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QADA > SEC Filings for QADA > Form 10-Q on 10-Jun-2013All Recent SEC Filings

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Form 10-Q for QAD INC


10-Jun-2013

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. Any statements contained herein that are not statements of historical fact should be construed as forward looking statements, including statements that are preceded or accompanied by such words as "may," "believe," "could," "anticipate," "would," "might," "plan," "expect," "intend" and words of similar meaning or the negative of these terms or other comparable terminology. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in Part I, Item 1A entitled "Risk Factors" within our Annual Report on Form 10-K for the year ended January 31, 2013. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date hereof and are subject to risks, uncertainties and assumptions about our business. We undertake no obligation to revise or update or publicly release the results of any revision or update to these forward-looking statements except as required by applicable securities laws. Readers should carefully review the risk factors and other information described in other documents we file from time to time with the Securities and Exchange Commission ("SEC").

INTRODUCTION

The following discussion should be read in conjunction with the information included within our Annual Report on Form 10-K for the year ended January 31, 2013, and the Condensed Consolidated Financial Statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q.

CRITICAL ACCOUNTING POLICIES

Our condensed consolidated financial statements are prepared applying certain critical accounting policies. The SEC defines "critical accounting policies" as those that require application of management's most difficult, subjective, or complex judgments. Critical accounting policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variations and may significantly affect our reported results and financial position for the period or in future periods. Changes in underlying factors, assumptions, or estimates in any of these areas could have a material impact on our future financial condition and results of operations. Our financial statements are prepared in accordance with U.S. GAAP, and they conform to general practices in our industry. We apply critical accounting policies consistently from period to period and intend that any change in methodology occur in an appropriate manner. Accounting policies currently deemed critical, including a) revenue recognition; b) accounts receivable allowances for bad debt and sales returns; c) capitalized software development costs; d) impairment assessments on goodwill and intangible assets; e) business combinations; f) valuation of deferred tax assets and tax contingency reserves; and g) stock-based compensation are further discussed in the Annual Report on Form 10-K for the fiscal year ended January 31, 2013. There have been no significant changes to our accounting policies and estimates as discussed in our Annual Report on Form 10-K for the fiscal year ended January 31, 2013.

BUSINESS OVERVIEW

QAD is a global provider of enterprise software applications, and related services and support. We provide enterprise software applications to global manufacturing companies primarily in the automotive, consumer products, food and beverage, high technology, industrial products and life sciences industries. More than 2,000 global manufacturing companies use QAD software. QAD was founded in 1979, incorporated in California in 1986 and reincorporated in Delaware in 1997.

QAD's enterprise resource planning ("ERP") suite is called QAD Enterprise Applications, which is also known as MFG/PRO. QAD Enterprise Applications supports the core business processes of our global manufacturing customers and includes the following functional areas: financials, customer management, manufacturing, demand and supply chain planning, supply chain execution, service and support, enterprise asset management, analytics, interoperability, process and performance, and internationalization. We sell QAD Enterprise Applications as a base ERP product with the option of purchasing various add-on modules depending on the functionality the customer requires.


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QAD offers two options for deploying our ERP products: On Premise and On Demand. With the On Premise model, QAD sells a perpetual license for the software and our customers deploy the software on their own computer servers. Under the perpetual licensing model, customers may separately purchase contracts for maintenance and additional services. With the On Demand model, customers subscribe to a service, and QAD provides access to the software as well as ongoing support services and management of the environment. The majority of QAD customers use the On Premise model, although the On Demand model is increasing in acceptance. As a result, we are focusing on expanding the use of the On Demand model. We also make it possible for customers to operate in a blended environment where some users can be deployed via On Premise and some users deployed via On Demand while offering the same end-user experience.

We have four principal sources of revenue:

Licenses of our integrated suite of software applications;

Maintenance and support, including technical support, training materials, product enhancements and upgrades;

Subscription of our Enterprise Applications through our On Demand offering in a Software as a Service model as well as other hosted Internet applications;

Professional services, including implementations, technical and application consulting, training, migrations and upgrades.

We operate primarily in the following four geographic regions: North America, Latin America, EMEA and Asia Pacific. In the first quarter of fiscal 2014, approximately 43% of our total revenue was generated in North America, 32% in EMEA, 19% in Asia Pacific and 6% in Latin America. Over 80% of our revenue is generated from large, global customers who have operations in multiple countries. License and subscription revenues are assigned to the geographic regions based on both the proportion of users in each region and sales effort. Maintenance revenue is allocated to the region where the end user is located. Services revenue is assigned based on the region where the services are performed. A significant portion of our revenue and expenses are derived from international operations which are primarily conducted in foreign currencies. As a result, changes in the value of foreign currencies relative to the U.S. dollar have impacted our results of operations and may impact our future results of operations. At April 30, 2013, we employed approximately 1,540 employees worldwide, of which 570 employees were based in North America, 460 employees in Asia Pacific, 440 employees in EMEA and 70 employees in Latin America.

GLOBAL ECONOMIC OUTLOOK AND INDUSTRY TRENDS

Our customer base and our target markets are global manufacturing companies; therefore, our results are heavily influenced by the state of the global manufacturing economy. Our management team monitors several economic indicators, with particular attention to the Global and Country Purchasing Managers' Indexes ("PMI"). The PMI is a survey conducted on a monthly basis by polling businesses that represent the makeup of respective sectors. Since most of our customers are manufacturers, our revenue has historically correlated with fluctuations in the manufacturing PMI. Global macro economic trends and manufacturing spending are important barometers for our business, and the health of the U.S., Western European and Asian economies have a meaningful impact on our financial results. In the first quarter of fiscal 2014, approximately 57% of our total revenue was generated outside of North America and we expect to continue generating a significant portion of our revenue outside the U.S. The U.S. manufacturing economy has been expanding, as have the economies in many of the Asian and Latin American markets, while the European economies have been more fragile and have, for the most part, been contracting. We plan our business accordingly by deploying additional resources to areas of expansion, while continuing to monitor our overall expenditures given the economic uncertainties of our target markets.


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SUMMARY OF FISCAL 2014 FIRST QUARTER

Total revenue for the first quarter of fiscal 2014 was $61.9 million, representing a $1.8 million, or 3%, decrease from the first quarter of fiscal 2013. We did not meet our license revenue forecast. The decrease in total revenue was primarily driven by lower license and professional services revenue. License revenue was impacted by revenue recognition deferrals and closing a higher amount of On Demand transactions versus license transactions. Services revenue was impacted by multi-element arrangements where we did not have Vendor Specific Objective Evidence ("VSOE") for all undelivered elements and, therefore, are required to recognize revenue ratably over the longer maintenance term rather than recognizing the revenue over the shorter service performance period. Services costs are expensed as incurred and as a result services margins fluctuate. Net loss was $1.3 million for the first quarter of fiscal 2014 compared to net income of $1.8 million for the first quarter of fiscal 2013. Our results for the first quarter of fiscal 2014 were negatively impacted by several factors, including lower revenue and additional expenses from DynaSys and CEBOS, the entities we acquired in fiscal 2013.

License revenue. License revenue is primarily derived from software license fees that customers pay for our base product, QAD Enterprise Applications, and any add-on modules they purchase. In the first quarter of fiscal 2014, license revenue totaled $6.2 million, or 10% of total revenue. License revenue growth is influenced by the strength of the manufacturing industry and general economic conditions as well as the competitive position of our software products. Long sales cycles and the unpredictability in determining when license deals will close can have a material impact on our license revenues, net income and earnings per share. Our first quarter license revenue was negatively impacted by revenue recognition deferrals as well as closing a higher number of On Demand transactions versus On Premise transactions.

Revenue recognition deferrals can have a significant impact on quarterly earnings. When we enter into a multi-element transaction with fixed fee services or when we sell licenses for additional users under a pricing model that does not satisfy VSOE requirements, we may be required to recognize license revenue ratably over the longer of the maintenance period or expected services implementation timeframe rather than recognizing license revenue at the time of sale. Our executives emphasize structuring commercially sound business deals that facilitate long-term, mutually beneficial relationships with our customers and, as a result, do not necessarily structure sales specifically to achieve short-term accounting results. In the first quarter of fiscal 2014, we deferred in full three transactions over $0.1 million totaling $0.9 million of license revenue. This compared to two license deals over $0.1 million deferred in full totaling $0.3 million in the first quarter of fiscal 2013.

Our success in closing license deals for existing customers, new customers that are affiliates of existing customers and customers that have employees with historical experience working with QAD tends to be higher than with new customers that have no QAD affiliations. As a result, we place increased focus on these opportunities. A majority of our license revenue is generated from existing customers and their affiliates. With global GDP growth and the level of the PMI continuing to be below pre-fiscal 2009 levels, we believe global economic volatility will continue to shape customers' and prospects' buying decisions, making it more difficult to forecast the sales cycles for our products and the timing of large software license sales. Our license revenue has not reached pre-fiscal 2009 levels, which we believe is partially caused by economic volatility in certain parts of the world delaying customer buying decisions and partially caused by our increased focus on selling our solution via our On Demand offering.

Maintenance revenue. We offer support services 24 hours a day, seven days a week. In addition, we provide software upgrades which include additional or improved functionality when and if available. Our maintenance and other revenues totaled $35.2 million in the first quarter of fiscal 2014, representing 57% of total revenue. Maintenance revenue fluctuations are influenced by: (1) new license revenue growth; (2) annual renewal of support contracts; (3) increase in customers through acquisitions; (4) fluctuations in currency rates; and (5) adjustments to revenue as a result of revenue recognition rules. The vast majority of our customers renew their annual support contracts. Over the last three years, our annual renewal rate of customers who subscribe to maintenance has been greater than 90%. Maintenance revenue is generally billed on an annual basis and recognized ratably over the term of the agreement, typically twelve months.


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Subscription revenue. The majority of our software continues to be sold via the On Premise model, which generates license revenue. The On Demand model generates subscription revenue, which for the first quarter of fiscal 2014 totaled $4.0 million, or 6% of total revenue. Our On Demand customers include a mix of existing customers who have converted from our On Premise model and new user implementations of our On Demand product. The growth rate of subscription revenue has declined primarily due to slower than expected deployment by existing customers. Subscription revenue is generally billed on a quarterly basis and recognized ratably over the term of the agreement, typically 12 to 36 months. Growing our On Demand product and offering our products as software as a service continues to be a key strategic initiative for us.

Professional services revenue. Our professional services business includes consulting and training services related to our solutions. In the first quarter of fiscal 2014, our professional services revenue totaled $16.5 million, or 27% of total revenue. Our professional services organization provides our customers with expertise and assistance in planning and implementing our software solutions. Consultants typically assist customers with the initial installation of a system, the conversion and transfer of the customer's historical data into our software, ongoing training and education, and system upgrades. Our professional services enable customers to implement our software efficiently, support a customer's success with our solution, strengthen our customer relationships, and add to our industry-specific knowledge base for use in future implementations and product innovations. Our services margins tend to range from about breakeven to 10%. We view our services organization as a department supporting the implementation and deployment of our products and improving the overall customer experience. Services margins lower our overall operating margin as services margins are inherently lower than margins for our license, maintenance and subscription revenues.

Although our professional services are optional, many of our customers use these services for some of their planning, implementation, or related needs. Professional services are typically rendered under time and materials-based contracts with services typically billed on an hourly basis. Professional services are sometimes rendered under fixed-fee contracts with payments due on specific dates or milestones. When we enter into multiple element arrangements where we do not have VSOE for one or more of our undelivered elements, we recognize the entire arrangement ratably over the longer of the maintenance term or implementation period. Services costs related to these engagements are expensed as incurred. As a result, our professional services revenues and margins tend to fluctuate.

Our professional services revenue typically trails our license revenue by several quarters as implementation services and related consulting are performed after the purchase of the software. Services revenue growth is contingent upon license revenue growth and customer upgrade cycles, which are influenced by the strength of general economic and business conditions and the competitive position of our software products. We use our partners and subcontractors to supplement our internal professional services resources. This allows us to quickly respond to demand fluctuations while somewhat mitigating low utilization in slow times. We believe working with our partners also helps us extend our global reach by keeping a higher number of partners engaged and knowledgeable about our product. Our professional services business has competitive exposure to offshore providers. All of these factors potentially create the risk of pricing pressure, fewer customer orders and reduced gross margins.

Cash flow and financial condition. During the first quarter of fiscal 2014, we generated cash flow from operating activities of $12.3 million. Our cash and equivalents at April 30, 2013 totaled $73.8 million and the only debt on our balance sheet was $15.8 million related to the mortgage on our Santa Barbara headquarters. Our primary uses of cash have been funding investment in research and development and operations to drive earnings growth, acquisitions, dividend payments and repurchases of common stock.

In fiscal 2014, we anticipate that our priorities for use of cash will be developing sales and services resources and continued investment in research and development to drive and support growth and profitability. We will continue to evaluate acquisition opportunities that are complementary to our product footprint and technology direction. We will also continue to assess share repurchases and dividend payments. We do not anticipate a need for additional borrowing in fiscal 2014.


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RESULTS OF OPERATIONS

We operate in several geographical regions as described in Note 12 "Business Segment Information" within Notes to Condensed Consolidated Financial Statements. In order to present our results of operations without the effects of changes in foreign currency, we provide certain financial information on a "constant currency basis", which is in addition to the actual financial information presented in the following tables. In order to calculate our constant currency results, we apply the foreign currency exchange rates that were in effect during the prior period to the current period results.

Revenue

                                                      Increase (Decrease)
                               Three Months            Compared to Prior            Three Months
                                   Ended                     Period                     Ended
                              April 30, 2013           $                  %        April 30, 2012
(in thousands)
Revenue
License fees                  $         6,218     $     (1,647 )           -21 %   $         7,865
Percentage of total revenue                10 %                                                 12 %
Maintenance and other                  35,201              681               2 %            34,520
Percentage of total revenue                57 %                                                 54 %
Subscription fees                       4,042              819              25 %             3,223
Percentage of total revenue                 6 %                                                  5 %
Professional services                  16,466           (1,634 )            -9 %            18,100
Percentage of total revenue                27 %                                                 29 %
Total revenue                 $        61,927     $     (1,781 )            -3 %   $        63,708

Total Revenue. Total revenue was $61.9 million and $63.7 million for the first quarter of fiscal 2014 and 2013, respectively. Holding foreign currency exchange rates constant to fiscal 2013, total revenue for the current quarter would have been approximately $62.5 million, representing a $1.2 million, or 2%, decrease from the same period last year. When comparing categories within total revenue at constant rates, our current quarter results included decreases in our license and professional services revenue categories and increases in our maintenance and other and subscription revenue categories. Revenue outside the North America region as a percentage of total revenue was 57% and 55% for the first quarter of fiscal 2014 and fiscal 2013, respectively. Total revenue decreased in our North America and Latin America regions, remained relatively flat in our Asia Pacific region and increased in our EMEA region during the first quarter of fiscal 2014 when compared to the same quarter last year. Our fiscal 2013 acquisitions of DynaSys and CEBOS contributed $2.0 million to total revenue during the first quarter of fiscal 2014. Our products are sold to manufacturing companies that operate mainly in the following six industries: automotive, consumer products, food and beverage, high technology, industrial products and life sciences. Given the similarities between food and beverage and consumer products as well as between high technology and industrial products, we aggregate them for management review. Revenue by industry for the first quarter of fiscal 2014 was approximately 28% in automotive, 22% in consumer products and food and beverage, 34% in high technology and industrial products and 16% in life sciences. In comparison, revenue by industry for the first quarter of fiscal 2013 was approximately 29% in automotive, 23% in consumer products and food and beverage, 34% in high technology and industrial products and 14% in life sciences.

License Revenue. License revenue was $6.2 million and $7.9 million for the first quarter of fiscal 2014 and 2013, respectively. Holding foreign currency exchange rates constant to fiscal 2013, license revenue for the current quarter would have been approximately $6.3 million, representing a $1.6 million, or 20%, decrease from the same period last year. Excluding $0.4 million of revenue recognized from our fiscal 2013 acquisitions, license revenue decreased in our North America and Latin America regions and remained relatively flat in our EMEA and Asia Pacific regions during the first quarter of fiscal 2014 when compared to the same quarter last year. One of the metrics that management uses to measure license revenue performance is the number of customers that have placed sizable license orders in the period. During the first quarter of fiscal 2014, two customers placed license orders totaling more than $0.3 million and no orders exceeded $1.0 million. In comparison, during the first quarter of fiscal 2013, three customers placed license orders totaling more than $0.3 million and no orders exceeded $1.0 million. Our license revenue was negatively affected by revenue recognition deferrals. Three license deals over $0.1 million were deferred in full totaling $0.9 million in the first quarter of fiscal 2014. In the first quarter of fiscal 2013, two license deals over $0.1 million were deferred in full totaling $0.3 million.


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Maintenance and Other Revenue. Maintenance and other revenue was $35.2 million and $34.5 million for the first quarter of fiscal 2014 and 2013, respectively. Holding foreign currency exchange rates constant to fiscal 2013, the first quarter of fiscal 2014 maintenance and other revenue would have been approximately $35.6 million, representing a $1.1 million, or 3%, increase from the same period last year. Excluding $0.9 million of revenue recognized from our fiscal 2013 acquisitions, maintenance and other revenue increased in our Asia Pacific region, was relatively flat in our EMEA and Latin America regions, and decreased in our North America region during the first quarter of fiscal 2014 when compared to the same quarter last year.

We track our rate of contract renewals by determining the number of customer sites with active contracts as of the end of the previous reporting period and compare this to the number of customers that renewed, or are in the process of renewing, their maintenance contracts as of the current period end. Our maintenance contract renewal rate has remained in excess of 90% for the first quarters of both fiscal 2014 and 2013.

Subscription Revenue. Subscription revenue was $4.0 million and $3.2 million for the first quarter of fiscal 2014 and 2013, respectively. Holding foreign currency exchange rates constant to fiscal 2013, subscription revenue for the current quarter would have been unchanged at $4.0 million, representing a $0.8 million, or 25%, increase from the same period last year. Subscription revenue increased in our EMEA, Asia Pacific and Latin America regions and was relatively flat in our North America region during the first quarter of fiscal 2014 when compared to the same quarter last year. The increase in subscription revenue was due to additional revenue related to our On Demand product offering. Currently, a majority of our On Demand sales are in the North America region. We expect the growth rate of subscription revenue in the future to be primarily attributable to growth in sales of our On Demand product offering.

Professional Services Revenue. Professional services revenue was $16.5 million and $18.1 million for the first quarter of fiscal 2014 and 2013, respectively. Holding foreign currency exchange rates constant to fiscal 2013, professional services revenue for the first quarter of fiscal 2014 would have been approximately $16.7 million, representing a $1.4 million, or 8%, decrease from the same period last year. Excluding $0.7 million of revenue recognized from our fiscal 2013 acquisitions, professional services revenue decreased across all our regions during the first quarter of fiscal 2014 compared to the same quarter last year. The number of engagements was higher in the first quarter of fiscal 2014 than in the same period of last year, but the average revenue per engagement was lower. A main factor contributing to lower average revenue per engagement is the accounting of our multi-element arrangements. During the first quarter of fiscal 2013, we recognized $1.3 million of services revenue related to one customer for which expenses had been recorded in prior periods. Conversely, during the first quarter of fiscal 2014, we deferred services revenue of $600,000 related to two customers for which expenses were recorded in the current quarter.

Cost of Revenue

                                                                Increase
                                     Three Months               Compared               Three Months
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