Good morning, ladies and gentlemen. Welcome to the Kinaxis Inc. Fiscal 2018 First Quarter Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. I'd like to remind everyone that this call is being recorded today, Thursday, May 3, 2018. I will now turn the call over to Rick Wadsworth, Vice President of Investor Relations at Kinaxis Inc.. Please go ahead, Mr. Wadsworth.
Thanks, operator. Good morning, welcome to the Kinaxis earnings call. Today, we'll be discussing our results that we issued after the market closed last night. With me on the call are John Sicard, our President and Chief Executive Officer, and Richard Monkman, our Chief Financial Officer. Before we get started, I want to emphasize that some of the information discussed on this call is based on information as of today, May 3, 2018, and contains forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the forward-looking statements disclosure in the earnings press release, as well as in Kinaxis' SEDAR filings. During this call, we'll discuss IFRS and non-IFRS financial measures.
A reconciliation between the two is available in our earnings press release in our MD&A, both of which can be found in the investor relations section of our website, kinaxis.com, and on SEDAR. Participants are advised that the webcast is live and is also being recorded for playback purposes. An archive of the webcast will be made available on the investor relations section of our website. Neither this call nor the webcast archive may be re-recorded or otherwise reproduced or distributed without prior written permission from Kinaxis. To begin our call, John will discuss the highlights of our first quarter and our recent developments, followed by Richard, who will review our financials for the quarter. Finally, John will make some closing statements before opening up the line for questions. I'll now turn the call over to John.
Good morning, thank you for joining us today. Q1 represented another quarter of strong execution by Kinaxis, as we grew subscription services revenue by 24% and delivered EBITDA of 26% of revenue prior to the adoption of new accounting standards, which Richard will talk through momentarily. Under these new standards, our total subscription revenue was $30.5 million, and adjusted EBITDA was $12.5 million, or 34% of revenue. Since our last call, we have continued to show great progress in traditional markets, like the high-tech and electronics vertical with our win at Power Integrations. As a leading innovator in the development and production of semiconductor technologies, Power Integrations selected RapidResponse and its unique ability to provide end-to-end supply chain visibility. They recognized the need to manage their supply chain from a global perspective on a unified platform through tight integration and alignment of all the planning functions.
Even more encouraging than this success is our progress in markets that we have been targeting most recently. As we indicated on our last investor call, early in the first quarter, we added another automotive leader to our growing list of marquee brands that includes Toyota, Nissan, Ford, and others. We are very pleased that our momentum in this market has continued and hope to be able to name our new customer soon. Recently, we also announced more headway in the consumer packaged goods space with Pulmuone, South Korea's largest fresh food company and the world's leading tofu manufacturer. Pulmuone is particularly sensitive to product freshness, and the packaged foods business overall is very sensitive to rapid changes in consumer preferences. Creating a nimble supply chain that has end-to-end visibility and responsive real-time management capabilities is key to their success.
We look forward to working together with this exciting new customer. As we mentioned last call, we are addressing the increasing opportunities in Europe through significant expansion in the region. I am pleased to say that we have already completed our planned hiring for the European sales team, and we are well positioned to take advantage of the momentum and the opportunities in that geography. Our success in this fertile region continues with yet another win in the pharmaceutical group based in Europe, and hope to be in a position to announce them publicly soon. Europe is not only our focus for growth. Recently, we announced firm plans to launch two new data centers in Japan, one in Osaka and another in Tokyo, to support our growing base of business there. We've begun operations, and I expect they will be fully operational in the third quarter.
These data centers will help us support large-scale customers in Japan, including Toyota, Nissan, ASICS, [Zentek], and Olympus. With that, I'll turn the call over to Richard for an overview of the financials.
Thank you, John, and good morning. As a reminder, all figures reported on today's call are in US dollars under IFRS. Readers will notice additional disclosures and commentary in our Q1 financial statements and MD&A. This is due to the adoption of new IFRS standards effective January 2018. Many companies are reporting under these new standards for the first time. The relevant new standards for Kinaxis are, first, IFRS 15, which provides new guidance regarding the timing of revenue, treatment of customer acquisition costs, and disclosure of contract backlog
Second, IFRS 16, which deals with leases. Our business model, focused on long-term subscription arrangements and cash generation, remains unchanged. While these standards must be applied retroactively, which in Kinaxis case increased prior period earnings and our opening retained earnings by $23.8 million after tax, we are not restating those prior periods. We are, however, providing a framework to explain the changes as well as provide additional disclosures to help readers better understand our progress on an apples-to-apples basis. Detailed analysis is provided in the financial statements and the MD&A. Let me take a few minutes to highlight some of the key changes. First, regarding the timing of revenue. While the vast majority of our subscription arrangements are on-demand or cloud-based, we do support some customers through on-premise or customer-hosted subscription arrangements.
Under IFRS 15, we are continuing to ratably recognize the subscription revenue for cloud arrangements over the full term of the agreement. We are also not changing the revenue reporting for professional services or the legacy maintenance and support services. For the on-premise subscription arrangements, IFRS requires us to look beyond the subscription payment terms, which are generally annual prepayment, and allocate the total revenue stream to two elements. The first element is related to the right-to-use RapidResponse over the subscription contract term. This is now recognized as one amount on the first month of the subscription term arrangement. This is recognized as subscription term license. The remainder of the revenue is attributable to maintenance and support and is recognized over the entire contract term.
If we signed or renewed an on-premise agreement in 2016 for a three-year term, we have retroactively recognized the subscription term license revenue for the full three-year term in 2016, now reflected in our opening retained earnings, and we continually to ratably recognize the remainder attributed to ongoing maintenance and support as subscription services revenue until the end of the term. The total accelerated recognition for this on-premise software component was just under $21 million as at January 1, 2018. In Q1 of 2018, we recognized $4.5 million of subscription term license related to ongoing premise agreements renewing in Q1. Another change under IFRS 15 is that we are now required to capitalize customer acquisition costs and amortize them, in our case, generally over a six-year period. Prior to adopting IFRS 15, we fully expensed customer acquisition costs upon the commencement of the related contract arrangement.
The new IFRS treatment of customer acquisition costs resulted in Kinaxis capitalizing $11.5 million of costs that we had previously expensed in prior periods. These costs relate to customers acquired prior to 2018, the weighted average remaining life of these costs is approximately three and one-third years. We have not restated 2017 results for IFRS 15 and 16, which going forward I'm going to call the standards, I'm going to reference the supplemental IFRS standard information when discussing comparative performance. Prior to IFRS standards, total revenue in the first quarter increased 10% to $35.9 million. This total is driven predominantly by our strong base of subscription revenue, which increased 24% to $29.5 million due to contracts secured with new customers, as well as the expansion of existing customer subscriptions.
Under IFRS 15, total revenue was $36.9 million, and total subscription revenue, including both subscription services and subscription term licenses, was $30.5 million. As we've discussed on previous calls, our partners continue to assume a greater role in customer deployment activity. Professional services revenue will also vary quarter-to-quarter due to the size, timing, and scheduling of customer engagements. Consequently, professional services revenue declined by 28% to $6.1 million from the same period in 2017. Prior to adoption of IFRS standards, gross profit grew 16% to $25.7 million, and gross profit margin grew to 72% from 68%. This performance reflects the higher growth rate of revenue relative to related costs of that revenue. Under the IFRS standards, gross profit for the first quarter of 2018 was $26.7 million or 72% of revenue.
Prior to the adoption of IFRS standards, profit for the first quarter of 2018 was $3.2 million, or $0.13 per basic share and $0.12 per diluted share, which is approximately equivalent to the same period in 2017. Profit was also in line with 2017, primarily given our investments in headcount and business expansion. Under IFRS standards, profit was $4.6 million, or $0.18 per basic share, and $0.17 per diluted share. Prior to the effect of the IFRS standards, adjusted EBITDA for the first quarter of 2018 grew 8% to $9.2 million, or 26% of revenue. The increased depreciation, primarily attributed to our increased data center investments and higher stock-based compensation, resulted in this higher adjusted EBITDA performance. Under IFRS standards, adjusted EBITDA was $12.5 million, or 34% of revenue.
Demonstrating the ongoing robustness of our business model, cash generated by operating activities was $10.5 million for the first quarter, up 3% over the prior period. We also adopted IFRS 16 effective January 1, 2018, which specifies how to recognize, measure, present, and disclose leases. As a result, Kinaxis has recognized an asset with corresponding short and long-term liabilities relating to our major leases. On January 1, 2018, we recognized $10.8 million in right-of-use assets and corresponding lease obligations for outstanding leases, primarily related to our office premises and data center facilities with terms greater than one year. At March 31st, 2018, the balance of right-of-use assets was $11.9 million, net of additions and accumulated depreciation. The balance of the related lease obligations, net of deemed finance costs, was $11.8 million, of which $2.6 million is a current liability.
The assets and liabilities increased compared to January 1st due to the additional data center leases entered into during the quarter. The nature of our long-term contracts provides us with a high level of visibility into future contracted subscription revenue. Effective this quarter, we are disclosing the minimum contract commitments. As of March 31st, 2018, the total backlog of subscription service commitments was $192.6 million. $70.2 million of this commitment will be recognized in the remaining three quarters of 2018, with $71.5 million in fiscal 2019, and the remaining $50.9 million for fiscal 2020 and thereafter. This backlog, together with a strong pipeline of new and customer expansion opportunities, supports our ability to provide full-year guidance. We are reaffirming the pre-standards 2018 guidance we provided approximately two months ago. That is, we expect annual revenue for fiscal 2018 to be in the range of $158 million-$163 million.
We expect subscription revenue will continue to be the key growth driver, and we expect it to grow between 23% and 26% compared to 2017. We still expect the sales and marketing expense will be in the range of 24%-27% of revenue, and that research and development expense will be in the range of 17%-19% of revenue. We still expect adjusted EBITDA as a percentage of total revenue to be in the range of 23%-26% for 2018. We are now also providing guidance reflecting the adoption of the IFRS standards. As previously discussed and disclosed, the adoption of the IFRS standards results in fully recognizing the subscription term license component of on-premise arrangements for the full term upon the commencement of the arrangement. This, as I noted earlier, was nearly $21 million retroactively recognized.
The amount of the recognition of subscription term license in any period will fluctuate depending upon the number of arrangements, their size, and the length of the term of any renewal or new arrangement. Regarding customer acquisition costs, we will be including the amortization of $11.5 million capitalized from prior periods. We will also no longer be fully expensing additional customer acquisition costs in 2018, but rather capitalizing these and then commencing amortization. We have considered the timing of this revenue recognition and amortization in our post-IFRS standard guidance. With the adoption of the IFRS standards, we expect total revenue for fiscal 2018 to be in the range of $150 million and $154 million, with subscription services revenue to be in the range of $109 million and $111 million, and subscription term license revenue to be between $7 million and $8 million for the year.
We further expect that approximately one half of the remaining subscription term license revenue for fiscal 2018 will be recognized in the second quarter. Following adoption of the IFRS standards, we expect sales and marketing expense will be in the range of 24%-27% of revenue, and that net research and development expense will be in the range of 19% and 21% of revenue. We expect annual adjusted EBITDA to be in the range of 24%-27% of revenue for 2018. With that, I turn the call back over to John.
Thanks, Richard. With all the accounting changes this quarter, it would be easy to miss the fact that our underlying business hasn't changed one bit. That is perfectly reflected in our reaffirmation of the projected revenue and EBITDA guidance. We sell RapidResponse on a subscription basis to the who's who of customers across six major market verticals, many of which we have only begun to penetrate. We are a high-growth SaaS company with all the predictability to our business that such a model entails. We also distinguish ourselves amongst SaaS companies by being highly profitable and generating substantial cash quarter to quarter. We continue to win some important new customers, most notably in our emerging markets, adding to marquee brands in the automotive sector and adding depth to our customer base in consumer packaged goods, life sciences, and high tech, remaining very strong for us.
In fact, overall, I'm very pleased with the diversification of our revenue across all of our market segments. We continue to execute on an investment strategy that will help the company scale to the next level, and we are making excellent progress. On behalf of Kinaxis, I would like to thank you for your support, and as always, for taking the time to join us. With that, I'll turn the line over to the operator for Q&A.
Ladies and gentlemen, we will now conduct a question and answer session. If you would like to ask a question at this time, simply press star followed by the number one on your telephone keypad. Your first question today comes from the line of Richard Tse with National Bank Financial. Please go ahead.
Thank you. You guys have made a bunch of operational changes over the past few quarters. It certainly seems like it's sort of helping in your pipeline. Are you pretty much where you want to be now going forward? Should we expect some additional changes for the rest of the year here?
Morning, Richard, and thank you for that question. At this stage, from a sales perspective, we are at plan in terms of our investment. I can also say we, in fact, we're kind of ahead of plan in terms of our investment and what we intended to do. That is certainly thanks to Paul Carreiro, who came on board on the executive team late last year. I don't anticipate any changes. At this point, we are in full execution mode, exercising the strategy that we set forth for the company.
Okay, thanks. We've been hearing in the marketplace that some of your competitors are using fairly aggressive price tactics. How are you responding to that, and has it changed the way you bid on these deals in any way?
Of course, when you can't compete with product, you compete with price. That's quite common in the market, certainly in the software market. It isn't uncommon for a competitor to attempt to, what I call, poison the well, and try to get the prices down and compete that way. Frankly, our customers are selecting RapidResponse because they're in pain. They're struggling with supply chain planning. They're looking for an end-to-end concurrent planning solution, which I believe can't be found anywhere else. With a compromise in price comes a significant compromise in product. It is not uncommon, frankly, for us to maintain our pricing model. As I like to say, we respect our shareholders, we respect the employees who produce the software. We know it works, and I don't anticipate it changing our model going forward.
Okay, just one last one for me. I'm not sure it's for you or Richard, if you look at the reported numbers, let's say, on a pre-standard basis, zoning in on subscription services specifically, that was a pretty good number here this quarter, certainly a little bit better than our expectations. Why is it that you guys are not taking up your sort of pre-standard guidance for the year in light of that?
Well, our standard is to provide just the annual guidance. I mean, we're feeling very strong. What we're dealing with, as John says, is quite unique. Sometimes deals may slip a month or two. What we're doing is while we're actively tracking them, our goal is to look at the longer term and closure of that deal. That bodes very well for the out years. As you can appreciate, if a deal were to slip a month or two, that can have some short-term impact. We're very bullish on the year, we're not changing things. Second of all, the guidance that we did provide was thoughtful and was just within two months. We'll continue to monitor situations and as appropriate, provide guidance at the end of our Q2.
Okay, great. Thank you.
Your next question comes from the line of Thanos Moschopoulos with BMO Capital Markets. Please go ahead.
Hi, good morning. Richard, can you provide some guidance on the or some color at least on the anticipated impact that the new accounting standards might have on 2019 revenue and EBITDA? I realize you're a ways away from providing us with 2019 guidance, but any color as far as the potential magnitude of the impact or just the direction of the impact for 2019 would be helpful. Thanks.
Well, Thanos, thank you for that question. We're fortunate in that with this long-term visibility and with a long history of customers, and in many cases, the on-premise customers, we have a very long legacy. In many cases, these are customers that actually were existing prior to 2005, and we converted to a subscription, and in many cases, converted to an on-demand subscription. Our practice is just to provide that annual guidance. It's important to understand, as I noted in my comments in the script, is that the impact of the timing of that subscription term license component will vary depending upon the term. So for instance, if a renewal term was just one year, the total revenue of that subscription agreement would be taken in the full year.
You would just have that increase in the initial quarter of the term, and then it would soften itself out through the rest. If the term was 3 years, well, then you're going to have a higher level of subscription revenue with that acceleration upfront, and then the revenue lower in the out years. What we need to do is gain further insight into the actual length of that term. We're very comfortable with the, as I noted, with a very strong backlog, with the continued growth of the business, but it's not appropriate at this point in time to provide guidance beyond 2018.
Fair enough. Can you clarify how large the term license component typically tends to be as a percentage of total contract value?
Again, that will vary depending upon the term. If it's a 1-year term, then the maintenance and support element is typically in line with industries, which is typically sort of an 18%-22% range. Where it becomes mathematically interesting is when you try to allocate that over a 3-year term. It's not linear in the sense that you have to associate the total value. I'm sure people on the call right now need a lot of coffee to understand some of that math. Ultimately, what's happening is that it's the same subscription revenue. The customers are still doing the annual prepayment over the 3 years. That cash is coming in over those 3 years. We just need to adjust the timing of that revenue. As we noted, the vast majority of our subscription arrangements are cloud-based.
We are going to have this element. I've quantified that. We expect that to be $7 million-$8 million this year, of which $4.5 million has already been recognized. It's going to vary, Thanos.
Finally, as we look at your contract acquisition costs for modeling purposes, can you provide color as to how large those tend to be as a % of total contract value?
Well, again, they'll vary depending upon the nature of the arrangement, to the way in which a partner is involved in the partner deals. We are going to be continuing to disclose the total customer acquisition cost. Again, they will vary on a number of factors. Where I think it's best is to take a look at the guidance that we provided with regards to sales and marketing. The continuation of our pre-IFRS standard, we noted the 24%-27%, so that reflects a combination of the significant ramp in our sales personnel globally, in particular in Europe, as well as the expected customer acquisition cost on a traditional basis where we fully expense.
The guidance that we provided post-IFRS standards is also in the 24%-27% range, that picks up the amortization of this $11.5 million, which we had to recapitalize, as well as, don't forget, it does impact going forward that we won't be taking the full expense, amortizing that new amount. It is, again, a bit of a timing difference. Certainly, that $11.5 is a non-cash charge, I think it's best to provide that range of sales and marketing expenses guidance.
All right, thanks. I'll pass the line.
Your next question comes from the line of Stephanie Price with CIBC. Please go ahead.
Good morning. Just following up on the IFRS questions. Can you talk about the 34% IFRS margin in the quarter and the one-time adjustments that could be in there?
Sure, Stephanie. Good question. Again, with $4.5 million of subscription term license, that, as you can appreciate, it essentially drops to the bottom line, drops right down to EBITDA. That was really the key delta between the 26% on the prior accounting basis, adjusted EBIT performance and the new. Again, with the timing of subscription term license amounts, that will vary. Clearly, cash flow remained the same for the quarter under both methods. Just again, because of the timing of these adjustments, you're going to see some movement in the EBITDA. Again, that's why it was very important for us to provide this framework so that we can provide the readers with that apples-to-apples basis. In this case here, we're providing 23%-26% guidance for the full year. On the pre-IFRS standard for EBITDA performance.
Okay, thanks. In terms of the expansion of the European sales team, now that it's completed, can you talk a little bit about the pipeline in that region and how quickly you think the team could ramp up?
Sure, Stephanie. With the added sales force, or some call it feet on the street, in Europe, we are seeing some expansion in the pipeline in that region, across all the market verticals, quite frankly. In terms of a ramp and our sales cycles, as we've intonated in the past, still tend to be in that 9 to 18-month range. In terms of getting closure of activity through that pipeline, that's kind of the measure that we're looking at at the moment. I can say that the pipeline in general in that region is extremely healthy.
Great. Thank you very much.
Thank you.
Your next question today comes from the line of Robert Young with Canaccord. Please go ahead.
Hi, good morning. One simple question from me on the IFRS changes, if you could. The difference on the top line looks like $8 million-$9 million of revenue lower under the new rules. Can you just draw a simple bridge between those two? It looks like it's mostly in the recurring piece. I know you've explained this at nauseam, but if you could simplify that would be helpful.
Sure, Rob. I understand this is something new for not only the analysts, but just for our broader investor base, more than pleased to help continue to provide insight. The range is, as you can see, in the $7 million-$8 million total, and it is predominantly related to the timing of that subscription term license component. I must come back to that retroactive almost $21 million of subscription term license that we had to put in our opening statements, which in effect really means you will not see that recorded as revenue in any of our statements, because again, it was done retroactively. That really represents revenue that is related and under pre-IFRS standards, which would've been recognized this year and in the next, depending upon the term, the next few years.
One thing that is important is those payments of those subscription terms will continue, and their contract models will continue to be subscription-based. What that has resulted in, and that's why I touched on a few of the other balance sheet items, you'll see that there's an increase in what's termed unbilled receivables. Obviously, to balance when you retroactively recognize that revenue, which is a payment stream coming at a future period, you need to set that up on the balance sheet. That provides a little insight into some of the timing differences. It really is just a matter of how we would've unwound that $21 million in this period and in future periods. Now, that does draw down.
Again, that is why we thought it was very important to provide this apples-to-apples basis so that the readers can see the continued growth in the business, the continued profitability and the cash generation.
Okay. It's basically just the upfront recognition of the on-premise that would've been recognized in 2018. It's been pushed back to 2016, 2017. That's basically the-
Yeah
the difference.
That's correct. Prior period.
Okay.
Yes. Depending upon the term.
Okay. The top 10 customers, 42%. That's lower than previous. Could you talk about whether that's a function of the IFRS changes or if that should be taken as a sign that the average contract value might be declining?
No, actually you should take it as a positive sign. It's driven by two elements. First, it's driven by the number of additional marquee names that we continue to attract and grow. As a result, we're just dealing with larger customer bases. Second of all, with our partners taking an increased role in the deployment, the revenue from a number of our top 10 customers is really just the subscription. In the past, it would've been subscription as well as professional services revenue. The third element is just really broader diversification. We are very excited by the growth that's happening. Again, this comes back to my first comment about marquee names in automotive, in life sciences, and continues in high-tech electronics and consumer packaged goods. It's really, in our view, reflective of the health and the diversity of our growing customer base.
Okay, great. Then in the quarter, the professional services revenue was lower than I expected. I was hoping that you could talk about the overall activity that's happening. If you consider the activity in the channel and the activity that you have reported in your revenue under the professional services line, while what you've reported is down, could you talk about the amount of activity that's happening? Is that increased year-over-year?
Yes, absolutely. The activity has increased. The number of certified partners continues to increase. In fact, the number of certified customers, which is great to see where professionals and our customers are certifying themselves as growing. You also have to understand that depending upon the quarter, some companies, they don't finalize their budget till later in the first quarter. That can have an impact. One of the key items that we do is we do an annual pulling our partners as well as all our employees together for what we call a Connect@Event. We're actually taking them out of the field, but it's very important just to keep them understanding the developments in the industry, developments in RapidResponse. Yes, absolutely it's lower, but we are very pleased to see the level of increased activity with our partners.
The guidance that we've provided, when you run the numbers, you'll see that we do anticipate that you'll continue to growth in basically all areas of the business.
Rob, I'll just add to what Richard described there, that we are first and foremost a SaaS company. We focus our growth on subscription revenue, and we have long stated that Kinaxis and their success in getting through an inflection point will be directly related to the speed at which we can light up the partner ecosystem. The investments we've made over the last two years in certification, and these are all online, some very extremely difficult exams to pass. All of these investments have been targeted to preparing the partners to do exactly what they're doing. The professional services performance that you're seeing is by design, quite frankly. We want partners to pick this up. I've said this before, the worst thing we could do as a high-growth SaaS company is to stick our hands into the pockets of our partners. We won't do it.
That would be short-term thinking, and that's just not who we are. We're building a giant, and our strategies are designed around succeeding in that endeavor.
If I draw that back to dollars, like assuming you didn't have a channel, if you didn't have partners, would the professional services, in dollar terms, would that have been up year-over-year?
Yes.
One last question from me is just related to the South Korea win. Congrats on that. Could you talk about that as a new vertical? I know it's part of CPG, but it's a different flavor, pardon the pun, in the food area. Talk about that, then if you could talk about the Korea footprint. You've made some investments there. It's good to see a Korea win. What's the future for South Korea? I'll pass the line.
Sure. I've said this before, we're in business in South Korea, and we have a great team. We're really proud of what they've done. This is a South Korean win, born from the South Korean team. We're certainly excited that it is in the food and beverage industry, and you're right to point that out. The CPG space is a collection of segments, white goods, et cetera. This is the first time we've publicly announced a food and beverage type of a win. Not our first win in that segment, by the way, but certainly the first public one, and it's very exciting for us, as we penetrate the consumer packaged goods segment. We're going to continue to harvest there. We think it's fertile and this is just one sign of that belief.
Do you think of this as expanding the total addressable market, or is that included in the numbers you've shared in the past?
That's included in the numbers that we've shared in the past for the geographies that we're serving. Yes.
Great. Thanks.
Your next question comes from the line of Paul Treiber with RBC Capital Markets. Please go ahead.
First question, just on the IFRS 15, the seasonality in term license revenue this year, is that typical or would it vary depending on the year?
It does vary depending upon the year, Paul. We have now been writing subscriptions for a dozen years. Unlike sort of some traditional models where they're focused on that lump sum perpetual, it does go through the year, and it really depends upon the renewal cycle. Traditionally, we've signed contracts in the two to five-year range, generally around the three-year mark seems to be about the natural. You're going to see a little seasonality. What our job is going to do is, as we continue to provide guidance, our plan would be that when we do introduce that guidance for 2019, we'll provide some insight into the timing of that subscription term license amount. Again, and I think you fully appreciate this, the actual underlying business is not changing.
Those long-term customers, they're going to continue to do the annual prepay, and the cash is going to come in along the lines that it has traditionally.
At this point, from a business point of view, are you considering any changes to the contracts in terms of the term to better manage that revenue?
We don't necessarily view it as a management issue in the sense that first, the vast majority of our arrangements are on the cloud basis. In fact, a number of the customers that go way back, prior to 2005, when we made this conversion, first went to continue their on-premise arrangement through subscription, and then understood the value of having the full Kinaxis-hosted, if you will, environment. We anticipate that there are going to be other customers that will move to that. There's also going to be some. We have deep relationships that, for a number of reasons, the customer may just wish to continue hosting. They do want to drive that longer-term benefit from RapidResponse, and so we'll engage in subscription, and we'll do that. It really is a minority. I think what's happening is evident in Japan, for instance.
Japan was one of the last areas that at least we support that had moved to the cloud. They're very, very comfortable. Now that we, in particular, have a global distribution of data centers, we can respond to local geographies as well as provide that global support. We just don't see this as an issue. What we're first and foremost focused on is supporting, landing, growing with customers, and maintaining that long-term visibility and cash generation.
Looking at longer term, just with the decreasing mix of professional services relative to subscription, also with the increasing participation of partners, is the reason we'd assume that gross margins and EBITDA margins would expand over time, or there are offsets that we should be aware of?
Yes, mathematically, you will see expansion. In fact, what we have talked about in the past is sort of aspirational goals, where we see an 80/20 mix, 80% on a subscription, 20% on professional services. Just this quarter alone, we've seen expansion in gross profit. By the way, that expansion reflects the investments that we've made most recently in not only expanding the North America footprint, but building out the Japan footprint. On a same year basis, having the European data center in. You'll see that we still drive out very strong gross profit. Yes, longer term, we anticipate that this will be an expansion, even with that level of investment.
Just one last one from me. Just on the data center side, what's the rationale for the two separate data centers in Japan as opposed to a single one? Just seems a little counterintuitive from an economies of scale point of view. Thanks very much.
Our customers look at RapidResponse as being mission-critical, and part of being a mission-critical subscription service is a pretty significant SLA. Having two data centers, in fact, is quite common for disaster recovery. That is the primary purpose for it. In some cases, it can be intercontinental, but in this case, it really didn't make sense. It was more economical to just choose two distinctly different cities in Japan. One is a backup. It's that simple.
It is a network, and from a global basis, there is some very sophisticated technology, very low latency with regards. So, we are really putting multiple levels of redundancy in place. As John noted, that level of investment made sense to us at this time.
Okay, thanks very much. I'll pass it on.
Your next question comes from the line of Paul Steep with Scotia Capital. Please go ahead.
Thanks. John, could you talk maybe a little bit about what you've seen on the trending around partner-influenced sales and their efforts, maybe over the last couple quarters, and some of the changes that Paul had been implementing on that side? Thanks.
Sure. Obviously the longer the program has been in existence, the more mature those relationships get and the more competent, quite frankly, the partners get in not only deploying RapidResponse, but in selling it. I've said this on the last earnings call, and frankly, the trend is, as it's always been, at least for the last 12 months, the vast majority of new name sales activities are coming through partner influence. They have privilege, which would be difficult for us to have. They have entry points into some of the largest corporations, and trusts, quite frankly. They have trusted relationships already in place that we wouldn't ordinarily have. That leverage for us is extremely important and frankly important for the partners as well.
This notion of what we call revolutionizing the planning function and providing concurrent planning, in my opinion, just isn't available anywhere else in the world. When these large manufacturing firms are looking to transform their supply chain practice, they go partners first, in general. They go to their trusted advisors first. One area of expansion that Paul has introduced. When we say he's expanded the sales function significantly, that includes the partner managers, not just adding account executives and the pre-sales and industry principals. The partner management layer of Kinaxis has also increased since Paul's entry to the management team.
Great. I guess maybe the other one, it sounds like you're agnostic in terms of selling these on-premise deals. Is that the right way to think about it? Richard, on the minority, I'm assuming this is just falling off over time, that you're not proactively seeking to sell on-prem term licenses. Thanks.
That's a great question, Paul. Thank you. Actually, we do have a very strong bias to focus on the cloud base. This is the best way we believe we can drive value for our customers. It is absolutely, the first and lead, it's actually an unusual situation now, I would say, a very unusual situation where there's a discussion about on-premise, and quite frankly, even when that arises, it's one of education. Because it's not just simply the capabilities of concurrent planning and unique capabilities of RapidResponse, it's the rest of the package, is our ability to directly host in our data centers, monitor the performance, relieve the customer of that sort of service management, and just engage directly. When it does come up, we move really into an education mode.
Our sales team is very capable in this regard, overall they just understand that it is just a better delivery platform. It is absolutely That's why, as we've noted multiple times, that the vast majority are on the cloud basis.
I would say, quite frankly, we have a bias for business. That's our bias, we're revolutionizing planning. I for one, refuse to disqualify a prospect that's in need because they may have policies that restrict their data center activities. Aerospace and defense is a perfect example. Whether you make missile systems or fighter jets, if someone is in need of concurrent planning and transforming their supply chain, we're going to serve. Those, as Richard said, are definitely fewer and far between, in our market segments. Some of these have been, as again, dated pre-2005. I would say rather than suggesting we have a bias towards one or another, we have a bias for good business, and on occasion, this may occur, but it's quite rare.
The underlying business model will continue to be one of subscription-
Yep
annual prepayment, long-term visibility.
Yeah.
Great. Thanks, guys.
Your next question comes to the line of Deepak Kaushal with GMP Securities. Please go ahead.
Hey, guys. Good morning. Thanks for taking my questions. I've got thousands of them, none related to accounting. I'll ask only three. Thanks. First off, John, you mentioned earlier you want a new major automotive customer. I know you're not disclosing who that is. Could you help us understand what geographic region it's in? I know you've made some inroads in Japan. You're already in North America. How's Korea and Europe doing?
I can tell you that this large automotive manufacturer's in Europe.
Excellent.
It's European. Again, we're obviously very excited about it, and we're hoping to be able to disclose that in the near future here.
That's good to know, and I appreciate the extra color on that. Second question. At your recent Investor Day , one of your partners said that they're seeing bake-offs now reduced to one or two out of the gate, one or two bidders rather than the usual four or five. Can you say what you're seeing on a competitive front in terms of Oracle and Infor? I know Oracle recently is pushing to the cloud. Are you seeing these guys less? Is it just specifically geographic? Any kind of color on the competitive change that you're seeing?
Sure. I struggle to point to any competitor other than SAP. Certainly, we do encounter others, but SAP is very often the incumbent. You're right, it's often down to a couple of us or a very small subset, which has changed over the last five-plus years. I would tell you that often the competition is less about product and more about technique. It's about describing the benefits of inextricably connected planning processes that you get only through concurrent planning. You just flat out don't get it any other way. We often compete first on technique. We don't talk about technology. We talk about the merits of this breakthrough technique. Once we get someone to say "That sounds like fantasy," you know you've generated the right amount of interest and intrigue, and all you have left to do is trust and confidence.
That gets done through, "Let me show you. Let me show you the technology that brings about this fantastic transformation.
Okay, maybe I'll push-.
Yeah.
Go ahead.
Go ahead.
Well, no, I wanted to push my luck and ask then, is your European automotive customer then a competitor replacement? Are you doing it in parallel with some competitors, or?
Yeah. Again, we generally don't talk about any specific.
Yeah
Customer account or competitive situation about anybody specific. I can tell you in generalities, as I said, we typically compete first on technique and then the technologies that bring about that value proposition. In terms of whether we replace versus augment, quite honestly, quite frequently it is a replacement. Whether somebody is running a competitive product or not, without concurrency, we often see rampant Excel use. Excel is the glue between all these planning processes, and certainly, that gets ripped and replaced with RapidResponse.
That's very helpful, thank you. My final question, and this is my usual question every time I see you guys. You've been at quote, about 100 customers for a couple of years now. Any change in that, or any sense of when we might be able to hear about 200 customers or at about 300 customers? Are you seeing any meaningful acceleration?
There is meaningful acceleration. We are continuing to grow and grow profitably. We have arrangements with customers, even the initial arrangement could be $4 million or $5 million a year, but it could also be $400 thousand or $500 thousand. Our goal has always been to establish that relationship, to build on that relationship. We don't really see it as valuable right now, noting the customer count. What we do think of value is that long-term sustained growth, noting the 100%-plus net revenue retention of dollars, noting the strong, consistent performance. That's really where our message is going to remain.
Got. If I can ask it a different way. Now that more of your new wins are partner-influenced, how is the makeup of partner-influenced wins trending? Are they more trending towards new customer additions or expansions within existing customers?
It is absolutely focused more on new customer arrangements. We also have terrific relationships with our partners, as well as our customers, and in some cases, there has been a transition of existing customer ongoing deployments expansions to our partners. The partner theme has always been two key measures. One is we want to virtually expand the company and to drive growth, and we believe that's best through partners, so hence their focus on new name opportunities. Second of all, to be able to execute upon those deployments, and hence the expansion of certified professional partner personnel that can manage these deployments. It is very much focused on new name.
Excellent. Thank you for taking my questions. I know the call is long, thank you. Appreciate it.
No problem.
Your next question comes from the line of Blair Abernethy with Industrial Alliance. Please go ahead.
Thanks for squeezing me in, guys. John, just expanding on the automotive vertical, can you talk a little bit about the opportunity and perhaps traction that you've been seeing in the supply chains of the automotives? Are your existing auto customers influencing the supply chain to maybe pick up RapidResponse?
Yeah. It's a great question. This is an opinion, that automotive supply chains are transforming right now. From my vantage point, in looking at how automotive companies have been planning supply chain, they haven't seen a transformation in a very long time. Now that automobiles are, in my opinion again, largely computers with a motor attached, and in some cases, no motor attached at all, the methods used for manufacturing these machines require change. The notion of line stocking, just-in-time line stocking of nuts and bolts and so on, are quite difficult to do with electronic components. We're definitely seeing that as a catalyst for change and transformation. I think that if you are going to transform, you learn from the electronics sector first.
I think they were first to transform and adopt, again, what I believe to be the breakthrough here of concurrent planning. Certainly, we're proud to have the names that we have in that sector. I do think, to some degree, that gives you some trust by association, when you can win the types of names that we've described already, companies like Nissan and Toyota and Ford and others. That definitely points to some very world-leading manufacturers, let alone world-leading auto manufacturers, for a transformative approach to supply chain.
Great. Thank you very much for the color. Just one quick one for you, Richard. The deferred revenue, just $64 million versus under prior IFRS, $76 million. I assume, is most of that change due to the term license amount? Can you remind us, is there any professional services revenue in that deferred revenue?
You are correct, Blair, that change, and as you can see how we've noted it on the comparative basis in note three, is driven in large measure by that retroactive recognition of revenue and consequently, a reduction of deferred revenue. Our deferred revenue is almost exclusively on the subscription side, yes.
Perfect. Thank you very much, guys.
Your next question comes to the line of Suthan Sukumar with Eight Capital. Please go ahead.
Good morning, guys. Appreciate you guys squeezing me in here. Just wanted to ask a question on R&D. Noticed there was an uptick in spend this quarter. Kind of broadly, can you speak to some of the recent progress you're making from an R&D perspective, some of the areas of focus and the level of activity with respect to joint efforts with partners and customers?
Sure. I've mentioned some of the innovative investments we've made in R&D on previous calls. We're certainly making a lot of progress on this notion of a self-healing supply chain. Folks have heard me talk about machine learning in the context of a use case rather than the academically interesting technique of machine learning. We've made some terrific progress on that front. There are other significant investments driving new innovations, things that we're calling Live Lens, for example. You'll hear about entering the market shortly here that we're excited about. Much of our investments are also tied to driving into new market segments. We're obviously very excited with the uptick in consumer packaged goods. Every time you enter a new vertical like that, it influences the analytics that you need to invest in inside of RapidResponse, what I call the brain function of RapidResponse.
We continue to invest to make sure that we're able to take advantage of every opportunity in the CPG space.
Okay, great. Thank you. That's quite helpful. I'll pass the line.
We have no further questions at this time. I would now like to turn the call back over to Mr. Wadsworth for closing remarks.
Thank you. Pardon me. Thank you for participating on today's call, everyone. We appreciate your questions as well as your ongoing interest and support of Kinaxis. We look forward to speaking with you again in August when we report our Q2 results. Bye-bye.
Thank you to everyone for attending today. This will conclude today's call, and you may now disconnect.