QAD Inc. yesterday posted fiscal second-quarter results that showed continued shrinkage in profit and new license revenues, but the mid-tier ERP software vendor told analysts that its growth prospects are improving with the advent of a new .NET interface that substantially improves application usability amid growing demand for its products in North America and the Asia-Pacific region.
For the period ended July 31, QAD posted revenue of $58.4 million, up only $400,000 from the year-earlier period. The results, however, slightly exceeded guidance the Carpinteria, CA, company provided earlier in the fiscal year. Net income in the second quarter was $1.1 million, or three cents per diluted share (including stock compensation and tax expenses), a figure that was impacted by the company's continued investment in offshore R&D activities. QAD earned $3.8 million, or 12 cents per diluted share, in the year-earlier period.
More worrisome for QAD was its continued decline in license revenue, which totaled $13.5 million in the quarter, off $2.8 million from the like period last year. QAD company officials told analysts during a conference call to discuss the fiscal Q2 performance that the year-earlier period benefited from a $4 million contract signed with a Japanese automotive parts supplier, which at the time appeared to signal that the ERP vendor was poised to resume growth after an extended period of stagnation.
On the up side, maintenance and other revenue reached $30.7 million, up $1.2 million from last year's fiscal second quarter, a result QAD officials said reflected the company's strong customer retention rate, which CFO Daniel Lender estimated has remained in the steady "mid-90% range." Services revenue was $14.2 million, up $1.9 million from last year's second quarter.
Lender said QAD won 13 deals in the period valued in excess of $500,000, two of which totaled over $1 million, including licenses and maintenance and services. New customers represented 17% to 18% of revenue, which was slightly below the company's quarterly average, he added.
QAD's lackluster Q2 performance follows a tough first quarter, which the company blamed partially on the severe downturn in the domestic automotive market. For the six-month period, QAD's revenues were $111.8 million, versus $114.0 million in the comparable period last year. Net income for the first six months of fiscal 2007 was $2.5 million, or eight cents per diluted share (including stock compensation and tax expenses), compared with $6.4 million, or 19 cents per diluted share, recorded in the like period last year.
Despite the uninspiring results, QAD CEO Karl Lopker said the quarter was a "reasonably good" one, which "keeps us on track for a solid performance later this year." He noted that QAD is seeing "a positive attitude" in its customer and prospect base, which has contributed to a sales funnel that is "up over 10%" from this time last year. "The larger economic situation also appears to be positive," he added.
Analysts pressed Lopker during the conference call to explain QAD's inability to grow total revenue over the last few quarters, and homed in on the drop-off in new license revenue. Lopker pointed to the original user interface (UI) designed for its 15-month-old GXE applications suite as a primary culprit for the revenue shortfall. Last spring, the software received a much-needed usability upgrade courtesy of Microsoft .NET framework technology.
"We were not seeing as much new business as we would like to have seen since some other user interfaces had a more modern look even though the software was not as functional underneath, so we found it more difficult to compete," Lopker said. "Now that's gone away and we believe we have a UI that is on a par [with] if not better than other people['s]."
With the new UI available, demand management software heading toward production,, new sales force and marketing automation technology available via an acquisition of a small UK company, and the September release of a new product configuration tool and manufacturing execution capability that will bridge manufacturing planning with shop floor execution requirements, QAD officials indicated that new license growth could return as soon as this quarter.
The company is projecting total revenue to be in the $56 million to $59 million range for the October period. Year-over-year license growth would depend on where the final revenue figure ends up, CFO Lender said.
QAD expects full-year fiscal 2007 revenue of between $230 million and $240 million and earnings in the range of 16 to 27 cents per diluted share.
In addition, President Pam Lopker cited upcoming products she said QAD expects to contribute to a revitalized top line in the periods to come. She pointed to new sales and operations planning software, as well as an upgrade to GXE's core service-oriented architecture, as well as improvements to the software suite's global shared financial services facility that should contribute to growth next year.
Further, the QAD president said the company is actively looking to acquire synergistic technologies and companies to further propel growth. Without revealing specifics, she said QAD is "actively looking at opportunities in transportation, enterprise asset management, and quality." When questioned further by analysts, she added warranty, quoting and costing, and MES connectivity software, plus -- "possibly" -- PLM and human resource software to the acquisition wish list.
The new product development activity is helping to burnish the company's sales funnel, particularly in the Asia-Pacific region, Karl Lopker said. "We're excited by that because that's where manufacturing is moving," he pointed out.
The continuing struggles of domestic automotive manufacturers is pushing QAD to refocus it marketing efforts on Asia-Pacific region, Japan in particular, where the company has had some success. "We need to shift capability from being primarily a North American multinational [supplier] to the Japanese, who have a bigger part of the market now," Pam Lopker added.
A shift in emphasis might also help stem erosion in QAD's automotive segment. Automotive only contributed 22% of the company's overall revenues in the second quarter, down considerably from its historical average of 30%-plus, Lender said. Asia-Pacific, in fact, contributed 17% of QAD's revenue in the second quarter, while North America, EMEA, and Latin America represented 43%, 34%, and 6%, respectively, he added.
Also addressed during the conference call was QAD's net profit decline, which the company said was fueled by increased R&D spending. The company has accelerated hiring in its China and India R&D facilities, resulting in head count increases in those offices of nearly 60% year over year, Pam Lopker explained.
Karl Lopker said QAD's more aggressive spending on development was necessary to fill out the company's product line because "there are fewer and fewer partners available to provide add-on products due to consolidation in the industry," and the demand by customers for pre-integrated products.
Lender said that while the company hasn't completed its budgeting for next fiscal year, QAD expects R&D spending as a percentage of revenue to start stabilizing next year toward historical levels of between 14% and 15%.
Pam Lopker said the company wasn't encountering escalating competition from SAP, with whom it shares many customers (i.e., SAP back office software working with QAD plant-floor manufacturing applications), despite the company's big push into the mid-market. Neither was it seeing Oracle or Lawson (via its recent acquisition of Intentia) in regions outside the U.S.
Analysts were not so sure, contending that QAD, like other traditional mid-market ERP vendors, is getting squeezed by the big players like SAP, Microsoft, and Oracle, which see the segment as critical to their growth plans.
Bob Parker, a vice president at Manufacturing Insights, a research unit within International Data Corp. (Framingham, MA), said QAD and other mid-tier ERP vendors might be better served by taking "a sheep laying down with the lion" approach and align with one of the big three and its technology ecosystem. He pointed to IFS's recent alliance with Oracle in winning a major Air Force contract as an example.
"QAD has a fabulous product line and is a well-managed company," Parker said. "They need to come to grips with the fact that future cash flow may depend on maintenance revenue," he said. The company may also need to do something dramatic -- like make source code freely available -- to gain attention in a quickly consolidating market. "Neither one of those options is particularly desirable," he said, but the fact that the company has experienced numerous flat quarters shows that it needs to do something extraordinary to jumpstart growth.
AMR Research Inc. (Boston) senior vice president Judy Sweeney questioned whether QAD is really not encountering SAP across its existing customer and prospect base. QAD's biggest challenge, she said, is to keep SAP from replacing QAD plant-floor applications with its own software by leveraging its back-office strength. That's why, Sweeney said, it's critical that QAD "keep ahead of the functionality curve."
The fact that QAD's maintenance revenue has held strong is an indication that customers are getting value out of the product line, she said. But QAD's product strategy, as laid out, will not deliver big growth, only an incremental increase. That is an accomplishment in itself, she noted, given steady ERP market consolidation. "Remaining flat is a high mountain to climb" given these market conditions, she concluded.