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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
(Mark One)
R QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended October 31, 2015

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)

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. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting 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 ☐
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 November 30, 2015, there were 15,566,580 shares of the Registrant’s Class A common stock outstanding and 3,203,384 shares of the Registrant’s Class B common stock outstanding.
 


QAD INC.
INDEX
 
PART I - FINANCIAL INFORMATION
Page
       
 
ITEM 1.
Financial Statements (unaudited)
 
       
   
1
       
   
2
       
   
3
       
   
4
       
 
ITEM 2.
14
       
 
ITEM 3.
32
       
 
ITEM 4.
33
       
PART II - OTHER INFORMATION
 
       
 
ITEM 1.
34
       
 
ITEM 1A.
34
       
 
ITEM 2.
34
       
 
ITEM 3.
34
       
 
ITEM 4.
34
       
 
ITEM 5.
34
       
 
ITEM 6
34
       
 
35
 
PART I
 
ITEM 1 – FINANCIAL STATEMENTS
 
QAD INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
 
   
October 31,
2015
   
January 31,
2015
 
Assets
       
Current assets:
       
Cash and equivalents
 
$
126,621
   
$
120,526
 
Accounts receivable, net of allowances of $2,661 and $2,524 at October 31, 2015 and January 31, 2015, respectively
   
41,233
     
78,887
 
Deferred tax assets, net
   
8,597
     
9,313
 
Other current assets
   
13,162
     
14,799
 
Total current assets
   
189,613
     
223,525
 
Property and equipment, net
   
32,646
     
33,154
 
Capitalized software costs, net
   
1,733
     
2,485
 
Goodwill
   
10,706
     
10,911
 
Deferred tax assets, net
   
10,515
     
9,680
 
Other assets, net
   
2,953
     
3,614
 
Total assets
 
$
248,166
   
$
283,369
 
                 
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Current portion of long-term debt
 
$
417
   
$
406
 
Accounts payable
   
8,310
     
12,872
 
Deferred revenue
   
69,616
     
102,721
 
Other current liabilities
   
27,194
     
35,765
 
Total current liabilities
   
105,537
     
151,764
 
Long-term debt
   
14,364
     
14,680
 
Other liabilities
   
4,455
     
5,219
 
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  16,603,729 shares and 16,152,405 shares at October 31, 2015 and January 31, 2015, respectively
   
17
     
16
 
Class B, $0.001 par value. Authorized 4,000,000 shares; issued 3,537,366 shares and 3,537,298 shares at October 31, 2015 and January 31, 2015, respectively
   
4
     
4
 
Additional paid-in capital
   
193,836
     
185,546
 
Treasury stock, at cost (1,371,554 shares and 1,609,958 shares at October 31, 2015 and January 31, 2015,  respectively)
   
(18,816
)
   
(22,977
)
Accumulated deficit
   
(42,675
)
   
(43,465
)
Accumulated other comprehensive loss
   
(8,556
)
   
(7,418
)
Total stockholders’ equity
   
123,810
     
111,706
 
Total liabilities and stockholders’ equity
 
$
248,166
   
$
283,369
 
 
See Accompanying Notes to Condensed Consolidated Financial Statements.
 
1

QAD INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)
 
   
Three Months Ended
October 31,
   
Nine Months Ended
October 31,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Revenue:
               
License fees
 
$
6,350
   
$
8,616
   
$
21,761
   
$
24,231
 
Subscription fees
   
9,659
     
7,710
     
28,223
     
20,344
 
Maintenance and other
   
33,395
     
35,029
     
100,611
     
107,225
 
Professional services
   
18,633
     
22,649
     
57,998
     
63,739
 
Total revenue
   
68,037
     
74,004
     
208,593
     
215,539
 
                                 
Costs of revenue:
                               
License fees
   
827
     
1,217
     
2,728
     
3,270
 
Subscription fees
   
5,134
     
4,134
     
15,360
     
12,132
 
Maintenance and other
   
7,924
     
7,921
     
23,608
     
24,344
 
Professional services
   
17,120
     
19,799
     
54,035
     
57,975
 
Total cost of revenue
   
31,005
     
33,071
     
95,731
     
97,721
 
                                 
Gross profit
   
37,032
     
40,933
     
112,862
     
117,818
 
                                 
Operating expenses:
                               
Sales and marketing
   
15,531
     
16,421
     
49,658
     
50,319
 
Research and development
   
10,193
     
10,152
     
31,440
     
32,249
 
General and administrative
   
7,676
     
8,295
     
24,719
     
26,464
 
Amortization of intangibles from acquisitions
   
165
     
176
     
495
     
535
 
Total operating expenses
   
33,565
     
35,044
     
106,312
     
109,567
 
                                 
Operating income
   
3,467
     
5,889
     
6,550
     
8,251
 
                                 
Other (income) expense:
                               
Interest income
   
(80
)
   
(56
)
   
(224
)
   
(169
)
Interest expense
   
171
     
185
     
544
     
598
 
Other (income) expense, net
   
61
     
(164
)
   
(471
)
   
(56
)
Total other (income) expense
   
152
     
(35
)
   
(151
)
   
373
 
                                 
Income before income taxes
   
3,315
     
5,924
     
6,701
     
7,878
 
Income tax expense
   
729
     
834
     
1,935
     
1,879
 
                                 
Net income
 
$
2,586
   
$
5,090
   
$
4,766
   
$
5,999
 
                                 
Basic net income per share
                               
Class A
 
$
0.14
   
$
0.33
   
$
0.26
   
$
0.39
 
Class B
 
$
0.12
   
$
0.27
   
$
0.22
   
$
0.32
 
Diluted net income per share
                               
Class A
 
$
0.14
   
$
0.31
   
$
0.25
   
$
0.37
 
Class B
 
$
0.12
   
$
0.27
   
$
0.21
   
$
0.31
 
                                 
Net income
 
$
2,586
   
$
5,090
   
$
4,766
   
$
5,999
 
Other comprehensive income, net of tax:
                               
Foreign currency translation adjustment
   
(466
)
   
873
     
(1,138
)
   
666
 
Total comprehensive income
 
$
2,120
   
$
5,963
   
$
3,628
   
$
6,665
 
 
See Accompanying Notes to Condensed Consolidated Financial Statements.
 
2

QAD INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
   
Nine Months Ended
October 31,
 
   
2015
   
2014
 
         
Cash flows from operating activities:
       
Net income
 
$
4,766
   
$
5,999
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
4,324
     
4,284
 
Provision for doubtful accounts and sales adjustments
   
623
     
535
 
Stock compensation expense
   
5,618
     
3,794
 
Change in fair value of derivative instrument
   
(164
)
   
321
 
Excess tax benefits from share-based payment arrangements
   
(930
)
   
 
Other, net
   
10
     
42
 
Changes in assets and liabilities:
               
Accounts receivable
   
35,517
     
23,304
 
Other assets
   
1,960
     
(1,042
)
Accounts payable
   
(4,113
)
   
(1,369
)
Deferred revenue
   
(31,587
)
   
(27,944
)
Other liabilities
   
(6,789
)
   
(2,893
)
Net cash provided by operating activities
   
9,235
     
5,031
 
Cash flows from investing activities:
               
Purchase of property and equipment
   
(2,641
)
   
(3,337
)
Capitalized software costs
   
(70
)
   
(115
)
Net cash used in investing activities
   
(2,711
)
   
(3,452
)
Cash flows from financing activities:
               
Repayments of debt
   
(305
)
   
(291
)
Tax payments, net of proceeds, related to stock awards
   
(2,419
)
   
(2,354
)
Payment of contingent liability associated with acquisitions
   
(750
)
   
(471
)
Excess tax benefits from share-based payment arrangements
   
930
     
 
Proceeds from issuance of common stock, net of issuance costs
   
8,365
     
 
Cash dividends paid
   
(3,922
)
   
(3,334
)
Net cash provided by (used in) financing activities
   
1,899
     
(6,450
)
                 
Effect of exchange rates on cash and equivalents
   
(2,328
)
   
298
 
                 
Net increase (decrease) in cash and equivalents
   
6,095
     
(4,573
)
                 
Cash and equivalents at beginning of period
   
120,526
     
75,984
 
                 
Cash and equivalents at end of period
 
$
126,621
   
$
71,411
 
 
See Accompanying Notes to Condensed Consolidated Financial Statements.
 
3

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 (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. 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 accounting principles generally accepted in the United States of America 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-K for the year ended January 31, 2015. The Condensed Consolidated Financial Statements include the results of the Company and its wholly owned subsidiaries. The results of operations for the three and nine months ended October 31, 2015 are not necessarily indicative of the results to be expected for the year ending January 31, 2016.
 
Recent Accounting Pronouncements
 
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. ASU 2014-09 will be effective for the Company’s fiscal year beginning February 1, 2018. Early adoption is permitted for the Company’s fiscal year beginning February 1, 2017. The standard permits the use of either the retrospective or cumulative transition method. The Company is currently evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.
 
In May 2013, the FASB issued ASU 2013-270, a revision of the 2010 proposed FASB Accounting Standards Update, Leases (Topic 840) to place leases on lessee’s balance sheets. ASU 2013-270 states a lessee would recognize a lease liability for lease payments and recognize an asset for its right to use the leased asset during the lease term. In November 2015, the FASB set an effective date for annual periods after December 2018. The Company plans to adopt ASU 2013-270 in fiscal 2020 and is currently evaluating the impact to its consolidated financial statements.
 
In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”), which requires deferred tax liabilities and assets be presented as noncurrent on the classified statement of financial position. ASU 2015-17 will be effective for the Company’s fiscal year beginning February 1, 2017. The standard permits the use of either prospective or retrospective application to all periods presented. The Company does not expect this adoption to have a significant impact on its consolidated financial statements.
 
4

2.
COMPUTATION OF NET INCOME PER SHARE
 
The following table sets forth the computation of basic and diluted net income per share:
 
   
Three Months Ended
October 31,
   
Nine Months Ended
October 31,
 
   
2015
   
2014
   
2015
   
2014
 
   
(in thousands, except per share data)
   
(in thousands, except per share data)
 
Net income
 
$
2,586
   
$
5,090
   
$
4,766
   
$
5,999
 
Less: Dividends declared
   
(1,313
)
   
(1,118
)
   
(3,922
)
   
(3,334
)
Undistributed net income
 
$
1,273
   
$
3,972
   
$
844
   
$
2,665
 
                                 
Net income per share – Class A Common Stock
                               
Dividends declared
 
$
1,121
   
$
926
   
$
3,346
   
$
2,761
 
Allocation of undistributed net income
   
1,087
     
3,292
     
721
     
2,210
 
Net income attributable to Class A common stock
 
$
2,208
   
$
4,218
   
$
4,067
   
$
4,971
 
                                 
Weighted average shares of Class A common stock outstanding—basic
   
15,559
     
12,865
     
15,431
     
12,755
 
Weighted average potential shares of Class A common stock
   
749
     
622
     
777
     
719
 
Weighted average shares of Class A common stock and potential common shares outstanding—diluted
   
16,308
     
13,487
     
16,208
     
13,474
 
                                 
Basic net income per Class A common share
 
$
0.14
   
$
0.33
   
$
0.26
   
$
0.39
 
Diluted net income per Class A common share
 
$
0.14
   
$
0.31
   
$
0.25
   
$
0.37
 
                                 
Net income per share – Class B Common Stock
                               
Dividends declared
 
$
192
   
$
192
   
$
576
   
$
573
 
Allocation of undistributed net income
   
186
     
680
     
123
     
455
 
Net income attributable to Class B common stock
 
$
378
   
$
872
   
$
699
   
$
1,028
 
                                 
Weighted average shares of Class B common stock outstanding—basic
   
3,203
     
3,189
     
3,200
     
3,180
 
Weighted average potential shares of Class B common stock
   
83
     
76
     
83
     
90
 
Weighted average shares of Class B common stock and potential common shares outstanding—diluted
   
3,286
     
3,265
     
3,283
     
3,270
 
                                 
Basic net income per Class B common share
 
$
0.12
   
$
0.27
   
$
0.22
   
$
0.32
 
Diluted net income per Class B common share
 
$
0.12
   
$
0.27
   
$
0.21
   
$
0.31
 
 
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:
 
   
Three Months Ended
October 31,
   
Nine Months Ended
October 31,
 
   
2015
   
2014
   
2015
   
2014 
 
   
(in thousands)
   
(in thousands)
 
Class A
   
640
     
330
     
490
     
277
 
Class B
   
120
     
67
     
92
     
38
 
 
5

3.
FAIR VALUE MEASUREMENTS
 
When determining fair value, the Company uses a three-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.
 
· Level 1 - Money market mutual funds are recorded at fair value based upon quoted market prices.
· 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.
· Level 3 - The contingent liability associated with the acquisition of CEBOS is recorded at fair value based on significant inputs that are not observable in the market. This measure includes an assessment of the probability of achieving certain milestones and discounting the amount of each potential payment based on expected timing of the payment. Key assumptions include a discount rate of 4.6%, probability of achieving profitability and probability of achieving product development goals. As of January 31, 2015, there was one remaining future payment due April 2015 which consisted of a guaranteed payment of $0.3 million and $0.5 million contingent upon certain milestones. The maximum contingent liability of $0.8 million was paid in March 2015.

The following table sets forth the financial assets, measured at fair value, as of October 31, 2015 and January 31, 2015:
 
   
Fair value measurement at reporting date using
 
   
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 October 31, 2015
 
$
107,155
             
Money market mutual funds as of January 31, 2015
 
$
98,294
             
Liability related to the interest rate swap as of October 31, 2015
         
$
(462
)
     
Liability related to the interest rate swap as of January 31, 2015
         
$
(626
)
     
Contingent liability associated with acquisitions as of October 31, 2015
                 
$
 
Contingent liability associated with acquisitions as of January 31, 2015
                 
$
(750
)
 
Money market mutual funds are classified as part of “Cash and equivalents” in the accompanying Condensed Consolidated Balance Sheets. In addition, the amount of cash and equivalents, including cash deposited with commercial banks, was $19 million and $22 million as of October 31, 2015 and January 31, 2015, respectively.
 
The Company’s line of credit and notes payable both bear a variable market interest rate commensurate with the Company’s credit standing. Therefore, the carrying amounts outstanding under the line of credit and note payable reasonably approximate fair value based on Level 2 inputs.
 
There have been no transfers between fair value measurements levels during the nine months ended October 31, 2015.
 
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 6 “Debt” within these Notes to Condensed Consolidated Financial Statements. The fair value of the interest rate swap is reflected as an asset or liability in the Condensed Consolidated Balance Sheets and the change in fair value is reported in “Other (income) expense, net” in the Condensed Consolidated Statements of Income and Comprehensive 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.
 
6

The fair values of the derivative instrument at October 31, 2015 and January 31, 2015 were as follows (in thousands):
 
 
(Liability) derivative
 
      
Fair Value
 
Balance Sheet
Location
  October 31,
2015
 
January 31,
2015
 
Derivative instrument:
       
Interest rate swap
Other liabilities
   
$
(462
)
 
$
(626
)
Total
     
$
(462
)
 
$
(626
)
 
The change in fair value of the interest rate swap recognized in the Condensed Consolidated Statement of Operations and Comprehensive Income for the nine months ended October 31, 2015 and 2014 was $164,000 and $(321,000), respectively.
 
4.
CAPITALIZED SOFTWARE COSTS
 
Capitalized software costs and accumulated amortization at October 31, 2015 and January 31, 2015 were as follows:
 
   
October 31,
2015
   
January 31,
2015
 
   
(in thousands)
 
Capitalized software costs:
           
Acquired software technology
 
$
3,458
   
$
3,458
 
Capitalized software development costs (1)
   
987
     
1,206
 
     
4,445
     
4,664
 
Less accumulated amortization
   
(2,712
)
   
(2,179
)
Capitalized software costs, net
 
$
1,733
   
$
2,485
 
 

(1) Capitalized software development costs include the impact of foreign currency translation.
 
Acquired software technology costs relate to technology purchased as a result of the Company’s fiscal 2013 acquisitions of DynaSys and CEBOS. In addition to the acquired software technology, the Company has capitalized costs related to translations and localizations of QAD Enterprise Applications.
 
Amortization of capitalized software costs was $0.8 million and $0.9 million for the nine months ended October 31, 2015 and 2014, respectively. Amortization of capitalized software costs is included in “Cost of license fees” in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income.
 
The following table summarizes the estimated amortization expense relating to the Company’s capitalized software costs as of October 31, 2015:
 
Fiscal Years
 
(in thousands)
 
2016 remaining
 
$
260
 
2017
   
927
 
2018
   
535
 
2019
   
11
 
   
$
1,733
 
 
7

5.
GOODWILL AND INTANGIBLE ASSETS
 
Goodwill
 
The changes in the carrying amount of goodwill for the nine months ended October 31, 2015 were as follows:
 
  Gross Carrying
Amount
   
Accumulated
Impairment
   
Goodwill, Net
 
 
(in thousands)
 
Balance at January 31, 2015
 
$
26,519
   
$
(15,608
)
 
$
10,911
 
Impact of foreign currency translation
   
(205
)
   
     
(205
)
Balance at October 31, 2015
 
$
26,314
   
$
(15,608
)
 
$
10,706
 
 
The Company performed its annual goodwill impairment review during the fourth quarter of fiscal 2015. The analysis compared the Company’s market capitalization to its net assets as of the test date, November 30, 2014. As the market capitalization significantly exceeded the Company’s net assets, there was no indication of goodwill impairment for fiscal 2015. The Company monitors the indicators for goodwill impairment testing between annual tests. No adverse events occurred during the nine months ended October 31, 2015, that would cause the Company to test goodwill for impairment.
 
Intangible Assets
 
  October 31,
2015
 
January 31,
2015
 
 
(in thousands)
 
Amortizable intangible assets
   
Customer relationships (1)
 
$
2,754
   
$
2,793
 
Trade name
   
515
     
515
 
     
3,269
     
3,308
 
Less: accumulated amortization
   
(2,030
)
   
(1,558
)
Net amortizable intangible assets
 
$
1,239
   
$
1,750
 
 

(1) Customer relationships include the impact of foreign currency translation.
 
The Company’s intangible assets are related to the DynaSys and CEBOS acquisitions completed in fiscal 2013. Intangible assets are included in “Other assets, net” in the accompanying Condensed Consolidated Balance Sheets. As of October 31, 2015, all of the Company’s intangible assets were determined to have finite useful lives, and therefore were subject to amortization.
 
Amortization of intangible assets was $0.5 million for each of the nine months ended October 31, 2015 and 2014, respectively. The following table summarizes the estimated amortization expense relating to the Company’s intangible assets as of October 31, 2015:
 
Fiscal Years
 
(in thousands)
 
2016 remaining
 
$
164
 
2017
   
657
 
2018
   
418
 
   
$
1,239
 
 
8

6.
DEBT
 
   
October 31,
2015
   
January 31,
2015
 
   
(in thousands)
 
Note payable
 
$
14,781
   
$
15,086
 
Less current maturities
   
(417
)
   
(406
)
Long-term debt
 
$
14,364
   
$
14,680
 
 
Note Payable
 
Effective May 30, 2012, QAD Ortega Hill, LLC 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 0.19% at October 31, 2015. 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 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 October 31, 2015 was $14.8 million.
 
Credit Facility
 
The Company has an unsecured credit agreement with Rabobank, N.A. (the “Facility”). The Facility provides a commitment through July 15, 2017 for a $20 million line of credit for working capital or other business needs. The Company pays a commitment fee of 0.25% per annum of the daily average of the unused portion of the $20 million Facility. Borrowings under the Facility bear interest at a rate equal to one month LIBOR plus 0.75%. At October 31, 2015, the effective borrowing rate would have been 0.94%.
 
The Facility provides that the Company maintain certain financial and operating ratios which include, among other provisions, minimum liquidity on a consolidated basis of $25 million in cash and equivalents at all times, a current ratio (calculated using current liabilities excluding deferred revenue) of not less than 1.3 to 1.0 determined at the end of each fiscal quarter, a leverage ratio of not more than 1.5 to 1.0 determined at the end of each fiscal quarter, and a debt service coverage ratio of not less than 1.5 to 1.0 determined at the end of each fiscal year. The Facility also contains customary covenants that could restrict the Company’s ability to incur additional indebtedness.
 
As of October 31, 2015, there were no borrowings under the Facility and the Company was in compliance with all financial covenants.
 
7.
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, 2015
 
$
(7,418
)
Other comprehensive income
   
(1,138
)
Amounts reclassified from accumulated other comprehensive loss
   
 
Net current period other comprehensive income
   
(1,138
)
Balance as of October 31, 2015
 
$
(8,556
)
 
During the first nine months of fiscal 2016 there were no reclassifications from accumulated other comprehensive loss.
 
9

8.
INCOME TAXES
 
The gross amount of unrecognized tax benefits was $1.7 million at October 31, 2015, including interest and penalties.  During the first quarter of fiscal 2015 the Company adopted ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"), which requires an unrecognized tax benefit to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, similar tax loss, or a tax credit carryforward.  As a result of adoption of ASU 2013-11, the Company reduced its unrecognized tax benefits by $1.2 million with an accompanying reduction of deferred tax assets by $1.2 million.  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.  In the next twelve months, due to potential settlements with domestic tax authorities related to tax credits and lapse in statute of limitations, an estimated $0.2 million of unrecognized tax benefits may be recognized.
 
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 October 31, 2015, the Company has accrued approximately $0.2 million of interest and penalty expense relating to unrecognized tax benefits.
 
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 the fiscal years ended March 31, 1998, 1999,  2009, 2010, 2012 and 2013
· Italy for the fiscal years ended 2011, 2012, 2013 and 2014
 
During the fiscal year 2016, QAD has settled the following audits with immaterial or no adjustments made as a result of the settlements:
 
· India for the fiscal year ended March 31, 2008
· California for the fiscal year ended 2004
· Minnesota for the fiscal years ended 2010, 2011, 2012 and 2013
 
9.
STOCKHOLDERS’ EQUITY
 
Issuance of Common Stock
 
On January 22, 2015, the Company closed an offering of 2,000,000 shares of Class A common stock. The net proceeds to the Company from the sale of the stock were $37.0 million after deducting underwriting discounts and commissions and offering expenses. On February 18, 2015 the offering underwriters exercised in full an option to purchase additional shares. As a result, 450,000 shares of Class A common stock were issued generating approximately $8.4 million in additional net proceeds.
 
Dividends
 
The following table sets forth the dividends that were declared by the Company during the first nine months of fiscal 2016:
 
Declaration
Date
 
Record Date
 
Payable
 
Dividend
Class A
   
Dividend
Class B
   
Amount
 
9/9/2015
 
9/23/2015
 
9/30/2015
 
$
0.072
   
$
0.06
   
$
1,313,000
 
6/9/2015
 
6/23/2015
 
6/30/2015
 
$
0.072
   
$
0.06
   
$
1,310,000
 
4/15/2015
 
4/29/2015
 
5/6/2015
 
$
0.072
   
$
0.06
   
$
1,299,000
 
 
10

10.
STOCK-BASED COMPENSATION
 
The Company’s equity awards consist of SARs and RSUs. For a description of the Company’s stock-based compensation plans, see Note 5 “Stock-Based Compensation” in Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended January 31, 2015.
 
Stock-Based Compensation
 
The following table sets forth reported stock-based compensation expense for the three and nine months ended October 31, 2015 and 2014:
 
   
Three Months Ended
October 31,
   
Nine Months Ended
October 31,
 
   
2015
   
2014
   
2015
   
2014
 
   
(in thousands)
   
(in thousands)
 
Cost of subscription
 
$
21
   
$
13
   
$
55
   
$
35
 
Cost of maintenance and other revenue
   
69
     
38
     
202
     
115
 
Cost of professional services
   
189
     
121
     
542
     
364
 
Sales and marketing
   
350
     
203
     
1,040
     
587
 
Research and development
   
227
     
132
     
665
     
400
 
General and administrative
   
1,025
     
702
     
3,114
     
2,293
 
Total stock-based compensation expense
 
$
1,881
   
$
1,209
   
$
5,618
   
$
3,794
 
 
SAR Information
 
The weighted average assumptions used to value SARs granted in the nine months ended October 31, 2015 and 2014 are shown in the following table:
 
   
Nine Months Ended
October 31,
 
   
2015
   
2014
 
Expected life in years (1)
   
5.00
     
4.98
 
Risk free interest rate (2)
   
1.64
%
   
1.58
%
Volatility (3)
   
41
%
   
47
%
Dividend rate (4)
   
1.10
%
   
1.32
%
 

(1) The expected life of SARs granted under the stock-based compensation plans is based on historical vested SAR exercise and post-vest forfeiture patterns and includes an estimate of the expected term for SARs that were fully vested and outstanding.
 
(2) The risk-free interest rate is based on the U.S. Treasury yield for a term consistent with the expected life of SARs in effect at the time of grant.
 
(3) The Company estimates the volatility of its common stock at the date of grant based on the historical volatility of the Company’s common stock for a period equivalent to the expected life of the SARs, which it believes is representative of the expected volatility over the expected life of the SARs.
 
(4) The Company expects to continue paying quarterly dividends at the same rate as the nine months ending on October 31, 2015.
 
11

The following table summarizes the activity for outstanding SARs for the nine months ended October 31, 2015:
 
   
SARs
(in thousands)
   
Weighted
Average
Exercise
Price per
Share
 
Weighted
Average
Remaining
Contractual
Term (years)
 
Aggregate
Intrinsic Value
(in thousands)
 
Outstanding at January 31, 2015
   
2,499
   
$
12.69
     
Granted
   
380
     
25.34
     
Exercised
   
(251
)
   
10.65
     
Expired
   
(12
)
   
14.24
     
Forfeited
   
(5
)
   
12.05
     
Outstanding at October 31, 2015
   
2,611
   
$
14.72
     
5.0
   
$
27,067
 
Vested and expected to vest at October 31, 2015 (1)
   
2,604
   
$
14.73
     
5.0
   
$
26,972
 
Vested and exercisable at October 31, 2015
   
1,461
   
$
11.55
     
4.0
   
$
19,663
 
 

(1) The expected-to-vest SARs are the result of applying the pre-vesting forfeiture rate assumptions to total outstanding SARs.
 
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 October 31, 2015, and the exercise price for in-the-money SARs) that would have been received by the holders if all SARs had been exercised on October 31, 2015. The total intrinsic value of SARs exercised in the nine months ended October 31, 2015 was $3.6 million.
 
The number of SARs exercised includes shares withheld on behalf of employees to satisfy minimum statutory tax withholding requirements.  During the three months ended October 31, 2015, the Company withheld 7,800 shares for payment of these taxes at a value of $0.2 million.  During the nine months ended October 31, 2015, the Company withheld 41,900 shares for payment of these taxes at a value of $1.0 million.
 
At October 31, 2015, there was approximately $6.5 million of total unrecognized compensation cost related to unvested SARs. This cost is expected to be recognized over a weighted-average period of approximately 2.8 years.
 
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 nine months ended October 31, 2015:
 
RSUs
 
Weighted
Average
Grant Date
Fair Value
 
 
(in thousands)
   
     
Restricted stock at January 31, 2015
   
503
   
$
16.27
 
Granted
   
324
     
24.77
 
Released (1)
   
(192
)
   
15.57
 
Forfeited
   
(16
)
   
18.76
 
Restricted stock at October 31, 2015
   
619
   
$
20.89
 
 

(1) The number of RSUs released includes shares withheld on behalf of employees to satisfy the minimum statutory tax withholding requirements.
 
The Company withholds, at the employee’s election, a portion of the released shares as consideration for the Company’s payment of applicable employee income taxes. During the three months ended October 31, 2015, the Company withheld 2,600 shares for payment of these taxes at a value of $65,000.  During the nine months ended October 31, 2015, the Company withheld 52,000 shares for payment of these taxes at a value of $1.4 million.
 
12

Total unrecognized compensation cost related to RSUs was approximately $10.0 million as of October 31, 2015. This cost is expected to be recognized over a weighted-average period of approximately 3.0 years.
 
11.
DEFERRED REVENUES
 
Deferred revenues consisted of the following:
 
   
October 31,
2015
   
January 31,
2015
 
   
(in thousands)
 
Deferred maintenance revenue
 
$
54,678
   
$
86,381
 
Deferred subscription revenue
   
12,271
     
11,563
 
Deferred services revenue
   
2,056
     
2,813
 
Deferred license revenue
   
520
     
1,890
 
Deferred other revenue
   
91
     
74
 
Deferred revenues, current
   
69,616
     
102,721
 
Deferred revenues, non-current (in Other liabilities)
   
1,857
     
2,361
 
Total deferred revenues
 
$
71,473
   
$
105,082
 
 
Deferred maintenance and subscription revenues represent customer payments made in advance for support and subscription contracts. Support and subscription are billed in advance with corresponding revenues being recognized ratably over the support and subscription periods. Support is typically billed annually while subscription is typically billed quarterly. Deferred license revenues result from undelivered products or specified enhancements, customer specific acceptance provisions and software license transactions that cannot be segmented from undelivered consulting or other services. Deferred services revenues represent both prepayments for our professional services where revenues for these services are generally recognized as the Company completes the performance obligations for the prepaid services; and services already provided but deferred due to software revenue recognition rules.
 
12.
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.
 
13

13.
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. The Company’s Chief Operating Decision Maker, the Chief Executive Officer, reviews the consolidated results within one operating segment.
 
License and subscription revenues are assigned to the geographic regions based on both the proportion of users in each region and sales effort. Maintenance revenue is allocated to the region where the end user customer is located. Services revenue is assigned based on the region where the services are performed.
 
   
Three Months Ended
October 31,
   
Nine Months Ended
October 31,
 
   
2015
   
2014
   
2015
   
2014
 
   
(in thousands)
   
(in thousands)
 
Revenue:
               
North America (1)
 
$
32,417
   
$
33,069
   
$
96,168
   
$
93,115
 
EMEA
   
19,376
     
23,362
     
62,730
     
73,244
 
Asia Pacific
   
11,813
     
12,485
     
35,135
     
35,688
 
Latin America
   
4,431
     
5,088
     
14,560
     
13,492
 
   
$
68,037
   
$
74,004
   
$
208,593
   
$
215,539
 
 

(1) Sales into Canada accounted for 2% of North America total revenue in each of the three and nine months ended October 31, 2015 and 2014.
 
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
FORWARD-LOOKING STATEMENTS
 
In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. Any statements contained herein that are not statements of historical fact should be construed as forward looking statements, including statements that are preceded or accompanied by such words as “may,” “believe,” “could,” “anticipate,” “would,” “might,” “plan,” “expect,” “intend” and words of similar meaning or the negative of these terms or other comparable terminology. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in Part I, Item 1A entitled “Risk Factors” within our Annual Report on Form 10-K for the year ended January 31, 2015. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof and are subject to risks, uncertainties and assumptions about our business. We undertake no obligation to revise or update or publicly release the results of any revision or update to these forward-looking statements except as required by applicable securities laws. Readers should carefully review the risk factors and other information described in other documents we file from time to time with the Securities and Exchange Commission (“SEC”).
 
14

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, 2015, and the Condensed Consolidated Financial Statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q.
 
CRITICAL ACCOUNTING POLICIES
 
Our condensed consolidated financial statements are prepared applying certain critical accounting policies. The SEC defines “critical accounting policies” as those that require application of management’s most difficult, subjective, or complex judgments. Critical accounting policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variations and may significantly affect our reported results and financial position for the period or in future periods. Changes in underlying factors, assumptions, or estimates in any of these areas could have a material impact on our future financial condition and results of operations. Our financial statements are prepared in accordance with U.S. GAAP, and they conform to general practices in our industry. We apply critical accounting policies consistently from period to period and intend that any change in methodology occur in an appropriate manner. Accounting policies currently deemed critical, including a) revenue recognition; b) accounts receivable allowances for bad debt and sales returns; c) capitalized software development costs; d) impairment assessments on goodwill and intangible assets; e) business combinations; f) valuation of deferred tax assets and tax contingency reserves; and g) stock-based compensation are further discussed in the Annual Report on Form 10-K for the fiscal year ended January 31, 2015. There have been no significant changes to our accounting policies and estimates as discussed in our Annual Report on Form 10-K for the fiscal year ended January 31, 2015.
 
BUSINESS OVERVIEW
 
QAD Inc. (“QAD”, the “Company”, “we” or “us”) is a leading global provider of vertically-oriented, mission-critical enterprise software solutions for global manufacturing companies across the automotive, life sciences, consumer products, food and beverage, high technology and industrial products industries. Our mission is to deliver best-in-class software that enables our customers to operate more effectively on a global basis. QAD Enterprise Applications enables measurement and control of key business processes and supports operational requirements. We deliver our software solutions to our customers in a format that best meets their current and future needs - either in the cloud, on premise, or blended. Increasingly, our customers are selecting either a cloud-based deployment or a blended deployment, which is a combination of on-premise and cloud-based software, as they expand their businesses globally and as they recognize the benefits of full featured ERP cloud-based software.
 
 At the core of our solutions is our enterprise resource planning (“ERP”) suite called QAD Enterprise Applications or MFG/PRO. Our ERP suite is also deployed in the cloud as QAD Cloud ERP. QAD Enterprise Applications supports the core business processes of our global manufacturing customers, including key functions in the following areas: financials, customer management, manufacturing, demand and supply chain planning, supply chain execution, transportation management, service and support, enterprise asset management, analytics, enterprise quality management, interoperability, process and performance, and internationalization. We also focus on the foundation and technology of our applications, such as user interface and usability.
 
We have four principal sources of revenue:
 
License purchases of our Enterprise Applications;
 
Subscription of our Enterprise Applications through our cloud offering in a Software as a Service (“SaaS”) model as well as other hosted Internet 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.
 
15

We operate primarily in the following four geographic regions: North America, Latin America, EMEA and Asia Pacific. In the first nine months of fiscal 2016, approximately 46% of our total revenue was generated in North America, 30% in EMEA, 17% in Asia Pacific and 7% in Latin America. The majority of our revenue is generated from global customers who have operations in multiple countries throughout the world. License and subscription revenues are assigned to the geographic regions based on both the proportion of users in each region and sales effort. Maintenance revenue is allocated to the region where the end user is located. Services revenue is assigned based on the region where the services are performed. A significant portion of our revenue and expenses are derived from international operations which are primarily conducted in foreign currencies. As a result, changes in the value of foreign currencies relative to the U.S. dollar have impacted our results of operations and may impact our future results of operations. At October 31, 2015, we employed approximately 1,670 employees worldwide, of which 635 employees were based in North America, 500 employees in EMEA, 455 employees in Asia Pacific and 80 employees in Latin America.

Our customer base and our target markets are 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 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.

Our business model is evolving. We continue to assess current business offerings and introduce more flexible license and service offerings in the cloud which have ratable revenue streams. The accounting impact of these cloud offerings and other business decisions are expected to result in an increase in the percentage of our ratable revenue, making for more predictable revenue over time, while correspondingly reducing our up-front perpetual license revenue stream. Over time, we expect our business model transition to expand our customer base by eliminating higher up-front licensing costs and providing more flexibility in how customers gain access to and pay for our products. We expect this business model transition will increase our long-term revenue growth rate by increasing total subscriptions and customer value over time.

We remain diligent about managing our expenditures while making essential investments to drive growth. If we are unable to successfully achieve our major business initiatives we may not achieve our financial goals.
 
OVERVIEW OF THE FIRST NINE MONTHS OF FISCAL 2016
 
A significant portion of our business is conducted in currencies other than the U.S. dollar, particularly the euro.  We operate in several geographical regions as described in Note 13 “Business Segment Information” within the Notes to Condensed Consolidated Financial Statements. In the first nine months of fiscal 2016, approximately 54% of our total revenue was generated outside of North America and we expect to continue generating a significant portion of our revenue outside the U.S. Weakening of the value of the U.S. dollar compared to foreign currency exchange rates generally has the effect of increasing our revenues but also increasing our expenses denominated in currencies other than the U.S. dollar. Similarly, strengthening of the U.S. dollar compared to foreign currency exchange rates generally has the effect of reducing our revenues but also reducing our expenses denominated in currencies other than the U.S. dollar. We plan our business accordingly by deploying additional resources to areas of expansion, while continuing to monitor our overall expenditures given the economic uncertainties of our target markets. In order to provide a framework for assessing how our underlying businesses performed excluding the effect of foreign currency fluctuations, we compare the changes in results from one period to another period using constant currency. In order to calculate our constant currency results, we apply the current foreign currency exchange rates to the prior period results. In the table below, we present the change based on actual results in reported currency and in constant currency.
 
   
Three Months
Ended
October 31, 2015
   
Three Months
Ended
October 31, 2014
   
Change in
Constant
Currency
   
Change due
to Currency
Fluctuations
   
Total
Change as
Reported
 
(in thousands)
                   
Total revenue
 
$
68,037
   
$
74,004
   
$
(1,047
)
 
$
(4,920
)
 
$
(5,967
)
Cost of revenue
   
31,005
     
33,071
     
85
     
1,981
     
2,066
 
Gross profit
   
37,032
     
40,933
     
(962
)
   
(2,939
)
   
(3,901
)
Operating expenses
   
33,565
     
35,044
     
(269
)
   
1,748
     
1,479
 
Income from operations
 
$
3,467
   
$
5,889
   
$
(1,231
)
 
$
(1,191
)
 
$
(2,422
)
 
16

   
Nine Months
Ended
October 31, 2015
   
Nine Months
Ended
October 31, 2014
   
Change in
Constant
Currency
   
Change due
to Currency
Fluctuations
   
Total
Change as
Reported
 
(in thousands)
                   
Total revenue
 
$
208,593
   
$
215,539
   
$
8,915
   
$
(15,861
)
 
$
(6,946
)
Cost of revenue
   
95,731
     
97,721
     
(4,408
)
   
6,398
     
1,990
 
Gross profit
   
112,862
     
117,818
     
4,507
     
(9,463
)
   
(4,956
)
Operating expenses
   
106,312
     
109,567
     
(2,674
)
   
5,929
     
3,255
 
Income from operations
 
$
6,550
   
$
8,251
   
$
1,833
   
$
(3,534
)
 
$
(1,701
)
 
Operating Results. Our results were significantly impacted by foreign currency fluctuations. Total revenue for the first nine months of fiscal 2016 decreased by 3%, to $208.6 million, when compared to the same period last year. Currency had an adverse impact on total revenue of $15.9 million. On a constant currency basis, total revenue increased by $8.9 million, or 4%. The primary driver of our revenue growth on a constant currency basis was subscription revenue from our cloud offering.
 
While the impact of currency changes negatively affected our revenue, it also reduced our expenses. Total cost of revenue for the first nine months of fiscal 2016 decreased by 2% to $95.7 million, when compared to the same period last year. Currency had a favorable impact on total cost of revenue of $6.4 million. On a constant currency basis, total cost of revenue increased by $4.4 million, or 5%. Similarly, operating expenses decreased by 3% to $106.3 million. Currency had a favorable impact on operating expenses of $5.9 million. On a constant currency basis operating expenses increased by $2.7 million, or 3%. The net unfavorable impact of currency fluctuations on our income from operations was $3.5 million for the first nine months of fiscal 2016.
 
License Revenue. License revenue is primarily derived from software license fees that customers pay for our core product, QAD Enterprise Applications, and any add-on modules they purchase. In the first nine months of fiscal 2016 and on a constant currency basis, license revenue decreased by 2% to $21.8 million compared to the same period last year. Currency had an adverse impact on license revenue of $1.9 million. When we enter into a multi-element transaction with fixed fee services or when we sell licenses for additional users under a pricing model that does not satisfy vendor specific objective evidence (“VSOE”) requirements, we may be required to recognize license revenue ratably over the longer of the maintenance period or expected services implementation timeframe rather than recognizing license revenue at the time of sale. Additionally, if at the time of the license sale we have not finalized the services agreement, we will defer the entire arrangement until the services agreement is signed.
 
Our success in closing license deals for existing customers, new customers that are affiliates of existing customers and customers that have employees with historical experience working with QAD tends to be higher than with new customers that have no QAD affiliations. As a result, we place increased focus on these opportunities. A majority of our license revenue is generated from existing customers and their affiliates. We believe global economic volatility will continue to shape customers’ and prospects’ buying decisions, making it difficult to forecast sales cycles for our products and the timing of large software license sales.  In addition, as we focus on our cloud sales we may experience a correspondingly negative effect on license revenue.
 
Subscription Revenue. Subscription revenue is generally billed on a quarterly basis and recognized ratably over the term of the agreement, typically 12 to 36 months. In the first nine months of fiscal 2016 and on a constant currency basis, subscription revenue increased by 44% to $28.2 million compared to the same period last year. Currency had an adverse impact on subscription revenue of $0.7 million. Growing our cloud solution and offering our products as SaaS continues to be a key strategic and growth initiative for us. Our cloud customers include a mix of existing customers who have converted from our on-premise model and new user implementations of our cloud solution.
 
17

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. In the first nine months of fiscal 2016 and on a constant currency basis, maintenance revenue increased by 1% to $99.9 million compared to the same period last year. Currency had an adverse impact on maintenance revenue of $7.9 million. Maintenance revenue fluctuations are influenced by: (1) new license revenue growth; (2) annual renewal of support contracts; (3) increase in customers through acquisitions; (4) fluctuations in currency rates; (5) adjustments to revenue as a result of revenue recognition rules; and (6) customer conversions to QAD Cloud ERP. The vast majority of our customers renew their annual support contracts. Over the last three years, our annual revenue renewal rate of customers subscribing to maintenance has been greater than 90%. Maintenance revenue is generally billed on an annual basis and recognized ratably over the term of the agreement, typically twelve months. As we focus on our cloud sales we may experience a corresponding negative effect on maintenance revenue. When customers convert to QAD Cloud ERP they no longer pay for maintenance as those services are included as a component of the subscription offering.
 
Other revenue consists primarily of hardware sales. We occasionally resell third party hardware as part of an end-to-end solution requested by our customers. Hardware revenue is recognized on a gross basis when delivery has occurred, the fee is fixed or determinable and collection is considered reasonably assured. We consider delivery to occur when the product is shipped and title and risk of loss have passed to the customer.
 
Professional Services Revenue.  Our services business consists of professional services, including consulting and training related to our solutions. In the first nine months of fiscal 2016 and on a constant currency basis, professional services revenue decreased by 1% to $58.0 million compared to the same period last year. Currency had an adverse impact on professional services revenue of $5.3 million. Our professional services organization provides our customers with expertise and assistance in planning and implementing our solutions whether in the cloud or on-premise. Consultants typically assist customers with the initial installation of a system, the conversion and transfer of the customer’s historical data into our software, and ongoing training, education, and system upgrades. We believe our professional services enable customers to implement our software efficiently, support a customer’s success with our solution, strengthen our customer relationships, and add to our industry-specific knowledge base for use in future implementations and product innovations. Our services margins tend to range from about breakeven to 10%. We believe we offer competitive rates and view our services organization as a department supporting the implementation and deployment of our products and improving the overall customer experience. Services margins lower our overall operating margin as services margins are inherently lower than margins for our license, maintenance and subscription revenues. We expect that our professional services revenue will grow only as fast as needed in order to complete our customer implementations and conversions to the cloud. Services revenue may be impacted by currency fluctuations; however, since we generally use local resources our costs are also impacted by similar currency fluctuations, providing a natural hedge. As a result, our margins tend to remain consistent.
 
Although our professional services are optional, many of our customers use these services for some of their planning, implementation, or related needs. Professional services are typically rendered under time and materials-based contracts with services typically billed on an hourly basis. Professional services are sometimes rendered under fixed-fee based contracts with payments due on specific dates or milestones.
 
Professional services revenue growth is contingent upon license and subscription revenue growth and customer upgrade cycles, which are influenced by the strength of general economic and business conditions and the competitive position of our software products. We use our partners and subcontractors to supplement our internal resources. This allows us to quickly respond to demand fluctuations while somewhat mitigating low utilization in slow times. We believe this also helps us extend our global reach by keeping a higher number of partners engaged and knowledgeable about our product.
 
Our professional services business has competitive exposure to offshore providers which could create the risk of pricing pressure, fewer customer orders and reduced gross margins.
 
Cash Flow and Financial Condition. In fiscal 2015, we successfully closed a public offering of 2 million shares of our Class A stock resulting in net cash received of $37.0 million after underwriting discounts and commissions and offering expenses. In the first quarter of fiscal 2016 the offering underwriters exercised in full an option to purchase additional shares. As a result, a further 450,000 shares of Class A common stock were issued generating approximately $8.4 million in additional net proceeds.
 
18

Our cash and equivalents at October 31, 2015 totaled $126.6 million, with the only debt on our balance sheet of $14.8 million related to the mortgage of our headquarters. Our primary uses of cash have been funding investment in research and development and funding operations to drive revenue and earnings growth. In addition, we use cash for acquisitions, dividend payments, share repurchase programs and other equity related transactions.

In fiscal 2016, we anticipate that our priorities for use of cash will be growing our cloud business in addition to developing sales and services resources and continued investment in research and development to drive and support growth and profitability. We will continue to evaluate acquisition opportunities that are complementary to our product footprint, solutions delivery and technology direction. We will also continue to assess share repurchases and dividend payments. We do not anticipate additional borrowing requirements in fiscal 2016.
 
RESULTS OF OPERATIONS
 
Revenue
 
   
Three Months
Ended
October 31, 2015
   
Three Months
Ended
October 31, 2014
   
Change in
Constant
Currency
   
Change due
to Currency
Fluctuations
   
Total Change
as Reported
$
   
%
 
(in thousands)
                       
Revenue
                       
License fees
 
$
6,350
   
$
8,616
   
$
(1,737
)
 
$
(529
)
 
$
(2,266
)
   
-26
%
Percentage of total revenue
   
9
%
   
12
%
                               
Subscription fees
   
9,659
     
7,710
     
2,244
     
(295
)
   
1,949
     
25
%
Percentage of total revenue
   
14
%
   
10
%
                               
Maintenance and other
   
33,395
     
35,029
     
787
     
(2,421
)
   
(1,634
)
   
-5
%
Percentage of total revenue
   
49
%
   
47
%
                               
Professional services
   
18,633
     
22,649
     
(2,341
)
   
(1,675
)
   
(4,016
)
   
-18
%
Percentage of total revenue
   
28
%
   
31
%
                               
Total revenue
 
$
68,037
   
$
74,004
   
$
(1,047
)
 
$
(4,920
)
 
$
(5,967
)
   
-8
%
 
   
Nine Months
Ended
October 31, 2015
   
Nine Months
Ended
October 31, 2014
   
Change in
Constant
Currency
   
Change due
to Currency
Fluctuations
   
Total Change
as Reported
$
   
%
 
(in thousands)
                       
Revenue
                       
License fees
 
$
21,761
   
$
24,231
   
$
(571
)
 
$
(1,899
)
 
$
(2,470
)
   
-10
%
Percentage of total revenue
   
10
%
   
11
%
                               
Subscription fees
   
28,223
     
20,344
     
8,614
     
(735
)
   
7,879
     
39
%
Percentage of total revenue
   
14
%
   
9
%
                               
Maintenance and other
   
100,611
     
107,225
     
1,322
     
(7,936
)
   
(6,614
)
   
-6
%
Percentage of total revenue
   
48
%
   
50
%
                               
Professional services
   
57,998
     
63,739
     
(450
)
   
(5,291
)
   
(5,741
)
   
-9
%
Percentage of total revenue
   
28
%
   
30
%
                               
Total revenue
 
$
208,593
   
$
215,539
   
$
8,915
   
$
(15,861
)
 
$
(6,946
)
   
-3
%
 
Total Revenue. On a constant currency basis, total revenue was $68.0 million and $69.1 million for the third quarter of fiscal 2016 and 2015, respectively, representing a $1.1 million, or 2%, decrease from the same period last year. When comparing categories within total revenue at constant rates, our results for the third quarter of fiscal 2016 included higher subscription fees and maintenance and other revenue and lower license fees and professional services revenue. Total revenue was lower than expected for the third quarter of fiscal 2016 mostly due to a lower number of large license orders and lower professional services revenue. Although services revenue decreased, our services margins remained stable through subcontractor management and lower bonus expense.
 
On a constant currency basis, total revenue decreased in our North America and EMEA regions and increased in our Latin America and Asia Pacific regions during the third quarter of fiscal 2016 when compared to the same period last 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 food and beverage and consumer products as well as between high technology and industrial products, we aggregate them for management review. Revenue by industry for the third quarter of fiscal 2016 was approximately 33% in automotive, 20% in consumer products and food and beverage, 32% in high technology and industrial products and 15% in life sciences. In comparison, revenue by industry for the third quarter of fiscal 2015 was approximately 31% in automotive, 21% in consumer products and food and beverage, 32% in high technology and industrial products and 16% in life sciences.
 
19

On a constant currency basis, total revenue was $208.6 million and $199.7 million for the first nine months of fiscal 2016 and 2015, respectively, representing a $8.9 million, or 4%, increase from the same period last year. When comparing categories within total revenue at constant rates, our results for the first nine months of fiscal 2016 included increases in subscription fees and maintenance and other revenue and decreases in license fees and professional services revenue. On a constant currency basis, total revenue increased across all regions, except for the EMEA region where total revenue decreased, during the first nine months of fiscal 2016 when compared to the same period last year.  Revenue by industry for the first nine months of fiscal 2016 was approximately 32% in automotive, 21% in consumer products and food and beverage, 33% in high technology and industrial products and 14% in life sciences. In comparison, revenue by industry for the first nine months of fiscal 2015 was approximately 30% in automotive, 22% in consumer products and food and beverage, 33% in high technology and industrial products and 15% in life sciences.
 
License Revenue. On a constant currency basis, license revenue was $6.4 million and $8.1 million for the third quarter of fiscal 2016 and 2015, respectively, representing a $1.7 million, or 21%, decrease from the same period last year. License revenue decreased in our North America and EMEA regions and increased in our Latin America and Asia Pacific regions during the third quarter of fiscal 2016 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 third quarter of fiscal 2016, no customers placed license orders totaling more than $0.3 million. This compared to the third quarter of fiscal 2015 in which five customers placed license orders totaling more than $0.3 million and no orders exceeded $1.0 million.
 
On a constant currency basis, license revenue was $21.8 million and $22.3 million for the first nine months of fiscal 2016 and 2015, respectively, representing a $0.5 million, or 2%, decrease from the same period last year. License revenue decreased in our EMEA and Asia Pacific regions and increased in our North America and Latin America regions during the first nine months of fiscal 2016 when compared to the same period last year. During the first nine months of fiscal 2016, thirteen customers placed license orders totaling more than $0.3 million and no orders exceeded $1.0 million. This compared to the first nine months of fiscal 2015 when twelve customers placed license orders totaling more than $0.3 million, and no orders exceeded $1.0 million. The decrease in license revenue was primarily due to lower than expected third quarter revenue.
 
Subscription Revenue. On a constant currency basis, subscription revenue was $9.7 million and $7.4 million for the third quarter of fiscal 2016 and 2015, respectively, representing a $2.2 million, or 30%, increase from the same period last year. Subscription revenue increased across all regions during the third quarter of fiscal 2016 when compared to the same period last year. The increase in subscription revenue was primarily due to sales of our QAD Cloud ERP product offering which represented over 80% of total subscription revenue in each of the third quarters of fiscal 2016 and 2015. QAD Cloud ERP revenue (“cloud revenue”) consists of new customers, customers converting from on-premise and additional users and modules purchased by our existing cloud customers. In the third quarter of fiscal 2016 and 2015 our North America region generated approximately 63% and 61%, respectively, of our global cloud revenue. Cloud revenue by industry for the third quarter of fiscal 2016 was approximately 40% in automotive, 16% in consumer products and food and beverage, 16% in high technology and industrial products and 28% in life sciences. In comparison, cloud revenue by industry for the third quarter of fiscal 2015 was approximately 40% in automotive, 17% in consumer products and food and beverage, 15% in high technology and industrial products and 28% in life sciences. We expect the growth rate of subscription revenue in the future to be primarily attributable to growth in sales of our QAD Cloud ERP product offering.
 
On a constant currency basis, subscription revenue was $28.2 million and $19.6 million for the first nine months of fiscal 2016 and 2015, respectively, representing an $8.6 million, or 44%, increase from the same period last year.  Subscription revenue increased across all regions during the first nine months of fiscal 2016 when compared to the same period last year. Included in our fiscal 2016 subscription revenue is $0.9 million of subscription revenue in our Latin America region related to one customer where we had deferred revenue in previous periods due to a complex implementation. We recognized the revenue once the implementation and rollout of their users was completed and we received confirmation from the customer that the local requirements were being met by the service offering. Excluding the one-time recognition, on a constant currency basis subscription revenue growth would have been 39%. For the first nine months of fiscal 2016 and 2015 our North America region generated approximately 61% and 65%, respectively, of our global cloud revenue. As cloud becomes more widely accepted globally, we expect to see the percentage of North America cloud revenue compared to all other regions similar to that of total revenue. Cloud revenue by industry for the first nine months of fiscal 2016 was approximately 43% in automotive, 16% in consumer products and food and beverage, 15% in high technology and industrial products and 26% in life sciences. In comparison, cloud revenue by industry for the first nine months of fiscal 2015 was approximately 42% in automotive, 19% in consumer products and food and beverage, 15% in high technology and industrial products and 24% in life sciences.

20

Maintenance and Other Revenue. On a constant currency basis, maintenance and other revenue was $33.4 million and $32.6 million for the third quarter of fiscal 2016 and 2015, respectively, representing a $0.8 million, or 2%, increase compared to the same period last year. Maintenance and other revenue increased in all of our regions except North America, where it decreased, during the third quarter of fiscal 2016 when compared to the same period last year. The increase in maintenance and other revenue was primarily attributable to price increases, new customers, new users and new modules partially offset by the impact of customers converting to QAD Cloud ERP and customer cancellations. When customers convert to QAD Cloud ERP they no longer pay for maintenance as those services are included as a component of the subscription offering.
 
On a constant currency basis, maintenance and other revenue was $100.6 million and $99.3 million for the first nine months of fiscal 2016 and 2015, respectively, representing a $1.3 million, or 1%, increase from the same period last year. Maintenance and other revenue increased in all of our regions except North America, where it decreased, during the first nine months of fiscal 2016 when compared to the same period last year.
 
We track our rate of contract renewals by determining the number of customer sites with active contracts as of the end of the previous reporting period and compare this to the number of customers that renewed, or are in the process of renewing, their maintenance contracts as of the current period end. Our maintenance contract renewal rate has remained in excess of 90% for the third quarter and the first nine months of both fiscal 2016 and 2015.  Our deferred maintenance revenue was $54.7 million as of October 31, 2015 compared to $57.7 million as of October 31, 2014. We monitor our deferred maintenance revenue balance on a constant currency basis in order to gauge the health of our recurring revenue and track customer conversions from maintenance to subscription revenue.  Deferred maintenance revenue was negatively impacted by foreign currency changes, particularly due to the changes in the euro compared to the U.S. dollar.  On a constant currency basis, deferred maintenance revenue would have been $3.5 million higher as of October 31, 2015, or $58.2 million, consistent with October 31, 2014.
 
Products are generally shipped as orders are received or within a short period thereafter. Accordingly, we have historically operated with little backlog. Because of the generally short cycle between order and shipment and the relatively small percentage of subscription revenue, we believe that our backlog as of any particular date is not currently significant. As of October 31, 2015 and 2014 our total short-term deferred revenue was $69.6 million and $72.7 million, respectively, which consisted of the following (in thousands):
 
   
October 31, 2015
   
October 31, 2014
 
Deferred maintenance revenue
 
$
54,678
   
$
57,707
 
Deferred subscription revenue
   
12,271
     
9,572
 
Deferred services revenue
   
2,056
     
3,369
 
Deferred license revenue
   
520
     
2,001
 
Deferred other revenue
   
91
     
53
 
Deferred revenues, current
 
$
69,616
   
$
72,702
 
 
Deferred maintenance will be recognized over the period of the maintenance support. Deferred subscription is primarily related to hosting and cloud services which we will provide over periods up to the next twelve months. Deferred services represents prepayments for our professional services where revenues for these services are recognized as we complete the performance obligations as well as services already provided but deferred due to U.S. GAAP revenue recognition rules. The deferred licenses are primarily due to U.S. GAAP revenue recognition rules.
 
21

Professional Services Revenue. On a constant currency basis, professional services revenue was $18.6 million and $21.0 million for the third quarter of fiscal 2016 and 2015, respectively, representing a $2.4 million, or 11%, decrease compared to the same period last year. Professional services revenue decreased in all of our regions during the third quarter of fiscal 2016 when compared to the same period last year. Professional services revenue decreased period over period due to lower revenue per engagement, lower than expected post-go-live services, and delayed starts to projects in our EMEA and Latin America regions. Services revenue recognized from cloud customers was between 14% and 18% of total services revenue in each period.
 
On a constant currency basis, professional services revenue was $58.0 million and $58.4 million for the first nine months of fiscal 2016 and 2015, respectively, representing a $0.4 million, or 1%, decrease from the same period last year. Professional services revenue decreased in our North America and EMEA regions, remained flat in our Asia Pacific region and increased in our Latin America region during the first nine months of fiscal 2016 when compared to the same period last year.  The decrease in services revenue was due to lower revenue per engagement partially offset by a higher number of implementation and upgrade projects. Services revenue recognized from cloud customers was between 14% and 18% of total services revenue in each period.
 
Cost of Revenue
 
   
Three Months
Ended
October 31, 2015
   
Three Months
Ended
October 31, 2014
   
Change in
Constant
Currency
   
Change due
to Currency
Fluctuations
   
Total Change
as Reported
$
   
%
 
(in thousands)
                       
Cost of revenue
                       
Cost of license fees
 
$
827
   
$
1,217
   
$
372
   
$
18
   
$
390
     
32
%
Cost of subscription
   
5,134
     
4,134
     
(1,152
)
   
152
     
(1,000
)
   
-24
%
Cost of maintenance and other
   
7,924
     
7,921
     
(376
)
   
373
     
(3
)
   
0
%
Cost of professional services
   
17,120
     
19,799
     
1,241
     
1,438
     
2,679
     
14
%
Total cost of revenue
 
$
31,005
   
$
33,071
   
$
85
   
$
1,981
   
$
2,066
     
6
%
Percentage of revenue
   
46
%
   
45
%
                               
 
   
Nine Months
Ended
October 31, 2015
   
Nine Months
Ended
October 31, 2014
   
Change in
Constant
Currency
   
Change due
to Currency
Fluctuations
   
Total Change
as Reported
$
   
%
 
(in thousands)
                       
Cost of revenue
                       
Cost of license fees
 
$
2,728
   
$
3,270
   
$
501
   
$
41
   
$
542
     
17
%
Cost of subscription
   
15,360
     
12,132
     
(3,585
)
   
357
     
(3,228
)
   
-27
%
Cost of maintenance and other
   
23,608
     
24,344
     
(469
)
   
1,205
     
736
     
3
%
Cost of professional services
   
54,035
     
57,975
     
(855
)
   
4,795
     
3,940
     
7
%
Total cost of revenue
 
$
95,731
   
$
97,721
   
$
(4,408
)
 
$
6,398
   
$
1,990
     
2
%
Percentage of revenue
   
46
%
   
45
%
                               
 
Cost of license fees includes license royalties, amortization of capitalized software costs and fulfillment. Cost of subscription includes salaries, benefits and bonuses of our cloud operations group, located in the United States and India; stock-based compensation for those employees; hardware and hosting costs; royalties; professional fees; travel expense; and an allocation of information technology and facilities costs. Cost of maintenance and other includes salaries, benefits and bonuses of our support group located around the world; 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 and bonuses of employees fulfilling service contracts; stock-based compensation for those employees; subcontractor expense; travel expense for services employees; and an allocation of information technology and facilities costs.
 
22

Total Cost of Revenue. On a constant currency basis, total cost of revenue (combined cost of license fees, cost of subscription, cost of maintenance and other and cost of professional services) was $31.0 million and $31.1 million for the third quarter of fiscal 2016 and 2015, respectively, and as a percentage of total revenue was 46% and 45% for the third quarter of fiscal 2016 and 2015, respectively. The non-currency related decrease in cost of revenue of $0.1 million in the third quarter of fiscal 2016 compared to the third quarter of fiscal 2015 was primarily due to lower services expenses including lower subcontractor costs as a result of subcontractor management as well as lower bonuses which were aligned to lower revenue in the third quarter. These expense reductions were partially offset by higher hosting costs and higher subscription personnel expenses associated with higher subscription revenue.
 
On a constant currency basis, total cost of revenue (combined cost of license fees, cost of maintenance, subscription and other and cost of professional services) was $95.7 million and $91.3 million for the first nine months of fiscal 2016 and 2015, respectively, and as a percentage of total revenue was 46% for both the first nine months of fiscal 2016 and 2015. The non-currency related increase in cost of revenue of $4.4 million, or 5%, for the first nine months of fiscal 2016 compared to the first nine months of fiscal 2015 was primarily due to higher personnel and hosting costs associated with higher subscription revenue and higher services expenses including personnel partially offset by lower subcontractor costs.
 
Cost of License Fees.  On a constant currency basis, cost of license fees was $0.8 million and $1.2 million for the third quarter of fiscal 2016 and 2015, respectively, representing a decrease of $0.4 million, or 33%. The non-currency related decrease in cost of license fees of $0.4 million for the third quarter of fiscal 2016 compared to the third quarter of fiscal 2015 was due to lower royalties. Cost of license fees as a percentage of license revenue was 13% and 14% for the third quarter of fiscal 2016 and 2015, respectively.
 
On a constant currency basis, cost of license fees was $2.7 million and $3.2 million for the first nine months of fiscal 2016 and 2015, respectively, representing a decrease of $0.5 million, or 16%. The non-currency related decrease in cost of license fees of $0.5 million for the first nine months of fiscal 2016 compared to the first nine months of fiscal 2015 was due to lower royalties and lower fulfillment costs.  Cost of license fees as a percentage of license revenue was 13% for each of the first nine months of fiscal 2016 and fiscal 2015, respectively.
 
Cost of Subscription. On a constant currency basis, cost of subscription was $5.1 million and $4.0 million for the third quarter of fiscal 2016 and 2015, respectively, representing an increase of $1.1 million, or 28%. The non-currency related increase in cost of subscription of $1.1 million in the third quarter of fiscal 2016 compared to the third quarter of fiscal 2015 was primarily due to higher hosting costs of $0.7 million and higher salaries and related costs of $0.3 million as a result of higher headcount of approximately 8 people, both of which are to support the growth in our cloud business. We expect to continue investing in our cloud business and, as a result, we expect costs will continue to increase and margins may be impacted. Cost of subscription as a percentage of subscription revenue was 53% and 54% in the third quarter of fiscal 2016 and 2015, respectively. As we achieve efficiencies in our cloud operations we expect to see continued improvement in our subscription margin over the long term, but we also expect volatility in our subscription margin as a result of increased investment necessary to grow our cloud business.
 
On a constant currency basis, cost of subscription was $15.4 million and $11.8 million for the first nine months of fiscal 2016 and fiscal 2015, respectively, representing an increase of $3.6 million, or 31%. The non-currency related increase in cost of subscription of $3.6 million for the first nine months of fiscal 2016 compared to the first nine months of fiscal 2015 was primarily due to higher hosting costs of $1.6 million and higher personnel costs of $1.4 million as a result of increased headcount of 8 people, both of which are to support the growth in our cloud business, and higher information technology and facilities allocated costs of $0.4 million. Cost of subscription as a percentage of subscription revenue was 54% and 60% in the first nine months of fiscal 2016 and fiscal 2015, respectively. Excluding the one-time $0.9 million subscription recognition, cost of subscription as a percentage of subscription revenue would have been 56% for the first nine months of fiscal 2016.
 
Cost of Maintenance and Other.  On a constant currency basis, cost of maintenance was $7.6 million and $7.5 million for the third quarter of fiscal 2016 and 2015, respectively, representing an increase of $0.1 million, or 1%. The non-currency related increase in cost of maintenance of $0.1 million for the third quarter of fiscal 2016 compared to the third quarter of fiscal 2015 was primarily due to higher salaries and related costs of $0.2 million. Cost of maintenance as a percentage of maintenance revenue was 23% in each of the third quarters of fiscal 2016 and 2015. On a constant currency basis, other costs, consisting of hardware, was $0.3 million and zero in the third quarter of fiscal 2016 and 2015, respectively.
 
23

On a constant currency basis, cost of maintenance was $23.1 million and $23.0 million for the first nine months of fiscal 2016 and fiscal 2015, respectively, representing an increase of $0.1 million. The non-currency related increase in cost of maintenance of $0.1 million for the first nine months of fiscal 2016 compared to the first nine months of fiscal 2015 was primarily due to higher salaries and related costs of $0.4 million partially offset by lower royalties of $0.3 million. Cost of maintenance as a percentage of maintenance revenue was 23% for the first nine months of both fiscal 2016 and fiscal 2015. On a constant currency basis, other costs, consisting of hardware, was $0.5 million and $0.1 million for the first nine months of fiscal 2016 and 2015, respectively.
 
Cost of Professional Services.  On a constant currency basis, cost of professional services was $17.1 million and $18.4 million for the third quarter of fiscal 2016 and 2015, respectively, representing a decrease of $1.3 million, or 7%. The non-currency related decrease in cost of professional services of $1.3 million in the third quarter of fiscal 2016 compared to the third quarter of fiscal 2015 was due primarily to lower subcontractor costs of $1.0 million, lower recruiting costs of $0.3 million, lower bonuses of $0.2 million and lower travel of $0.2 million, partially offset by higher salaries and related costs of $0.6 million as a result of higher headcount of approximately 16 people. In addition, the decrease in cost of professional services included lower personnel costs of $0.4 million from other departments supporting services engagements. Cost of professional services as a percentage of professional services revenues was 92% and 87% for the third quarter of fiscal 2016 and 2015, respectively.
 
On a constant currency basis, cost of professional services was $54.0 million and $53.2 million for the first nine months of fiscal 2016 and 2015, respectively, representing an increase of $0.8 million, or 2%. The non-currency related increase in cost of professional services of $0.8 million in the first nine months of fiscal 2016 compared to the first nine months of fiscal 2015 was due to higher salaries and related costs of $2.7 million as a result of increased headcount of 16 people and higher information technology and facilities allocated costs of $0.4 million, partially offset by lower subcontractor costs of $1.8 million and lower recruiting costs of $0.3 million. Cost of professional services as a percentage of professional services revenues was 93% and 91% for the first nine months of fiscal 2016 and fiscal 2015, respectively.
 
Sales and Marketing
 
    Three Months
Ended
October 31, 2015
    Three Months
Ended
October 31, 2014
    Change in
Constant
Currency
    Change due
to Currency
Fluctuations
    Total Change
as Reported
$
   
%
 
(in thousands)
           
Sales and marketing
 
$
15,531
   
$
16,421
   
$
(93
)
 
$
983
   
$
890
     
5
%
Percentage of revenue
   
23
%
   
22
%
                               
 
    Nine Months
Ended
October 31, 2015
    Nine Months
Ended
October 31, 2014
    Change in
Constant
Currency
    Change due
to Currency
Fluctuations
    Total Change
as Reported
$
   
%
 
(in thousands)
           
Sales and marketing
 
$
49,658
   
$
50,319
   
$
(2,633
)
 
$
3,294
   
$
661
     
1
%
Percentage of revenue
   
24
%
   
24
%
                               
 
Sales and marketing expense includes salaries, benefits, bonuses, stock-based compensation and travel expense for our sales and marketing employees in addition to costs of programs aimed at increasing revenue, such as trade shows, user group events, 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 $15.5 million and $15.4 million for the third quarter of fiscal 2016 and 2015, respectively, representing an increase of $0.1 million, or 1%. The non-currency related increase in sales and marketing expense of $0.1 million in the third quarter of fiscal 2016 compared to the third quarter of fiscal 2015 was primarily due to higher salaries and related costs of $0.3 million and higher travel expense of $0.3 million partially offset by lower commissions of $0.5 million.
 
24

On a constant currency basis, sales and marketing expense was $49.7 million and $47.0 million for the first nine months of fiscal 2016 and fiscal 2015, respectively, representing an increase of $2.7 million, or 6%. The non-currency related increase in sales and marketing expense of $2.7 million for first nine months of fiscal 2016 compared to the first nine months of fiscal 2015 was due primarily to higher salaries and related expense of $1.5 million, higher travel expense of $0.6 million, higher sales agent fees of $0.4 million, higher stock compensation of $0.4 million, higher expenses of $0.3 million related to our annual Explore user conference and higher information technology and facilities allocated costs of $0.3 million partially offset by lower commissions of $0.8 million.
 
Research and Development
 
    Three Months
Ended
October 31, 2015
    Three Months
Ended
October 31, 2014
    Change in
Constant
Currency
    Change due
to Currency
Fluctuations
    Total Change
as Reported
$
   
%
 
(in thousands)
           
Research and development
 
$
10,193
   
$
10,152
   
$
(514
)
 
$
473
   
$
(41
)
   
0
%
Percentage of revenue
   
15
%
   
14
%
                               
 
    Nine Months
Ended
October 31, 2015
    Nine Months
Ended
October 31, 2014
    Change in
Constant
Currency
    Change due
to Currency
Fluctuations
    Total Change
as Reported
$
   
%
 
(in thousands)
           
Research and development
 
$
31,440
   
$
32,249
   
$
(816
)
 
$
1,625
   
$
809
     
3
%
Percentage of revenue
   
15
%
   
15
%
                               
 
Research and development is expensed as incurred and consists primarily of salaries, benefits, bonuses, stock-based compensation, training and travel expense for research and development employees and 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 reimbursements from joint development projects. As part of our vertical focus we regularly seek joint development arrangements with our customers in order to enhance specific functionality and industry experience, although the number and size of joint development arrangements may fluctuate.
 
On a constant currency basis, research and development expense was $10.2 million and $9.7 million for the third quarter of fiscal 2016 and 2015, respectively, representing an increase of $0.5 million, or 5%. The non-currency related increase in research and development expense of $0.5 million for the third quarter of fiscal 2016 compared to the third quarter of fiscal 2015 was due primarily to higher salaries and related expense of $0.2 million and higher information technology and facilities allocated costs of $0.2 million partially offset by lower bonuses of $0.3 million. In addition, research and development employees worked on a higher number of services engagements in the prior year, resulting in lower cost relief for the third quarter of fiscal 2016 of $0.3 million when compared to the same period last year.
 
On a constant currency basis, research and development expense was $31.4 million and $30.6 million for the first nine months of fiscal 2016 and fiscal 2015, respectively, representing an increase of $0.8 million, or 3%. The non-currency related increase in research and development expense of $0.8 million for the first nine months of fiscal 2016 compared to the first nine months of fiscal 2015 was due primarily to higher salaries and related expense of $0.3 million, higher stock compensation of $0.3 million and higher information technology and facilities allocated costs of $0.2 million partially offset by lower bonuses of $0.5 million. In addition, research and development employees worked on a higher number of services engagements in the prior year, resulting in lower cost relief for the first nine months of fiscal 2016 of $0.4 million when compared to the same period last year.
 
General and Administrative
 
    Three Months
Ended
October 31, 2015
    Three Months
Ended
October 31, 2014
    Change in
Constant
Currency
    Change due
to Currency
Fluctuations
    Total Change
as Reported
$
   
%
 
(in thousands)
           
General and administrative
 
$
7,676
   
$
8,295
   
$
337
   
$
282
   
$
619
     
7
%
Percentage of revenue
   
11
%
   
11
%
                               
 
  Nine Months
Ended
October 31, 2015
    Nine Months
Ended
October 31, 2014
    Change in
Constant
Currency
    Change due
to Currency
Fluctuations
    Total Change
as Reported
$
   
%
 
(in thousands)
           
General and administrative
 
$
24,719
   
$
26,464
   
$
775
   
$
970
   
$
1,745
     
7
%
Percentage of revenue
   
12
%
   
12
%
                               
 
25

General and administrative expense includes salaries, benefits, bonuses, stock-based compensation and travel expense for our finance, human resources, legal and executive personnel, as well as 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 $7.7 million and $8.0 million for the third quarter of fiscal 2016 and 2015, respectively, representing a decrease of $0.3 million, or 4%. The non-currency related decrease in general and administrative expense of $0.3 million in the third quarter of fiscal 2016 compared to the third quarter of fiscal 2015 was primarily due to lower bonuses of $0.3 million, lower professional fees of $0.1 million and lower costs associated with an internal systems upgrade project of $0.1 million partially offset by higher stock compensation of $0.3 million due to higher stock valuations.
 
On a constant currency basis, general and administrative expense was $24.7 million and $25.5 million for the first nine months of fiscal 2016 and fiscal 2015, respectively, representing a decrease of $0.8 million, or 3%. The non-currency related decrease in general and administrative expense of $0.8 million for first nine months of fiscal 2016 compared to the first nine months of fiscal 2015 was primarily due to lower professional fees of $0.7 million, lower bonuses of $0.5 million and lower costs associated with an internal systems upgrade of $0.4 million partially offset by higher stock compensation of $0.8 million due to higher stock valuations.
 
Amortization of Intangibles from Acquisitions
 
Amortization of intangibles from acquisitions was $0.2 million in the third quarter of both fiscal 2016 and 2015, and $0.5 million in the first nine months of both fiscal 2016 and 2015. Amortization expense for all periods was due to the intangible assets acquired in our fiscal 2013 acquisitions of DynaSys and CEBOS.
 
Other Expense (Income)
 
     
Three Months
Ended
   
Increase (Decrease)
Compared
   
Three
Months Ended
   
Nine Months
Ended
   
Increase (Decrease)
Compared
   
Nine Months
Ended
 
    October 31,    
to Prior Period     
    October 31,     October 31,    
to Prior Period     
    October 31,  
   
2015
   
$
   
%
   
2014
   
2015
   
$
   
%
   
2014
 
(in thousands)
                                       
Other (income) expense
                                       
Interest income
 
$
(80
)
 
$
(24
)
   
-43
%
 
$
(56
)
 
$
(224
)
 
$
(55
)
   
-33
%
 
$
(169
)
Interest expense
   
171
     
(14
)
   
-8
%
   
185
     
544
     
(54
)
   
-9
%
   
598
 
Other (income) expense, net
   
61
     
225
     
137
%
   
(164
)
   
(471
)
   
(415
)
   
-741
%
   
(56
)
Total other  expense (income)
 
$
152
   
$
187
     
534
%
 
$
(35
)
 
$
(151
)
 
$
(524
)
   
-140
%
 
$
373
 
Percentage of revenue
   
0
%
                   
0
%
   
0
%
                   
0
%
 
Total other expense (income) was $152,000 and $(35,000) for the third quarter of fiscal 2016 and fiscal 2015, respectively. The difference was due to a government incentive funding of $0.2 million paid in the third quarter of fiscal 2015 to one of our subsidiaries.

Total other (income) expense was $(0.2) million and $0.4 million for the first nine months of fiscal 2016 and 2015, respectively. The difference was due primarily to a favorable change of $0.5 million related to the fair market value of the interest rate swap associated with the mortgage on our headquarters.
 
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.
 
26

Income Tax Expense
 
    
Three Months
Ended
   
Increase (Decrease)
Compared to Prior
    
Three Months
Ended
    
Nine Months
Ended
   
Increase (Decrease)
Compared to Prior
    
Nine Months
Ended
 
    October 31,      Period     October 31,     
October 31,  
    Period    
October 31,  
 
   2015