Adaptive Applications in an Era of Disruption

We attended QAD’s (QADA) Explore 2019 customer conference in New Orleans last week. The now 40-year old company has been a mainstay in the manufacturing sector, providing customers with enterprise resource planning (ERP) and adjacent applications embedded with deep domain expertise. Much like other events we have attended over the past year, attendees were presented with empirical evidence that disruption is occurring at an unprecedented rate. Unfortunately, legacy ERP systems are unable to keep pace with this change. As anyone who has experienced an ERP implementation or has heard management teams bemoan the challenges encountered in such undertakings can attest, long implementation and upgrade times, extensive customizations, and the mission-critical nature of such systems all but ensure a high cost and high risk of business disruption are present when any change to the core is considered.

Recognizing the need for agility and speed to handle the unknown, QAD has spent the past six years rewriting its software for the cloud, modernizing its user experience, modularizing its applications, and developing a low-code/no-code platform to support the extensibility and creation of applications that won’t break with each upgrade. Cutting edge technologies, including the Cassandra data lake and Spark machine learning algorithms, have also been incorporated to automate and improve upon a myriad of business processes. These efforts have culminated with the introduction of QAD’s Adaptive Applications, encompassing the flagship QAD Adaptive ERP solution and a host of modules for demand and supply planning, manufacturing resource planning, order management, quality management, trade management, and transportation management among others.

To be clear, various components of the Adaptive Applications suite have been made generally available as the development initiative, also known as Channel Islands, progressed. However, recent releases like the low-code/no-code QAD Enterprise Platform and the upcoming launch of manufacturing modules addressing production planning and shop floor execution bring the company much closer to fulfilling its vision of a comprehensive platform with the flexibility to adapt to any requirements. With the right product, global deployment capabilities, and a compelling value proposition, management believes the company is poised for growth with existing customers and to capture an increasing share of the estimated $1.5-$1.6 billion market for cloud-based manufacturing ERP systems.

While organizations may be reluctant to undertake a major ERP project absent a clear catalyst, CEO Anton Chilton’s call-to-action for attendees was to prepare now. After all, by the time an organization is faced with disruption, the systems of yesterday may not be adequate to support new business requirements. Of course, adoption of QAD’s Adaptive Applications is the end goal. In this regard, the company’s top priority is growth, specifically subscription revenue growth. Over the past 18 months, management has implemented a new sales methodology, revamped the sales organization and realigned incentives. A customer success team now farms for business from existing accounts that was already likely to materialize, freeing the field sales organization to pursue both conversions to the cloud and new logos. With incentives directly tied to license and cloud bookings, QAD is growing the areas that matter and at a lower cost to boot. To ensure the success of the new structure, however, the company has hired senior business development resources with vertical expertise and brought on inside sales and junior account reps focused on demand generation. Early returns have been promising with strength already seen in North America, which has accounted for much of the company’s growth in the cloud. Asia Pacific and Latin America are now also contributing to cloud revenue growth and additional investments, particularly in China, are anticipated. More generally, management has indicated a willingness to invest in sales and marketing ahead of the curve given a $300 million revenue opportunity from simply converting existing customers to the cloud and the potential to capture market share as SAP’s 2025 deadline for transitioning all customers to its S/4HANA database creates competitive displacement possibilities.

QAD ended FY ’19 (January) on a strong note, but shares declined following the company’s Q4 ’19 results due to disappointing guidance for Q1 and FY ’20. Management attributed the softness to execution challenges in EMEA, which have since been addressed. QAD had lost several senior sales reps and was also coming off a big year, leading to a lower funnel heading into this year. Steve Gardner, who ran the region’s sales, marketing and support teams during his first 10 years at QAD, is again leading the charge there after a 5-year stint heading QAD’s Precision division, which saw sales double during his tenure. Three months in, the pieces are starting to come together but a couple more quarters may be required before the desired structure is in place. Mr. Gardners’ focus is on attracting more hunters to the sales organization, instituting teams of three to four individuals with varying degrees of experience and responsibilities to ensure a consistent sales process, and expanding down market with the help of channel partners. Should these efforts prove successful, growth in Europe could outpace that of North America albeit on lower absolute dollars.

We believe QAD remains in the early innings of its transition to the cloud. More significantly, the company has the potential to emerge as a leader in the cloud ERP market. Key milestones to watch for over the next three to five years include the company’s ability to sustain cloud revenue growth in excess of 30%, double its revenue from partners, and achieve an adjusted EBITDA margin of 15%. Should these goals be met, shares of QADA should fetch a higher valuation than the 2.5x EV/Sales multiple garnered at present.