Robust Growth in Cloud Bookings Fuels Q3 Upside
QAD (QADA) reported fiscal Q3 ’21 results ahead of expectations. Much like the manufacturing economy has taken flight after a hard landing brought on by the pandemic, QAD’s sales engine is revving once again as evidenced by a 50% Y/Y increase in the value of deals closed during the quarter. The strong sales performance builds upon the stabilization exhibited last quarter and leaves the company well positioned to exit the year on an accelerating growth trajectory. Specific to Q3, favorable linearity in the timing of deal closures drove the upside on the top line, while ongoing expense controls amid the pandemic allowed for another significant beat on the bottom line.
Per management, QAD successfully pulled several Q4 opportunities into Q3. The return of COVID-related restrictions in various regions means sales cycles will remain difficult to predict in the near-term, although management remains cautiously optimistic in ending the year on a high note. That QAD’s weighted pipeline was up 26% Y/Y in mid-November, an increase similar to what was reported 90 days ago, bodes well for another quarter of solid bookings, in our opinion. Moreover, the overall funnel has hit a new high, up 96% Y/Y and accelerating from the 48% Y/Y increase reported last quarter. The near doubling of the pipeline leaves management confident in the medium to longer-term outlook. In any event, Q4 guidance was limited to anticipated maintenance and subscription revenue, both of which compared favorably with our prior estimates. From a profitability perspective, management indicated that cost containment measures implemented in response to COVID-19 may well persist even as some semblance of the pre-pandemic normal returns. We believe this suggests QAD is likely to sustain and improve upon the enhanced operating leverage exhibited thus far in FY ’20.
Considering the strong performance in Q3 and the sustainability of the margin improvement seen to date, we raise our estimates for this year and next. We also introduce our FY ’23 projections, which reflect a return to double digit top line growth and additional strides towards management’s long-term margin targets. With QAD’s cloud business back on an accelerating growth trajectory and non-recurring revenues now comprising just 20% of revenue, we expect the market to re-rate shares at a multiple more consistent with SaaS peers. We therefore increase our price target from $51.00 to $68.00, which we derive based on a FY ’22 EV/Sales multiple of approximately 4x versus 3x previously. We believe shares could garner an even higher multiple as subscription growth approaches historical levels in excess of 30%, increasing partner activity limits QAD’s exposure to non-recurring services revenue and margins expand to management’s targeted levels.
Exhibit I: Reported Results Versus Expectations
Total revenue of $76.7 million (-1.5% Y/Y) was above consensus of $74.8 million and our estimate of $73.6 million. Subscription revenue of $33.8 million (+23.5% Y/Y) outpaced management’s guidance and our estimate of $32.5 million as favorable linearity in the timing of deal closures enabled QAD to recognize more revenue than anticipated from intra-quarter wins. QAD closed 22 cloud deals, of which 13 were conversions and 9 were net new customers. Per management, the dollar value of cloud bookings increased 50% Y/Y as the company successfully pulled-in a number of opportunities slated to close later in the year. Strength was broad based across the company’s core verticals. By geography, both North America and EMEA performed well, offsetting some ongoing sluggishness in Asia Pacific and Latin America. Maintenance revenue of $27.0 million (-9.0% Y/Y) also exceeded management’s guidance and our estimate of $26.0 million. Both license and professional services revenue of $1.7 million (-49.0% Y/Y) and $14.2 million (-18.9% Y/Y), respectively, were also ahead of our estimates of $1.3 million and $13.8 million.
Reflecting significant expansion in the subscription gross margin, the consolidated gross margin was 270 basis points above our assumption. Sales and marketing expenses also compared favorably with our estimates and helped offset slightly higher expenses elsewhere. As a result, adjusted EBITDA of $9.2 million and non-GAAP EPS of $0.34 topped our estimates of $5.2 million and $0.13, respectively, and comfortably exceeded Street expectations for $5.1 million and $0.14. QAD exited Q3 with cash and investments of $143.4 million and outstanding debt of $12.5 million. Management’s Q4 guidance, which was limited to subscription and maintenance revenue of $35.0 million and $26.0 million, respectively, was ahead of our estimates of $34.0 million and $25.2 million.
Exhibit II: Estimate Revisions
Our revenue estimates increase for this year and next due to a higher recurring revenue run rate exiting Q3 and a slight uptick in our projections for professional services revenue. We also increase our subscription gross margin assumptions, which combined with a reduction in our forecast for sales and marketing expenses yields a meaningful increase in our profitability expectations for Q4 and beyond. Worth noting, we had previously anticipated a dip in margins and earnings next year as we assumed this year’s reductions in travel and marketing expenses would be temporary in nature. However, management’s plans to review its long-term facility requirements and workforce structure along with indications that travel may not fully revert back to pre-pandemic levels point to potential for further margin expansion in FY ‘22. Finally, we also introduce our FY ’23 estimates, which call for an acceleration in cloud growth into the mid-20% range and reflect further progress towards QAD’s long-term margin targets.
Our report with model and disclosures is available here.