1.2 million. As a reminder, maintenance contracts are billed annually and subscription contracts can be billed either annually or quarterly.

Our cash flow from operations was $9.1 million for the first six months of fiscal '19 compared with $7.6 million last year. I'll finish up our financial review with guidance.

For the fiscal 2019 third quarter, we're expecting total revenue of approximately $80 million to $82 million including approximately $22.9 million to $23.4 million of subscription revenue. Our GAAP pre-tax income of approximately breakeven and non-GAAP pre-tax income approximately $2.5 million to $3.7 million.

We are raising our full year guidance to total revenue of approximately $332 million to $336 million including approximately $91 million to $93 million of subscription revenue. GAAP pre-tax income of approximately $5 million to $7 million and non-GAAP pre-tax income of approximately $16 million to $19 million.

Now, I'd like to turn the call over to Pam for a closer look at our cloud and product area. Pam?

Thanks Daniel. Q2 was another good cloud quarter.

We had 11 new cloud deal, which included 6 new cloud customers and 5 conversions. On a regional basis, North America was the strongest and our DynaSys division was the standout.

One of the conversions actually involved multiple customers as it entails the conversion of all customers from one of our partners in Asia to the cloud as part of our cloud franchise model. I'd like to highlight a conversion of the business unit of an existing industrial customer to the cloud.

They're able to show very high value of upgrading by the addition of our QAD demand and supply chain management, automation solutions and transportation management. We beat out SAP on this one that was installed in many other sites and thus we've now become the divisions' standard platform going forward.

I'd like to share with you two new cloud from our DynaSys division. The first one is -- world leader in tableware one of my favorite, we stood out compared to the competition future master and plan due to our defunctionality and production planning in a very complex environment.

Our methodology of implementation and our ability to demonstrate rapid ROI. After 14-month sales cycle, we secured a five-year deal by the initial site, and our goal will be to deploy this solution globally after this first site is deployed.

The other new cloud customer of DynaSys is a global leader in the design and manufacturing of scuba diving and watersport equipment, a competition with Oracle, so they currently use for their ERP and future master. After a relatively short five month sales cycle, we signed a five-year cloud deal and beat our competition due to our ability to go live inside the calendar year which was supported by several very positive customer references.

Our focus on customer success extends across our product set and continues to be a key differentiator for us. On the product side, we're excited to be releasing Channel Island and to our general availability for QAD Cloud ERP customers this September.

At this time, we will be moving Channel Islands into limited availability for our on-premise customer. Feedback on Channel Islands has been quite positive with recent reviews by [indiscernible] Research, QAD recently received a Frost & Sullivan 2018 Customer Value Leadership Award for the automotive industry.

The QAD Enterprise platform was at the center of Frost & Sullivan's decision to get QAD, the award. I particularly liked the following statement on their report.

QAD has successfully secured a competitive edge over traditional ERP solution by eliminating the need for costly, time consuming customization as it has strategically architectured the QAD enterprise platform to accommodate changes without touching the source code. Thank you, Daniel.

Well, thanks a lot Pam. Although our sales funnel is relatively flat to last year cloud now comprises 70% versus 60% last year.

On a regional basis for the quarter, all regions performed well similar to previous years and our full time employee headcount ended up at about 1900 employees up about 4% from last year. The increase was across all categories except for G&A.

Today we also announced that we entered into a definitive agreement to acquire the assets of one of our partners, PT Iris which is headquartered in Jakarta, Indonesia. PT Iris has about 40 employees, which are primarily business consultants supporting our customers in Indonesia.

And we're excited to have this team work directly for QAD. The Indonesian market is one of the fastest growing economies in the Asian region with its strong automotive manufacturing presence.

We're not disclosing the specific terms of the transaction, but we do not expect a material impact to fiscal 2019 operating results. The manufacturing economy is still showing strength in the U.S.

and on a global basis and a success that we have had with our customers and the strength of our solution that puts us in a good position to continue executing to our strategy in the second half of the year. And as usual, we will now take our questions live.

Operator, can you please give the instructions for questions.

Great. Thanks very much.

Daniel as relates to FX headwinds for the second half guide, can you give us any color on that?

Yes. So, there is actually some headwinds Brad.

We did experience some headwinds as I mentioned from Q1 to Q2. We expect particularly the maintenance line to be mostly affected in the 3% to 4% range.

Great. So X all things being equal, the guide would have been higher, if not for the FX headwinds by a few percentage points especially in maintenance?

Yes. Especially in maintenance, yes.

We do also get on the cost side. We do get some benefit.

So on the operating profit basis there is a minimal impact.

Great. And Pam, maybe you could give us a quick update on how the install is going for the large auto deal that you signed the last quarter?

I think that's last quarter or last year, okay. Yes, we have -- trying to think of last quarter, Daniel, am I thinking of the one that you just said that the services revenue would start to decrease because of that?

That was the year ago.

Yes. So, the large auto -- the OES indeed was signed last year.

We did signed another one last quarter Pam, in fact, you just had a call with them.

Thank you. Fair enough.

Yes, that's going well. They are scheduled to go live here within about, I want to say six months.

So that seems to be on track. I just did a review with them this morning.

Thank you. Thanks Daniel.

You're welcome.

Great. Thanks very much.

Thanks Brad.

Hey guys. Thanks for taking my questions.

And maybe Pam, I just want to touch on one -- I'm sorry on Channel Islands piece, as it goes to GA, you've always sort of had this idea that the cloud piece would have incremental functionality that would incentivize existing customers to migrate from on-premise to get that functionality in Channel Islands, it's available on cloud not that Channel Islands has but modular based approach due to that migration. As you think about the customer base, you think about the customer conversations you had and you think about now going GA, when we look at the number of existing to new ratio cloud deals per quarter, do you think that mix shifts tremendously into the favor of the existing base or do you think it stays relatively where it is, obviously, the next year or two years?

So, I do think that customers particularly as they upgrade to new releases and Channel Islands being a great one, was to go to the cloud because they instead of having to learn new technologies, new capabilities in on-premise environment, it makes sense for them to go to the cloud. So I do believe that many of our on-premise customers are really now seriously looking at moving to the cloud.

So I would expect the number of ratios to be leaning more towards on-premise conversions going to the cloud. But at the same time, we still keep picking up new customers.

So it is kind of perplexing. I always thought that we would get proportionately more conversions, but we seem to keep on that half and half.

Yes. I guess and then a follow-up and then on the sales motion, I know it's still relatively early, but sort of the shift inside sales is something that a little different for you guys.

Just any early impact or traction or sort of what you might be seeing from that team?

Yes. That is Bhavan, I think the good thing with any changes in sales -- in sales structure, the main thing that we would look for is actually making sure that there is no significant disruption to the sales force.

And so far there hasn't been any and early indications are that the overall structure of the sales force is being effective. And we are continuing our path of implementing a number of additional techniques and so forth into the overall sales force that we think that over the long-term should benefit us significantly.

Got it. One last one from me, Daniel for you maybe, you sort of explained a little bit about the billings mix and sort of in fact some of the cloud deals that are not months -- not annual, and so billing is sort of is not a good indicator to look at.

But I was just a little surprised given the strength in the existing cloud deals which typically 3x -- 2.5x, 3.5x in annual recurring revenue that the subscription revenue growth slowed a bit. So I was just wondering how much of FX impact they might have missed it or is that was just something seasonally, we expect that to pick back up to sort of above that 30%, 35% range?

How should we think about that? I know you've given guidance, but sort of [indiscernible] 40% it slowed quite a bit despite the fact we've got these existing customers layering on fairly healthy annual recurring revenue.

I don't mean going away, but sort of description line that would be helpful. So just walk through the puts and takes.

Thank you.

Yes. So, on a year-to-date basis Bhavan the growth is 34, comparing Q2 to Q2 of last year the growth was 29.

If you go back to last year in Q2, Q2 there was a very significant up tick to that particular quarter. And there were some onetime subscription revenue recognition that affected that one quarter.

So from a standpoint you are correct, from a quarter-to-quarter it does now look as good and that's why we're really highlighting what the year-to-date number is because that's more indicative of where the business is at.

Got it. It's helpful.

Thanks guys. Nice job.

Thanks for taking my question.

Hey, good afternoon. Was just hoping you could touch on at a high level, if you're seeing any sort of impact on sales cycles just from kind of the ongoing trade negotiations and some of the higher input costs, some of the manufacturers might be seeing in their businesses?

We are certainly watching that because you can see with the PMI and the change of people buying anticipation of tariffs, but it has more to do with purchasing, right? So it's like getting the hard time getting that still in before the tariff goes into effect.

But, not necessarily with production actually making and selling things as much because they're more raw material. But I think it's definitely an interesting time seeing that all going on.

I bet our customers for the most part are all global. So whether they're making something in the U.S.

or now they're making something in France or Asia, doesn't really make much difference to us because they're still making stuff and they're still having to add users or buy for users initially. So I do think that with the tariffs we could have a change in where things are being made but not necessarily how much is being made.

And Daniel, you have another thought on that?

No. I agree with all your comments, Pam.

Thanks.

Appreciate the color. And then, just on the subscription gross margin, Daniel, I know you touched on the slower pace of hiring so far.

But, obviously, you guys are ahead of where you want to be at this point. And even if we assume 100 to 200 basis points going forward you guys are now at levels above that.

So just curious how steep a ramp you expect during the back half in terms of COGS and beyond this current year as you roll out Channel Islands and it becomes generally available. What sort of requirements do you have in terms of continuing to ramp up headcount as well as associates capacity on that side?

Yes. So with regards to headcount as I mentioned in my remarks, we're a little bit behind in terms of where we would like to be in terms of hiring.

So but so I do expect, I do expect that to go up. We're also looking at potentially opening up another data center.

We haven't finalized that decision yet, but that could happen towards the back end of the year. So that would have some additional cost.

So if I mentioned we do think that there's a good chance that we will exceed our goal of the 60% particularly how strong that number has been in the first half of the year. But I think there are a couple of factors that will that will have an impact then.

With regards to Channel Islands, specifically that could have a temporary increase in cost as well. I think it's a little bit early to tell right now exactly what sort of impact we may see on the cost of goods sold line in the cloud on that end.

Okay. And then, just lastly for me, as it relates to kind of your partner strategy here, on the one hand you guys, are you buying in one of your international distributors.

And then, also I know you've been more focused on certifying other parties to help implement and sell your products. I'm so curious if you could talk about that dynamic.

Are there other distributors you would look to bring in-house or why this particular instance did it make sense? And then, how is kind of that certification process in terms of ramping up new professionals to support you guys externally.

How is that going?

Yes. So first let me touch based on the one distributor that will be acquiring.

I mean that has to do more with specifically the Indonesian local market the fact that the automotive sector there is a particularly robust and growing. And as you know we're quite strong in that particular vertical.

So there was just a set of circumstances that led us to making that decision in order to not only support the local customers but really to ensure that we had the right level of support for global customers putting up production facilities and so forth there. With regards more to the services area, we have been growing our overall capabilities and the number of partners.

And in fact, we're -- the some were recently fine partners. We can see that they are already being utilized to a greater extent by some of our larger clients.

So our strategy is, yet to continue to add more capacity to the ecosystem. But at the same time ensuring that we have that capacity that those resources are very well trained.

We have a very robust training program within our services organization and we actually share our methodology with regard to implementation because our customers do need us to be able to deliver an implementation on a global basis. That's consistent across borders whether they are being performed by QAD, by one of our partners or a combination.

Okay. Thanks for taking the question.

A nice quarter.

Sure. Thank you very much Kevin.

Well, hank you very much. Thanks everybody for your attendance and your questions.

We will update you again in November with our third quarter results. And goodbye for now.

Thanks.

Thank you. Bye-bye.