QAD's Fiscal Q4 '20 Results Highlighted by Robust Cloud Bookings Growth and Margin Expansion

On the surface, QAD’s (QADA) fiscal Q4 ’20 results appeared mixed with revenue a hair shy of our estimate and consensus but profitability coming in comfortably ahead of Street expectations. We were quite pleased with the performance, however, as cloud bookings increased 71% Y/Y and subscription gross margin stepped-up significantly for the second consecutive quarter. Our only gripe was that QAD missed its Q4 subscription revenue guidance as several deals closed later than anticipated, reducing the intra-quarter amount recognized. With the deals in hand, however, the miss has no bearing on cloud growth in the coming quarters. Indeed, management guided Q1 subscription revenue ahead of our estimate. Unfortunately, the uncertainty wrought by COVID-19 precluded management from providing its usual slate of expectations for the quarter and year, so outside of recurring revenue guidance for Q1, we were left filling in the blanks.

We now project flat revenue growth for FY ’21 and a return to mid-single digit top line growth in FY ’22, in effect pushing our prior expectations out by a year. We expect professional services revenue to be muted by restrictions on travel and on-site gatherings in the near-term, and we assume cloud and license bookings will be negatively affected by extended sales cycles in Q1 and to a lesser extent in Q2. From an expense standpoint, management stands ready to adjust should circumstances dictate but for now, we anticipate the strong finish to FY ‘20 will prompt further investments despite the near-term impact of COVID-19. As such, our adjusted EBITDA and non-GAAP EPS estimates decline for this year and next. Regardless, we are sticking with our $51.00 price target, which represents a FY ’21 EV/Sales multiple of 3x.

In light of the recent market meltdown and the corresponding cut to multiples across the software space, we considered whether a more conservative target multiple might be in order. However, our valuation was already derived from ascribing a low multiple to QADA shares in both relative and absolute terms. Moreover, we note that our $51.00 price target equates to a multiple of 7x subscription revenue, which we believe is well supported by management’s newly issued long-term expectations for 25%-30% subscription revenue growth as well as precedent M&A transactions in the industry. Of course, the company also boasts a large base of high margin, recurring maintenance revenue, meaning QADA shares currently trade at just 2x total recurring revenue, a level not seen since the Great Recession. Buying low then ultimately proved lucrative, and we believe those willing to take the plunge now will be similarly rewarded.

Total revenue of $78.6 million (-5.0% Y/Y) was approximately in line with our estimate of $78.8 million and consensus of $78.7 million. Subscription fees of $28.6 million (+19.1% Y/Y) missed management’s implied guidance of $29.5 million and our $28.9 million estimate as several deals closed later in the quarter than anticipated. However, cloud bookings increased 71% Y/Y as QAD closed 35 deals with a relatively even split between net new customers and existing customer conversions to the cloud. Both maintenance and professional services revenue also fell short of our assumptions with the latter attributed to lower than anticipated contribution from the Asia Pacific region. Management noted that activity within the region is gradually returning to normal following the coronavirus outbreak but has yet to fully recover. With governments and enterprises across all major regions now implementing a host of restrictions to slow the spread of COVID-19, visibility into improved professional services growth remains limited in the interim. License revenue of $5.3 million outpaced our estimate of $3.3 million, mostly offsetting the shortfalls elsewhere.

For the second consecutive quarter, subscription gross margin expanded significantly on a sequential and Y/Y basis to 66.5%, which combined with the higher mix of license revenue enabled QAD to post gross profit ahead of our projection. Of note, management put forth long-term expectations calling for subscription revenue growth of 25%-30% over the next five years, which in turn should yield 500-600 basis points of expansion in subscription gross margin. Operating expenses were slightly below our projection, resulting in both adjusted EBITDA and non-GAAP EPS exceeding our estimates.

Due to the uncertain impact of COVID-19 on near-term bookings and professional services engagements, management refrained from providing its usual revenue and pre-tax income guidance for the current quarter and fiscal year. However, management issued Q1 subscription and maintenance revenue guidance for $31.0 million and $27.0 million, respectively, which were mixed versus our estimates of $30.3 million and $29.2 million. As mentioned previously, QAD also put forth new long-term targets, which reflect expectations for significant GAAP operating margin expansion from (2)% in FY ’20 to a range of 12%-17% over the next five years. While the timing is inauspicious given that FY ’21 is shaping up to be a throwaway year, the underlying assumptions leave us confident that QAD’s cloud transition will deliver accelerating revenue growth and substantially higher margins in time.

We lowered our Q1 and FY ’21 revenue estimates to reflect depressed levels of professional services activity as well as lower cloud and license bookings in 1H ‘21. While our current forecast reflects relatively flattish revenue versus the prior year, our adjusted EBITDA and non-GAAP EPS estimates decline significantly as we assume investments to sustain robust growth in the cloud will continue despite the near-term uncertainty. We also note that our expectation for a loss in Q1 reflects a pull-forward of expenses from Q2 due to the cancellation of QAD’s annual customer conference. While management has not yet indicated whether the cancellation will result in the recognition of associated expenses earlier than usual, we have gone ahead and pulled the expenses into Q1 to reduce the risk of an imminent earnings miss and because we think the expenses are likely to be recognized earlier. That said, the $2 million we shifted between quarters is simply a guess and may not fully capture the actual cost.

Turning to the out-year, the reduction in our cloud bookings growth forecast for this year impacts the amount of subscription revenue to be recognized next year. As such, both our revenue and profitability expectations for FY ’22 decline with the latter falling more so as incremental investments will continue to be made. As subscription revenue growth returns to levels consistent with management’s long-term model, we believe operating margin could expand 200 basis points or more on an annual basis.

Our report with model and disclosures is available here.