UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☑ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended July 31, 2018April 30, 2019
OR
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ____________________ to _________________________
Commission file number 0-22823
QAD Inc.
(Exact name of Registrant as specified in its charter)
Delaware | 77-0105228 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
100 Innovation Place, Santa Barbara, California 93108
(Address of principal executive offices)
(805) 566-6000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Class A Common Stock, $0.001 par value | QADA | NASDAQ Global Select Market |
Class B Common Stock, $0.001 par value | QADB | NASDAQ Global Select Market |
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No ☐.
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check One):
Large accelerated filer ☐ | Accelerated filer ☑ |
Non-accelerated filer ☐ (Do not check if a smaller reporting company) | Smaller reporting company ☐ |
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| Emerging growth company ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑.
As of AugustMay 31, 2018,2019, there were 16,357,16816,374,484 shares of the Registrant’s Class A common stock outstanding and 3,263,906 shares of the Registrant’s Class B common stock outstanding.
QAD INC.
INDEX
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PART I - FINANCIAL INFORMATION |
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| ITEM 1. | Financial Statements (unaudited) |
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| Condensed Consolidated Balance Sheets as of |
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| Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income |
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| Condensed Consolidated Statement of Stockholders' Equity for the Three Months Ended April 30, 2018 and 2019 | 5 | ||
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| Condensed Consolidated Statements of Cash Flows for the |
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| Notes to Condensed Consolidated Financial Statements |
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| ITEM 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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| ITEM 3. | Quantitative and Qualitative Disclosures About Market Risk |
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| ITEM 4. | Controls and Procedures |
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PART II - OTHER INFORMATION |
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| ITEM 1. | Legal Proceedings |
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| Risk Factors |
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| ITEM 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
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| ITEM 3. | Defaults Upon Senior Securities |
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| ITEM 4. | Mine Safety Disclosure |
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| ITEM 5. | Other Information |
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| ITEM 6 | Exhibits |
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| SIGNATURES |
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PART I
ITEM 1 – FINANCIAL STATEMENTS
QAD INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
(unaudited)
April 30, 2019 | January 31, 2019 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and equivalents | $ | 150,990 | $ | 139,413 | ||||
Short-term investments | 1,200 | 1,200 | ||||||
Accounts receivable, net of allowances of $2,753 and $2,901 at April 30, 2019 and January 31, 2019, respectively | 49,019 | 81,577 | ||||||
Other current assets, net | 22,469 | 22,150 | ||||||
Total current assets | 223,678 | 244,340 | ||||||
Property and equipment, net | 29,716 | 29,621 | ||||||
Lease right-of-use assets | 15,149 | — | ||||||
Capitalized software costs, net | 1,664 | 1,598 | ||||||
Goodwill | 12,333 | 12,423 | ||||||
Deferred tax assets, net | 16,059 | 16,172 | ||||||
Other assets, net | 12,824 | 13,020 | ||||||
Total assets | $ | 311,423 | $ | 317,174 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Current liabilities: | ||||||||
Current portion of long-term debt | $ | 487 | $ | 487 | ||||
Lease liabilities | 4,633 | — | ||||||
Accounts payable | 8,381 | 9,902 | ||||||
Deferred revenue | 104,471 | 115,253 | ||||||
Other current liabilities | 34,253 | 40,348 | ||||||
Total current liabilities | 152,225 | 165,990 | ||||||
Long-term debt | 12,712 | 12,836 | ||||||
Long-term lease liabilities | 11,210 | — | ||||||
Other liabilities | 5,004 | 5,101 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock, $0.001 par value. Authorized 5,000,000 shares; none issued or outstanding | — | — | ||||||
Common stock: | ||||||||
Class A, $0.001 par value. Authorized 71,000,000 shares; issued 16,605,215 shares at both April 30, 2019 and January 31, 2019 | 16 | 16 | ||||||
Class B, $0.001 par value. Authorized 4,000,000 shares; issued 3,537,380 shares at both April 30, 2019 and January 31, 2019 | 4 | 4 | ||||||
Additional paid-in capital | 198,664 | 196,723 | ||||||
Treasury stock, at cost (231,946 Class A shares and 273,474 Class B shares at April 30, 2019 and 241,667 Class A shares and 273,474 Class B shares at January 31, 2019) | (7,222 | ) | (7,350 | ) | ||||
Accumulated deficit | (53,266 | ) | (48,485 | ) | ||||
Accumulated other comprehensive loss | (7,924 | ) | (7,661 | ) | ||||
Total stockholders’ equity | 130,272 | 133,247 | ||||||
Total liabilities and stockholders’ equity | $ | 311,423 | $ | 317,174 | ||||
See Accompanying Notes to Condensed Consolidated Financial Statements.
July 31, 2018 | January 31, 2018 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and equivalents | $ | 139,528 | $ | 147,023 | ||||
Accounts receivable, net of allowances of $1,949 and $1,763 at July 31, 2018 and January 31, 2018, respectively | 54,258 | 83,518 | ||||||
Other current assets | 21,116 | 15,856 | ||||||
Total current assets | 214,902 | 246,397 | ||||||
Property and equipment, net | 29,741 | 30,408 | ||||||
Capitalized software costs, net | 1,405 | 990 | ||||||
Goodwill | 11,095 | 11,023 | ||||||
Deferred tax assets, net | 11,869 | 7,944 | ||||||
Other assets, net | 10,931 | 3,055 | ||||||
Total assets | $ | 279,943 | $ | 299,817 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Current liabilities: | ||||||||
Current portion of long-term debt | $ | 476 | $ | 466 | ||||
Accounts payable | 10,962 | 14,818 | ||||||
Deferred revenue | 91,195 | 116,693 | ||||||
Other current liabilities | 35,702 | 43,460 | ||||||
Total current liabilities | 138,335 | 175,437 | ||||||
Long-term debt | 13,075 | 13,313 | ||||||
Other liabilities | 4,943 | 5,439 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock, $0.001 par value. Authorized shares; none issued or outstanding | ||||||||
Common stock: | ||||||||
Class A, $0.001 par value. Authorized 71,000,000 shares; issued 16,605,215 shares at both July 31, 2018 and January 31, 2018 | 16 | 16 | ||||||
Class B, $0.001 par value. Authorized 4,000,000 shares; issued 3,537,380 shares at both July 31, 2018 and January 31, 2018 | 4 | 4 | ||||||
Additional paid-in capital | 192,421 | 200,456 | ||||||
Treasury stock, at cost (528,565 shares and 892,700 shares at July 31, 2018 and January 31, 2018, respectively) | (7,532 | ) | (12,461 | ) | ||||
Accumulated deficit | (53,655 | ) | (75,559 | ) | ||||
Accumulated other comprehensive loss | (7,664 | ) | (6,828 | ) | ||||
Total stockholders’ equity | 123,590 | 105,628 | ||||||
Total liabilities and stockholders’ equity | $ | 279,943 | $ | 299,817 | ||||
QAD INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME
(in thousands, except per share data)
(unaudited)
Three Months Ended April 30, | ||||||||
2019 | 2018 | |||||||
Revenue: | ||||||||
Subscription fees | $ | 25,306 | $ | 21,511 | ||||
License fees | 4,466 | 6,266 | ||||||
Maintenance and other | 29,899 | 31,483 | ||||||
Professional services | 18,364 | 26,930 | ||||||
Total revenue | 78,035 | 86,190 | ||||||
Costs of revenue: | ||||||||
Subscription fees | 9,417 | 8,228 | ||||||
License fees | 591 | 664 | ||||||
Maintenance and other | 7,603 | 7,865 | ||||||
Professional services | 19,323 | 24,310 | ||||||
Total cost of revenue | 36,934 | 41,067 | ||||||
Gross profit | 41,101 | 45,123 | ||||||
Operating expenses: | ||||||||
Sales and marketing | 20,891 | 19,946 | ||||||
Research and development | 13,987 | 14,006 | ||||||
General and administrative | 9,418 | 9,362 | ||||||
Amortization of intangibles from acquisitions | 67 | — | ||||||
Total operating expenses | 44,363 | 43,314 | ||||||
Operating (loss) income | (3,262 | ) | 1,809 | |||||
Other (income) expense: | ||||||||
Interest income | (724 | ) | (524 | ) | ||||
Interest expense | 153 | 157 | ||||||
Other (income), net | (172 | ) | (404 | ) | ||||
Total other (income), net | (743 | ) | (771 | ) | ||||
(Loss) income before income taxes | (2,519 | ) | 2,580 | |||||
Income tax expense | 715 | 1,183 | ||||||
Net (loss) income | $ | (3,234 | ) | $ | 1,397 | |||
Basic net (loss) income per share | ||||||||
Class A | $ | (0.17 | ) | $ | 0.07 | |||
Class B | $ | (0.14 | ) | $ | 0.06 | |||
Diluted net (loss) income per share | ||||||||
Class A | $ | (0.17 | ) | $ | 0.07 | |||
Class B | $ | (0.14 | ) | $ | 0.06 | |||
Net (loss) income | $ | (3,234 | ) | $ | 1,397 | |||
Other comprehensive loss, net of tax: | ||||||||
Foreign currency translation adjustments | (263 | ) | (510 | ) | ||||
Total comprehensive (loss) income | $ | (3,497 | ) | $ | 887 | |||
See Accompanying Notes to Condensed Consolidated Financial Statements.
QAD INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except per share data)
(unaudited)
Three Months Ended April 30, 2018 | ||||||||||||||||||||||||||||||||||||||||
Number of Shares | Amount | Additional Paid-in | Treasury | Accumulated | Accumulated Other Comprehensive | Total Stockholders’ | ||||||||||||||||||||||||||||||||||
Class A | Class B | Treasury | Class A | Class B | Capital | Stock | Deficit | Loss | Equity | |||||||||||||||||||||||||||||||
Balance, January 31, 2018 | 16,605 | 3,537 | (892 | ) | $ | 16 | $ | 4 | $ | 200,456 | $ | (12,461 | ) | $ | (75,559 | ) | $ | (6,828 | ) | $ | 105,628 | |||||||||||||||||||
Cumulative effect of the adoption of ASC606 and ASU2016-16 | — | — | — | — | — | — | — | 22,125 | — | 22,125 | ||||||||||||||||||||||||||||||
Adjusted balance at February 1, 2018 | 16,605 | 3,537 | (892 | ) | $ | 16 | $ | 4 | $ | 200,456 | $ | (12,461 | ) | $ | (53,434 | ) | $ | (6,828 | ) | $ | 127,753 | |||||||||||||||||||
Net income | — | — | — | — | — | — | — | 1,397 | — | 1,397 | ||||||||||||||||||||||||||||||
Foreign currency translation adjustments | — | — | — | — | — | — | — | — | (510 | ) | (510 | ) | ||||||||||||||||||||||||||||
Stock award exercises | — | — | 167 | — | — | (6,391 | ) | 2,495 | — | — | (3,896 | ) | ||||||||||||||||||||||||||||
Stock compensation expense | — | — | — | — | — | 2,106 | — | — | — | 2,106 | ||||||||||||||||||||||||||||||
Dividends declared ($0.072 and $0.06 per Class A and Class B share, respectively) | — | — | — | — — | — | — | — | (1,359 | ) | — | (1,359 | ) | ||||||||||||||||||||||||||||
Restricted stock | — | — | 7 | — | — | (113 | ) | (69 | ) | — | — | (182 | ) | |||||||||||||||||||||||||||
Balance, April 30, 2018 | 16,605 | 3,537 | (718 | ) | $ | 16 | $ | 4 | $ | 196,058 | $ | (10,035 | ) | $ | (53,396 | ) | $ | (7,338 | ) | $ | 125,309 | |||||||||||||||||||
Three Months Ended April 31, 2019 | ||||||||||||||||||||||||||||||||||||||||
Number of Shares | Amount | Additional Paid-in | Treasury | Accumulated | Accumulated Other Comprehensive | Total Stockholders’ | ||||||||||||||||||||||||||||||||||
Class A | Class B | Treasury | Class A | Class B | Capital | Stock | Deficit | Loss | Equity | |||||||||||||||||||||||||||||||
Balance, January 31, 2019 | 16,605 | 3,537 | (515 | ) | $ | 16 | $ | 4 | $ | 196,723 | $ | (7,350 | ) | $ | (48,485 | ) | $ | (7,661 | ) | $ | 133,247 | |||||||||||||||||||
Net loss | — | — | — | — | — | — | — | (3,234 | ) | — | (3,234 | ) | ||||||||||||||||||||||||||||
Foreign currency translation adjustments | — | — | — | — | — | — | — | — | (263 | ) | (263 | ) | ||||||||||||||||||||||||||||
Stock award exercises | — | — | 3 | — | — | (144 | ) | 87 | — | — | (57 | ) | ||||||||||||||||||||||||||||
Stock compensation expense | — | — | — | — | — | 2,304 | — | — | — | 2,304 | ||||||||||||||||||||||||||||||
Dividends declared ($0.072 and $0.06 per Class A and Class B share, respectively) | — | — | — | — | — | — | — | (1,374 | ) | — | (1,374 | ) | ||||||||||||||||||||||||||||
Restricted stock | — | — | 7 | — | — | (219 | ) | 41 | — | — | (178 | ) | ||||||||||||||||||||||||||||
Adoption of ASU2016-02, Leases (Topic 842) | — | — | — | — | — | — | — | (173 | ) | — | (173 | ) | ||||||||||||||||||||||||||||
Balance, April 30, 2019 | 16,605 | 3,537 | (505 | ) | $ | 16 | $ | 4 | $ | 198,664 | $ | (7,222 | ) | $ | (53,266 | ) | $ | (7,924 | ) | $ | 130,272 | |||||||||||||||||||
See Accompanying Notes to Condensed Consolidated Financial Statements.
QAD INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except per share data)
(unaudited)
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See Accompanying Notes to Condensed Consolidated Financial Statements.
QAD INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended July 31, | Three Months Ended April 30, | |||||||||||||||
2018 | 2017 | 2019 | 2018 | |||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net income (loss) | $ | 2,510 | $ | (3,732 | ) | |||||||||||
Adjustments to reconcile net income (loss) loss to net cash provided by operating activities: | ||||||||||||||||
Net (loss) income | $ | (3,234 | ) | $ | 1,397 | |||||||||||
Adjustments to reconcile net (loss) income to net cash provided by operating activities: | ||||||||||||||||
Depreciation and amortization | 2,699 | 2,971 | 1,493 | 1,362 | ||||||||||||
Amortization of costs capitalized to obtain and fulfill contracts | 2,051 | — | 1,073 | 1,004 | ||||||||||||
Non-cash lease expense | 1,456 | — | ||||||||||||||
Net change in valuation allowance | 4,553 | 2,957 | 809 | 1,416 | ||||||||||||
Other deferred income taxes | (1,649 | ) | (3,209 | ) | 37 | 1,053 | ||||||||||
Loss on disposal of equipment | 4 | 12 | ||||||||||||||
Provision for doubtful accounts and sales adjustments | 498 | 187 | (67 | ) | 270 | |||||||||||
Stock compensation expense | 5,470 | 4,360 | 2,304 | 2,106 | ||||||||||||
Change in fair value of derivative instrument | (152 | ) | 3 | 91 | (117 | ) | ||||||||||
Other, net | 64 | 3 | ||||||||||||||
Changes in assets and liabilities: | ||||||||||||||||
Accounts receivable | 27,033 | 28,110 | 32,033 | 25,543 | ||||||||||||
Costs capitalized to obtain and fulfill contracts | (1,692 | ) | — | (927 | ) | (765 | ) | |||||||||
Lease liabilities | (1,584 | ) | — | |||||||||||||
Other assets | (894 | ) | 1,147 | (1,753 | ) | (3,692 | ) | |||||||||
Accounts payable | (3,480 | ) | (2,580 | ) | (1,378 | ) | (5,459 | ) | ||||||||
Deferred revenue | (21,683 | ) | (17,987 | ) | (9,426 | ) | (11,020 | ) | ||||||||
Other liabilities | (6,122 | ) | (4,601 | ) | (6,796 | ) | (9,316 | ) | ||||||||
Net cash provided by operating activities | 9,146 | 7,638 | 14,195 | 3,785 | ||||||||||||
Cash flows from investing activities: | ||||||||||||||||
Purchase of property and equipment | (2,004 | ) | (1,571 | ) | (1,036 | ) | (1,093 | ) | ||||||||
Acquisition of business, net of cash acquired | (450 | ) | — | |||||||||||||
Capitalized software costs | (536 | ) | (480 | ) | (264 | ) | (179 | ) | ||||||||
Net cash used in investing activities | (2,990 | ) | (2,051 | ) | (1,300 | ) | (1,272 | ) | ||||||||
Cash flows from financing activities: | ||||||||||||||||
Repayments of debt | (234 | ) | (222 | ) | (122 | ) | (117 | ) | ||||||||
Tax payments related to stock awards | (8,576 | ) | (2,781 | ) | (235 | ) | (4,078 | ) | ||||||||
Cash dividends paid | (2,731 | ) | (2,675 | ) | ||||||||||||
Net cash used in financing activities | (11,541 | ) | (5,678 | ) | (357 | ) | (4,195 | ) | ||||||||
Effect of exchange rates on cash and equivalents | (2,110 | ) | 4,211 | (961 | ) | (952 | ) | |||||||||
Net (decrease) increase in cash and equivalents | (7,495 | ) | 4,120 | |||||||||||||
Net increase (decrease) in cash and equivalents | 11,577 | (2,634 | ) | |||||||||||||
Cash and equivalents at beginning of period | 147,023 | 145,082 | 139,413 | 147,023 | ||||||||||||
Cash and equivalents at end of period | $ | 139,528 | $ | 149,202 | $ | 150,990 | $ | 144,389 | ||||||||
Supplemental disclosure of non-cash activities | ||||||||||||||||
Obligations associated with dividend declaration | $ | 1,374 | $ | 1,359 | ||||||||||||
Supplemental disclosure of cash flow information: | ||||||||||||||||
Cash paid during the period for: | ||||||||||||||||
Interest | $ | 305 | $ | 303 | $ | 149 | $ | 154 | ||||||||
Income taxes, net of refunds | $ | 1,632 | $ | 2,030 | $ | 791 | $ | 799 | ||||||||
See Accompanying Notes to Condensed Consolidated Financial Statements.
QAD INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. | BASIS OF PRESENTATION AND RECENT ACCOUNTING PRONOUNCEMENTS |
Basis of Presentation
In the opinion of management, the accompanying unaudited Condensed Consolidated Financial Statements fairly present the financial information contained therein. These statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q10-Q and Article 10 of Regulation S-X.S-X. The financial statements and footnotes are unaudited. In management’s opinion, all necessary adjustments, consisting of normal, recurring and non-recurring adjustments, have been included in the accompanying Condensed Consolidated Financial Statements to present fairly the financial position and operating results of QAD Inc. (“QAD” or the “Company”). The Condensed Consolidated Financial Statements do not include all disclosures required by GAAP accounting principles for annual financial statements and should be read in conjunction with the audited financial statements and related notes included in the Company’s Annual Report on Form 10-K10-K for the year ended January 31, 2018. 2019. The Condensed Consolidated Financial Statements include the results of the Company and its wholly owned subsidiaries. Because of seasonal and other factors, results of operations for the three and six months ended July 31, 2018 April 30, 2019 are not necessarily indicative of the results to be expected for the year ending January 31, 2019.2020.
The Company’s accounting policies are set forth in detail in Note 1 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K10-K for the year ended January 31,2018 2019 with the Securities and Exchange Commission. Such Annual Report also contains a discussion of the Company’s critical accounting policies and estimates. The Company believes that these critical accounting policies and estimates affect its more significant estimates and judgments used in the preparation of the Company’s consolidated financial statements.
Effective February 1, 2018, the Company adopted the requirements of Accounting Standards Update (“ASU”) No.2014-09,Revenue from Contracts with Customers (“Topic 606”) using the modified retrospective method. The Company’s updated accounting policy on revenue recognition is described in Note 2 and in “Critical accounting policies” in Item 2 of this Form 10-Q.
Certain prior year amounts have been reclassified for consistency with the current year presentation. Adjustments were made to the operating activities section of the Condensed Consolidated Statements of Cash Flows. These reclassifications had no effect on the reported results of operations and no effect on previously reported cash flows from operating activities.
Recent Accounting Pronouncements
With the exception of thoseExcept as discussed below, there have been no recent changes in accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”) or adopted by the Company during the three or six months ended July 31, 2018, April 30, 2019, that are of significance, or potential significance, to the Company.
Recent Accounting Pronouncements Adopted
In OctoberFebruary 2016, the FASBFinancial Accounting Standards Board (“FASB”) issued ASU 2016-16,Intra-Entity Transfers of Assets Other Than Inventory,No. 2016-02, Leases (Topic 842). This pronouncement requires lessees to recognize a liability for lease obligations, which removesrepresents the prohibition against the immediate recognition of the current and deferred income tax effects of intra-entity transfers other than inventory. The guidance is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2017 with early adoption permitted as of the beginning of the annual reporting period in which the ASU was issued. ASU 2016-16 was adopted by the Company effective February 1, 2018 on a modified retrospective basis, resulting in a $9.6 million decreasediscounted obligation to accumulated deficitmake future lease payments, and a corresponding increaseright-of-use (“ROU”) asset on the balance sheet. The Company adopted ASU 2016-02, along with related clarifications and improvements, as of February 1, 2019, using the modified retrospective approach, which allows the Company to deferred tax assets.apply Accounting Standards Codification (“ASC”) 840, Leases, in the comparative periods presented in the year of adoption. Accordingly, the comparative periods and disclosures have not been restated. The cumulative effect of adoption was recorded as an adjustment to the opening balance sheet in the period of adoption.
In August 2016, The Company elected the FASB issued ASU 2016-15,Statementpackage of Cash Flows (Topic 230) Classificationpractical expedients not to reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs and the lessee practical expedient to combine lease and non-lease components for certain assets. Additionally, the Company adopted the policy election to not recognize right-of-use assets and lease liabilities for short-term leases for all asset classes.
Adoption of Certain Cash Receipts and Cash Payments, that modifies how certain cash receipts and cash payments are presented and classifiedthe new standard resulted in the statementrecording of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017 a non-cash transitional adjustment to ROU lease assets and interim periods within those fiscal years, with earlier adoption permitted. ASU 2016-15 was adopted by the Company effective lease liabilities of approximately $13.1 million and $13.9 million, respectively, as of February 1, 2018 on a retrospective basis, with no material changes reflected2019. The difference between the ROU lease assets and lease liabilities represented existing deferred rent expense and prepaid rent that were derecognized and recorded to retained earnings in the Condensed Consolidated Statement of Cash Flows.
In May 2014, the FASB issued ASU 2014-09,Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in Revenue Recognition (Topic 605) and Subtopic 985-605Software - Revenue Recognition. Topic 605 and Subtopic 985-605 are collectively referred to as “Topic 605” or “prior GAAP.” Under Topic 606, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, Topic 606 requires enhanced disclosures, including disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
Balance Sheets. The Company adopted Topic 606 on the first day of fiscal 2019 using the modified retrospective transition method. Under this method, QAD evaluated contracts that were in effect at the beginning of fiscal 2019 as if those contracts had been accounted for under Topic 606. The Company did not evaluate individual modifications for those periods prior to the adoption date, but the aggregate effect of all modifications as of the adoption date and such effects are provided below. Under the modified retrospective transition method, periods prior to the adoption date were not adjusted and continue to be reported in accordance with historical, pre-Topic 606 accounting. A cumulative catch-up adjustment was recorded to beginning accumulated deficit to reflect the impact of all existing arrangements under Topic 606.
The most significant impacts of the adoption of Topic 606 were as follows:
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The taxASU 2016-02 did not materially impact results of the above adjustments was assessed and, at adoption, QAD increased accumulated deficit and decreased net deferred tax assets by $1.6 million.operations or cash flows.
Adjustments to beginning consolidated balance sheet accounts
The following table presents the cumulative effect adjustments, net of income tax effects, to beginning consolidated balance sheet accounts for the new accounting standards adopted by the Company on the first day of fiscal 2019:
Jan. 31, 2018 | Topic 606 | ASU2016-16 (1) | Feb. 1, 2018 | |||||||||||||
(in thousands) | ||||||||||||||||
Assets | ||||||||||||||||
Current assets: | ||||||||||||||||
Cash and equivalents | $ | 147,023 | $ | - | $ | - | $ | 147,023 | ||||||||
Accounts receivable, net | 83,518 | - | - | 83,518 | ||||||||||||
Other current assets | 15,856 | 4,013 | - | 19,869 | ||||||||||||
Total current assets | 246,397 | 4,013 | - | 250,410 | ||||||||||||
Property and equipment, net | 30,408 | - | - | 30,408 | ||||||||||||
Capitalized software costs, net | 990 | - | - | 990 | ||||||||||||
Goodwill | 11,023 | - | - | 11,023 | ||||||||||||
Deferred tax assets, net | 7,944 | (1,643 | ) | 9,584 | 15,885 | |||||||||||
Other assets, net | 3,055 | 8,421 | - | 11,476 | ||||||||||||
Total assets | $ | 299,817 | $ | 10,791 | $ | 9,584 | $ | 320,192 | ||||||||
Liabilities and stockholders’ equity | ||||||||||||||||
Current portion of long-term debt | $ | 466 | $ | - | $ | - | $ | 466 | ||||||||
Accounts payable | 14,818 | - | - | 14,818 | ||||||||||||
Deferred revenue | 116,693 | (1,239 | ) | - | 115,454 | |||||||||||
Other current liabilities | 43,460 | - | - | 43,460 | ||||||||||||
Total current liabilities | 175,437 | (1,239 | ) | - | 174,198 | |||||||||||
Long-term debt | 13,313 | - | - | 13,313 | ||||||||||||
Other liabilities | 5,439 | (511 | ) | - | 4,928 | |||||||||||
Stockholders’ equity | ||||||||||||||||
Common stock - Class A | 16 | - | - | 16 | ||||||||||||
Common stock - Class B | 4 | - | - | 4 | ||||||||||||
Additional paid-in capital | 200,456 | - | - | 200,456 | ||||||||||||
Treasury stock | (12,461 | ) | - | - | (12,461 | ) | ||||||||||
Accumulated deficit | (75,559 | ) | 12,541 | 9,584 | (53,434 | ) | ||||||||||
Accumulated other comprehensive loss | (6,828 | ) | - | - | (6,828 | ) | ||||||||||
Total stockholders’ equity | 105,628 | 12,541 | 9,584 | 127,753 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 299,817 | $ | 10,791 | $ | 9,584 | $ | 320,192 | ||||||||
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The following table summarizes the effects of adopting Topic 606 on the Company’s Condensed Consolidated Balance Sheet as of July 31,2018:
As reported under Topic 606 | Adjustments | Balances under Prior GAAP | ||||||||||
(in thousands) | ||||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and equivalents | $ | 139,528 | $ | - | $ | 139,528 | ||||||
Accounts receivable, net | 54,258 | - | 54,258 | |||||||||
Other current assets | 21,116 | (4,194 | ) | 16,922 | ||||||||
Total current assets | 214,902 | (4,194 | ) | 210,708 | ||||||||
Property and equipment, net | 29,741 | - | 29,741 | |||||||||
Capitalized software costs, net | 1,405 | - | 1,405 | |||||||||
Goodwill | 11,095 | - | 11,095 | |||||||||
Deferred tax assets, net | 11,869 | 1,047 | 12,916 | |||||||||
Other assets, net | 10,931 | (7,697 | ) | 3,234 | ||||||||
Total assets | $ | 279,943 | $ | (10,844 | ) | $ | 269,099 | |||||
Liabilities and stockholders’ equity | ||||||||||||
Current portion of long-term debt | $ | 476 | $ | - | $ | 476 | ||||||
Accounts payable | 10,962 | - | 10,962 | |||||||||
Deferred revenue | 91,195 | 3,034 | 94,229 | |||||||||
Other current liabilities | 35,702 | - | 35,702 | |||||||||
Total current liabilities | 138,335 | 3,034 | 141,369 | |||||||||
Long-term debt | 13,075 | - | 13,075 | |||||||||
Other liabilities | 4,943 | 868 | 5,811 | |||||||||
Stockholders’ equity | ||||||||||||
Common stock - Class A | 16 | - | 16 | |||||||||
Common stock - Class B | 4 | - | 4 | |||||||||
Additional paid-in capital | 192,421 | - | 192,421 | |||||||||
Treasury stock | (7,532 | ) | - | (7,532 | ) | |||||||
Accumulated deficit | (53,655 | ) | (14,750 | ) | (68,405 | ) | ||||||
Accumulated other comprehensive loss | (7,664 | ) | 4 | (7,660 | ) | |||||||
Total stockholders’ equity | 123,590 | (14,746 | ) | 108,844 | ||||||||
Total liabilities and stockholders’ equity | $ | 279,943 | $ | (10,844 | ) | $ | 269,099 | |||||
The following table summarizes the effects of adopting Topic 606 on the Company’s Condensed Consolidated Statement of Income for the three months ended July 31, 2018:
As reported under Topic 606 | Adjustments | Balances under Prior GAAP | ||||||||||
(in thousands, except per share amounts) | ||||||||||||
Revenue | ||||||||||||
Subscription fees | $ | 22,439 | $ | (251 | ) | $ | 22,188 | |||||
License fees | 5,561 | (216 | ) | 5,345 | ||||||||
Maintenance and other | 30,574 | 40 | 30,614 | |||||||||
Professional services | 25,969 | 904 | 26,873 | |||||||||
Total revenue | 84,543 | 477 | 85,020 | |||||||||
Cost of revenue: | ||||||||||||
Subscription fees | 8,334 | 4 | 8,338 | |||||||||
License fees | 574 | - | 574 | |||||||||
Maintenance and other | 7,774 | - | 7,774 | |||||||||
Professional services | 23,754 | - | 23,754 | |||||||||
Total cost of revenue | 40,436 | 4 | 40,440 | |||||||||
Gross profit | 44,107 | 473 | 44,580 | |||||||||
Operating expenses: | ||||||||||||
Sales and marketing | 19,502 | (22 | ) | 19,480 | ||||||||
Research and development | 13,513 | (59 | ) | 13,454 | ||||||||
General and administrative | 9,366 | - | 9,366 | |||||||||
Total operating expenses | 42,381 | (81 | ) | 42,300 | ||||||||
Operating income | 1,726 | 554 | 2,280 | |||||||||
Other (income) expense | ||||||||||||
Interest income | (743 | ) | - | (743 | ) | |||||||
Interest expense | 154 | - | 154 | |||||||||
Other income | (269 | ) | - | (269 | ) | |||||||
Total other income, net | (858 | ) | - | (858 | ) | |||||||
Income before income taxes | 2,584 | 554 | 3,138 | |||||||||
Income tax expense | 1,471 | 112 | 1,583 | |||||||||
Net income | $ | 1,113 | $ | 442 | $ | 1,555 | ||||||
Basic income per share | ||||||||||||
Class A | $ | 0.06 | $ | 0.02 | $ | 0.08 | ||||||
Class B | $ | 0.05 | $ | 0.02 | $ | 0.07 | ||||||
Diluted income per share | ||||||||||||
Class A | $ | 0.05 | $ | 0.02 | $ | 0.07 | ||||||
Class B | $ | 0.05 | $ | 0.02 | $ | 0.07 | ||||||
The following table summarizes the effects of adopting Topic 606 on the Company’s Condensed Consolidated Statement of Income for the six months ended July 31, 2018:
As reported under Topic 606 | Adjustments | Balances under Prior GAAP | ||||||||||
(in thousands, except per share amounts) | ||||||||||||
Revenue | ||||||||||||
Subscription fees | $ | 43,950 | $ | (557 | ) | $ | 43,393 | |||||
License fees | 11,827 | (1,386 | ) | 10,441 | ||||||||
Maintenance and other | 62,057 | 113 | 62,170 | |||||||||
Professional services | 52,899 | (846 | ) | 52,053 | ||||||||
Total revenue | 170,733 | (2,676 | ) | 168,057 | ||||||||
Cost of revenue: | ||||||||||||
Subscription fees | 16,562 | 14 | 16,576 | |||||||||
License fees | 1,238 | - | 1,238 | |||||||||
Maintenance and other | 15,639 | - | 15,639 | |||||||||
Professional services | 48,064 | - | 48,064 | |||||||||
Total cost of revenue | 81,503 | 14 | 81,517 | |||||||||
Gross profit | 89,230 | (2,690 | ) | 86,540 | ||||||||
Operating expenses: | ||||||||||||
Sales and marketing | 39,448 | (284 | ) | 39,164 | ||||||||
Research and development | 27,519 | (118 | ) | 27,401 | ||||||||
General and administrative | 18,728 | - | 18,728 | |||||||||
Total operating expenses | 85,695 | (402 | ) | 85,293 | ||||||||
Operating income | 3,535 | (2,288 | ) | 1,247 | ||||||||
Other (income) expense | ||||||||||||
Interest income | (1,267 | ) | - | (1,267 | ) | |||||||
Interest expense | 311 | - | 311 | |||||||||
Other income | (673 | ) | - | (673 | ) | |||||||
Total other income, net | (1,629 | ) | - | (1,629 | ) | |||||||
Income before income taxes | 5,164 | (2,288 | ) | 2,876 | ||||||||
Income tax expense | 2,654 | (79 | ) | 2,575 | ||||||||
Net income | $ | 2,510 | $ | (2,209 | ) | $ | 301 | |||||
Basic income (loss) per share | ||||||||||||
Class A | $ | 0.13 | $ | (0.12 | ) | $ | 0.01 | |||||
Class B | $ | 0.11 | $ | (0.10 | ) | $ | 0.01 | |||||
Diluted income (loss) per share | ||||||||||||
Class A | $ | 0.12 | $ | (0.11 | ) | $ | 0.01 | |||||
Class B | $ | 0.11 | $ | (0.10 | ) | $ | 0.01 | |||||
The following table summarizes the effects of adopting Topic 606 on the financial statement line items of the Company’s Condensed Consolidated Statement of Cash Flows for the six months ended July 31, 2018:
As reported under Topic 606 | Adjustments | Balances under Prior GAAP | ||||||||||
(in thousands) | ||||||||||||
Net income (loss) | $ | 2,510 | $ | (2,209 | ) | $ | 301 | |||||
Amortization of costs capitalized to obtain and fulfill contracts | 2,051 | (1,636 | ) | 415 | ||||||||
Net change in valuation allowance | 4,553 | 648 | 5,201 | |||||||||
Changes in operating assets and liabilities: | ||||||||||||
Costs capitalized to obtain and fulfill contracts | (1,692 | ) | 1,366 | (326 | ) | |||||||
Other assets | (894 | ) | (325 | ) | (1,219 | ) | ||||||
Deferred revenue | (21,683 | ) | 2,152 | (19,531 | ) | |||||||
Net cash provided by operating activities | 9,146 | (4 | ) | 9,142 | ||||||||
Effect of exchange rates on cash and equivalents | (2,110 | ) | 4 | (2,106 | ) | |||||||
Recent Accounting Pronouncements Not Yet Adopted
In February 2016, January 2017, the FASB issued ASU 2016-02,Leases (Topic 842). ASU 2016-02 requires companies to generally recognize on the balance sheet operating and financing lease liabilities and corresponding right-of-use assets. ASU 2016-02 is effective for the Company in its first quarter of fiscal 2020 on a modified retrospective basis and earlier adoption is permitted. The Company is currently evaluating the impact of the pending adoption of ASU 2016-02 on its consolidated financial statements and expects that most of its operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon adoption of ASU 2016-02.
In January 2017, the FASB issued ASU 2017-04,2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill to eliminate Step 2 from the goodwill impairment test. In addition, it eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if that fails that qualitative test, to perform Step 2 of the goodwill impairment test. Therefore, the same impairment assessment applies to all reporting units. The amendments will be effective for the Company’s fiscal year beginning February 1, 2020. Early adoption is permitted. The new guidance is required to be applied on a prospective basis. The Company does not believe adoption of ASU 2017-042017-04 will have a material impact on its consolidated financial statements.
2. | REVENUE |
QAD offers its software using the same underlying technology via two models: a traditional on-premises licensing model and a cloud-based subscription model. The on-premises model involves the sale or license of software on a perpetual basis to customers who take possession of the software and install and maintain the software on their own hardware. Under the cloud-based subscription delivery model, QAD provides access to its software on a hosted basis as a service and customers generally do not have the contractual right to take possession of the software.
The Company generates revenue through sales of licenses and maintenance provided to its on-premises customers and through subscriptions of its cloud-based software. QAD offers professional services to both its on-premises and cloud customers to assist them with the design, testing and implementation of its software.
The Company determines revenue recognition through the following steps:
- | Identification of the contract, or contracts, with a customer; |
- | Identification of the performance obligations in the contract; |
- | Determination of the transaction price; |
- | Allocation of the transaction price to the performance obligations in the contract; and |
- | Recognition of revenue when, or as, |
The Company records the amount of revenue and related costs by considering whether the entity is a principal (gross presentation) or an agent (net presentation) by evaluating the nature of its promise to the customer. Revenue is presented net of sales, value-added and other taxes collected from customers and remitted to government authorities.
Performance Obligations
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account under Topic 606. The transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied by transferring the promised good or service to the customer. The Company identifies and tracks the performance obligations at contract inception so that the Company can monitor and account for the performance obligations over the life of the contract.
The Company’s contracts which contain multiple performance obligations generally consist of the initial purchase of subscription or licenses and a professional services engagement. License purchases generally have multiple performance obligations as customers purchase maintenance in addition to the licenses. The Company’s single performance obligation arrangements are typically maintenance renewals, subscription renewals and services engagements.
For contracts with multiple performance obligations where the contracted price differs from the standalone selling price ("SSP") for any distinct good or service, the Company may be required to allocate the contract’s transaction price to each performance obligation using its best estimate for the SSP. SSP is assessed annually using a historical analysis of contracts with customers executed in the most recently completed fiscal year to determine the range of selling prices applicable to a distinct good or service.
Judgment is required to determine the SSP for each distinct performance obligation. The Company rarely licenses or sells its software products on a stand-alone basis, so the Company is required to estimate the range of SSPs for each performance obligation. In instances where SSP is not directly observable because the Company does not sell the license, product or service separately, the Company determines the SSP using information that may include market conditions and other observable inputs. In making these judgments, the Company analyzes various factors, including its pricing methodology and consistency, size of the arrangement, length of term, customer demographics and overall market and economic conditions. Based on these results, the estimated SSP is set for each distinct product or service delivered to customers.
Subscription
Subscription revenue is recognized ratably over the initial subscription period committed to by the customer commencing when the cloud environment is made available to the customer. The initial subscription period is typically 12 to 60 months. The Company generally invoices its customers in advance in quarterly or annual installments and typical payment terms provide that customers make payment within 30 days of invoice.
Software Licenses
Transfer of control for software is considered to have occurred upon electronic delivery of the license key that provides immediate availability of the product to the customer. The Company’s typical payment terms tend to vary by region but its standard payment terms are within 30-9030-90 days of invoice.
Maintenance
Revenue from support services and product updates, referred to as maintenance revenue, is recognized ratably over the term of the maintenance period, which in most instances is one year. Software license updates provide customers with rights to unspecified software product updates, maintenance releases and patches released during the term of the support period on a when-and-if available basis. Product support includes Internet access to technical content, as well as Internet and telephone access to technical support personnel. The Company’s customers purchase both product support and license updates via the Company’s maintenance offering when they acquire new software licenses. In addition, a majority of customers renew their support servicesmaintenance contracts annually and typical payment terms provide that customers make payment within 30 days of invoice.
Professional Services
Revenue from professional services is typically comprised of implementation, development, training or other consulting services. Consulting services are generally sold on a time-and-materials or fixed fee basis and can include services ranging from software installation to data conversion and building non-complex interfaces to allow the software to operate in integrated environments. The Company recognizes revenue for time-and-materials arrangements as the services are performed. In fixed fee arrangements, revenue is recognized as services are performed as measured by costs incurred to date, compared to total estimated costs to complete the services project. Management applies judgment when estimating project status and the costs necessary to complete the services projects. A number of internal and external factors can affect these estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes. Services are generally invoiced upon milestones in the contract or upon consumption of the hourly resources and payments are typically due 30 days after invoice.
Indirect Sales Channels
The Company executes arrangements through indirect sales channels via sales agents and distributors who are authorized to market its software products to end users. In arrangements with sales agents, QAD contracts directly with the customer and sales agents are compensated on a commission basis. Distributor arrangements are those in which the resellers are authorized to market and distribute the Company’s software products to end users in specified territories and the distributor bears the risk of collection from the end user customer. The Company recognizes revenue from transactions with distributors when the distributor submits a signed agreement and transfer of control has occurred to the distributor in accordance with the five revenue recognition steps noted above. Revenue from distributor transactions is recorded on a net basis (the amount actually received by the Company from the distributor). QAD does not offer rights of return, product rotation or price protection to any of its distributors.
Disaggregated Revenue
The Company disaggregates revenue from contracts with customers by geography and by the customers’ industry within manufacturing, as it believes it best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.
The Company’s revenue by geography is as follows:
Three Months Ended July 31, | Six Months Ended July 31, | Three Months Ended April 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | |||||||||||||||||||
(in thousands) | (in thousands) | (in thousands) | ||||||||||||||||||||||
North America | $ | 39,288 | $ | 35,156 | $ | 79,313 | $ | 68,526 | $ | 37,659 | $ | 40,025 | ||||||||||||
EMEA | 26,906 | 22,227 | 51,993 | 43,108 | 22,509 | 25,087 | ||||||||||||||||||
Asia Pacific | 12,866 | 12,967 | 25,425 | 25,133 | 11,886 | 12,559 | ||||||||||||||||||
Latin America | 5,483 | 5,608 | 14,002 | 10,573 | 5,981 | 8,519 | ||||||||||||||||||
| Total revenue | $ | 84,543 | $ | 75,958 | $ | 170,733 | $ | 147,340 | $ | 78,035 | $ | 86,190 | ||||||||||||
The Company’s revenue by industry is as follows:
Three Months Ended July 31, | Six Months Ended July 31, | Three Months Ended April 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | |||||||||||||||||||
(in thousands) | (in thousands) | (in thousands) | ||||||||||||||||||||||
Automotive | $ | 34,663 | $ | 28,864 | $ | 71,725 | $ | 55,276 | $ | 29,072 | $ | 37,062 | ||||||||||||
Consumer products and food and beverage | 13,527 | 11,394 | 27,317 | 22,815 | 11,978 | 13,790 | ||||||||||||||||||
High technology and industrial products | 25,363 | 24,306 | 50,358 | 47,148 | 25,548 | 24,995 | ||||||||||||||||||
Life sciences | 10,990 | 11,394 | 21,333 | 22,101 | ||||||||||||||||||||
Life sciences and other | 11,437 | 10,343 | ||||||||||||||||||||||
Total revenue | $ | 84,543 | $ | 75,958 | $ | 170,733 | $ | 147,340 | $ | 78,035 | $ | 86,190 | ||||||||||||
SignificantManagement Judgments
More judgments and estimates are required under Topic 606 than were required under Topic 605.Due to the complexity of certain contracts, the actual revenue recognition treatment required under Topic 606 for the Company’s arrangements may be dependent on contract-specific terms and may vary in some instances.
Judgment is required to determine the SSP for each distinct performance obligation. The Company rarely licenses or sells products on a stand-alone basis, so the Company is required to estimate the range of SSPs for each performance obligation. In instances where SSP is not directly observable because the Company does not sell the license, product or service separately, the Company determines the SSP using information that may include market conditions and other observable inputs. In making these judgments, the Company analyzes various factors, including its pricing methodology and consistency, size of the arrangement, length of term, customer demographics and overall market and economic conditions. Based on these results, the estimated SSP is set for each distinct product or service delivered to customers.
Revenue is recognized over time for the Company’s subscription, maintenance and fixed fee professional services that are separate performance obligations. For the Company’s professional services, revenue is recognized over time, generally using costs incurred or hours expended to measure progress. Judgment is required in estimating project status and the costs necessary to complete projects. A number of internal and external factors can affect these estimates, including labor rates, utilization, specification variances and testing requirement changes.
If a group of agreements are entered at or near the same time and so closely related that they are, in effect, part of a single arrangement, such agreements are deemed to be combined as one arrangement for revenue recognition purposes. The Company exercises significant judgment to evaluate the relevant facts and circumstances in determining whether agreements should be accounted for separately or as a single arrangement. The Company’s judgments about whether a group of contracts comprise a single arrangement can affect the allocation of consideration to the distinct performance obligations, which could have an effect on results of operations for the periods involved.
If a contract includes variable consideration, the Company exercises judgment in estimating the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer. When estimating variable consideration, the Company will consider all relevant facts and circumstances.Variablecircumstances. Variable consideration will be estimated and included in the contract price only when it is probable that a significant reversal in the amount of revenue recognized will not occur.
Contract Balances
The timing of revenue recognition may differ from the timing of invoicing to customers and these timing differences result in receivables, contract assets, or contract liabilities (deferred revenue) on the Company’s Condensed Consolidated Balance Sheets. QAD records a contract asset when the Company has transferred goods or services but does not yet have the right to consideration. QAD records deferred revenue when the Company has received or has the right to receive consideration but has not yet transferred goods or services to the customer.
The contract assets indicated below are presented as other current and non-current assets in the Condensed Consolidated Balance Sheets. These assets primarily relate to professional services and subscription and consist of the Company’s rights to consideration for goods or services transferred but not billed as of July 31, 2018. April 30, 2019. The contract assets are transferred to receivables when the rights to consideration become unconditional, usually upon completion of a milestone.
The Company’s contract balances are as follows:
As of | April 30, 2019 | January 31, 2019 | ||||||||||||||
July 31, 2018 | Feb. 1, 2018 | (In thousands) | ||||||||||||||
(In thousands) | ||||||||||||||||
Contract assets, short-term | $ | 1,372 | $ | 890 | ||||||||||||
Contract assets, long-term | - | 110 | ||||||||||||||
Contract assets, short-term (in Other current assets, net) | $ | 2,370 | $ | 2,058 | ||||||||||||
Contract assets, long-term (in Other assets, net) | 345 | - | ||||||||||||||
Total contract assets | $ | 1,372 | $ | 1,000 | $ | 2,715 | $ | 2,058 | ||||||||
Deferred revenue, short-term | $ | 91,195 | $ | 115,454 | $ | 104,471 | $ | 115,253 | ||||||||
Deferred revenue, long-term | 1,054 | 1,644 | ||||||||||||||
Deferred revenue, long-term (in Other liabilities) | 1,713 | 1,465 | ||||||||||||||
Total deferred revenue | $ | 92,249 | $ | 117,098 | $ | 106,184 | $ | 116,718 | ||||||||
During the three and six months ended July 31, 2018, April 30, 2019, the Company recognized $49.7 million and $99.9$52.3 million of revenue respectively, that was included in the deferred revenue balance as adjusted for Topic 606, at the beginning of the period. All other activity in deferred revenue is due to the timing of invoicing in relation to the timing of revenue recognition.
Revenue allocated to remaining performance obligations represents the transaction price allocated to the performance obligations that are unsatisfied, or partially unsatisfied, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. Contracted but unsatisfied performance obligations were approximately $238.1$254.7 million as of July 31, 2018, April 30, 2019, of which the Company expects to recognize approximately $146.2$157.5 million of theas revenue over the next 12twelve months and the remainder thereafter. In instances where the timing of revenue recognition differs from the timing of invoicing, QAD has determined that its contracts generally do not include a significant financing component. The primary purpose of invoicing terms is to provide customers with simplified and predictable ways of purchasing the Company’s products and services, and not to facilitate financing arrangements.
Deferred Revenue
The Company typically invoices its customers for subscription and support fees in advance on a quarterly or annual basis, with payment due at the start of the subscription or support term. Unpaid invoice amounts for non-cancelable services starting in future periods are included in accounts receivable and deferred revenue. The portion of deferred revenue that QAD anticipates will be recognized after the succeeding twelve-monthtwelve-month period is recorded as non-current deferred revenue, and the remaining portion is recorded as current deferred revenue.
Deferred revenues consisted of the following:
As of | ||||||||||||||||
July 31, 2018 | January 31, 2018 | April 30, 2019 | January 31, 2019 | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
Deferred maintenance | $ | 61,650 | $ | 80,811 | $ | 68,416 | $ | 77,037 | ||||||||
Deferred subscription | 27,821 | 31,034 | 33,227 | 34,020 | ||||||||||||
Deferred professional services | 1,589 | 3,523 | 2,020 | 2,146 | ||||||||||||
Deferred license | 96 | 756 | 45 | 1,713 | ||||||||||||
Deferred other revenue | 39 | 569 | 763 | 337 | ||||||||||||
Deferred revenues, current | 91,195 | 116,693 | 104,471 | 115,253 | ||||||||||||
Deferred revenues, non-current (in Other liabilities) | 1,054 | 2,156 | 1,713 | 1,465 | ||||||||||||
Total deferred revenues | $ | 92,249 | $ | 118,849 | $ | 106,184 | $ | 116,718 | ||||||||
Practical Expedients and Exemptions
There are several practical expedients and exemptions allowed under Topic 606 that impact timing of revenue recognition and the Company’s disclosures. Below is a list of the practical expedients applied by the Company applied in the adoption and application of Topic 606:
ApplicationCompany:
● | The Company does not evaluate a contract for a significant financing component if payment is expected within one year or less from the transfer of the promised items to the customer. |
● | The Company generally expenses sales commissions and sales agent fees when incurred when the amortization period would have been one year or less. These costs are recorded within sales and marketing expense in the Condensed Consolidated Statement of Operations and Comprehensive |
● | The Company also used the practical expedient to calculate contract acquisition costs based on a portfolio of contracts with similar characteristics instead of a contract by contract analysis. |
● | The Company does not disclose the value of unsatisfied performance obligations for contracts for which the Company recognizes revenue at the amount to which it has the right to invoice for services performed (applies to time-and-material engagements). |
Modified Retrospective Transition Adjustments
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Costs to Obtain and Fulfill a Contract
The Company’s incremental direct costs of obtaining a contract consist of sales commissions and sales agent fees which are deferred and amortized ratably over the term of economic benefit which the Company has determined to be five years. These deferred costs are classified as current or non-current based on the timing of when the Company expects to recognize the expense. Incremental costs related to renewals are expensed as incurred because the term of economic benefit is one year or less. The current and non-current portions of deferred commissions are included in other current assets and other long-term assets, respectively, in the Company’s Condensed Consolidated Balance Sheets. At JulyApril 30, 2019 and January 31, 2018 and January 31,2018,2019, the Company had $10.6$10.9 million and $10.1$11.0 million, respectively, of deferred commissions and sales agent fees. For each of the three and six months ended July 31,April 30, 2019 and 2018, $0.9$0.9 million and $1.8 million, respectively, of amortization expense related to deferred commissions and sales agent fees was recorded in sales and marketing expense in the Company’s Condensed Consolidated Statement of Operations and Comprehensive Income (Loss). Income.
Costs to fulfill a contract, which are incurred upon initiation of certain services contracts and are related to initial customer setup, are included in other current assets and long-term assets in the Company’s Condensed Consolidated Balance Sheets. At JulyApril 30, 2019 and January 31, 2018 and January 31,20182019 the Company had deferred setup costs of $1.6$1.4 million and $1.5$1.5 million, respectively. These costs are amortized over the term of economic benefit which the Company has determined to be five years. During the three and six months ended July 31,April 30, 2019 and 2018, $0.1$0.1 million and $0.3 million, respectively, of amortization expense related to deferred setup costs was recorded in cost of subscription in the Company’s Condensed Consolidated Statement of Operations and Comprehensive Income (Loss). Income.
Recoverability of these costs is subject to various business risks. Quarterly, the Company compares the carrying value of these assets with the undiscounted future cash flows expected to be generated by them to determine if there is impairment. If impaired, these assets are reduced to an estimated fair value on a discounted cash flow basis. No impairment losses were recognized during the three or six months ended July 31, 2018.April 30, 2019.
| COMPUTATION OF NET (LOSS) INCOME |
The following table sets forth the computation of basic and diluted net (loss) income (loss) per share:
Three Months Ended | Six Months Ended | |||||||||||||||
July 31, | July 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
(in thousands, except per share data) | (in thousands, except per share data) | |||||||||||||||
Net income (loss) | $ | 1,113 | $ | (1,161 | ) | $ | 2,510 | $ | (3,732 | ) | ||||||
Less: Dividends declared | (1,372 | ) | (1,344 | ) | (2,731 | ) | (2,675 | ) | ||||||||
Undistributed net loss | $ | (259 | ) | $ | (2,505 | ) | $ | (221 | ) | $ | (6,407 | ) | ||||
Net income (loss) per share – Class A Common Stock | ||||||||||||||||
Dividends declared | $ | 1,176 | $ | 1,151 | $ | 2,340 | $ | 2,290 | ||||||||
Allocation of undistributed net loss | (222 | ) | (2,145 | ) | (190 | ) | (5,483 | ) | ||||||||
Net income (loss) attributable to Class A common stock | $ | 954 | $ | (994 | ) | $ | 2,150 | $ | (3,193 | ) | ||||||
Weighted average shares of Class A common stock outstanding— basic | 16,266 | 15,914 | 16,173 | 15,863 | ||||||||||||
Weighted average potential shares of Class A common stock | 1,661 | — | 1,713 | — | ||||||||||||
Weighted average shares of Class A common stock and potential common shares outstanding— diluted | 17,927 | 15,914 | 17,886 | 15,863 | ||||||||||||
Basic net income (loss) per Class A common share | $ | 0.06 | $ | (0.06 | ) | $ | 0.13 | $ | (0.20 | ) | ||||||
Diluted net income (loss) per Class A common share | $ | 0.05 | $ | (0.06 | ) | $ | 0.12 | $ | (0.20 | ) | ||||||
Net income (loss) per share – Class B Common Stock | ||||||||||||||||
Dividends declared | $ | 196 | $ | 193 | $ | 391 | $ | 385 | ||||||||
Allocation of undistributed net loss | (37 | ) | (360 | ) | (31 | ) | (924 | ) | ||||||||
Net income (loss) attributable to Class B common stock | $ | 159 | $ | (167 | ) | $ | 360 | $ | (539 | ) | ||||||
Weighted average shares of Class B common stock outstanding— basic | 3,263 | 3,212 | 3,248 | 3,211 | ||||||||||||
Weighted average potential shares of Class B common stock | 171 | — | 177 | — | ||||||||||||
Weighted average shares of Class B common stock and potential common shares outstanding— diluted | 3,434 | 3,212 | 3,425 | 3,211 | ||||||||||||
Basic net income (loss) per Class B common share | $ | 0.05 | $ | (0.05 | ) | $ | 0.11 | $ | (0.17 | ) | ||||||
Diluted net income (loss) per Class B common share | $ | 0.05 | $ | (0.05 | ) | $ | 0.11 | $ | (0.17 | ) | ||||||
Three Months Ended April 30, | ||||||||
2019 | 2018 | |||||||
(in thousands except per share data) | ||||||||
Net (loss) income | $ | (3,234 | ) | $ | 1,397 | |||
Less: Dividends declared | (1,374 | ) | (1,359 | ) | ||||
Undistributed net (loss) income | $ | (4,608 | ) | $ | 38 | |||
Net (loss) income per share – Class A Common Stock | ||||||||
Dividends declared | $ | 1,178 | $ | 1,164 | ||||
Allocation of undistributed net (loss) income | (3,952 | ) | 32 | |||||
Net (loss) income attributable to Class A common stock | $ | (2,774 | ) | $ | 1,196 | |||
Weighted average shares of Class A common stock outstanding—basic | 16,367 | 16,076 | ||||||
Weighted average potential shares of Class A common stock | — | 1,750 | ||||||
Weighted average shares of Class A common stock and potential common shares outstanding—diluted | 16,367 | 17,826 | ||||||
Basic net (loss) income per Class A common share | $ | (0.17 | ) | $ | 0.07 | |||
Diluted net (loss) income per Class A common share | $ | (0.17 | ) | $ | 0.07 | |||
Net (loss) income per share – Class B Common Stock | ||||||||
Dividends declared | $ | 196 | $ | 195 | ||||
Allocation of undistributed net (loss) income | (656 | ) | 6 | |||||
Net (loss) income attributable to Class B common stock | $ | (460 | ) | $ | 201 | |||
Weighted average shares of Class B common stock outstanding—basic | 3,264 | 3,232 | ||||||
Weighted average potential shares of Class B common stock | — | 182 | ||||||
Weighted average shares of Class B common stock and potential common shares outstanding—diluted | 3,264 | 3,414 | ||||||
Basic net (loss) income per Class B common share | $ | (0.14 | ) | $ | 0.06 | |||
Diluted net (loss) income per Class B common share | $ | (0.14 | ) | $ | 0.06 | |||
Potential common shares consist of the shares issuable upon the release of restricted stock units (“RSUs”) and the exercise of stock options and stock appreciation rights (“SARs”). The Company’s unvested RSUs and unexercised SARs are not considered participating securities as they do not have rights to dividends or dividend equivalents prior to release or exercise.
The following table sets forth the number of potential common shares not included in the calculation of diluted earnings per share because their effects were anti-dilutive:
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Three Months Ended April 30, | ||||||||
2019 | 2018 | |||||||
(in thousands) | ||||||||
Class A | 2,899 | — | ||||||
Class B | 278 | — | ||||||
| FAIR VALUE MEASUREMENTS |
When determining fair value, the Company uses a three-tierthree-tier value hierarchy which prioritizes the inputs used in measuring fair value. Whenever possible, the Company uses observable market data. The Company relies on unobservable inputs only when observable market data is not available. Classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.
The following table sets forth the financial assets, measured at fair value, as of July 31, 2018 and January 31, 2018:
• Level 1 - Money market mutual funds and short-term investments are recorded at fair value based upon quoted market prices. |
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||
(in thousands) | ||||||||||||
Money market mutual funds as of July 31, 2018 (a) | $ | 107,131 | ||||||||||
Money market mutual funds as of January 31, 2018 (a) | $ | 115,416 | ||||||||||
Asset related to the interest rate swap as of July 31, 2018 (b) | $ | 339 | ||||||||||
Asset related to the interest rate swap as of January 31, 2018 (b) | $ | 187 | ||||||||||
___________________________
(a) Money market mutual funds are recorded at fair value based upon quoted market prices.
(b)
• Level 2 - The asset or liability related to the interest rate swap is recorded at fair value based upon a valuation model that uses relevant observable market inputs at quoted intervals, such as forward yield curves. |
The following table sets forth the financial assets, measured at fair value, as of April 30, 2019 and January 31, 2019:
Fair value measurement at reporting date using | ||||||||||||
Quoted Prices | Significant | Significant | ||||||||||
(in thousands) | ||||||||||||
Money market mutual funds as of April 30, 2019 | $ | 119,247 | ||||||||||
Money market mutual funds as of January 31, 2019 | $ | 107,855 | ||||||||||
Short-term investments as of April 30, 2019 | $ | 1,200 | ||||||||||
Short-term investments as of January 31, 2019 | $ | 1,200 | ||||||||||
Asset related to the interest rate swap as of April 30, 2019 | $ | 45 | ||||||||||
Asset related to the interest rate swap as of January 31, 2019 | $ | 136 | ||||||||||
Money market mutual funds are classified as part of “Cash and equivalents” in the accompanying Condensed Consolidated Balance Sheets. The amount of cash and equivalents deposited with commercial banks was unchanged$31.7 million and $31.6 million at $32 million as of July 31, 2018 April 30, 2019 and January 31, 2018.2019, respectively.
The Company’s note payable bears a variable market interest rate commensurate with the Company’s credit standing. Therefore, the carrying amount outstanding under the note payable reasonably approximates fair value based on Level 2 inputs.
There have been no transfers between fair value measurementmeasurements levels during the sixthree months ended July 31, 2018.April 30, 2019.
Derivative Instruments
The Company entered into an interest rate swap in May 2012 to mitigate the exposure to the variability of one month LIBOR for its floating rate debt described in Note 67 “Debt” within these Notes to Condensed Consolidated Financial Statements. The fair value of the interest rate swap is reflected as aan asset or liability in the Condensed Consolidated Balance Sheets and the change in fair value is reported in “Other (income) expense”expense, net” in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Income. The fair value of the interest rate swap is estimated as the net present value of projected cash flows based upon forward interest rates at the balance sheet date.
The fair values of the derivative instrument at July 31, 2018 April 30, 2019 and January 31, 2018 2019 were as follows (in thousands):
Asset | Asset | ||||||||||||||||||||
Fair Value | Fair Value | ||||||||||||||||||||
Balance Sheet Location | July 31, 2018 | January 31, 2018 | Balance Sheet | April 30, | January 31, | ||||||||||||||||
Derivative instrument: | |||||||||||||||||||||
Interest rate swap | Other assets, net | $ | 339 | $ | 187 | Other assets, net | $ | 45 | $ | 136 | |||||||||||
| Total | $ | 339 | $ | 187 | $ | 45 | $ | 136 | |||||||||||||
The change in fair value of the interest rate swap recognized in the Condensed Consolidated StatementsStatement of Operations and Comprehensive Income (Loss) was $35,000 and $152,000Income for the three and six months ended July 31,April 30, 2019 and 2018 was $(91,000) and $(16,000) and $(3,000) for the three and six months ended July 31, 2017.$117,000, respectively.
5. | CAPITALIZED SOFTWARE COSTS |
Capitalized software costs and accumulated amortization at July 31, 2018 April 30, 2019 and January 31, 2018 2019 were as follows:
July 31, 2018 | January 31, 2018 | April 30, 2019 | January 31, 2019 | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
Capitalized software costs: | ||||||||||||||||
Capitalized software development costs | $ | 1,787 | $ | 1,516 | $ | 2,486 | $ | 2,314 | ||||||||
Acquired software technology | 135 | - | 135 | 135 | ||||||||||||
| 1,922 | 1,516 | 2,621 | 2,449 | |||||||||||||
Less accumulated amortization | (517 | ) | (526 | ) | (957 | ) | (851 | ) | ||||||||
Capitalized software costs, net | $ | 1,405 | $ | 990 | $ | 1,664 | $ | 1,598 | ||||||||
The Company’s capitalized software development costs relate to translations and localizations of QAD EnterpriseAdaptive Applications. Acquired software technology costs relate to acquired technology purchased during the second quarter fiscal 2019.2019.
It is the Company’s policy to write off capitalized software development costs once fully amortized. Accordingly, during the firstsix three months of fiscal 2019,2020, approximately $0.3$0.1 million of costs and accumulated amortization were removed from the balance sheet.
Amortization of capitalized software costs was $0.1$0.2 million and $0.3$0.1 million for the three and six months ended July 31,April 30, 2019 and 2018, and $0.2 million and $0.4 million for the three and six months ended July 31 2017. respectively. Amortization of capitalized software costs is included in “Cost of license” in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Income.
The following table summarizes the estimated amortization expense relating to the Company’s capitalized software costs as of July 31, 2018:April 30, 2019:
Fiscal Years | (in thousands) | (in thousands) | ||||||
2019 remaining | $ | 312 | ||||||
2020 | 580 | |||||||
2020 remaining | $ | 627 | ||||||
2021 | 395 | 660 | ||||||
2022 | 78 | 317 | ||||||
2023 | 47 | |||||||
Thereafter | 40 | 13 | ||||||
| $ | 1,405 | $ | 1,664 | |||||
6. | GOODWILL AND INTANGIBLE ASSETS |
Goodwill
The changes in the carrying amount of goodwill for the sixthree months ended July 31, 2018 April 30, 2019 were as follows:
Gross Carrying Amount | Accumulated Impairment | Goodwill, Net | ||||||||||
(in thousands) | ||||||||||||
Balance at January 31, 2018 | $ | 26,631 | $ | (15,608 | ) | $ | 11,023 | |||||
Additions | 243 | - | 243 | |||||||||
Impact of foreign currency translation | (171 | ) | - | (171 | ) | |||||||
Balance at July 31, 2018 | $ | 26,703 | $ | (15,608 | ) | $ | 11,095 | |||||
Gross Carrying Amount | Accumulated Impairment | Goodwill, Net | ||||||||||
(in thousands) | ||||||||||||
Balance at January 31, 2019 | $ | 28,031 | $ | (15,608 | ) | $ | 12,423 | |||||
Impact of foreign currency translation | (90 | ) | - | (90 | ) | |||||||
Balance at April 30, 2019 | $ | 27,941 | $ | (15,608 | ) | $ | 12,333 | |||||
Additions to goodwill relate to an immaterial acquisition that occurred during the second quarter of fiscal 2019 due to the excess purchase price over the estimated fair value of acquired net assets. Pro forma financial information for the acquisition has not been presented, as the effects were not material to the Company’s historical consolidated financial statements.
The Company performed its annual goodwill impairment review during the fourth quarter of fiscal 2018.2019. The analysis compared the Company’s market capitalization to its net assets as of the test date, November 30, 2017. 2018. As the market capitalization significantly exceeded the Company’s net assets, there was no indication of goodwill impairment for fiscal 2018.2019. The Company monitors the indicators for goodwill impairment testing between annual tests. No adverse events occurred during the sixthree months ended July 31, 2018 April 30, 2019 that would cause the Company to test goodwill for impairment.
Intangible Assets
July 31, 2018 | ||||
| (in thousands) | ||||
Amortizable intangible assets | ||||
Customer relationships | $ | 190 | ||
Less: accumulated amortization | - | |||
Net amortizable intangible assets | $ | 190 | ||
April 30, 2019 | January 31, 2019 | |||||||
(in thousands) | ||||||||
Amortizable intangible assets: | ||||||||
Customer relationships | $ | 1,335 | $ | 1,348 | ||||
Less accumulated amortization | (181 | ) | (115 | ) | ||||
Amortizable intangible assets, net | $ | 1,154 | $ | 1,233 | ||||
The Company’s intangible assets as of July 31, 2018 April 30, 2019 are related to the acquisitionacquisitions completed in the second quarter and third quarters of fiscal 2019. Intangible assets are included in “Other assets, net” in the accompanying Condensed Consolidated Balance Sheets.Sheets, and are amortized over an estimated 5 year useful life.
The following table summarizes the estimated amortization expense relating to the Company’s intangible assets as of July 31, 2018:April 30, 2019:
Fiscal Years | (in thousands) | (in thousands) | ||||||
2019 remaining | $ | 19 | ||||||
2020 | 38 | |||||||
2020 remaining | $ | 200 | ||||||
2021 | 38 | 267 | ||||||
2022 | 38 | 267 | ||||||
2023 | 267 | |||||||
Thereafter | 57 | 153 | ||||||
| $ | 190 | $ | 1,154 | |||||
7. | DEBT |
July 31, 2018 | January 31, 2018 | April 30, 2019 | January 31, 2019 | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
Note payable | $ | 13,591 | $ | 13,825 | $ | 13,231 | $ | 13,358 | ||||||||
Less current maturities | (476 | ) | (466 | ) | (487 | ) | (487 | ) | ||||||||
Less loan origination costs, net | (40 | ) | (46 | ) | (32 | ) | (35 | ) | ||||||||
Long-term debt | $ | 13,075 | $ | 13,313 | $ | 12,712 | $ | 12,836 | ||||||||
Note Payable
Effective May 30, 2012, QAD Ortega Hill, LLC wholly owned by the Company, entered into a variable rate credit agreement (the “2012“2012 Mortgage”) with Rabobank, N.A., to refinance a pre-existing mortgage. The 2012 Mortgage has an original principal balance of $16.1$16.1 million and bears interest at the one month LIBOR rate plus 2.25%. One month LIBOR was 2.08%2.48% at July 31, 2018. April 30, 2019. The 2012 Mortgage matures in June 2022 and is secured by the Company’s headquarters located in Santa Barbara, California. In conjunction with the 2012 Mortgage, QAD Ortega Hill, LLC entered into an interest rate swap with Rabobank, N.A. The swap agreement has an initial notional amount of $16.1$16.1 million and a schedule matching that of the underlying loan that synthetically fixes the interest rate on the debt at 4.31% for the entire term of the 2012 Mortgage. The terms of the 2012 Mortgage provide for QAD Ortega Hill, LLC to make net monthly payments of $88,100$88,100 consisting of principal and interest and one final payment of $11.7$11.7 million. The unpaid balance as of July 31, 2018 April 30, 2019 was $13.6$13.2 million.
8. | LEASES |
The Company leases certain office space, office equipment and autos with remaining lease terms of one year to eight years under leases classified as operating. The Company’s finance leases are immaterial. QAD has options to terminate some of its leases early. The lease term represents the period up to the early termination date unless it is reasonably certain that QAD will not exercise the early termination option. For certain leases, QAD has options to extend the lease term for additional periods ranging from one year to six years.
The Company treats a contract as a lease when the contract conveys the right to use a physically distinct asset for a period of time in exchange for consideration, the Company directs the use of the asset and obtains substantially all the economic benefits of the asset. These leases are recorded as right-of-use (“ROU”) assets and lease obligation liabilities for leases with terms greater than 12 months. ROU assets represent the Company’s right to use an underlying asset for the entirety of the lease term. Lease liabilities represent the Company's obligation to make payments over the life of the lease. An ROU asset and a lease liability are recognized at commencement of the lease based on the present value of the lease payments over the life of the lease. Initial direct costs are included as part of the ROU asset upon commencement of the lease. Since the interest rate implicit in a lease is generally not readily determinable, the Company uses an incremental borrowing rate to determine the present value of the lease payments. The incremental borrowing rate represents the rate of interest the Company would have to pay to borrow on a collateralized basis over a similar lease term to obtain an asset of similar value. QAD used the incremental borrowing rate on February 1, 2019 for all leases that commenced prior to that date.
QAD reviews the impairment of ROU assets consistent with the approach applied for the Company’s other long-lived assets. The Company reviews the recoverability of long-lived assets when events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable. The assessment of possible impairment is based on the Company’s ability to recover the carrying value of the asset from the expected undiscounted future pre-tax cash flows of the related operations.
The Company has applied the practical expedient available for lessees in which lease and non-lease components are accounted for as a single lease component for all asset classes. The Company also elected the practical expedient to exclude short-term leases (leases with original terms of 12 months or less) from ROU asset and lease liability accounts.
Lease expense is recognized on a straight-line basis over the lease term, while variable lease payments are expensed as incurred. Variable payments change due to facts or circumstances occurring after the commencement date, other than the passage of time, and do not result in a remeasurement of lease liabilities. The Company’s variable lease payments include payments to lessors for taxes, maintenance, insurance and other operating costs as well as payments that are adjusted based on a CPI index or rate and payments in excess of fixed amounts, such as excess mileage charges on leased autos. The Company's lease agreements do not contain any significant residual value guarantees or restrictive covenants.
Supplemental balance sheet information related to leases was as follows (in thousands):
April 30, 2019 | ||||
Assets | ||||
Operating lease assets, net | $ | 15,149 | ||
Liabilities | ||||
Current | ||||
Operating | $ | 4,633 | ||
Noncurrent | ||||
Operating | 11,210 | |||
Total lease liabilities | $ | 15,843 | ||
The components of lease cost were as follows (in thousands):
Three Months Ended | ||||
April 30, 2019 | ||||
Operating lease cost | $ | 1,456 | ||
Variable lease cost | 372 | |||
Short-term lease cost | 74 | |||
Net lease cost | $ | 1,902 | ||
Lease term and discount rate were as follows:
April 30, 2019 | ||||
Weighted-average remaining lease term (in years) | ||||
Operating leases | 4.4 | |||
Weighted-average discount rate | ||||
Operating leases | 5.98 | % | ||
Supplemental disclosures of cash flow information related to leases were as follows:
Three Months Ended | ||||
April 30, 2019 | ||||
Cash flows related to lease liabilities | ||||
Operating cash flows related to operating leases | $ | (1,584 | ) ) | |
Non-cash items | ||||
Leased assets obtained in exchange for new operating lease liabilities | $ | 3,425 | ||
Maturities of lease liabilities were as follows as of April 30, 2019 (in millions):
Operating | ||||
Leases | ||||
Within 1 year | $ | 5.6 | ||
2 years | 4.4 | |||
3 years | 2.6 | |||
4 years | 1.8 | |||
5 years | 1.5 | |||
Thereafter | 2.5 | |||
Total lease payments | $ | 18.4 | ||
Less: Imputed interest | (2.4 | ) | ||
Present value of lease liabilities | $ | 16.0 | ||
As of January 31, 2019 future minimum lease payments, as defined under the previous lease accounting guidance of ASC Topic 840, under non-cancelable operating leases for the following five fiscal years and thereafter were as follows (in millions):
2020 | $ | 5.6 | ||
2021 | 4.6 | |||
2022 | 2.8 | |||
2023 | 1.8 | |||
2024 | 1.5 | |||
Thereafter | 2.8 | |||
Total | $ | 19.1 |
The Company is a lessor for certain office space owned by the Company and leased to others under non-cancelable leases with initial terms ranging from three months to one year. These lease agreements provide for a fixed base rent and automatically renew for periods from three months to one year unless terminated. All leases are considered operating leases. There are no rights to purchase the premises and no residual value guarantees. For the period ending April 30, 2019 the Company received $0.2 million of lease income from company-owned locations.
9. | ACCUMULATED OTHER COMPREHENSIVE LOSS |
The components of accumulated other comprehensive loss, net of taxes, were as follows:
Foreign Currency Translation Adjustments | ||||
(in thousands) | ||||
Balance as of January 31, 2018 | $ | (6,828 | ) | |
Other comprehensive income before reclassifications | (836 | ) | ||
Amounts reclassified from accumulated other comprehensive loss | - | |||
Net current period other comprehensive income | (836 | ) | ||
Balance as of July 31, 2018 | $ | (7,664 | ) | |
Foreign Currency Translation Adjustments | ||||
(in thousands) | ||||
Balance as of January 31, 2019 | $ | (7,661 | ) | |
Other comprehensive loss before reclassifications | (263 | ) | ||
Amounts reclassified from accumulated other comprehensive loss | — |
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Net current period other comprehensive loss | (263 | ) | ||
Balance as of April 30, 2019 | $ | (7,924 | ) | |
During the firstsix months of fiscal 2018 there were no reclassifications from accumulated other comprehensive loss.
| INCOME TAXES |
In determining the quarterly provision for income taxes, for the firstsix months of fiscal 2019, the Company calculated income tax expense based on the estimated annual tax rate for the year, compared to the prior year when the Company calculated income tax expense based on actual quarterly results. The annual effective tax rate wasresults in the first quarters of fiscal years 2020 and 2019, respectively. These results were adjusted for discrete items recorded during both periods. The estimated annual tax rate for the year wasperiod. Actual quarterly results were used in the current periodfiscal 2020 and 2019 since the Company is forecasting profits for the full fiscal year 2019.they provided a more reliable estimate of quarterly tax expense.
The Company recorded income tax expense of $1.5$0.7 million and $0.8$1.2 million infor the second quarterfirst three months of fiscal 20192020 and 2018,2019, respectively. The Company’s effective tax rate increaseddecreased to 57%(28%) during the secondfirst quarter of fiscal 20192020 compared to (253%)46% for the same period in the prior year. The increasedecrease in the effective tax rate is primarily due to a taxable loss for the forecasted profits and pretax book income in the second quarterfirst three months of fiscal 20192020 compared to the pretax book lossa taxable profit for the same period of fiscal 2018.
The Company recorded income tax expense of $2.7 million and $1.5 million for the firstsix months of fiscal 2019 and 2018, respectively. The Company’s effective tax rate increased in addition to 51% from (64%) for the same periodchange in the prior year. The increase in the effective tax rate is primarily due to forecasted profits and pretax book income for the firstsix months of fiscal 2019 compared to the pretax book loss for the same period of fiscal 2018.jurisdictional mix.
When calculating QAD’s income tax expense for the firstsix three months of fiscal 2019,2020, the Company considered the U.S. Tax Cuts and Jobs Act (“Tax Act”) enacted December 22, 2017. The Tax Act imposed a deemed repatriation tax on accumulated earnings of foreign subsidiaries, reduced the U.S. corporate tax rate to 21% and introduced a new tax on global intangible low taxed income (“GILTI”). Based on current available information and technical guidance, the Company maintained its provisional estimate of the fiscal 2018 deemed repatriation tax of $10.0 million. This additional income tax expense was partially offset by net operating losses and tax credits. The Tax Act increased the Company’s fiscal 2018 U.S. estimated tax liability by $2.0 million. This estimate may be impacted by further analysis and future clarification and guidance regarding available tax accounting methods and elections, earnings and profits computations and state tax conformity to federal tax changes. The Company elected to pay the estimated repatriation tax liability over a period of eight years as permitted by the Tax Act. The Company has not yet completed the accounting for the fiscal 2018 effects of the Tax Act because of the complexity and ambiguity of certain of its tax and accounting effects. The Company expects to refine and complete the accounting for the Tax Act during the remainder of fiscal 2019 as it obtains, prepares and analyzes additional information in accordance with Staff Accounting Bulletin No.118.
The Company included a provision for GILTIglobal intangible low-tax income (“GILTI”) in the Company’s tax expense forexpense. The provisional GILTI estimate considered the proposed regulations released on September 13, 2018 by the U.S. Department of Treasury. These regulations provide computational, definitional, and anti-avoidance rule guidance relating to the determination of a U.S. shareholder’s GILTI inclusion. In the firstsix months quarter of fiscal 2019. Cash2019, cash taxes were slightlynot impacted by GILTI since the Company hashad sufficient tax credits to offset the additional liability. TheFor the first quarter of fiscal 2020, the Company does not have a GILTI provisions had a slight impactinclusion due to the Company’s effective tax rate since QAD’s U.S. deferred tax assets are fully valued. losses sustained in Ireland.
The Company has not recordedelected to treat the deferred taxes related to these GILTI provisions and has not yet determined its policy election with respect to whether it will treat GILTI as a current-period expense when incurred (the “period cost method”) or factor such amount into the measurement of deferred taxes (the “deferred method”). This decision will be made by year end as the GILTI guidance is issued.
The Company adopted ASU 2016-16Income taxes (Topic 740) Intra-entity Transfers of Assets Other Than Inventory during the three months ended April 30, 2018, which required all income tax effects of intra-entity transfers of assets other than inventory to be recognized in the Condensed Consolidated Statement of Operations and Comprehensive Income (Loss) when the transfer occurs. As a result of the adoption, the Company recorded $9.6 million to accumulated deficit and deferred tax asset at February 1, 2018 to account for the intra-entity sale of Intellectual Property that occurred in the fiscal year 2018.
The gross amount of unrecognized tax benefits was $1.8$1.3 million at July 31, 2018, April 30, 2019, including interest and penalties. The unrecognized tax benefits were reduced by $0.9$1 million with an accompanying reduction of deferred tax assets, as a result of the netting required under ASU 2013-11.2013-11. The entire amount of unrecognized tax benefits, if recognized, will impact the Company’s effective tax rate. This liability is classified as long-term unless the liability is expected to conclude within twelve months of the reporting date.
The Company’s policy is to recognize interest and penalties, if any, related to unrecognized tax benefits as a component of income tax expense. As of July 31, 2018, April 30, 2019, the Company has accrued approximately $0.3$0.1 million of interest and penalty expense relating to unrecognized tax benefits.
The Company reviews its net deferred tax assets by jurisdiction on a quarterly basis to determine whether a valuation allowance is necessary based on the more-likely-than-notmore-likely-than-not standard. Management assesses historic, current and future financial projections by jurisdiction to draw its conclusion. During fiscal 2017, aA valuation allowance has been established for select foreign jurisdictions (i.e. Germany, Belgium, Hong Kong and Brazil) along with U.S. federal and state deferred tax assets was established.assets. For the quarter ended July 31, 2018, April 30, 2019, the Company continues to maintain a full valuation allowance on its U.S. federal and state deferred tax assets. At July 31, 2018 April 30, 2019 and January 31, 2018, 2019, the valuation allowance attributable to deferred tax assets was $36.4$35.6 million and $33.7$34.9 million, respectively.
The Company files U.S. federal, state, and foreign tax returns that are subject to audit by various tax authorities. The Company is currently under audit in:
● | India for fiscal years ended March 31,2010,2013 and 2014 | |
● | Netherlands for fiscal year ended January 31, 2016 | |
● | Germany for fiscal years ended January 31, 2015, 2016 and 2017 | |
● | Switzerland for fiscal years ended January 31, 2014, 2015, 2016, 2017 and 2018 |
During fiscal 2019,2020, the Company closed the following audits with noan immaterial adjustment:
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| STOCKHOLDERS’ EQUITY |
Dividends
The following table sets forth the dividends that were declared by the Company during the firstsix three months of fiscal 2019:2020:
Declaration Date | Record Date | Payable | Dividend Class A | Dividend Class B | (in thousands) | |||||||||
6/11/2018 | 6/25/2018 | 7/6/2018 | $ | 0.072 | $ | 0.06 | $ | 1,372 | ||||||
4/10/2018 | 4/24/2018 | 5/1/2018 | $ | 0.072 | $ | 0.06 | $ | 1,359 | ||||||
Declaration Date | Record Date | Payable | Dividend Class A | Dividend Class B | (in thousands) | |||||||||
4/9/2019 | 4/23/2019 | 5/3/2019 | $ | 0.072 | $ | 0.06 | $ | 1,374 | ||||||
| STOCK-BASED COMPENSATION |
The Company’s equity awards consist of RSUs and SARs. For a description of the Company’s stock-based compensation plans, see Note 56 “Stock-Based Compensation” in Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K10-K for the year ended January 31, 2018.2019.
Stock-Based Compensation
The following table sets forth reported stock-based compensation expense for the three and six months ended July 31, 2018 April 30, 2019 and 2017:2018:
Three Months Ended July 31, | Six Months Ended July 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
Cost of subscription | $ | 68 | $ | 36 | $ | 117 | $ | 61 | ||||||||
Cost of maintenance and other revenue | 118 | 95 | 210 | 172 | ||||||||||||
Cost of professional services | 327 | 274 | 553 | 494 | ||||||||||||
Sales and marketing | 534 | 368 | 936 | 685 | ||||||||||||
Research and development | 413 | 304 | 728 | 557 | ||||||||||||
General and administrative | 1,904 | 1,515 | 2,926 | 2,391 | ||||||||||||
Total stock-based compensation expense | $ | 3,364 | $ | 2,592 | $ | 5,470 | $ | 4,360 | ||||||||
Three Months Ended April 30, | ||||||||
2019 | 2018 | |||||||
(in thousands) | ||||||||
Cost of subscription | $ | 70 | $ | 49 | ||||
Cost of maintenance and other | 121 | 92 | ||||||
Cost of professional services | 322 | 226 | ||||||
Sales and marketing | 380 | 402 | ||||||
Research and development | 427 | 315 | ||||||
General and administrative | 984 | 1,022 | ||||||
Total stock-based compensation expense | $ | 2,304 | $ | 2,106 | ||||
RSU Information
The estimated fair value of RSUs was calculated based on the closing price of the Company’s common stock on the date of grant, reduced by the present value of dividends foregone during the vesting period.
The following table summarizes the activity for RSUs for the sixthree months ended July 31, 2018: April 30, 2019:
RSUs | Weighted Average Grant Date Fair Value | RSUs | Weighted Average Grant Date Fair Value | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
Outstanding at January 31, 2018 | 653 | $ | 25.10 | |||||||||||||
Outstanding at January 31, 2019 | 663 | $ | 36.64 | |||||||||||||
Granted | 270 | 52.72 | 1 | 41.49 | ||||||||||||
Released (1) | (252 | ) | 25.56 | (11 | ) | 26.31 | ||||||||||
Forfeited | (13 | ) | 25.13 | (16 | ) | 36.79 | ||||||||||
Outstanding at July 31, 2018 | 658 | $ | 36.22 | |||||||||||||
Outstanding at April 30, 2019 | 637 | $ | 36.83 | |||||||||||||
_________________________
| The number of RSUs released includes shares withheld on behalf of employees to satisfy the minimum statutory tax withholding requirements. |
The Company withholds a portion of the released shares as consideration for the Company’s payment of applicable employee income taxes. During the three months ended July 31, 2018, April 30, 2019, the Company withheld 75,0004,000 shares for payment of these taxes at a value of $4.0$0.2 million. During the sixthree months ended July 31,April 30, 2018, the Company withheld 79,0004,000 shares for payment of these taxes at a value of $4.2$0.2 million.
Total unrecognized compensation cost related to RSUs was approximately $22.5$16.7 million as of July 31, 2018. April 30, 2019. This cost is expected to be recognized over a weighted-average period of approximately 3.22.7 years.
SAR Information
The weighted average assumptions used to value SARs granted in the six months ended July 31, 2018 and 2017 are shown in the following table:
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The following table summarizes the activity for outstanding SARs for the sixthree months ended July 31, 2018:April 30, 2019:
SARs (in thousands) | Weighted Average Exercise Price per Share | Weighted Average Remaining Contractual Term (years) | Aggregate Intrinsic Value (in thousands) | SARs (in thousands) | Weighted Average Exercise Price per Share | Weighted Average Remaining Contractual Term (years) | Aggregate Intrinsic Value (in thousands) | |||||||||||||||||||||||||
Outstanding at January 31, 2018 | 3,024 | $ | 17.78 | |||||||||||||||||||||||||||||
Outstanding at January 31, 2019 | 2,533 | $ | 20.81 | |||||||||||||||||||||||||||||
Granted | 380 | 53.50 | — | — | ||||||||||||||||||||||||||||
Exercised | (384 | ) | 9.39 | (5 | ) | 10.78 | ||||||||||||||||||||||||||
Expired | (5 | ) | 8.97 | — | — | |||||||||||||||||||||||||||
Forfeited | (1 | ) | 19.40 | — | — | |||||||||||||||||||||||||||
Outstanding at July 31, 2018 | 3,014 | $ | 23.37 | 4.5 | $ | 77,830 | ||||||||||||||||||||||||||
Vested and exercisable at July 31, 2018 | 2,064 | $ | 17.02 | 3.4 | $ | 64,899 | ||||||||||||||||||||||||||
Outstanding at April 30, 2019 | 2,528 | $ | 20.83 | 3.3 | $ | 63,211 | ||||||||||||||||||||||||||
Vested and exercisable at April 30, 2019 | 2,053 | (1) | $ | 17.06 | 2.6 | $ | 57,650 | |||||||||||||||||||||||||
(1) The number of SARs vested and exercisable at April 30, 2019 includes 877,500 Class A and 127,500 Class B shares previously held by Mr. Karl Lopker which will expire on August 25, 2019 if not exercised by his estate. Exercise prices for these SARs range from $10.50 to $31.65.
The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the aggregate difference between the closing stock price of the Company’s common stock based on the last trading day as of July 31, 2018, April 30, 2019, and the exercise price for in-the-money SARs) that would have been received by the holders if all SARs had been exercised on July 31, 2018. April 30, 2019. The total intrinsic value of SARs exercised in the sixthree months ended July 31, 2018 April 30, 2019 was $12.2$0.2 million. The weighted average grant date fair value per share of SARs granted in the three and six months ended July 31, 2018 was $16.99. The weighted average grant date fair value per share of SARs granted in the three and six months ended July 31, 2017 was $9.59.
The number of SARs exercised includes shares withheld on behalf of employees to satisfy minimum statutory tax withholding requirements. During the three months ended July 31, 2018, April 30, 2019, the Company withheld 10,0001,000 shares for payment of these taxes at a value of $0.5 million.$57,000. During the sixthree months ended July 31,April 30, 2018, the Company withheld 103,00093,000 shares for payment of these taxes at a value of $4.4$3.9 million.
At July 31, 2018, April 30, 2019, there was approximately $10.5$3.8 million of total unrecognized compensation cost related to unvested SARs. This cost is expected to be recognized over a weighted-average period of approximately 3.22.7 years.
| COMMITMENTS AND CONTINGENCIES |
Indemnifications
The Company sells software licenses and services to its customers under written agreements. Each agreement contains the relevant terms of the contractual arrangement with the customer and generally includes certain provisions for indemnifying the customer against losses, expenses and liabilities from damages that may be awarded against the customer in the event the Company’s software is found to infringe upon certain intellectual property rights of a third party. The agreements generally limit the scope of and remedies for such indemnification obligations in a variety of industry-standard respects.
The Company believes its internal development processes and other policies and practices limit its exposure related to the indemnification provisions of the agreements. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the agreements, the Company cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions.
Legal Actions
The Company is subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity.
| BUSINESS SEGMENT INFORMATION |
The Company markets its products and services worldwide, primarily to companies in the manufacturing industry, including automotive, consumer products, food and beverage, high technology, industrial products and life sciences industries. The Company sells and licenses its products through its direct sales force in four geographic regions: North America; Europe, the Middle East and Africa (“EMEA”); Asia Pacific; and Latin America and through distributors where third parties can extend sales reach more effectively or efficiently. The North America region includes the United States and Canada. The EMEA region includes Europe, the Middle East and Africa. The Asia Pacific region includes Asia and Australia. The Latin America region includes South America, Central America and Mexico. In accordance with Topic 606, the Company reports disaggregated revenue by geography and by industry as the Company believes it best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors. The Company does not consider reporting by industry an operating segment in accordance with ASC 280, Segment Reporting, because discrete financial information by industry is not available. The Company’s Chief Operating Decision Maker, the PrincipalChief Executive Officer, reviews the consolidated results within one operating segment.
Subscription, license and maintenance revenues are generally assigned to the region where a majority of end users are located. Professional services revenue is assigned based on the region where the services are delivered.
Three Months Ended July 31, | Six Months Ended July 31, | Three Months Ended April 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | |||||||||||||||||||
(in thousands) | (in thousands) | (in thousands) | ||||||||||||||||||||||
Revenue: | ||||||||||||||||||||||||
North America (1) | $ | 39,288 | $ | 35,156 | $ | 79,313 | $ | 68,526 | $ | 37,659 | $ | 40,025 | ||||||||||||
EMEA | 26,906 | 22,227 | 51,993 | 43,108 | 22,509 | 25,087 | ||||||||||||||||||
Asia Pacific | 12,866 | 12,967 | 25,425 | 25,133 | 11,886 | 12,559 | ||||||||||||||||||
Latin America | 5,483 | 5,608 | 14,002 | 10,573 | 5,981 | 8,519 | ||||||||||||||||||
| $ | 84,543 | $ | 75,958 | $ | 170,733 | $ | 147,340 | $ | 78,035 | $ | 86,190 | |||||||||||||
____________________________
| Sales into Canada accounted for |
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Subsequent to the end of the fiscal 2019second quarter, the Company announced the establishment of a wholly-owned Indonesian subsidiary. The Company’s Indonesian subsidiary acquired the assets of its distributor, PT Iris, a 40-person business consulting group supporting local and multinational companies in Indonesia and the ASEAN region on August 31,2018. The Company does not expect a material impact to fiscal 2019 operating results and deems the acquisition immaterial.
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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,” “projects,” “estimates,” “will likely result,” “should,” “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 the Company’s current expectations and assumptions regarding its business, the economy and future conditions. A number of risks and uncertainties 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, 2018.2019. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions, expectations and projections 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, 2018,2019, 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; b) accounts receivable allowances for doubtful accounts; c) goodwill and intangible assets – impairment assessments; d) income taxes; and e) stock-based compensation are further discussed in our Annual Report on Form 10-K for the fiscal year ended January 31, 2018.2019. There have been no significant changes to our accounting policies and estimates as discussed in our Annual Report on Form 10-K for the first six months of fiscal 2019 except as noted below.
Revenue. We offer our software using the same underlying technology via two models: a traditional on-premises licensing model and a cloud-based subscription model. The on-premises model involves the sale or license of software on a perpetual basis to customers who take possession of the software and install and maintain the software on their own hardware. Under the cloud-based subscription delivery model, we provide access to our software on a hosted basis as a service and customers generally do not have the contractual right to take possession of the software.
We generate revenue through sales of licenses and maintenance provided to our on-premises customers and through subscriptions of our cloud-based software. We offer professional services to both our on-premises and cloud customers to assist them with the design, testing and implementation of our software.
We determine revenue recognition through the following steps:
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We record the amount of revenue and related costs by considering whether the entity is a principal (gross presentation) or an agent (net presentation) by evaluating the nature of our promise to the customer. Revenue is presented net of sales, value-added and other taxes collected from customers and remitted to government authorities.
Performance Obligations
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account under Topic 606. The transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied by transferring the promised good or service to the customer. We identify and track the performance obligations at contract inception so that we can monitor and account for the performance obligations over the life of the contract.
Our contracts which contain multiple performance obligations generally consist of the initial purchase of subscription or licenses and a professional services engagement. License purchases generally have multiple performance obligations as customers purchase maintenance in addition to the licenses. Our single performance obligation arrangements are typically maintenance renewals, subscription renewals and services engagements.
For contracts with multiple performance obligations where the contracted price differs from the standalone selling price ("SSP") for any distinct good or service, we may be required to allocate the contract’s transaction price to each performance obligation using our best estimate for the SSP. SSP is assessed annually using a historical analysis of contracts with customers executed in the most recently completed fiscal year to determine the range of selling prices applicable to a distinct good or service.
Subscription
Subscription revenue is recognized ratably over the initial subscription period committed to by the customer commencing when the cloud environment is made available to the customer. The initial subscription period is typically 12 to 60 months. We generally invoice our customers in advance in quarterly or annual installments and typical payment terms provide that customers make payment within 30 days of invoice.
Software Licenses
Transfer of control for software is considered to have occurred upon electronic delivery of the license key that provides immediate availability of the product to the customer. Our typical payment terms tend to vary by region but our standard payment terms are within 30-90 days of invoice.
Maintenance
Revenue from support services and product updates, referred to as maintenance revenue, is recognized ratably over the term of the maintenance period, which in most instances is one year. Software license updates provide customers with rights to unspecified software product updates, maintenance releases and patches released during the term of the support period on a when-and-if available basis. Product support includes Internet access to technical content, as well as Internet and telephone access to technical support personnel. Our customers purchase both product support and license updates when they acquire new software licenses. In addition, a majority of customers renew their support services contracts annually and typical payment terms provide that customers make payment within 30 days of invoice.
Professional Services
Revenue from professional services is typically comprised of implementation, development, training or other consulting services. Consulting services are generally sold on a time-and-materials or fixed fee basis and can include services ranging from software installation to data conversion and building non-complex interfaces to allow the software to operate in integrated environments. We recognize revenue for time-and-materials arrangements as the services are performed. In fixed fee arrangements, revenue is recognized as services are performed as measured by costs incurred to date, compared to total estimated costs to complete the services project. Management applies judgment when estimating project status and the costs necessary to complete the services projects. A number of internal and external factors can affect these estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes. Services are generally invoiced upon milestones in the contract or upon consumption of the hourly resources and payments are typically due 30 days after invoice.
Indirect Sales Channels
We execute arrangements through indirect sales channels via sales agents and distributors who are authorized to market our software products to end users. In arrangements with sales agents, QAD contracts directly with the customer and the sales agents are compensated on a commission basis. Distributor arrangements are those in which the resellers are authorized to market and distribute our software products to end users in specified territories and the distributor bears the risk of collection from the end user customer. We recognize revenue from transactions with distributors when the distributor submits a signed agreement and transfer of control has occurred to the distributor, in accordance with the five revenue recognition steps noted above. Revenue from distributor transactions is recorded on a net basis (the amount actually received by us from the distributor). We do not offer rights of return, product rotation or price protection to any of our distributors.
Disaggregated Revenue
We disaggregate revenue from contracts with customers by geography and by the customers’ industry within manufacturing, as we believe it best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.
Our revenue by geography is as follows:
Three Months Ended July 31, | Six Months Ended July 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
North America | $ | 39,288 | $ | 35,156 | $ | 79,313 | $ | 68,526 | ||||||||
EMEA | 26,906 | 22,227 | 51,993 | 43,108 | ||||||||||||
Asia Pacific | 12,866 | 12,967 | 25,425 | 25,133 | ||||||||||||
Latin America | 5,483 | 5,608 | 14,002 | 10,573 | ||||||||||||
| Total revenue | $ | 84,543 | $ | 75,958 | $ | 170,733 | $ | 147,340 | ||||||||
Our revenue by industry is as follows:
Three Months Ended July 31, | Six Months Ended July 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
Automotive | $ | 34,663 | $ | 28,864 | $ | 71,725 | $ | 55,276 | ||||||||
Consumer products and food and beverage | 13,527 | 11,394 | 27,317 | 22,815 | ||||||||||||
High technology and industrial products | 25,363 | 24,306 | 50,358 | 47,148 | ||||||||||||
Life sciences | 10,990 | 11,394 | 21,333 | 22,101 | ||||||||||||
Total revenue | $ | 84,543 | $ | 75,958 | $ | 170,733 | $ | 147,340 | ||||||||
Significant Judgments
More judgments and estimates are required under Topic 606 than were required under Topic 605. Due to the complexity of certain contracts, the actual revenue recognition treatment required under Topic 606 for our arrangements may be dependent on contract-specific terms and may vary in some instances.
Judgment is required to determine the SSP for each distinct performance obligation. We rarely license or sell products on a stand-alone basis, so we are required to estimate the range of SSPs for each performance obligation. In instances where SSP is not directly observable because we do not sell the license, product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. In making these judgments, we analyze various factors, including our pricing methodology and consistency, size of the arrangement, length of term, customer demographics and overall market and economic conditions. Based on these results, the estimated SSP is set for each distinct product or service delivered to customers.
Revenue is recognized over time for our subscription, maintenance and fixed fee professional services that are separate performance obligations. For our professional services, revenue is recognized over time, generally using costs incurred or hours expended to measure progress. Judgment is required in estimating project status and the costs necessary to complete projects. A number of internal and external factors can affect these estimates, including labor rates, utilization, specification variances and testing requirement changes.
If a group of agreements are entered at or near the same time and so closely related that they are, in effect, part of a single arrangement, such agreements are deemed to be combined as one arrangement for revenue recognition purposes. We exercise significant judgment to evaluate the relevant facts and circumstances in determining whether agreements should be accounted for separately or as a single arrangement. Our judgments about whether a group of contracts comprise a single arrangement can affect the allocation of consideration to the distinct performance obligations, which could have an effect on results of operations for the periods involved.
If a contract includes variable consideration, we exercise judgment in estimating the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer. When estimating variable considerations, we will consider all relevant facts and circumstances. Variable consideration will be estimated and included in the contract price only when it is probable that a significant reversal in the amount of revenue recognized will not occur.
Practical Expedients and Exemptions
There are several practical expedients and exemptions allowed under Topic 606 that impact timing of revenue recognition and our disclosures. Below is a list of practical expedients we applied in the adoption and application of Topic 606:
Application
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Modified Retrospective Transition Adjustments
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Costs to Obtain and Fulfill a Contract
Our incremental direct costs of obtaining a contract consist of sales commissions and sales agent fees which are deferred and amortized ratably over the term of economic benefit which we have determined to be five years. These deferred costs are classified as current or non-current based on the timing of when we expect to recognize the expense. Incremental costs related to renewals are expensed as incurred because the term of economic benefit is one year or less. The current and non-current portions of deferred commissions are included in other current assets and other long-term assets, respectively, in our Condensed Consolidated Balance Sheets.
Costs to fulfill a contract, which are incurred upon initiation of certain services contracts and are related to initial customer setup, are included in other current assets and long-term assets in the Company’s Condensed Consolidated Balance Sheets. These costs are amortized over the term of economic benefit which we have determined to be five years.
Recoverability of these costs is subject to various business risks. Quarterly, we compare the carrying value of these assets with the undiscounted future cash flows expected to be generated by them to determine if there is impairment. If impaired, these assets are reduced to an estimated fair value on a discounted cash flow basis. No impairment losses were recognized during the six months ended JulyJanuary 31, 2018.2019.
BUSINESS OVERVIEW
QAD Inc. (“QAD”, the “Company”, “we” or “us”) is a leading provider of flexible, cloud-based and on-premises enterprise software and services for global manufacturing companies. At QAD’s annual user conference in early May, we officially launched our solution portfolio “QAD Adaptive Applications” and our flagship ERP solution “QAD Adaptive ERP” to reflect the value QAD brings to our manufacturing customers. In our Annual Report on Form 10-K for the fiscal year ended January 31, 2019, we referred to these solutions as “QAD Enterprise Applications” or “Enterprise Applications”. QAD Adaptive Applications support operational requirements in the areas of financials, customer management, supply chain, manufacturing, service and support, analytics, business process management and integration. QAD's portfolio also includes related solutions for quality management software, supply chain management software, transportation management software and business-to-business interoperability. Since 1979, QAD solutions have supportedsupport customers in the automotive, consumer products, food and beverage, high technology, industrial manufacturing and life sciences industries to better align operationsstreamline processes, improve operational performance, comply with their strategic goals to become Effective Enterprises.regulatory requirements and meet industry standards.
We have four principal sources of revenue:
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Subscription of QAD Adaptive Applications through our cloud offering in a Software as a Service (“SaaS”) model as well as other hosted applications;
License purchases of QAD Adaptive Applications;
Maintenance and support, including technical support, training materials, product enhancements and upgrades; and
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 halfthree months of fiscal 2019,2020, approximately 47%48% of our total revenue was generated in North America, 30%29% in EMEA, 15% in Asia Pacific and 8% in Latin America. The majority of our revenue is generated from global customers who have operations in multiple countries throughout the world. Subscription, license and maintenance revenues are generally assigned to the region where a majority of the end users are located. Professional services revenue is assigned based on the region where the services are delivered. 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 July 31, 2018,April 30, 2019, we employed approximately 1,9001,980 employees worldwide, of which 650 employees were based in North America, 600610 employees in EMEA, 540600 employees in Asia Pacific and 110120 employees in Latin America.
Our customer base and our target markets are primarily global manufacturing companies; therefore, our results are heavily influenced by the state of the manufacturing economy on a global basis. As a result, 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 economicmacro-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.
We are transitioning our business model from traditional on-premises licensing to cloud-based subscriptions. During fiscal 20182019 and the first sixthree months of fiscal 2019,2020, we closed most of our new customer deals in the cloud. In addition, we converted manyapproximately 15% of our existing customers from on-premises licenses to our cloud-based solution. Recurring revenue, which we define as subscription revenue plus maintenance revenue, grew 10%4% for the first three months of fiscal 2020 from the priorsame period last year, and accounted for 62%71% of total revenue for the first sixthree months of fiscal 2019,2020, compared to 65% one year ago. The decline as a percentage of total revenue was due to the large increase in professional services revenue in the first six months of fiscal 2019, which grew by 37% compared to61% for the same period last year. By reducing our customers’ up-front costs and providing continuous application and infrastructure support, we expect our cloud business model will be more attractive than on-premises licenses. We expect recurring revenue to remain a high percentmajority of total revenue as our subscription revenue continues to grow.
RESULTS OF OPERATIONS
We operate in several geographical regions as described in Note 1314 “Business Segment Information” within the Notes to Condensed Consolidated Financial Statements. In order to present our results of operations without the effects of changes in foreign currency exchange rates, 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 current foreign currency exchange rates to the prior period results.
Revenue
Three Months Ended July 31, 2018 | Three Months Ended July 31, 2017 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Revenue | ||||||||||||||||||||||||
Subscription | $ | 22,439 | $ | 17,420 | $ | 4,998 | $ | 21 | $ | 5,019 | 29 | % | ||||||||||||
Percentage of total revenue | 27 | % | 23 | % | ||||||||||||||||||||
License | 5,561 | 6,743 | (1,225 | ) | 43 | (1,182 | ) | -18 | % | |||||||||||||||
Percentage of total revenue | 6 | % | 9 | % | ||||||||||||||||||||
Maintenance and other | 30,574 | 31,971 | (1,694 | ) | 297 | (1,397 | ) | -4 | % | |||||||||||||||
Percentage of total revenue | 36 | % | 42 | % | ||||||||||||||||||||
Professional services | 25,969 | 19,824 | 6,079 | 66 | 6,145 | 31 | % | |||||||||||||||||
Percentage of total revenue | 31 | % | 26 | % | ||||||||||||||||||||
Total revenue | $ | 84,543 | $ | 75,958 | $ | 8,158 | $ | 427 | $ | 8,585 | 11 | % | ||||||||||||
Six Months Ended July 31, 2018 | Six Months Ended July 31, 2017 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | Three Months Ended | Three Months Ended | Change in | Change due | Total Change as Reported | ||||||||||||||||||||||||||||||||||||||
(in thousands) | April 30, 2019 | April 30, 2018 | Constant Currency | to Currency Fluctuations | $ | % | ||||||||||||||||||||||||||||||||||||||||||
Revenue | ||||||||||||||||||||||||||||||||||||||||||||||||
Subscription | $ | 43,950 | $ | 32,763 | $ | 10,663 | $ | 524 | $ | 11,187 | 34 | % | ||||||||||||||||||||||||||||||||||||
Subscription fees | $ | 25,306 | $ | 21,511 | $ | 4,379 | $ | (584 | ) | $ | 3,795 | 18 | % | |||||||||||||||||||||||||||||||||||
Percentage of total revenue | 26 | % | 22 | % | 32 | % | 25 | % | ||||||||||||||||||||||||||||||||||||||||
License | 11,827 | 12,008 | (481 | ) | 300 | (181 | ) | -2 | % | |||||||||||||||||||||||||||||||||||||||
License fees | 4,466 | 6,266 | (1,513 | ) | (287 | ) | (1,800 | ) | -29 | % | ||||||||||||||||||||||||||||||||||||||
Percentage of total revenue | 7 | % | 8 | % | 6 | % | 7 | % | ||||||||||||||||||||||||||||||||||||||||
Maintenance and other | 62,057 | 63,877 | (3,815 | ) | 1,995 | (1,820 | ) | -3 | % | 29,899 | 31,483 | (426 | ) | (1,158 | ) | (1,584 | ) | -5 | % | |||||||||||||||||||||||||||||
Percentage of total revenue | 36 | % | 43 | % | 38 | % | 37 | % | ||||||||||||||||||||||||||||||||||||||||
Professional services | 52,899 | 38,692 | 13,152 | 1,055 | 14,207 | 37 | % | 18,364 | 26,930 | (7,315 | ) | (1,251 | ) | (8,566 | ) | -32 | % | |||||||||||||||||||||||||||||||
Percentage of total revenue | 31 | % | 27 | % | 24 | % | 31 | % | ||||||||||||||||||||||||||||||||||||||||
Total revenue | $ | 170,733 | $ | 147,340 | $ | 19,519 | $ | 3,874 | $ | 23,393 | 16 | % | $ | 78,035 | $ | 86,190 | $ | (4,875 | ) | $ | (3,280 | ) | $ | (8,155 | ) | -9 | % | |||||||||||||||||||||
Total Revenue. On a constant currency basis, total revenue was $84.5$78.0 million for the secondfirst quarter of fiscal 2019,2020, representing an $8.1a $4.9 million, or 11%6%, increasedecrease from $76.4$82.9 million for the same period last year. When comparing categories within total revenue at constant rates, our results for the secondfirst quarter of fiscal 20192020 included increasesdecreases in subscription and professional services, partially offset by decreases in license and maintenance and other.other partially offset by an increase in subscription. Revenue outside the North America region as a percentage of total revenue was 53%52% and 54% for the secondfirst quarter of fiscal 20192020 and 2018,2019, respectively. On a constant currency basis, total revenue increased in our North America, EMEA and Latin America regions and decreased in all our Asia Pacific regionregions during the secondfirst quarter of fiscal 20192020 when compared to the prior year.
On a constant currency basis, total revenue was $170.7 million for the first six months of fiscal 2019, representing a $19.5 million, or 13%, increase from $151.2 million for the same period last year. Total revenue in the first six months of fiscal 2019 included $2.7 million of additional revenue recognized in accordance with new revenue recognition rules under Topic 606 compared to applying the historical revenue recognition rules under Topic 605. For additional explanation of the revenue recognition differences between Topic 606 and Topic 605, refer to the Recent Accounting Pronouncements section of Note 1 in the Notes to Condensed Consolidated Financial Statements of this Form 10-Q. When comparing categories within total revenue at constant rates, our results for the first six months of fiscal 2019 included increases in subscription and professional services partially offset by decreases in license and maintenance and other. Revenue outside the North America region as a percentage of total revenue was 53% for the first six months of both fiscal 2019 and 2018. On a constant currency basis, total revenue increased across all regions during the first six months of fiscal 2018 when compared to the prior year.
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 consumer products and food and beverage as well as between high technology and industrial products, we aggregate them for management review. The following table presents revenue by industry for the three and six months ended July 31, 2018April 30, 2019 and 2017:2018:
Three months ended July 31, | Six months ended July 31, | Three Months Ended April 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | |||||||||||||||||||
Automotive | 41 | % | 38 | % | 42 | % | 37 | % | 37 | % | 43 | % | ||||||||||||
Consumer products and food and beverage | 16 | % | 15 | % | 16 | % | 16 | % | 15 | % | 16 | % | ||||||||||||
High technology and industrial products | 30 | % | 32 | % | 29 | % | 32 | % | 33 | % | 29 | % | ||||||||||||
Life sciences | 13 | % | 15 | % | 13 | % | 15 | % | ||||||||||||||||
Life sciences and other | 15 | % | 12 | % | ||||||||||||||||||||
Total revenue | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | ||||||||||||
The decrease in percentage of revenue by industry for automotive, and the percentage increases in high technology and industrial products and life sciences and other, primarily related to a reduction in professional services revenue following the completion of a large, multisite global implementation project for a customer in the automotive industry.
Subscription Revenue. Subscription revenue consists of recurring fees from customers to access our products via the cloud and other subscription offerings. SubscriptionOur cloud offerings typically include access to QAD software, hosting, application support, maintenance support and product updates, if and when available. Included in subscription revenue is billed on a quarterly or annual basis and recognized ratably over the termare one-time set up fees for technical services such as configuration of the agreement, typically 12 to 60 months. On a constant currency basis, subscription revenue was $22.4 million for the second quarter of fiscal 2019, representing a $5.0 million, or 29%, increase from $17.4 million for the same period last year. On a constant currency basis, subscription revenue increased across all regions during the second quarter of fiscal 2019 when compareddatabase and access to the prior year. In the second quarter of fiscal 2019 we closed eleven cloud deals, including six new cloud customers and five conversions from existing customers who previously purchased on-premises licenses. This compared to the second quarter of fiscal 2018 when we closed eleven cloud deals, including eight new cloud customers and three conversions from existing customers who previously purchased on-premises licenses. Subscription revenue consists of new customer sites; existing Enterprise Applications users converting from on-premises; and additional users and modules purchased by our existing cloud customers.environment.
On a constant currency basis, subscription revenue was $44.0$25.3 million for the first six monthsquarter of fiscal 2019,2020, representing a $10.7$4.4 million, or 32%21%, increase from $33.3$20.9 million for the same period last year. On a constant currency basis, subscription revenue increased across all regions during the first six monthsquarter of fiscal 20192020 when compared to the priorsame period last year. One of the metrics that management uses to monitor subscription performance is the number of new cloud deals that have been signed in the period. In the first six monthsquarter of fiscal 20192020 we closed 2916 new cloud deals, including 19six new cloud customers and ten conversions from existing customers who previously purchased on-premises licenses. This compared to the first six monthsquarter of fiscal 20182019 when we closed 2818 new cloud deals, including 1813 new cloud customers and tenfive conversions from existing customers who previously were running our solutions on-premises. The increase in subscription revenue consists of new customer sites; existing Adaptive Applications users converting from on-premises; and additional users and modules purchased on-premises licenses.by our existing cloud customers.
We track our retention rate of subscription and maintenance by calculating the annualized revenue of customer sites with contracts up for renewal duringat the beginning of the period compared to the annualized revenue associated with the customer sites that have canceled during the period. The percentage of revenue not canceled is our retention rate. Conversions to the cloud are not considered cancellations for purposes of thisthe maintenance retention calculation. OurBoth our subscription and maintenance customer retention rate isrates are in excess of 90%.
The following table presents subscription revenue by region for the three and six months ended July 31, 2018April 30, 2019 and 2017:2018:
Three months ended July 31, | Six months ended July 31, | Three Months Ended April 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | |||||||||||||||||||
North America | 55 | % | 57 | % | 56 | % | 56 | % | 54 | % | 56 | % | ||||||||||||
EMEA | 27 | % | 22 | % | 26 | % | 22 | % | 27 | % | 26 | % | ||||||||||||
Asia Pacific | 13 | % | 14 | % | 13 | % | 14 | % | 13 | % | 13 | % | ||||||||||||
Latin America | 5 | % | 7 | % | 5 | % | 8 | % | 6 | % | 5 | % | ||||||||||||
Total cloud revenue | 100 | % | 100 | % | 100 | % | 100 | % | ||||||||||||||||
Total subscription revenue | 100 | % | 100 | % | ||||||||||||||||||||
The following table presents subscription revenue by industry for the three and six months ended July 31, 2018April 30, 2019 and 2017:2018:
Three months ended July 31, | Six months ended July 31, | Three Months Ended April 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | |||||||||||||||||||
Automotive | 33 | % | 35 | % | 34 | % | 36 | % | 33 | % | 34 | % | ||||||||||||
Consumer products and food and beverage | 18 | % | 12 | % | 18 | % | 13 | % | 17 | % | 18 | % | ||||||||||||
High technology and industrial products | 24 | % | 25 | % | 24 | % | 23 | % | 25 | % | 24 | % | ||||||||||||
Life sciences | 25 | % | 28 | % | 24 | % | 28 | % | ||||||||||||||||
Total cloud revenue | 100 | % | 100 | % | 100 | % | 100 | % | ||||||||||||||||
Life sciences and other | 25 | % | 24 | % | ||||||||||||||||||||
Total subscription revenue | 100 | % | 100 | % | ||||||||||||||||||||
License Revenue. License revenue is derived from software license fees that customers pay for our core product, QAD EnterpriseAdaptive Applications, and any add-on modules they purchase. Our revenue mix has continued to shift from license to subscription revenue as a result of our business model transition as more new customers subscribe to our cloud-based offerings rather than purchase traditional on-premises licenses. While we expect license revenue to decline over time, we do continue to experience quarterly fluctuations.
On a constant currency basis, license revenue was $5.6$4.5 million for the secondfirst quarter of fiscal 2019,2020, representing a $1.2$1.5 million, or 18%25%, decrease from $6.8$6.0 million for the same period last year. On a constant currency basis, license revenue decreased in our North America, Latin America and Asia Pacific regions and increasedremained flat in our EMEA region during the secondfirst quarter of fiscal 20192020 when compared to the same period 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 secondfirst quarter of fiscal 2020, one customer placed one license order totaling more than $1.0 million and no other customers placed orders totaling more than $0.3 million. This compared to the first quarter of fiscal 2019 twoin which three customers placed license orders totaling more than $0.3 million and no orders exceeded $1.0 million. This compared to fiscal 2018 in which five customers placed license orders totaling more than $0.3 million and no ordersone order exceeded $1.0 million. The majority of our license revenue has come from additional users and module purchases from modules purchased by our existing customers. We anticipate that license revenue will decrease as more new customers subscribe to our cloud-based products and more existing customers elect to subscribe to QAD products in the cloud instead of purchasing licenses.
On a constant currency basis, license revenue was $11.8 million for the first six months of fiscal 2019, representing a $0.5 million, or 4%, decrease from $12.3 million for the same period last year. On a constant currency basis, license revenue decreased in our North America, EMEA and Asia Pacific regions and increased in our Latin America region during the first six months of fiscal 2019 when compared to the same period last year. During the first six months of fiscal 2019, five customers placed license orders totaling more than $0.3 million and one order exceeded $1.0 million. This compared to the first six months of fiscal 2018 in which six customers placed license orders totaling more than $0.3 million and no orders exceeded $1.0 million.
Maintenance and Other Revenue. We offer support services 24 hours a day, seven days a week in addition to providing software upgrades, which include additional or improved functionality, when and if available.
On a constant currency basis, maintenance and other revenue was $30.6$29.9 million for the secondfirst quarter of fiscal 2019,2020, representing a $1.7$0.4 million, or 5%1%, decrease from $32.3$30.3 million for the same period last year. On a constant currency basis, maintenance and other revenue decreased in allour North America region, remained flat in our Latin America and Asia Pacific regions and increased in our EMEA region during the secondfirst quarter of fiscal 20192020 when compared to the priorsame period last year. The decrease in maintenance and other revenue period over period is primarily due to continued conversions of existing customers’ perpetualon-premises licenses to a cloud subscription,subscriptions, in addition to our historical attrition rates. When customers convert to the cloud they no longer pay for maintenance as those support services are included as a component of the subscription offering. Though we continue to see renewal rates above 90%, conversions from on-premises to cloud have resulted in decreases in maintenance revenue and we expect this trend to continue in the future.
On a constant currency basis, maintenance and other revenue was $62.1 million for the first six months of fiscal 2019, representing a $3.8 million, or 6%, decrease from $65.9 million for the same period last year. On a constant currency basis, maintenance and other revenue decreased in all regions during the first six months of fiscal 2019 when compared to the prior year. The decrease in maintenance and other revenue period over period is primarily due to conversions to the cloud, in addition to our historical attrition rates.
Our maintenance retention rate has remained in excess of 90% for the second quarter and first six months of fiscal 2019.
Professional Services Revenue. Our professional services business includes technical and application consulting andin addition to training, implementations, migrations and upgrades related to our solutions. Although our professional services are optional, our customers use these services when planning, implementing or upgrading our solutions whether in the cloud or on-premises. Professional services revenue growth is contingent upon subscription and license revenue growth and customer upgrade cycles, which are influenced by the strength of general economic and business conditions.
On a constant currency basis, professional services revenue was $26.0$18.4 million for the secondfirst quarter of fiscal 2019,2020, representing a $6.1$7.3 million, or 31%28%, increasedecrease from $19.9$25.7 million for the same period last year. On a constant currency basis, professional services revenue increaseddecreased in all our regions during the secondfirst quarter of fiscal 20192020 when compared to the prior year. The increase in professional services revenue period over period can be attributed to a higher number of engagements and a higher amount of professional services revenue per customer. New cloud implementations and existing customer upgrade projects continue to generate demand for our professional services. In addition, we also provided personnel augmentation services to one of our cloud customers, mainly through third-party contractors at low margins. We expect professional services revenue will decrease from its current level when the augmentation services are completed, which we currently expect to finish in the third quarter.
On a constant currency basis, professional services revenue was $52.9 million for the first six months of fiscal 2019, representing a $13.2 million, or 33%, increase from $39.7 million for the same period last year. OnThe decrease related to a constant currency basis, professional services revenue increased in all regions during the first six months of fiscal 2019 when compared to the prior year. The increasereduction in professional services revenue period over period can be attributed tofollowing the completion of a higher number of engagements and a higher amount of professional services revenue per customer. In addition, we also provided personnel augmentation services to one of our cloud customers, mainly through third-party contractors at low margins.large, multisite global implementation project.
Total Cost of Revenue
Three Months Ended July 31, 2018 | Three Months Ended July 31, 2017 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | Three Months Ended April 30, 2019 | Three Months Ended April 30, 2018 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | |||||||||||||||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||||||||||||||||||
Cost of revenue | ||||||||||||||||||||||||||||||||||||||||||||||||
Cost of subscription | $ | 8,334 | $ | 7,428 | $ | (910 | ) | $ | 4 | $ | (906 | ) | -12 | % | $ | 9,417 | $ | 8,228 | $ | (1,261 | ) | $ | 72 | $ | (1,189 | ) | -14 | % | ||||||||||||||||||||
Cost of license | 574 | 828 | 254 | — | 254 | 31 | % | 591 | 664 | 72 | 1 | 73 | 11 | % | ||||||||||||||||||||||||||||||||||
Cost of maintenance and other | 7,774 | 7,840 | 62 | 4 | 66 | -1 | % | 7,603 | 7,865 | 55 | 207 | 262 | 3 | % | ||||||||||||||||||||||||||||||||||
Cost of professional services | 23,754 | 20,598 | (3,055 | ) | (101 | ) | (3,156 | ) | -15 | % | 19,323 | 24,310 | 3,969 | 1,018 | 4,987 |
| 21 | % | ||||||||||||||||||||||||||||||
Total cost of revenue | $ | 40,436 | $ | 36,694 | $ | (3,649 | ) | $ | (93 | ) | $ | (3,742 | ) | -10 | % | $ | 36,934 | $ | 41,067 | $ | 2,835 | $ | 1,298 | $ | 4,133 | 10 | % | |||||||||||||||||||||
Percentage of revenue | 48 | % | 48 | % | 47 | % | 48 | % | ||||||||||||||||||||||||||||||||||||||||
Six Months Ended July 31, 2018 | Six Months Ended July 31, 2017 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Cost of revenue | ||||||||||||||||||||||||
Cost of subscription | $ | 16,562 | $ | 15,148 | $ | (1,326 | ) | $ | (88 | ) | $ | (1,414 | ) | -9 | % | |||||||||
Cost of license | 1,238 | 1,513 | 275 | — | 275 | 18 | % | |||||||||||||||||
Cost of maintenance and other | 15,639 | 15,534 | 90 | (195 | ) | (105 | ) | -1 | % | |||||||||||||||
Cost of professional services | 48,064 | 39,365 | (7,569 | ) | (1,130 | ) | (8,699 | ) | -22 | % | ||||||||||||||
Total cost of revenue | $ | 81,503 | $ | 71,560 | $ | (8,530 | ) | $ | (1,413 | ) | $ | (9,943 | ) | -14 | % | |||||||||
Percentage of revenue | 48 | % | 49 | % | ||||||||||||||||||||
Total cost of revenue consists of cost of subscription, cost of license, cost of maintenance and other and cost of professional services. Cost of subscription includes salaries, benefits, bonuses and bonusesother personnel expenses of our cloud operations employees; stock-based compensation for those employees; third-party contractor expense;expense, third-party hosting and hardware costs; royalties; professional fees; travel;travel expense; and an allocation of information technology and facilities costs. Cost of license includes license royalties and amortization of capitalized software costs and fulfillment.costs. Cost of maintenance and other includes salaries, benefits, bonuses and bonusesother personnel expenses of our support group, stock-based compensation for those employees, travel expense, professional fees fulfillment and an allocation of information technology and facilities costs. Cost of professional services includes salaries, benefits, bonuses and bonuses, costsother personnel expenses of fulfilling service contracts,our services employees, stock-based compensation for those employees, third-party contractor expense, travel expense for services employees and an allocation of information technology and facilities costs.
Total Cost of Revenue. On a constant currency basis, total cost of revenue was $40.4$36.9 million and $36.8$39.8 million for the secondfirst quarter of fiscal 20192020 and 2018,2019, respectively, and as a percentage of total revenue was 47% and 48% in each of the second quartersfirst quarter of fiscal 2020 and 2019, and 2018.respectively. The non-currency related increasedecrease in cost of revenue of $3.6$2.9 million or 10%, in the secondfirst quarter of fiscal 2020 compared to the first quarter of fiscal 2019 compared to the second quarter of fiscal 2018 was primarily due to higherlower professional services third-party contractor travel and personnel costs associated with increased servicesdecreased professional service revenue andpartially offset by higher hosting costs associated with the growth of our cloud business.
On a constant currency basis, total cost of revenue was $81.5 million and $73.0 million for the first six months of fiscal 2019 and 2018, respectively, and as a percentage of total revenue was 48% for the first six months of both fiscal 2019 and 2018, respectively. The non-currency related increase in cost of revenue of $8.5 million, or 12%, in the first six months of fiscal 2019 compared to the first six months of fiscal 2018 was primarily due to higher professional services personnel, travel and third-party contractor costs associated with increased services revenue and higher hosting costs associated with the growth of our cloud business.subscription revenue.
Cost of Subscription. On a constant currency basis, cost of subscription was $8.3$9.4 million for the secondfirst quarter of fiscal 2019,2020, representing a $0.9$1.2 million, or 12%15%, increase from $7.4$8.2 million for the same period last year. The non-currency related increase in cost of subscription of $0.9$1.2 million in the secondfirst quarter of fiscal 20192020 compared to the secondfirst quarter of fiscal 20182019 was primarily due to higher hosting costs of $0.9 million.$0.6 million and higher salaries and related costs of $0.3 million, as a result of additional headcount of 31 people. Cost of subscription as a percentage of subscription revenue was 37% and 43%38% in the secondfirst quarter of fiscal 2020 and 2019, and 2018, respectively. Subscription margins improved due to achieving greater economies of scale as we increased revenue as well as improved automation of some processes in our cloud operations department. We expect to continuehave continued to improve our subscription margins over time as we leveragedue to leveraging of ongoing economies of scale and implementing operational efficiencies, but we also anticipateefficiencies. We have experienced and may experience in the future quarterly fluctuations in our subscription margins as we make investments in our data centers and cloud operations to support future growth. Our strategic investments in cloud growth may not match the timing of revenue increases.
On a constant currency basis, cost of subscription was $16.6 million for the first six months of fiscal 2019, representing a $1.4 million, or 9%, increase from $15.2 million for the same period last year. The non-currency related increase in cost of subscription of $1.4 million in the first six months of fiscal 2019 compared to the first six months of fiscal 2018 was primarily due to higher hosting costs of $1.6 million partially offset by $0.2 million of personnel costs cross charged to our services department to support conversion and upgrade projects. Cost of subscription as a percentage of subscription revenue was 38% and 46% in the first six months of fiscal 2019 and 2018, respectively.
Cost of License. On a constant currency basis, cost of license was $0.6 million for the secondfirst quarter of fiscal 2019,2020, representing a $0.2$0.1 million, or 25%14%, decrease from $0.8$0.7 million for the same period last year. CostA majority of license as a percentage of license revenue was 10% and 12% for the second quarters of fiscal 2019 and 2018, respectively.
On a constant currency basis, cost of license was $1.2 million for the first six months of fiscal 2019, representing a $0.3 million, or 20%, decrease from $1.5 million for the same period last year. Cost of licenseroyalty expense, which as a percentagepercent of license revenue, was 10% and 13% for the first six months of fiscal 2019 and 2018, respectively.remained relatively consistent year over year.
Cost of Maintenance and Other. On a constant currency basis, cost of maintenance and other was $7.8$7.6 million for the secondfirst quarter of both fiscal 2019 and 2018.2020, representing a $0.1 million, or 1%, decrease from $7.7 million for the same period last year. Expense categories within cost of maintenance and other were relatively consistent for the secondfirst quarter of fiscal 20192020 compared to the same period last year. Cost of maintenance and other as a percentage of maintenance and other revenue was 25% in the secondfirst quarter of both fiscal 20192020 and 2018.
On a constant currency basis, cost of maintenance and other was $15.6 million for the first six months of fiscal 2019, representing a $0.1 million, or 1%, decrease from $15.7 million for the same period last year. Expense categories within cost of maintenance and other were relatively consistent for the first six months of fiscal 2019 compared to the same period last year. Cost of maintenance and other as a percentage of maintenance and other revenue was 25% and 24% in the first six months of fiscal 2019 and 2018, respectively.2019.
Cost of Professional Services. On a constant currency basis, cost of professional services was $23.8$19.3 million for the secondfirst quarter of fiscal 2019,2020, representing a $3.1$4.0 million, or 15%17%, increasedecrease from $20.7$23.3 million for the same period last year. The non-currency related increasedecrease in cost of professional services of $3.1$4.0 million in the secondfirst quarter of fiscal 2020 compared to the first quarter of fiscal 2019 compared to the second quarter of fiscal 2018 was primarily due to higherlower third-party contractor costs of $1.6$2.6 million, higherlower travel expense of $0.7$0.8 million and higher salaries and related costslower bonuses of $0.5 million, as a result of additional headcount of ten people. Cost of professional services as a percentage of professional services revenues was 91% and 104% for the second quarter of fiscal 2019 and 2018, respectively. Our professional services margin has gradually improved as the additional resources hired in fiscal 2018 have become utilized.
On a constant currency basis, cost of professional services was $48.1 million for the first six months of fiscal 2019, representing a $7.6 million, or 19%, increase from $40.5 million for the same period last year. The non-currency related increase in cost of professional services of $7.6 million in the first six months of fiscal 2019 compared to the first six months of fiscal 2018 was primarily due to higher third-party contractor costs of $3.6 million, higher travel expense of $1.7 million, higher salaries and related costs of $1.7 million, as a result of additional headcount of ten people and higher cross-charges from other departments to support conversion and upgrade projects of $0.4$0.2 million. Cost of professional services as a percentage of professional services revenues was 91%105% and 102%90% for the first six monthsquarter of fiscal 20192020 and 2018,2019, respectively.
Sales and Marketing
Three Months Ended July 31, 2018 | Three Months Ended July 31, 2017 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Sales and marketing | $ | 19,502 | $ | 17,697 | $ | (1,658 | ) | $ | (147 | ) | $ | (1,805 | ) | -10 | % | |||||||||
Percentage of revenue | 23 | % | 24 | % | ||||||||||||||||||||
Six Months Ended July 31, 2018 | Six Months Ended July 31, 2017 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | Three Months Ended April 30, 2019 | Three Months Ended April 30, 2018 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | |||||||||||||||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||||||||||||||||||
Sales and marketing | $ | 39,448 | $ | 35,284 | $ | (3,228 | ) | $ | (936 | ) | $ | (4,164 | ) | -12 | % | $ | 20,891 | $ | 19,946 | $ | (1,509 | ) | $ | 564 | $ | (945 | ) | -5 | % | |||||||||||||||||||
Percentage of revenue | 23 | % | 24 | % | 27 | % | 23 | % | ||||||||||||||||||||||||||||||||||||||||
Sales and marketing expense includes salaries, benefits, commissions, bonuses, stock-based compensation, and travel expense forand other personnel costs of our sales and marketing employees in addition to costs of programs aimed at increasing revenue, such as trade shows, user group events, lead generation, advertising and various sales and promotional programs. Sales and marketing expense also includes personnel costs of order processing, sales agent fees and an allocation of information technology and facilities costs.
On a constant currency basis, sales and marketing expense was $19.5$20.9 million for the secondfirst quarter of fiscal 2019,2020, representing a $1.7$1.5 million, or 10%8%, increase from $17.8$19.4 million for the same period last year. The non-currency related increase in sales and marketing expense of $1.7$1.5 million in the secondfirst quarter of fiscal 20192020 compared to the secondfirst quarter of fiscal 20182019 was primarily due to higher salaries and related costs of $1.1$0.7 million, as a result of additional headcount of 1821 people, and higher bonuses of $0.7 million. In fiscal 2019 we made some changes to the structure of our sales force, which increased the total size of the group by about 10%.
On a constant currency basis, sales and marketing expense was $39.4 million for the first six months of fiscal 2019, representing a $3.2 million, or 9%, increase from $36.2 million for the same period last year. The non-currency related increase in sales and marketing expense of $3.2 million in the first six months of fiscal 2019 compared to the first six months of fiscal 2018 was primarily due to higher salaries and related costs of $1.9 million, as a result of additional headcount of 18 people, higher bonuses of $0.8 million and higher severance of $0.4$0.5 million, higher recruiting expense of $0.2 million and a higher allocation of information technology and facilities costs of $0.2 million partially offset by lower sales agent/partner fees of $0.2 million.
Research and Development
Three Months Ended July 31, 2018 | Three Months Ended July 31, 2017 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Research and development | $ | 13,513 | $ | 11,689 | $ | (1,718 | ) | $ | (106 | ) | $ | (1,824 | ) | -16 | % | |||||||||
Percentage of revenue | 16 | % | 15 | % | ||||||||||||||||||||
Six Months Ended July 31, 2018 | Six Months Ended July 31, 2017 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | Three Months Ended April 30, 2019 | Three Months Ended April 30, 2018 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | |||||||||||||||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||||||||||||||||||
Research and development | $ | 27,519 | $ | 23,221 | $ | (3,738 | ) | $ | (560 | ) | $ | (4,298 | ) | -19 | % | $ | 13,987 | $ | 14,006 | $ | (399 | ) | $ | 418 | $ | 19 | 0 | % | ||||||||||||||||||||
Percentage of revenue | 16 | % | 16 | % | 18 | % | 16 | % | ||||||||||||||||||||||||||||||||||||||||
Research and development is expensed as incurred and consists primarily of salaries, benefits, bonuses, stock-based compensation, trainingtravel expense and travel expenseother personnel costs for research and development employees andin addition to professional services, such as fees paid to software development firms and independent contractors. Research and development expense also includes an allocation of information technology and facilities costs, and is reduced by capitalized localization and translation costs.
On a constant currency basis, research and development expense was $13.5$14.0 million for the secondfirst quarter of fiscal 2019,2020, representing a $1.7$0.4 million, or 14%3%, increase from $11.8$13.6 million for the same period last year. The non-currency related increase in research and development expense of $1.7$0.4 million in the secondfirst quarter of fiscal 20192020 compared to the secondfirst quarter of fiscal 20182019 was primarily due to higher salaries and related costs of $0.7 million, as a result of additional headcount of 18 people, higher third-party contractor costs of $0.5$0.3 million and higher information technology and facilities allocated costs of $0.2 million.
On a constant currency basis, research and development expense was $27.5 million for the first six months of fiscal 2019, representing a $3.7 million, or 16%, increase from $23.8 million for the same period last year. The non-currency related increase in research and development expense of $3.7 million in the first six months of fiscal 2019 compared to the first six months of fiscal 2018 was primarily due to higher salaries and related costs of $1.6 million, as a result of additional headcount of 18 people, higher third-party contractor costs of $1.2 million, higher information technology and facilities allocated costs of $0.3 million, higher stock compensation expense of $0.2 million and higher travel expense of $0.2 million.
General and Administrative
Three Months Ended July 31, 2018 | Three Months Ended July 31, 2017 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
General and administrative | $ | 9,366 | $ | 9,224 | $ | (92 | ) | $ | (50 | ) | $ | (142 | ) | -2 | % | |||||||||
Percentage of revenue | 11 | % | 12 | % | ||||||||||||||||||||
Six Months Ended July 31, 2018 | Six Months Ended July 31, 2017 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
General and administrative | $ | 18,728 | $ | 17,817 | $ | (601 | ) | $ | (310 | ) | $ | (911 | ) | -5 | % | |||||||||
Percentage of revenue | 11 | % | 12 | % | ||||||||||||||||||||
Three Months Ended April 30, 2019 | Three Months Ended April 30, 2018 | Change in Constant Currency | Change due to Currency Fluctuations | Total Change as Reported $ | % | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
General and administrative | $ | 9,418 | $ | 9,362 | $ | (259 | ) | $ | 203 | $ | (56 | ) | -1 | % | ||||||||||
Percentage of revenue | 12 | % | 11 | % | ||||||||||||||||||||
General and administrative expense includes salaries, benefits, bonuses, stock-based compensation, and travel expense forand other personnel costs related to our finance, human resources, legal and executive personnel. General and administrative expense also includes personnel as well ascosts of order processing, professional fees for accounting and legal services, bad debt expense and an allocation of information technology and facilities costs.
On a constant currency basis, general and administrative expense was $9.4 million for the secondfirst quarter of fiscal 2019,2020, representing a $0.1$0.2 million, or 1%2%, increase from $9.3$9.2 million for the same period last year. The non-currency related increase in general and administrative expense of $0.1$0.2 million in the secondfirst quarter of fiscal 20192020 compared to the secondfirst quarter of fiscal 20182019 was primarily due to higher stock compensationsalaries and related costs of $0.6 million, as a result of moving our order processing employees from sales and marketing expense of $0.4 millionto general and administrative expense, partially offset by lower professional fees of $0.3 million.
On a constant currency basis, general and administrative expense was $18.7 million for the first six months of fiscal 2019, representing a $0.6 million, or 3%, increase from $18.1 million for the same period last year. The non-currency related increase in general and administrative expense of $0.6 million in the first six months of fiscal 2019 compared to the first six months of fiscal 2018 was primarily due to higher stock compensation expense of $0.5 million and higher payroll taxes of $0.2 million partially offset by lower bonus expense of $0.3 million.
Amortization of Intangibles from Acquisitions
Amortization of intangibles from acquisitions was zero$67,000 and $0.1 millionzero in the secondfirst quarter of fiscal 20192020 and 2018, respectively, and zero and $0.3 million for the first six months of fiscal 2019, and 2018, respectively. Amortization expense for all periodsthe first quarter of fiscal 2020 was due to the intangible assets acquired in ourduring fiscal 2013 acquisitions of DynaSys and CEBOS. 2019.
Total Other (Income) Expense
Three Months Ended | Increase (Decrease) Compared to Prior Period | Three Months Ended | ||||||||||||||
July 31, 2018 | $ | % | July 31, 2017 | |||||||||||||
(in thousands) | ||||||||||||||||
Other (income) expense | ||||||||||||||||
Interest income | $ | (743 | ) | $ | (250 | ) | -51 | % | $ | (493 | ) | |||||
Interest expense | 154 | (3 | ) | -2 | % | 157 | ||||||||||
Other (income) expense, net | (269 | ) | (1,477 | ) | -122 | % | 1,208 | |||||||||
Total other (income) expense, net | $ | (858 | ) | $ | (1,730 | ) | -198 | % | $ | 872 | ||||||
Percentage of revenue | -1 | % | 1 | % | ||||||||||||
Six Months Ended | Increase (Decrease) Compared to Prior Period | Six Months Ended | ||||||||||||||
July 31, 2018 | $ | % | July 31, 2017 | |||||||||||||
(in thousands) | ||||||||||||||||
Other (income) expense | ||||||||||||||||
Interest income | $ | (1,267 | ) | $ | (606 | ) | -92 | % | $ | (661 | ) | |||||
Interest expense | 311 | (2 | ) | -1 | % | 313 | ||||||||||
Other (income) expense, net | (673 | ) | (2,485 | ) | -137 | % | 1,812 | |||||||||
Total other (income) expense, net | $ | (1,629 | ) | $ | (3,093 | ) | -211 | % | $ | 1,464 | ||||||
Percentage of revenue | -1 | % | 1 | % | ||||||||||||
Total other (income) expense, net was $(0.9) million and $0.9 million for the second quarter of fiscal 2019 and fiscal 2018, respectively. The change in net other (income) expense was primarily related to lower foreign exchange losses of $1.3 million and an increase in interest income of $0.3 million.
Three Months Ended | Increase (Decrease) Compared to Prior Period | Three Months Ended | ||||||||||||||
April 30, 2019 | $ | % | April 30, 2018 | |||||||||||||
(in thousands) | ||||||||||||||||
Other (income) expense | ||||||||||||||||
Interest income | $ | (724 | ) | $ | (200 | ) | -38 | % | $ | (524 | ) | |||||
Interest expense | 153 | (4 | ) | -3 | % | 157 | ||||||||||
Other (income) expense, net | (172 | ) | 232 | 57 | % | (404 | ) | |||||||||
Total other (income), net | $ | (743 | ) | $ | 28 | 4 | % | $ | (771 | ) | ||||||
Percentage of revenue | -1 | % | -1 | % | ||||||||||||
Total other (income) expense, net was $(1.6)$(0.7) million and $1.5$(0.8) million for the first six monthsquarter of fiscal 20192020 and fiscal 2018,2019, respectively. The change in net other (income) expense was primarily related to lower foreign exchange losses of $2.2 million, higher interest income of $0.6$0.2 million anddue to interest rate increases partially offset by the favorableunfavorable change in the fair market value of the interest ratecredit swap associated with the mortgage on our headquarters of $0.2 million.
Interest rate swap valuations and foreign exchange gains and losses are subject to changes which are inherently unpredictable. Our interest rate swap is accounted for using mark-to-market accounting. Accordingly, changes in the fair value of the swap each reporting period are adjusted through earnings, subjecting us to non-cash volatility in our results of operations. The swap fixes the interest rate on our mortgage to 4.31% over the entire term of the mortgage and effectively lowered our interest rate from the previous mortgage rate of 6.5%. Although the agreement allows us to prepay the loan and exit the agreement early, we have no intention of doing so. As a result, we will have non-cash adjustments through earnings each reporting period. Over the term of the mortgage, however, the net impact of these mark-to-market adjustments on earnings will be zero.
Income Tax Expense
Three Months Ended | Increase Compared to Prior Period | Three Months Ended | ||||||||||||||
July 31, 2018 | $ | % | July 31, 2017 | |||||||||||||
(in thousands) | ||||||||||||||||
Income tax expense | $ | 1,471 | $ | 639 | 77 | % | $ | 832 | ||||||||
Percentage of revenue | 2 | % | 1 | % | ||||||||||||
Effective tax rate | 57 | % | -253 | % | ||||||||||||
Six Months Ended | Increase Compared to Prior Period | Six Months Ended | Three Months Ended | Increase (Decrease) Compared to Prior Period | Three Months Ended | |||||||||||||||||||||||||||
July 31, 2018 | $ | % | July 31, 2017 | April 30, 2019 | $ | % | April 30, 2018 | |||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||
Income tax expense | $ | 2,654 | $ | 1,202 | 83 | % | $ | 1,452 | $ | 715 | $ | (468 | ) | -40 | % | $ | 1,183 | |||||||||||||||
Percentage of revenue | 2 | % | 1 | % | 1 | % | 1 | % | ||||||||||||||||||||||||
Effective tax rate | 51 | % | -64 | % | -28 | % | 46 | % | ||||||||||||||||||||||||
In determining the quarterly provision for income taxes, for the second quarter of fiscal 2019, we calculated income tax expense based on actual quarterly results in the estimated annual tax rate for the year, compared to the prior year when we calculated the actual tax expense based on actualfirst quarters of fiscal years 2020 and 2019, respectively. These results for the quarter. The annual effective tax rate waswere adjusted for discrete items recorded during both periods. The estimated annual tax rate for the year wasperiod. Actual quarterly results were used in the current periodfiscal 2020 and 2019 since we are forecasting profits for the full fiscal year 2019.they provided a more reliable estimate of quarterly tax expense.
We recorded income tax expense of $1.5$0.7 million and $0.8$1.2 million infor the second quarterfirst three months of fiscal 20192020 and 2018,2019, respectively. Our effective tax rate increased to 57% for the second quarter of fiscal 2019was (28%) compared to (253%)46% for the same period in the prior year. The increasechange in the effective tax rate is primarily due to a taxable loss for the forecasted profits and pretax book income in the second quarterfirst three months of fiscal 20192020 compared to a pretax lossthe taxable profits for the same period of fiscal 2018.
We recorded income tax expense of $2.7 million and $1.5 million for2019 in addition to the first six months of fiscal 2019 and 2018, respectively. Our effective tax rate increased to 51% from (64%) for the same periodchange in the prior year. The increase in the effective tax rate is primarily due to forecasted profits and pretax book income for the first six months of fiscal 2019 compared to a pretax book loss for the same period of fiscal 2018.jurisdictional mix.
Non-GAAP Financial Measures
Regulation S-K Item 10(e), “Use of Non-GAAP Financial Measures in Commission Filings,” defines and prescribes the conditions for use of non-GAAP financial information. Our measures of non-GAAP adjusted EBITDA, non-GAAP adjusted EBITDA margins, non-GAAP pre-tax income and estimatednon-GAAP income tax expense on GAAPnon-GAAP earnings each meet the definition of a non-GAAP financial measure. We define the non-GAAP measures as follows:
● | Non-GAAP adjusted EBITDA - EBITDA is GAAP net income before net interest expense, income tax expense, depreciation and amortization. Non-GAAP adjusted EBITDA is EBITDA less stock-based compensation expense and the change in the fair value of the interest rate swap. |
● | Non-GAAP adjusted EBITDA margins - Calculated by dividing non-GAAP adjusted EBITDA by total revenue. |
● | Non-GAAP pre-tax income - GAAP income before income taxes not including the effects of stock-based compensation expense, amortization of purchased intangible assets and the change in fair value of the interest rate swap. |
● |
|
QAD’s management uses non-GAAP measures internally to evaluate the business and believes that presenting non-GAAP measures provides useful information to investors regarding the underlying business trends and performance of our ongoing operations as well as useful metrics for monitoring our performance and evaluating it against industry peers. The non-GAAP financial measures presented should be used in addition to, and in conjunction with, results presented in accordance with GAAP, and should not be relied upon to the exclusion of GAAP financial measures. Management strongly encourages investors to review our consolidated financial statements in their entirety and to not rely on any single financial measure in evaluating the company.
QAD non-GAAP measures reflect adjustments based on the following items:
Stock-based compensation expense: We have excluded the effect of stock-based compensation expense from our non-GAAP adjusted EBITDA and non-GAAP pre-tax income calculations. Although stock-based compensation expense is calculated in accordance with current GAAP and constitutes an ongoing and recurring expense, such expense is excluded from non-GAAP results because it is not an expense which generally requires cash settlement by QAD, and therefore is not used by us to assess the profitability of our operations. We also believe the exclusion of stock-based compensation expense provides a more useful comparison of our operating results to the operating results of our peers.
Amortization of purchased intangible assets: We amortize purchased intangible assets in connection with our acquisitions. We have excluded the effect of amortization of purchased intangible assets, which include purchased technology, customer relationships, trade names and other intangible assets, from our non-GAAP pre-tax income calculation, because doing so makes internal comparisons to our historical operating results more consistent. In addition, we believe excluding amortization of purchased intangible assets provides a more useful comparison of our operating results to the operating results of our peers.
Change in fair value of the interest rate swap: We entered into an interest rate swap to mitigate our exposure to the variability of one-month LIBOR for our floating rate debt related to the mortgage of our headquarters. We have excluded the gain/loss adjustments to record the interest rate swap at fair value from our non-GAAP adjusted EBITDA and non-GAAP pre-tax income calculations. We believe that these fluctuations are not indicative of our operational costs or meaningful in evaluating comparative period results because we currently have no intention of exiting the debt agreement early; and therefore over the life of the debt the sum of the fair value adjustments will be zero.
Non-GAAP income tax on non-GAAP earnings: We disclose non-GAAP income tax on non-GAAP earnings in order to provide a reader with the ability to calculate non-GAAP earnings per share. Our estimate of non-GAAP income tax expense excludes the tax effect of stock-based compensation and other discrete items. We believe it is appropriate to exclude discrete items from the non-GAAP income tax expense on non-GAAP earnings calculation because non-GAAP pre-tax income excludes the effect of stock-based compensation; and discrete items are unpredictable and generally are not recognized until incurred.
The following table sets forth the reconciliation of the non-GAAP financial measures of adjusted EBITDA, adjusted EBITDA margins and non-GAAP pre-tax income to the most comparable GAAP measures for the three and six months ended July 31, 2018April 30, 2019 and 2017:2018:
Three Months Ended July 31, | Six Months Ended July 31, | Three Months Ended April 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Total revenue | $ | 84,543 | $ | 75,958 | $ | 170,733 | $ | 147,340 | $ | 78,035 | $ | 86,190 | ||||||||||||
Net income (loss) | 1,113 | (1,161 | ) | 2,510 | (3,732 | ) | ||||||||||||||||||
Net (loss) income | (3,234 | ) | 1,397 | |||||||||||||||||||||
Add back: | ||||||||||||||||||||||||
Net interest expense | (589 | ) | (336 | ) | (956 | ) | (348 | ) | ||||||||||||||||
Net interest (income) expense | (571 | ) | (367 | ) | ||||||||||||||||||||
Depreciation | 1,188 | 1,139 | 2,388 | 2,243 | 1,327 | 1,200 | ||||||||||||||||||
Amortization | 146 | 307 | 305 | 723 | 274 | 159 | ||||||||||||||||||
Income tax expense | 1,471 | 832 | 2,654 | 1,452 | ||||||||||||||||||||
Income taxes | 715 | 1,183 | ||||||||||||||||||||||
EBITDA | $ | 3,329 | $ | 781 | $ | 6,901 | $ | 338 | $ | (1,489 | ) | $ | 3,572 | |||||||||||
Add back: | ||||||||||||||||||||||||
Stock-based compensation expense | 3,364 | 2,592 | 5,470 | 4,360 | 2,304 | 2,106 | ||||||||||||||||||
Change in fair value of interest rate swap | (35 | ) | 16 | (152 | ) | 3 | 91 | (117 | ) | |||||||||||||||
Adjusted EBITDA | $ | 6,658 | $ | 3,389 | $ | 12,219 | $ | 4,701 | $ | 906 | $ | 5,561 | ||||||||||||
Adjusted EBITDA margin | 8 | % | 4 | % | 7 | % | 3 | % | 1 | % | 6 | % | ||||||||||||
Non-GAAP pre-tax income reconciliation | ||||||||||||||||||||||||
Income (loss) before income taxes | $ | 2,584 | $ | (329 | ) | $ | 5,164 | $ | (2,280 | ) | ||||||||||||||
Add back: | ||||||||||||||||||||||||
Non-GAAP pre-tax (loss) income reconciliation | ||||||||||||||||||||||||
(Loss) income before income taxes | $ | (2,519 | ) | $ | 2,580 | |||||||||||||||||||
Add back | ||||||||||||||||||||||||
Stock-based compensation expense | 3,364 | 2,592 | 5,470 | 4,360 | 2,304 | 2,106 | ||||||||||||||||||
Amortization of purchased intangible assets | - | 225 | - | 567 | 74 | — | ||||||||||||||||||
Change in fair value of interest rate swap | (35 | ) | 16 | (152 | ) | 3 | 91 | (117 | ) | |||||||||||||||
Non-GAAP income before income taxes | $ | 5,913 | $ | 2,504 | $ | 10,482 | $ | 2,650 | ||||||||||||||||
Non-GAAP (loss) income before income taxes | $ | (50 | ) | $ | 4,569 | |||||||||||||||||||
Estimated income tax expense on GAAP earnings | $ | 1,622 | $ | 849 | $ | 2,734 | $ | 1,497 | ||||||||||||||||
Non-GAAP income tax expense on non-GAAP earnings reconciliation | ||||||||||||||||||||||||
Income tax expense | $ | 715 | $ | 1,183 | ||||||||||||||||||||
Less discrete items: | ||||||||||||||||||||||||
Return to provision adjustments | (1 | ) | (1 | ) | ||||||||||||||||||||
Stock-based compensation (windfalls)/shortfalls | 62 | 2,289 | ||||||||||||||||||||||
Rate change impacts | (270 | ) | (41 | ) | ||||||||||||||||||||
New valuation allowances on new positions | 225 | (2,284 | ) | |||||||||||||||||||||
Changes in reserves for unrecognized tax benefits | (134 | ) | (34 | ) | ||||||||||||||||||||
Other: adoption of ASC842 Leases | (14 | ) | — | |||||||||||||||||||||
Non-GAAP income tax expense on non-GAAP earnings | $ | 583 | $ | 1,112 | ||||||||||||||||||||
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of cash is from the sale of subscription, licenses, maintenance and professional services to our customers. Our primary use of cash is payment of our operating expenses which mainly consist of employee-related expenses, such as compensation and benefits, as well as general operating expenses for facilities, third-party hosting providers, third party contractors and other overhead costs. In addition to operating expenses, we may also use cash for capital expenditures; payment of dividends, withholding taxes on settlement of stock-based compensation and stock repurchases; and to invest in our growth initiatives, which may include acquisitions of products, technologies and businesses.
At July 31, 2018,April 30, 2019, our principal sources of liquidity were cash and equivalents totaling $139.5$151.0 million, short-term investments of $1.2 million and net accounts receivable of $54.3$49.0 million. Our cash and equivalents consisted of current bank accounts, registered money market funds and time delineated deposits. Approximately 85%87% of our cash and equivalents were held in U.S. dollar denominated accounts as of July 31, 2018.April 30, 2019.
Our primary commercial banking relationship is with Bank of America and its global affiliates. Our cash and equivalents are held by diversified financial institutions globally, and as of July 31, 2018, the portion of our cash and equivalents held by or invested through Bank of America was approximately 95%. Our largest cash concentrations are in the United States and Ireland. The percentage of cash and equivalents held by foreign subsidiariesoutside of the United States was 74%68% and 69%74% as of July 31, 2018April 30, 2019 and January 31, 2018,2019, respectively. The majority of our cash and equivalents are held in investment accounts which are predominantly placed in money market mutual funds, and in U.S. Treasury and government securities funds. The remaining cash and equivalents and short-term investments are held in deposit accounts and certificates of deposit.
We are a U.S.-based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. In addition to providing for U.S. income taxes on earnings from the United States, we provide for U.S. income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered permanently reinvested outside the United States. We do not anticipate changing our intention regarding permanently reinvested earnings as
As of the balance sheet date.
In December 2017, the U.S. Tax Cuts and Jobs Act ("Tax Act") was signed into law. The Tax Act includes a mandatory one-time tax on accumulated earnings of our foreign subsidiaries which resulted in an estimated $2 million of additional U.S. tax and will be paid in equal installments over eight years beginning in fiscal 2019. In spite of the U.S. taxation on these earnings,date, we intend to permanently reinvest the earnings inof our foreign subsidiaries. Should we decide to repatriate these earnings in the future, we would not expect to incur significant additional taxes; however, foreign withholding taxes, currency translation, state taxes and currency control laws must always be considered.
The following table summarizes our cash flows for the sixthree months ended July 31, 2018April 30, 2019 and 2017:2018:
Six Months Ended July 31, | Three Months Ended April 30, | |||||||||||||||
(in thousands) | 2018 | 2017 | 2019 | 2018 | ||||||||||||
Net cash provided by operating activities | $ | 9,146 | $ | 7,638 | $ | 14,195 | $ | 3,785 | ||||||||
Net cash used in investing activities | (2,990 | ) | (2,051 | ) | (1,300 | ) | (1,272 | ) | ||||||||
Net cash used in financing activities | (11,541 | ) | (5,678 | ) | (357 | ) | (4,195 | ) | ||||||||
Effect of foreign exchange rates on cash and equivalents | (2,110 | ) | 4,211 | (961 | ) | (952 | ) | |||||||||
Net (decrease) increase in cash and equivalents | $ | (7,495 | ) | $ | 4,120 | |||||||||||
Net increase (decrease) in cash and equivalents | $ | 11,577 | $ | (2,634 | ) | |||||||||||
Typical factors affecting our cash provided by operating activities include our level of revenue and earnings for the period; the timing and amount of employee bonusemployee-related compensation payments, vendor payments and income tax payments; and the timing and amount of billings and cash collections from our customers, which is our largest source of operating cash flow. Net cash flows provided by operating activities were $9.1$14.2 million and $7.6$3.8 million for the first sixthree months of fiscal 20192020 and 2018,2019, respectively. The increase in cash flows from operating activities was due primarily to an increase in profitability partially offset by the negativepositive cash flow effect of changes in deferred revenue. accounts receivable of $6.5 million and other liabilities and accounts payable of $6.6 million, partially offset by lower net income of $4.6 million.
Net cash used in investing activities consisted primarily ofincluded capital expenditures of $2.0$1.0 million and $1.6$1.1 million for the first sixthree months of fiscal 20192020 and 2018,2019, respectively. We continue to monitor our capital spending and do not believe we are delaying critical capital expenditures required to run our business.
Net cash used in financing activities consisted primarily of payments of withholding taxes on settlement of stock-based compensation and payment of dividends. In the first sixthree months of fiscal 20192020 and 2018,2019, we paid withholding taxes of $8.6$0.2 million and $2.8$4.1 million, respectively, on vested restricted stock units and exercised stock appreciation rights. In the first six months of both fiscal 2019 and 2018, we made dividend payments of $2.7 million. On a regular basis the Board of Directors evaluates our ability to continue to pay dividends and the structure of potential future dividend payments.
We have historically calculated accounts receivable days’ sales outstanding (“DSO”), using the countback, or last-in first-out, method. This method calculates the number of days of billed revenue represented by the accounts receivable balance as of period end. When reviewing the performance of our entities, DSO under the countback method is used by management. It is management’s belief that the countback method best reflects the relative health of our accounts receivable as of a given quarter-end or year-end because of the cyclical nature of our billings. Our billing cycle includes high annual maintenance renewal billings at year-end that will not be recognized as earned revenue until future periods.
DSO under the countback method was 5355 days and 5156 days as of July 31,April 30, 2019 and 2018, and 2017, respectively. DSO using the average method, which is calculated utilizing the accounts receivable balance and earned revenue for the most recent quarter, was 5857 days and 5059 days at July 31,April 30, 2019 and 2018, and 2017, respectively. The aging of our accounts receivable remained consistent when compared with the same period last year. We believe our reserve methodology is adequate, our reserves are properly stated as of July 31, 2018April 30, 2019 and the quality of our receivables remains good.
There have been no material changes in our contractual obligations or commercial commitments outside the ordinary course of business. Cash requirements for items other than normal operating expenses are anticipated for capital expenditures, dividend payments and other equity transactions. We may require cash for acquisitions of new businesses, software products or technologies complementary to our business.
We believe that our cash on hand and net cash provided by operating activities will provide us with sufficient resources to meet our current and long-term working capital requirements, debt service, dividend payments and other cash needs for at least the next twelve months.
Our revenue, earnings, cash flows, receivables, and payables are subject to fluctuations due to changes in foreign currency exchange rates. See Part I, Item 3, “Quantitative and Qualitative Disclosures about Market Risk” for further discussion.
CONTRACTUAL OBLIGATIONS
A summary of future obligations under our various contractual obligations and commitments as of January 31, 20182019 was disclosed in our Annual Report on Form 10-K for the year ended January 31, 2018.2019. During the quarter and six months ended July 31, 2018April 30, 2019 there have been no material changes in our contractual obligations or commercial commitments outside the ordinary course of business.
Notes Payable
Effective May 30, 2012, QAD Ortega Hill, LLC, our wholly owned limited liability company, entered into a variable rate credit agreement (the “2012 Mortgage”) with Rabobank, N.A., to refinance a pre-existing mortgage. The 2012 Mortgage has an original principal balance of $16.1 million and bears interest at the one month LIBOR rate plus 2.25%. One month LIBOR was 2.08%2.48% at July 31, 2018.April 30, 2019. The 2012 Mortgage matures in June 2022 and is secured by our headquarters located in Santa Barbara, California. In conjunction with the 2012 Mortgage, QAD Ortega Hill, LLC entered into an interest rate swap with Rabobank, N.A. The swap agreement has an initial notional amount of $16.1 million and a schedule matching that of the underlying loan that synthetically fixes the interest rate on the debt at 4.31% for the entire term of the 2012 Mortgage. The terms of the 2012 Mortgage provide for QAD Ortega Hill, LLC to make net monthly payments of $88,100 consisting of principal and interest and one final payment of $11.7 million. The unpaid balance as of July 31, 2018April 30, 2019 was $13.6$13.2 million.
ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Exchange Rates. We have operations in foreign locations around the world and we are exposed to risk resulting from fluctuations in foreign currency exchange rates. We have experienced significant foreign currency fluctuations during fiscal 20182019 and the first sixthree months of fiscal 20192020 due primarily to the volatility of the euro in relation to the U.S. dollar. The foreign currencies for which we currently have the most significant exposure are the euro and Mexican peso. Foreign currency exchange rate movements could create a foreign currency gain or loss that could be realized or unrealized for us. Unfavorable movements in foreign currency exchange rates between the U.S. dollar and other foreign currencies may have an adverse impact on our operations. We did not have any foreign currency forward or option contracts or other foreign currency denominated derivatives or other financial instruments open as of July 31, 2018.April 30, 2019.
We face two risks related to foreign currency exchange rates—translation risk and transaction risk. Translation risk relates to amounts invested in our foreign operations that are translated into U.S. dollars using period-end exchange rates. The resulting translation adjustments are recorded as a component of accumulated other comprehensive loss in the Condensed Consolidated Balance Sheets. Revenues and expenses in foreign currencies translate into higher or lower revenues and expenses in U.S. dollars as the U.S. dollar weakens or strengthens against other currencies. Furthermore, we have exposure to foreign exchange fluctuations arising from the remeasurement of non-functional currency assets, liabilities and intercompany balances into U.S. dollars for financial reporting purposes. Transaction risk is related to our international subsidiaries holding non-local currency net monetary accounts subject to revaluation into their local currency, which results in realized or unrealized foreign currency gains or losses.
For the sixthree months ended July 31,April 30, 2019 and 2018, approximately 50% and 2017, approximately 53% and 51%54%, respectively, of our revenue was generated in foreign currencies. We also incurred a significant portion of our expenses in currencies other than the U.S. dollar, approximately 41%40% and 40%41% for the sixthree months ended July 31,April 30, 2019 and 2018, and 2017, respectively. Based on a hypothetical 10% strengthening of the U.S. dollar against all foreign currencies, our revenue would be adversely affected by approximately 5% partially offset by a positive effect on our expenses of approximately 4%, and our operating income would be adversely affected by approximately 55%18%.
For each of the sixthree months ended July 31,April 30, 2019 and 2018, and 2017, foreign currency transaction and remeasurement (gains) lossesgains totaled ($0.3)$0.3 million and $1.9 million, respectively, and are included in “Other (income) expense, net” in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Income. We performed a sensitivity analysis on the net U.S. dollar and euro-based monetary accounts subject to revaluation that are held by our international subsidiaries and on the non-functional currency assets, liabilities and intercompany balances that are remeasured into U.S. dollars. A hypothetical 10% adverse movement in all foreign currency exchange rates would result in foreign currency transaction and remeasurement losses of approximately $2.5$2.9 million.
These estimates assume adverse shifts in all foreign currency exchange rates against the U.S. dollar, which do not always move in the same direction or in the same degrees. Actual results may differ materially from the hypothetical analysis.
Interest Rates. We invest our surplus cash in a variety of financial instruments, consisting principally of short-term marketable securities with maturities of less than 90 days at the date of purchase. Our investment securities are held for purposes other than trading. Cash balances held by subsidiaries are invested primarily in registered money market funds with local operating banks. Based on an interest rate sensitivity analysis of our cash and equivalents we estimate that a 10% adverse change in interest rates from the 20182019 fiscal year-end rates would not have a material adverse effect on our cash flows or financial condition for the next fiscal year.
Our long-term debt is comprised of a loan agreement, secured by real property, which bears interest at the one month LIBOR rate plus 2.25%. In conjunction with the loan agreement, we entered into an interest rate swap. The swap agreement has an initial notional amount and schedule matching that of the underlying loan that synthetically fixes the interest rate on the debt at 4.31%.
Our interest rate swap is accounted for using mark-to-market accounting. Accordingly, changes in the fair value of the swap each reporting period are adjusted through earnings, subjecting us to non-cash volatility in our results of operations. We prepared a sensitivity analysis using a modeling technique that measures the change in the fair values arising from a hypothetical 10% adverse movement in levels of interest rates across the entire yield curve, with all other variables held constant. Based upon the results of this analysis a 10% adverse change in interest rates from the July 31, 2018April 30, 2019 rates would cause a $0.1 million reduction in our results of operations. We believe it is prudent to hedge the expected volatility of the variable rate mortgage on our corporate headquarters. The swap fixes the interest rate on our mortgage to 4.31% over the entire term of the mortgage and effectively lowers our interest rate from the previous mortgage rate of 6.5%. Although the agreement allows us to prepay the loan and exit the agreement early, we have no intention of doing so. As a result, we will have non-cash adjustments through earnings each reporting period. However, over the term of the mortgage, the net impact of these mark-to-market adjustments on earnings will be zero.
ITEM 4 – CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our PrincipalChief Executive Officer and PrincipalChief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our PrincipalChief Executive Officer and PrincipalChief Financial Officer have concluded that our disclosure controls and procedures are designed to, and are effective to, provide assurance at a reasonable level that the information required to be disclosed by us in this Quarterly Report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our PrincipalChief Executive Officer and PrincipalChief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Changes in internal control over financial reporting. Effective February 1, 2019, we adopted ASU 2016-02 Leases (Topic 842), and all related amendments, which resulted in the modification of certain processes and internal controls related to leases. These included the development of new policies and training, ongoing contract review requirements, and gathering of information provided for disclosures. There were no other changes in ourthe Company’s internal control over financial reporting that occurred during ourthe Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, ourthe Company’s internal control over financial reporting.
Inherent limitations of internal controls. QAD’s management does not expect that its disclosure controls and procedures or its internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within QAD have been detected. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate.
PART II
ITEM 1. | LEGAL PROCEEDINGS |
The Company is not party to any material legal proceedings. From time to time, QAD is party, either as plaintiff or defendant, to various legal proceedings and claims which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity.
ITEM 1A. | RISK FACTORS |
There have been no material changes to the risk factors reported in Item 1A within the Company’s Annual Report on Form 10-K for the year ended January 31, 2018.2019.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
None.
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
Not applicable.
ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable.
ITEM 5. | OTHER INFORMATION |
None.
ITEM 6. | EXHIBITS |
Exhibits |
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31.1 | |
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31.2 | |
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32.1 | |
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101.INS | XBRL Instance Document |
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101.SCH | XBRL Taxonomy Extension Schema Document |
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101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document |
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101.DEF | XBRL Taxonomy Extension Definition Linkbase Document |
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101.LAB | XBRL Taxonomy Extension Label Linkbase Document |
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101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document |
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
QAD Inc.
(Registrant)
Date: | By: | /s/ DANIEL LENDER |
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| Daniel Lender |
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| Executive Vice President, Chief Financial Officer |
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| ( |
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| By: | /s/ KARA BELLAMY |
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| Kara Bellamy |
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| Senior Vice President, Corporate Controller |
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| (Chief Accounting Officer) |
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