Attached files

file filename
EX-32.1 - EXHIBIT 32.1 - QAD INCex_131309.htm
EX-31.2 - EXHIBIT 31.2 - QAD INCex_131308.htm
EX-31.1 - EXHIBIT 31.1 - QAD INCex_131307.htm
 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended October 31, 2018

 

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 every Interactive Data File required to be submitted 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 such files). Yes ☑ No ☐.

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.  (Check One):

 

Large accelerated filer ☐

Accelerated filer ☑

Non-accelerated filer ☐  (Do not check if a smaller reporting company)

Smaller reporting company ☐

 

 

 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐ 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐ No ☑.

 

As of November 30, 2018, there were 16,362,810 shares of the Registrant’s Class A common stock outstanding and 3,263,906 shares of the Registrant’s Class B common stock outstanding. 

 

1

 

 

 

QAD INC.

INDEX

 

 

Page

PART I - FINANCIAL INFORMATION

 

 

 

 

 

 

ITEM 1.

Financial Statements (unaudited)

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of October 31, 2018 and January 31, 2018

3

 

 

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended October 31, 2018 and 2017

4

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended October 31, 2018 and 2017

5

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

 

 

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

 

 

 

 

 

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

40

 

 

 

 

 

ITEM 4.

Controls and Procedures

41

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

 

 

ITEM 1.

Legal Proceedings

41

 

 

 

 

 

ITEM1A.

Risk Factors

42

 

 

 

 

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

 

 

 

 

 

ITEM 3.

Defaults Upon Senior Securities

42

 

 

 

 

 

ITEM 4.

Mine Safety Disclosure

42

 

 

 

 

 

ITEM 5.

Other Information

42

 

 

 

 

 

ITEM 6

Exhibits

42

 

 

 

 

 

SIGNATURES

43

 

2

 

 

 

PART I

 

ITEM 1 – FINANCIAL STATEMENTS

 

QAD INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

(unaudited)

 

   

October 31,

2018

   

January 31,

2018

 

Assets

               
                 

Current assets:

               

Cash and equivalents

  $ 138,080     $ 147,023  

Accounts receivable, net of allowances of $2,161 and $1,763 at October 31, 2018 and January 31, 2018, respectively

    46,420       83,518  

Other current assets, net

    19,493       15,856  

Total current assets

    203,993       246,397  

Property and equipment, net

    29,600       30,408  

Capitalized software costs, net

    1,486       990  

Goodwill

    12,284       11,023  

Deferred tax assets, net

    11,363       7,944  

Other assets, net

    11,784       3,055  

Total assets

  $ 270,510     $ 299,817  
                 

Liabilities and Stockholders’ Equity

               

Current liabilities:

               

Current portion of long-term debt

  $ 481     $ 466  

Accounts payable

    10,660       14,818  

Deferred revenue

    80,537       116,693  

Other current liabilities

    35,059       43,460  

Total current liabilities

    126,737       175,437  

Long-term debt

    12,957       13,313  

Other liabilities

    4,773       5,439  

Commitments and contingencies

               

Stockholders’ equity:

               

Preferred stock, $0.001 par value. Authorized 5,000,000 shares; none issued or outstanding

               

Common stock:

               

Class A, $0.001 par value. Authorized 71,000,000 shares; issued 16,605,215 shares at both October 31, 2018 and January 31, 2018

    16       16  

Class B, $0.001 par value. Authorized 4,000,000 shares; issued 3,537,380 shares at both October 31, 2018 and January 31, 2018

    4       4  

Additional paid-in capital

    194,292       200,456  

Treasury stock, at cost (517,582 shares and 892,700 shares at October 31, 2018 and January 31, 2018, respectively)

    (7,384

)

    (12,461

)

Accumulated deficit

    (52,047

)

    (75,559

)

Accumulated other comprehensive loss

    (8,838

)

    (6,828

)

Total stockholders’ equity

    126,043       105,628  

Total liabilities and stockholders’ equity

  $ 270,510     $ 299,817  

 

See Accompanying Notes to Condensed Consolidated Financial Statements.

 

3

 

 

 

QAD INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share data)

(unaudited)

 

   

Three Months Ended

   

Nine Months Ended

 
   

October 31,

   

October 31,

 
   

2018

   

2017

   

2018

   

2017

 
                                 

Revenue:

                               

Subscription

  $ 23,863     $ 17,190     $ 67,813     $ 49,953  

License

    4,631       6,628       16,458       18,636  

Maintenance and other

    30,401       32,407       92,458       96,284  

Professional services

    20,682       20,700       73,581       59,392  

Total revenue

    79,577       76,925       250,310       224,265  
                                 

Costs of revenue:

                               

Subscription

    8,686       7,605       25,248       22,753  

License

    534       690       1,772       2,203  

Maintenance and other

    7,716       7,840       23,355       23,374  

Professional services

    20,425       21,911       68,489       61,276  

Total cost of revenue

    37,361       38,046       118,864       109,606  
                                 

Gross profit

    42,216       38,879       131,446       114,659  
                                 

Operating expenses:

                               

Sales and marketing

    18,447       17,697       57,895       52,981  

Research and development

    13,155       12,111       40,674       35,332  

General and administrative

    8,095       8,556       26,823       26,373  

Amortization of intangibles from acquisitions

    45       85       45       359  

Total operating expenses

    39,742       38,449       125,437       115,045  
                                 

Operating income (loss)

    2,474       430       6,009       (386

)

                                 

Other (income) expense:

                               

Interest income

    (646

)

    (440

)

    (1,913

)

    (1,101

)

Interest expense

    177       195       488       508  

Other (income) expense, net

    (636

)

    (413

)

    (1,309

)

    1,399  

Total other (income) expense

    (1,105

)

    (658

)

    (2,734

)

    806  
                                 

Income (loss) before income taxes

    3,579       1,088       8,743       (1,192

)

Income tax expense

    597       1,249       3,251       2,701  
                                 

Net income (loss)

  $ 2,982     $ (161

)

  $ 5,492     $ (3,893

)

                                 

Basic net income (loss) per share

                               

Class A

  $ 0.16     $ (0.01

)

  $ 0.29     $ (0.21

)

Class B

  $ 0.13     $ (0.01

)

  $ 0.24     $ (0.17

)

Diluted net (loss) income per share

                               

Class A

  $ 0.14     $ (0.01

)

  $ 0.26     $ (0.21

)

Class B

  $ 0.12     $ (0.01

)

  $ 0.23     $ (0.17

)

                                 

Net income (loss)

  $ 2,982     $ (161

)

  $ 5,492     $ (3,893

)

Other comprehensive income, net of tax:

                               

Foreign currency translation adjustment

    (1,174

)

    (743

)

    (2,010

)

    1,029  

Total comprehensive income (loss)

  $ 1,808     $ (904

)

  $ 3,482     $ (2,864

)

 

See Accompanying Notes to Condensed Consolidated Financial Statements.

 

4

 

 

 

QAD INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

   

Nine Months Ended

October 31,

 
   

2018

   

2017

 
                 

Cash flows from operating activities:

               

Net income (loss)

  $ 5,492     $ (3,893

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

               

Depreciation and amortization

    4,100       4,401  

Amortization of costs capitalized to obtain and fulfill contracts

    3,107       -  

Net change in valuation allowance

    3,760       4,182  

Other deferred income taxes

    (824

)

    (4,565

)

Loss on disposal of equipment

    26       52  

Provision for doubtful accounts and sales adjustments

    926       675  

Stock compensation expense

    7,618       6,671  

Change in fair value of derivative instrument

    (198

)

    (103 )

Changes in assets and liabilities:

               

Accounts receivable

    33,923       19,085  

Costs capitalized to obtain and fulfill contracts

    (2,510

)

    -  

Other assets

    688       2,023  

Accounts payable

    (3,503

)

    (981

)

Deferred revenue

    (30,977

)

    (23,839

)

Other liabilities

    (6,511

)

    (864

)

Net cash provided by operating activities

    15,117       2,844  

Cash flows from investing activities:

               

Purchase of property and equipment

    (3,225

)

    (2,587

)

Acquisition of businesses, net of cash acquired

    (2,655

)

    -  

Capitalized software costs

    (778

)

    (809

)

Net cash used in investing activities

    (6,658

)

    (3,396

)

Cash flows from financing activities:

               

Repayments of debt

    (350

)

    (333

)

Tax payments related to stock awards

    (8,705

)

    (3,243

)

Cash dividends paid

    (4,105

)

    (4,021

)

Net cash used in financing activities

    (13,160

)

    (7,597

)

                 

Effect of exchange rates on cash and equivalents

    (4,242

)

    3,094  
                 

Net decrease in cash and equivalents

    (8,943

)

    (5,055

)

                 

Cash and equivalents at beginning of period

    147,023       145,082  
                 

Cash and equivalents at end of period

  $ 138,080     $ 140,027  
                 

Supplemental disclosure of cash flow information:

               

Cash paid during the period for:

               

Interest

  $ 458     $ 458  

Income taxes, net of refunds

  $ 2,558     $ 2,865  

 

See Accompanying Notes to Condensed Consolidated Financial Statements.

 

5

 

 

QAD INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

  

 

 

 

1.

BASIS OF PRESENTATION AND RECENT ACCOUNTING PRONOUNCEMENTS

 

Basis of Presentation

 

In the opinion of management, the accompanying unaudited Condensed Consolidated Financial Statements fairly present the financial information contained therein. These statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  The financial statements and footnotes are unaudited.  In management’s opinion, all necessary adjustments, consisting of normal, recurring and non-recurring adjustments, have been included in the accompanying Condensed Consolidated Financial Statements to present fairly the financial position and operating results of QAD Inc. (“QAD” or the “Company”). The Condensed Consolidated Financial Statements do not include all disclosures required by GAAP accounting principles for annual financial statements and should be read in conjunction with the audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended January 31, 2018. The Condensed Consolidated Financial Statements include the results of the Company and its wholly owned subsidiaries. Because of seasonal and other factors, results of operations for the three and nine months ended October 31, 2018 are not necessarily indicative of the results to be expected for the year ending January 31, 2019.

 

The Company’s accounting policies are set forth in detail in Note 1 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended January 31, 2018 with the Securities and Exchange Commission. Such Annual Report also contains a discussion of the Company’s critical accounting policies and estimates. The Company believes that these critical accounting policies and estimates affect its more significant estimates and judgments used in the preparation of the Company’s consolidated financial statements.

 

Effective February 1, 2018, the Company adopted the requirements of Accounting Standards Update (“ASU”) No.2014-09, Revenue from Contracts with Customers (“Topic 606”) using the modified retrospective method. The Company’s updated accounting policy on revenue recognition is described in Note 2 and in “Critical accounting policies” in Item 2 of this Form 10-Q. 

 

Certain prior year amounts have been reclassified for consistency with the current year presentation. Adjustments were made to the operating activities section of the Condensed Consolidated Statements of Cash Flows. These reclassifications had no effect on the reported results of operations and no effect on previously reported cash flows from operating activities. 

 

Recent Accounting Pronouncements

 

With the exception of those discussed below, there have been no recent changes in accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”) or adopted by the Company during the three or nine months ended October 31, 2018, that are of significance, or potential significance, to the Company.

 

Recent Accounting Pronouncements Adopted

 

In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory, which removes the prohibition against the immediate recognition of the current and deferred income tax effects of intra-entity transfers other than inventory. The guidance is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2017 with early adoption permitted as of the beginning of the annual reporting period in which the ASU was issued. ASU 2016-16 was adopted by the Company effective February 1, 2018 on a modified retrospective basis, resulting in a $9.6 million decrease to accumulated deficit and a corresponding increase to deferred tax assets.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments, that modifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, with earlier adoption permitted. ASU 2016-15 was adopted by the Company effective February 1, 2018 on a retrospective basis, with no material changes reflected in the Condensed Consolidated Statement of Cash Flows.

 

6

 

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in Revenue Recognition (Topic 605) and Subtopic 985-605 Software - Revenue Recognition. Topic 605 and Subtopic 985-605 are collectively referred to as “Topic 605” or “prior GAAP.” Under Topic 606, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, Topic 606 requires enhanced disclosures, including disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

 

The Company adopted Topic 606 on the first day of fiscal 2019 using the modified retrospective transition method. Under this method, QAD evaluated contracts that were in effect at the beginning of fiscal 2019 as if those contracts had been accounted for under Topic 606. The Company did not evaluate individual modifications for those periods prior to the adoption date, but the aggregate effect of all modifications as of the adoption date and such effects are provided below. Under the modified retrospective transition method, periods prior to the adoption date were not adjusted and continue to be reported in accordance with historical, pre-Topic 606 accounting. A cumulative catch-up adjustment was recorded to beginning accumulated deficit to reflect the impact of all existing arrangements under Topic 606.

 

 

The most significant impacts of the adoption of Topic 606 were as follows:

 

 

Removal of vendor specific objective evidence (“VSOE”) under prior GAAP resulted in earlier recognition of license and services revenues in those instances where the Company sold a multi-element deal where services did not have VSOE. At adoption, QAD decreased accumulated deficit and deferred revenue by $2.0 million as this revenue would otherwise have been recognized in future periods according to prior GAAP;

 

 

Removal of the limitation on contingent revenue resulted in revenue being recognized earlier for certain contracts. At adoption, QAD decreased accumulated deficit and increased contract assets by $0.8 million as this revenue would otherwise have been recognized in future periods as invoiced according to prior GAAP;

 

 

Contracts containing a future option to the customer represented a material right which resulted in deferral of revenue. At adoption, QAD increased accumulated deficit and deferred revenue by $0.3 million as this revenue would have been otherwise earned in previous periods according to prior GAAP;

 

 

Commission expenses related to new cloud and maintenance contracts are no longer expensed as incurred; rather these incremental commission costs and other associated fringe benefits are capitalized and amortized over the associated term of economic benefit which the Company has determined to be five years. As a result, QAD decreased accumulated deficit and increased other current and non-current assets by $9.1 million at the adoption date;

 

 

Sales agent fees to obtain new cloud and maintenance contracts are no longer be expensed as incurred; rather these costs will be capitalized and amortized over the associated term of economic benefit which the Company has determined to be five years. As a result, QAD decreased accumulated deficit and increased other current and non-current assets by $1.0 million at the adoption date; and

 

 

Cloud environment setup costs incurred to fulfill new cloud customer contracts are no longer expensed as incurred; rather these costs are capitalized and amortized over the associated term of economic benefit which the Company has determined to be five years. As a result, QAD decreased accumulated deficit and increased other current and non-current assets by $1.5 million at the adoption date.

 

The tax impact of the above adjustments was assessed and, at adoption, QAD increased accumulated deficit and decreased net deferred tax assets by $1.6 million.

 

7

 

 

 Adjustments to beginning consolidated balance sheet accounts

 

The following table presents the cumulative effect adjustments, net of income tax effects, to beginning consolidated balance sheet accounts for the new accounting standards adopted by the Company on the first day of fiscal 2019:

 

   

Jan. 31, 2018

   

Topic 606

   

ASU2016-16 (1)

   

Feb. 1, 2018

 
   

(in thousands)

 

Assets

                               

Current assets:

                               

Cash and equivalents

  $ 147,023     $ -     $ -     $ 147,023  

Accounts receivable, net

    83,518       -       -       83,518  

Other current assets, net

    15,856       4,013       -       19,869  

Total current assets

    246,397       4,013       -       250,410  

Property and equipment, net

    30,408       -       -       30,408  

Capitalized software costs, net

    990       -       -       990  

Goodwill

    11,023       -       -       11,023  

Deferred tax assets, net

    7,944       (1,643

)

    9,584       15,885  

Other assets, net

    3,055       8,421       -       11,476  

Total assets

  $ 299,817     $ 10,791     $ 9,584     $ 320,192  
                                 

Liabilities and stockholders’ equity

                               

Current portion of long-term debt

  $ 466     $ -     $ -     $ 466  

Accounts payable

    14,818       -       -       14,818  

Deferred revenue

    116,693       (1,239

)

    -       115,454  

Other current liabilities

    43,460       -       -       43,460  

Total current liabilities

    175,437       (1,239

)

    -       174,198  

Long-term debt

    13,313       -       -       13,313  

Other liabilities

    5,439       (511

)

    -       4,928  

Stockholders’ equity

                               

Common stock - Class A

    16       -       -       16  

Common stock - Class B

    4       -       -       4  

Additional paid-in capital

    200,456       -       -       200,456  

Treasury stock

    (12,461

)

    -       -       (12,461

)

Accumulated deficit

    (75,559

)

    12,541       9,584       (53,434

)

Accumulated other comprehensive loss

    (6,828

)

    -       -       (6,828

)

Total stockholders’ equity

    105,628       12,541       9,584       127,753  

Total liabilities and stockholders’ equity

  $ 299,817     $ 10,791     $ 9,584     $ 320,192  

 ___________________________

 

 

(1)

For further information about the adoption of Income taxes (Topic 740): Intra-entity Transfers of Assets Other Than Inventory see Note 9 “Income Taxes.”

 

8

 

 

The following table summarizes the effects of adopting Topic 606 on the Company’s Condensed Consolidated Balance Sheet as of October 31, 2018:

 

   

As reported

under Topic 606

   

Adjustments

   

Balances under

Prior GAAP

 
   

(in thousands)

 

Assets

                       

Current assets:

                       

Cash and equivalents

  $ 138,080     $ -     $ 138,080  

Accounts receivable, net

    46,420       -       46,420  

Other current assets, net

    19,493       (4,087

)

    15,406  

Total current assets

    203,993       (4,087

)

    199,906  

Property and equipment, net

    29,600       -       29,600  

Capitalized software costs, net

    1,486       -       1,486  

Goodwill

    12,284       -       12,284  

Deferred tax assets, net

    11,363       959       12,322  

Other assets, net

    11,784       (7,438

)

    4,346  

Total assets

  $ 270,510     $ (10,566

)

  $ 259,944  
                         

Liabilities and stockholders’ equity

                       

Current portion of long-term debt

  $ 481     $ -     $ 481  

Accounts payable

    10,660       -       10,660  

Deferred revenue

    80,537       3,630       84,167  

Other current liabilities

    35,059       -       35,059  

Total current liabilities

    126,737       3,630       130,367  

Long-term debt

    12,957       -       12,957  

Other liabilities

    4,773       645       5,418  

Stockholders’ equity

                       

Common stock - Class A

    16       -       16  

Common stock - Class B

    4       -       4  

Additional paid-in capital

    194,292       -       194,292  

Treasury stock

    (7,384

)

    -       (7,384

)

Accumulated deficit

    (52,047

)

    (14,861

)

    (66,908

)

Accumulated other comprehensive loss

    (8,838

)

    20       (8,818

)

Total stockholders’ equity

    126,043       (14,841

)

    111,202  

Total liabilities and stockholders’ equity

  $ 270,510     $ (10,566

)

  $ 259,944  

 

9

 

 

The following table summarizes the effects of adopting Topic 606 on the Company’s Condensed Consolidated Statement of Income for the three months ended October 31, 2018:

 

   

As reported

under Topic 606

   

Adjustments

   

Balances under

Prior GAAP

 
   

(in thousands, except per share amounts)

 

Revenue

                       

Subscription fees

  $ 23,863     $ (517

)

  $ 23,346  

License fees

    4,631       188       4,819  

Maintenance and other

    30,401       50       30,451  

Professional services

    20,682       (231

)

    20,451  

Total revenue

    79,577       (510

)

    79,067  

Cost of revenue:

                       

Subscription fees

    8,686       (38

)

    8,648  

License fees

    534       -       534  

Maintenance and other

    7,716       -       7,716  

Professional services

    20,425       -       20,425  

Total cost of revenue

    37,361       (38

)

    37,323  

Gross profit

    42,216       (472

)

    41,744  

Operating expenses:

                       

Sales and marketing

    18,447       (306

)

    18,141  

Research and development

    13,155       (59

)

    13,096  

General and administrative

    8,095       -       8,095  

Amortization of intangibles from acquisitions

    45       -       45  

Total operating expenses

    39,742       (365

)

    39,377  

Operating income

    2,474       (107

)

    2,367  

Other (income) expense

                       

Interest income

    (646

)

    -       (646

)

Interest expense

    177       -       177  

Other income

    (636

)

    -       (636

)

Total other income, net

    (1,105

)

    -       (1,105

)

Income before income taxes

    3,579       (107

)

    3,472  

Income tax expense

    597       4       601  

Net income

  $ 2,982     $ (111

)

  $ 2,871  

Basic income per share

                       

Class A

  $ 0.16     $ (0.01

)

  $ 0.15  

Class B

  $ 0.13     $ (0.00

)

  $ 0.13  

Diluted income per share

                       

Class A

  $ 0.14     $ (0.01

)

  $ 0.13  

Class B

  $ 0.12     $ (0.00

)

  $ 0.12  

  

10

 

 

The following table summarizes the effects of adopting Topic 606 on the Company’s Condensed Consolidated Statement of Income for the nine months ended October 31, 2018:

 

 

 

As reported

under Topic 606

 

 

Adjustments

 

 

Balances under

Prior GAAP

 

 

 

(in thousands, except per share amounts)

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

Subscription fees

 

$

67,813

 

 

$

(1,074

)

 

$

66,739

 

License fees

 

 

16,458

 

 

 

(1,198

)

 

 

15,260

 

Maintenance and other

 

 

92,458

 

 

 

163

 

 

 

92,621

 

Professional services

 

 

73,581

 

 

 

(1,077

)

 

 

72,504

 

Total revenue

 

 

250,310

 

 

 

(3,186

)

 

 

247,124

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Subscription fees

 

 

25,248

 

 

 

(24

)

 

 

25,224

 

License fees

 

 

1,772

 

 

 

-

 

 

 

1,772

 

Maintenance and other

 

 

23,355

 

 

 

-

 

 

 

23,355

 

Professional services

 

 

68,489

 

 

 

-

 

 

 

68,489

 

Total cost of revenue

 

 

118,864

 

 

 

(24

)

 

 

118,840

 

Gross profit

 

 

131,446

 

 

 

(3,162

)

 

 

128,284

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

 

57,895

 

 

 

(590

)

 

 

57,305

 

Research and development

 

 

40,674

 

 

 

(177

)

 

 

40,497

 

General and administrative

 

 

26,823

 

 

 

-

 

 

 

26,823

 

Amortization of intangibles from acquisitions

   

45

     

-

 

   

45

 

Total operating expenses

 

 

125,437

 

 

 

(767

)

 

 

124,670

 

Operating income

 

 

6,009

 

 

 

(2,395

)

 

 

3,614

 

Other (income) expense

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

(1,913

)

 

 

-

 

 

 

(1,913

)

Interest expense

 

 

488

 

 

 

-

 

 

 

488

 

Other income

 

 

(1,309

)

 

 

-

 

 

 

(1,309

)

Total other income, net

 

 

(2,734

)

 

 

-

 

 

 

(2,734

)

Income before income taxes

 

 

8,743

 

 

 

(2,395

)

 

 

6,348

 

Income tax expense

 

 

3,251

 

 

 

(75

)

 

 

3,176

 

Net income

 

$

5,492

 

 

$

(2,320

)

 

$

3,172

 

Basic income per share

 

 

 

 

 

 

 

 

 

 

 

 

Class A

 

$

0.29

 

 

$

(0.12

)

 

$

0.17

 

Class B

 

$

0.24

 

 

$

(0.10

)

 

$

0.14

 

Diluted income per share

 

 

 

 

 

 

 

 

 

 

 

 

Class A

 

$

0.26

 

 

$

(0.11

)

 

$

0.15

 

Class B

 

$

0.23

 

 

$

(0.10

)

 

$

0.13

 

   

The following table summarizes the effects of adopting Topic 606 on the financial statement line items of the Company’s Condensed Consolidated Statement of Cash Flows for the nine months ended October 31, 2018:

 

 

 

As reported

under Topic 606

 

 

Adjustments

 

 

Balances under

Prior GAAP

 

 

 

(in thousands)

 

Net income

 

$

5,492

 

 

$

(2,320

)

 

$

3,172

 

Amortization of costs capitalized to obtain and fulfill contracts

 

 

3,107

 

 

 

(2,483

)

 

 

624

 

Net change in valuation allowance

 

 

3,760

 

 

 

648

 

 

 

4,408

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Costs capitalized to obtain and fulfill contracts

 

 

(2,510

)

 

 

1,868

 

 

 

(642

)

Other assets

 

 

688

 

 

 

(258

)

 

 

430

 

Deferred revenue

 

 

(30,977

)

 

 

2,525

 

 

 

(28,452

)

Net cash provided by operating activities

 

 

15,117

 

 

 

(20

)

 

 

15,097

 

Effect of exchange rates on cash and equivalents

 

 

(4,242

)

 

 

20

 

 

 

(4,222

)

 

Recent Accounting Pronouncements Not Yet Adopted

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842).  ASU 2016-02 requires companies to generally recognize on the balance sheet operating and financing lease liabilities and corresponding right-of-use (“ROU”) assets. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842), Targeted Improvements, which allows for an additional optional transition method where comparative periods presented in the financial statements in the period of adoption will not be restated and instead those periods will be presented under existing guidance in accordance with ASC 840, Leases. The ASUs are effective for the Company in its first quarter of fiscal 2020 on a modified retrospective basis and earlier adoption is permitted. The Company has elected to not restate prior periods and will present the cumulative effect of applying the new standard within the opening balance of retained earnings on February 1, 2019, and the Company intends to elect certain other available practical expedients upon adoption. The Company’s leases are made up mostly of real estate, vehicle and equipment leases. As a result, the Company anticipates that ASC 842 will have a material impact on the condensed consolidated balance sheet due to the recognition of ROU assets and lease liabilities for operating leases. The Company does not expect that adoption will have a material impact on the condensed consolidated statement of operations and the statement of cash flows.

 

11

 

 

The Company has completed the first phase of the lease implementation project which includes scoping and contract review. The Company is in the process of completing the quantification of the lease assets and liabilities, assessment of implementation controls, and documentation of the new ASC 842 accounting policy. The Company is continuing to evaluate the impact of this guidance on its financial position, results of operations, cash flows and related disclosures and anticipates that adoption may require changes to its systems and processes.

 

 In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill to eliminate Step 2 from the goodwill impairment test. In addition, it eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if that fails that qualitative test, to perform Step 2 of the goodwill impairment test. Therefore, the same impairment assessment applies to all reporting units. The amendments will be effective for the Company’s fiscal year beginning February 1, 2020. Early adoption is permitted. The new guidance is required to be applied on a prospective basis. The Company does not believe adoption of ASU 2017-04 will have a material impact on its consolidated financial statements.

 

 

 

2.

REVENUE

 

QAD offers its software using the same underlying technology via two models: a traditional on-premises licensing model and a cloud-based subscription model. The on-premises model involves the sale or license of software on a perpetual basis to customers who take possession of the software and install and maintain the software on their own hardware. Under the cloud-based subscription delivery model, QAD provides access to its software on a hosted basis as a service and customers generally do not have the contractual right to take possession of the software.

 

The Company generates revenue through sales of licenses and maintenance provided to its on-premises customers and through subscriptions of its cloud-based software. QAD offers professional services to both its on-premises and cloud customers to assist them with the design, testing and implementation of its software.

 

The Company determines revenue recognition through the following steps:

 -

Identification of the contract, or contracts, with a customer;

 -

Identification of the performance obligations in the contract;

 -

Determination of the transaction price;

 -

Allocation of the transaction price to the performance obligations in the contract; and

 -

Recognition of revenue when, or as, the Company satisfies a performance obligation.

 

Revenue is presented net of sales, value-added and other taxes collected from customers and remitted to government authorities. 

 

Performance Obligations

 

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account under Topic 606. The transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied by transferring the promised good or service to the customer. The Company identifies and tracks the performance obligations at contract inception so that the Company can monitor and account for the performance obligations over the life of the contract.

 

The Company’s contracts which contain multiple performance obligations generally consist of the initial purchase of subscription or licenses and a professional services engagement.  License purchases generally have multiple performance obligations as customers purchase maintenance in addition to the licenses.  The Company’s single performance obligation arrangements are typically maintenance renewals, subscription renewals and services engagements. 

 

For contracts with multiple performance obligations where the contracted price differs from the standalone selling price ("SSP") for any distinct good or service, the Company may be required to allocate the contract’s transaction price to each performance obligation using its best estimate for the SSP. SSP is assessed annually using a historical analysis of contracts with customers executed in the most recently completed fiscal year to determine the range of selling prices applicable to a distinct good or service.

 

Judgment is required to determine the SSP for each distinct performance obligation. The Company rarely licenses or sells its software products on a stand-alone basis, so the Company is required to estimate the range of SSPs for each performance obligation. In instances where SSP is not directly observable because the Company does not sell the license, product or service separately, the Company determines the SSP using information that may include market conditions and other observable inputs. In making these judgments, the Company analyzes various factors, including its pricing methodology and consistency, size of the arrangement, length of term, customer demographics and overall market and economic conditions. Based on these results, the estimated SSP is set for each distinct product or service delivered to customers.

 

Subscription

 

Subscription revenue is recognized ratably over the initial subscription period committed to by the customer commencing when the cloud environment is made available to the customer. The initial subscription period is typically 12 to 60 months. The Company generally invoices its customers in advance in quarterly or annual installments and typical payment terms provide that customers make payment within 30 days of invoice.

 

12

 

 

Software Licenses

 

Transfer of control for software is considered to have occurred upon electronic delivery of the license key that provides immediate availability of the product to the customer. The Company’s typical payment terms tend to vary by region but its standard payment terms are within 30-90 days of invoice.

 

Maintenance

 

Revenue from support services and product updates, referred to as maintenance revenue, is recognized ratably over the term of the maintenance period, which in most instances is one year. Software license updates provide customers with rights to unspecified software product updates, maintenance releases and patches released during the term of the support period on a when-and-if available basis. Product support includes Internet access to technical content, as well as Internet and telephone access to technical support personnel. The Company’s customers purchase both product support and license updates when they acquire new software licenses. In addition, a majority of customers renew their support services contracts annually and typical payment terms provide that customers make payment within 30 days of invoice.

 

Professional Services

 

Revenue from professional services is typically comprised of implementation, development, training or other consulting services. Consulting services are generally sold on a time-and-materials or fixed fee basis and can include services ranging from software installation to data conversion and building non-complex interfaces to allow the software to operate in integrated environments. The Company recognizes revenue for time-and-materials arrangements as the services are performed.  In fixed fee arrangements, revenue is recognized as services are performed as measured by costs incurred to date, compared to total estimated costs to complete the services project.  Management applies judgment when estimating project status and the costs necessary to complete the services projects.  A number of internal and external factors can affect these estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes.  Services are generally invoiced upon milestones in the contract or upon consumption of the hourly resources and payments are typically due 30 days after invoice. 

 

Indirect Sales Channels

 

The Company executes arrangements through indirect sales channels via sales agents and distributors who are authorized to market its software products to end users. In arrangements with sales agents, QAD contracts directly with the customer and sales agents are compensated on a commission basis. Distributor arrangements are those in which the resellers are authorized to market and distribute the Company’s software products to end users in specified territories and the distributor bears the risk of collection from the end user customer. The Company recognizes revenue from transactions with distributors when the distributor submits a signed agreement and transfer of control has occurred to the distributor in accordance with the five revenue recognition steps noted above. Revenue from distributor transactions is recorded on a net basis (the amount actually received by the Company from the distributor). QAD does not offer rights of return, product rotation or price protection to any of its distributors.

 

Disaggregated Revenue

 

The Company disaggregates revenue from contracts with customers by geography and by the customers’ industry within manufacturing, as it believes it best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.

 

The Company’s revenue by geography is as follows:

 

   

Three Months Ended

October 31,

   

Nine Months Ended

October 31,

 
   

2018

   

2017

   

2018

   

2017

 
   

(in thousands)

   

(in thousands)

 

North America

  $ 39,870     $ 37,319     $ 119,183     $ 105,845  

EMEA

    22,549       21,439       74,542       64,547  

Asia Pacific

    12,348       12,550       37,773       37,683  

Latin America

    4,810       5,617       18,812       16,190  

Total revenue

  $ 79,577     $ 76,925     $ 250,310     $ 224,265  

 

13

 

 

The Company’s revenue by industry is as follows:

 

   

Three Months Ended

October 31,

   

Nine Months Ended

October 31,

 
   

2018

   

2017

   

2018

   

2017

 
   

(in thousands)

   

(in thousands)

 

Automotive

  $ 31,035     $ 29,232     $ 102,760     $ 84,508  

Consumer products and food and beverage

    12,732       11,539       40,049       34,353  

High technology and industrial products

    23,873       25,385       74,231       72,534  

Life sciences

    11,937       10,769       33,270       32,870  

Total revenue

  $ 79,577     $ 76,925     $ 250,310     $ 224,265  

 

Management Judgments

 

More judgments and estimates are required under Topic 606 than were required under Topic 605. Due to the complexity of certain contracts, the actual revenue recognition treatment required under Topic 606 for the Company’s arrangements may be dependent on contract-specific terms and may vary in some instances.

 

Revenue is recognized over time for the Company’s subscription, maintenance and fixed fee professional services that are separate performance obligations.  For the Company’s professional services, revenue is recognized over time, generally using costs incurred or hours expended to measure progress. Judgment is required in estimating project status and the costs necessary to complete projects. A number of internal and external factors can affect these estimates, including labor rates, utilization, specification variances and testing requirement changes. 

 

If a group of agreements are entered at or near the same time and so closely related that they are, in effect, part of a single arrangement, such agreements are deemed to be combined as one arrangement for revenue recognition purposes. The Company exercises judgment to evaluate the relevant facts and circumstances in determining whether agreements should be accounted for separately or as a single arrangement. The Company’s judgments about whether a group of contracts comprise a single arrangement can affect the allocation of consideration to the distinct performance obligations, which could have an effect on results of operations for the periods involved.

 

If a contract includes variable consideration, the Company exercises judgment in estimating the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer. When estimating variable consideration, the Company will consider all relevant facts and circumstances. Variable consideration will be estimated and included in the contract price only when it is probable that a significant reversal in the amount of revenue recognized will not occur.

 

Contract Balances  

 

The timing of revenue recognition may differ from the timing of invoicing to customers and these timing differences result in receivables, contract assets, or contract liabilities (deferred revenue) on the Company’s Condensed Consolidated Balance Sheets. QAD records a contract asset when the Company has transferred goods or services but does not yet have the right to consideration. QAD records deferred revenue when the Company has received or has the right to receive consideration but has not yet transferred goods or services to the customer.

 

The contract assets indicated below are presented as other current and non-current assets in the Condensed Consolidated Balance Sheets. These assets primarily relate to professional services and subscription and consist of the Company’s rights to consideration for goods or services transferred but not billed as of October 31, 2018. The contract assets are transferred to receivables when the rights to consideration become unconditional, usually upon completion of a milestone.

 

14

 

 

The Company’s contract balances are as follows:

 

   

As of

 
   

October 31,

2018

   

February 1,

2018

 
   

(In thousands)

 

Contract assets, short-term (in Other current assets, net)

  $ 1,452     $ 890  

Contract assets, long-term (in Other assets, net)

    -       110  

Total contract assets

  $ 1,452     $ 1,000  

Deferred revenue, short-term

  $ 80,537     $ 115,454  

Deferred revenue, long-term (in Other labilities)

    1,071       1,644  

Total deferred revenue

  $ 81,608     $ 117,098  

 

During the three and nine months ended October 31, 2018, the Company recognized $50.2 million and $150.1 million of revenue, respectively, that was included in the deferred revenue balance, as adjusted for Topic 606, at the beginning of the period. All other activity in deferred revenue is due to the timing of invoicing in relation to the timing of revenue recognition.

 

Revenue allocated to remaining performance obligations represents the transaction price allocated to the performance obligations that are unsatisfied, or partially unsatisfied, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. Contracted but unsatisfied performance obligations were approximately $214 million as of October 31, 2018, of which the Company expects to recognize approximately $130.6 million as revenue over the next 12 months and the remainder thereafter. In instances where the timing of revenue recognition differs from the timing of invoicing, QAD has determined that its contracts generally do not include a significant financing component. The primary purpose of invoicing terms is to provide customers with simplified and predictable ways of purchasing the Company’s products and services, and not to facilitate financing arrangements.

 

Deferred Revenue

 

The Company typically invoices its customers for subscription and support fees in advance on a quarterly or annual basis, with payment due at the start of the subscription or support term. Unpaid invoice amounts for non-cancelable services starting in future periods are included in accounts receivable and deferred revenue. The portion of deferred revenue that QAD anticipates will be recognized after the succeeding twelve-month period is recorded as non-current deferred revenue, and the remaining portion is recorded as current deferred revenue.  

 

Deferred revenues consisted of the following:

 

   

As of

 
   

October 31,

2018

   

January 31,

2018

 
   

(in thousands)

 

Deferred maintenance

  $ 50,708     $ 80,811  

Deferred subscription

    27,751       31,034  

Deferred professional services

    1,811       3,523  

Deferred license

    95       756  

Deferred other revenue

    172       569  

Deferred revenues, current

    80,537       116,693  

Deferred revenues, non-current (in Other liabilities)

    1,071       2,156  

Total deferred revenues

  $ 81,608     $ 118,849  

 

Practical Expedients and Exemptions

 

There are several practical expedients and exemptions allowed under Topic 606 that impact timing of revenue recognition and the Company’s disclosures. Below is a list of practical expedients the Company applied in the adoption and application of Topic 606:

 

Application

 

 

The Company does not evaluate a contract for a significant financing component if payment is expected within one year or less from the transfer of the promised items to the customer.

 

 

The Company generally expenses sales commissions and sales agent fees when incurred when the amortization period would have been one year or less. These costs are recorded within sales and marketing expense in the Condensed Consolidated Statement of Operations and Comprehensive Income (Loss).

 

 

The Company also used the practical expedient to calculate contract acquisition costs based on a portfolio of contracts with similar characteristics instead of a contract by contract analysis.

 

15

 

 

 

The Company does not disclose the value of unsatisfied performance obligations for contracts for which the Company recognizes revenue at the amount to which it has the right to invoice for services performed (applies to time-and-material engagements).

 

Modified Retrospective Transition Adjustments

 

 

For contract modifications, the Company reflected the aggregate effect of all modifications that occurred prior to the adoption date when identifying the satisfied and unsatisfied performance obligations, determining the transaction price and allocating the transaction price to satisfied and unsatisfied performance obligations for the modified contract at transition.

 

Costs to Obtain and Fulfill a Contract

 

The Company’s incremental direct costs of obtaining a contract consist of sales commissions and sales agent fees which are deferred and amortized ratably over the term of economic benefit which the Company has determined to be five years. These deferred costs are classified as current or non-current based on the timing of when the Company expects to recognize the expense. Incremental costs related to renewals are expensed as incurred because the term of economic benefit is one year or less. The current and non-current portions of deferred commissions are included in other current assets and other long-term assets, respectively, in the Company’s Condensed Consolidated Balance Sheets. At October 31, 2018 and January 31, 2018, the Company had $10.4 million and $10.1 million, respectively, of deferred commissions and sales agent fees. For the three and nine months ended October 31, 2018, $0.9 million and $2.7 million, respectively, of amortization expense related to deferred commissions and sales agent fees was recorded in sales and marketing expense in the Company’s Condensed Consolidated Statement of Operations and Comprehensive Income (Loss).

 

Costs to fulfill a contract, which are incurred upon initiation of certain services contracts and are related to initial customer setup, are included in other current assets and long-term assets in the Company’s Condensed Consolidated Balance Sheets. At October 31, 2018 and January 31, 2018 the Company had deferred setup costs of $1.5 million. These costs are amortized over the term of economic benefit which the Company has determined to be five years. During the three and nine months ended October 31, 2018, $0.1 million and $0.4 million, respectively, of amortization expense related to deferred setup costs was recorded in cost of subscription in the Company’s Condensed Consolidated Statement of Operations and Comprehensive Income (Loss).

 

Recoverability of these costs is subject to various business risks. Quarterly, the Company compares the carrying value of these assets with the undiscounted future cash flows expected to be generated by them to determine if there is impairment. If impaired, these assets are reduced to an estimated fair value on a discounted cash flow basis. No impairment losses were recognized during the three or nine months ended October 31, 2018.

 

 

 

3.

COMPUTATION OF NET INCOME (LOSS) PER SHARE

 

The following table sets forth the computation of basic and diluted net income (loss) per share:

 

   

Three Months Ended

   

Nine Months Ended

 
   

October 31,

   

October 31,

 
   

2018

   

2017

   

2018

   

2017

 
   

(in thousands, except per share data)

   

(in thousands, except per share data)

 

Net income (loss)

  $ 2,982     $ (161

)

  $ 5,492     $ (3,893

)

Less: Dividends declared

    (1,374

)

    (1,345

)

    (4,105

)

    (4,021

)

Undistributed net income (loss)

  $ 1,608     $ (1,506

)

  $ 1,387     $ (7,914

)

                                 

Net income (loss) per share – Class A Common Stock

                               

Dividends declared

  $ 1,178     $ 1,152     $ 3,518     $ 3,442  

Allocation of undistributed net income (loss)

    1,379       (1,291

)

    1,189       (6,774

)

Net income (loss) attributable to Class A common stock

  $ 2,557     $ (139

)

  $ 4,707     $ (3,332

)

                                 

Weighted average shares of Class A common stock outstanding— basic

    16,358       16,011       16,235       15,913  

Weighted average potential shares of Class A common stock

    1,590             1,676        

Weighted average shares of Class A common stock and potential common shares outstanding— diluted

    17,948       16,011       17,911       15,913  
                                 

Basic net income (loss) per Class A common share

  $ 0.16     $ (0.01

)

  $ 0.29     $ (0.21

)

Diluted net income (loss) per Class A common share

  $ 0.14     $ (0.01

)

  $ 0.26     $ (0.21

)

                                 

Net income (loss) per share – Class B Common Stock

                               

Dividends declared

  $ 196     $ 193     $ 587     $ 579  

Allocation of undistributed net income (loss)

    229       (215

)

    198       (1,140

)

                                 

Net income (loss) attributable to Class B common stock

  $ 425     $ (22

)

  $ 785     $ (561

)

                                 

Weighted average shares of Class B common stock outstanding— basic

    3,264       3,214       3,253       3,212  

Weighted average potential shares of Class B common stock

    169             176        

Weighted average shares of Class B common stock and potential common shares outstanding— diluted

    3,433       3,214       3,429       3,212  
                                 

Basic net income (loss) per Class B common share

  $ 0.13     $ (0.01

)

  $ 0.24     $ (0.17

)

Diluted net income (loss) per Class B common share

  $ 0.12     $ (0.01

)

  $ 0.23     $ (0.17

)

 

16

 

 

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

   

Nine Months Ended

 
   

October 31,

   

October 31,

 
   

2018

   

2017

   

2018

   

2017

 
   

(in thousands)

   

(in thousands)

 

Class A

    241       3,366       285       3,209  

Class B

          378             384  

   

 

4.

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.

 

The following table sets forth the financial assets, measured at fair value, as of October 31, 2018 and January 31, 2018:

 

   

Quoted Prices in

Active Markets for

Identical Assets

(Level 1)

   

Significant Other

Observable Inputs

(Level 2)

 
   

(in thousands)

 

Money market mutual funds as of October 31, 2018 (a)

  $ 110,893          

Money market mutual funds as of January 31, 2018 (a)

  $ 115,416          

Asset related to the interest rate swap as of October 31, 2018 (b)

          $ 385  

Asset related to the interest rate swap as of January 31, 2018 (b)

          $ 187  

___________________________

(a) Money market mutual funds are recorded at fair value based upon quoted market prices.

(b) The asset 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.

(c) There were no financial assets measured using Significant Unobservable Inputs (Level 3).

 

17

 

 

Money market mutual funds are classified as part of “Cash and equivalents” in the accompanying Condensed Consolidated Balance Sheets. The amount of cash and equivalents deposited with commercial banks was $27 million and $32 million as of October 31, 2018 and January 31, 2018, respectively.

 

The Company’s note payable bears a variable market interest rate commensurate with the Company’s credit standing. Therefore, the carrying amount outstanding under the note payable reasonably approximates fair value based on Level 2 inputs.

 

There have been no transfers between fair value measurement levels during the nine months ended October 31, 2018.

 

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 7 “Debt” within these Notes to Condensed Consolidated Financial Statements. The fair value of the interest rate swap is reflected as an asset in the Condensed Consolidated Balance Sheets and the change in fair value is reported in “Other (income) expense” in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). The fair value of the interest rate swap is estimated as the net present value of projected cash flows based upon forward interest rates at the balance sheet date.

 

The fair values of the derivative instrument at October 31, 2018 and January 31, 2018 were as follows (in thousands):

 

 

Asset

 

 

 

 

Fair Value

 

 

Balance Sheet

Location

 

October 31,

2018

 

 

January 31,

2018

 

Derivative instrument:

 

 

 

 

 

 

 

 

 

Interest rate swap

Other assets, net

 

$

385

 

 

$

187

 

Total

 

 

$

385

 

 

$

187

 

 

The change in fair value of the interest rate swap recognized in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) was $46,000 and $198,000 for the three and nine months ended October 31, 2018 and $106,000 and $103,000 for the three and nine months ended October 31, 2017.

 

 

5.

CAPITALIZED SOFTWARE COSTS

 

Capitalized software costs and accumulated amortization at October 31, 2018 and January 31, 2018 were as follows:

 

   

October 31,

2018

   

January 31,

2018

 
   

(in thousands)

 

Capitalized software costs:

               

Capitalized software development costs

  $ 2,026     $ 1,516  

Acquired software technology

    135       -  
      2,161       1,516  

Less accumulated amortization

    (675

)

    (526

)

Capitalized software costs, net

  $ 1,486     $ 990  

 

The Company’s capitalized software development costs relate to translations and localizations of QAD Enterprise Applications. Acquired software technology costs relate to acquired technology purchased during the second quarter fiscal 2019.

 

It is the Company’s policy to write off capitalized software development costs once fully amortized. Accordingly, during the first nine months of fiscal 2019, approximately $0.3 million of costs and accumulated amortization were removed from the balance sheet.

 

Amortization of capitalized software costs was $0.2 million and $0.4 million for the three and nine months ended October 31, 2018 and $0.2 million and $0.6 million for the three and nine months ended October 31, 2017. Amortization of capitalized software costs is included in “Cost of license” in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).

 

18

 

 

The following table summarizes the estimated amortization expense relating to the Company’s capitalized software costs as of October 31, 2018:

 

Fiscal Years

 

(in thousands)

 

2019 remaining

  $ 177  

2020

    660  

2021

    476  

2022

    132  

Thereafter

    41  
    $ 1,486  

 

 

6.

GOODWILL AND INTANGIBLE ASSETS

 

Goodwill

 

The changes in the carrying amount of goodwill for the nine months ended October 31, 2018 were as follows:

 

   

Gross Carrying

Amount

   

Accumulated

Impairment

   

Goodwill, Net

 
   

(in thousands)

 

Balance at January 31, 2018

  $ 26,631     $ (15,608

)

  $ 11,023  

Additions

    1,584       -       1,584  

Impact of foreign currency translation

    (323

)

    -       (323

)

Balance at October 31, 2018

  $ 27,892     $ (15,608

)

  $ 12,284  

 

Additions to goodwill were a result of immaterial acquisitions where the purchase price exceeded the estimated fair value of the acquired net assets. Pro forma financial information for the acquisitions has not been presented, as the effects were not material to the Company’s historical consolidated financial statements.

 

The Company performed its annual goodwill impairment review during the fourth quarter of fiscal 2018. The analysis compared the Company’s market capitalization to its net assets as of the test date, November 30, 2017. As the market capitalization significantly exceeded the Company’s net assets, there was no indication of goodwill impairment for fiscal 2018. The Company monitors the indicators for goodwill impairment testing between annual tests. No adverse events occurred during the nine months ended October 31, 2018 that would cause the Company to test goodwill for impairment.

 

Intangible Assets

 

   

October 31,

2018

 
   

(in thousands)

 

Amortizable intangible assets

       

Customer relationships

  $ 1,258  

Less: accumulated amortization

    (45

)

Net amortizable intangible assets

  $ 1,213  

 

The Company’s intangible assets as of October 31, 2018 are related to the acquisitions completed in the second and third quarters of fiscal 2019. Intangible assets are included in “Other assets, net” in the accompanying Condensed Consolidated Balance Sheets, and are amortized over an estimated 5 year useful life.

 

The following table summarizes the estimated amortization expense relating to the Company’s intangible assets as of October 31, 2018:

 

Fiscal Years

 

(in thousands)

 

2019 remaining

  $ 60  

2020

    243  

2021

    243  

2022

    243  

Thereafter

    424  
    $ 1,213  

 

19

 

 

 

7.

DEBT

 

   

October 31,

2018

   

January 31,

2018

 
   

(in thousands)

 

Note payable

  $ 13,476     $ 13,825  

Less current maturities

    (481

)

    (466

)

Less loan origination costs, net

    (38

)

    (46

)

Long-term debt

  $ 12,957     $ 13,313  

 

Note Payable

 

Effective May 30, 2012, QAD Ortega Hill, LLC, wholly owned by the Company, entered into a variable rate credit agreement (the “2012 Mortgage”) with Rabobank, N.A., to refinance a pre-existing mortgage. The 2012 Mortgage has an original principal balance of $16.1 million and bears interest at the one month LIBOR rate plus 2.25%. One month LIBOR was 2.29% at October 31, 2018. 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, 2018 was $13.5 million.

  

 

8.

ACCUMULATED OTHER COMPREHENSIVE LOSS

 

The components of accumulated other comprehensive loss, net of taxes, were as follows:

 

   

Foreign

Currency

Translation

Adjustments

 
   

(in thousands)

 

Balance as of January 31, 2018

  $ (6,828

)

Other comprehensive loss before reclassifications

    (2,010

)

Amounts reclassified from accumulated other comprehensive loss

    -  

Net current period other comprehensive loss

    (2,010

)

Balance as of October 31, 2018

  $ (8,838

)

 

 

9.

INCOME TAXES

 

In determining the provision for income taxes for the first nine months of fiscal 2019, the Company calculated income tax expense based on the estimated annual tax rate for the year, compared to the prior year when the Company calculated income tax expense based on actual quarterly results. The annual effective tax rate was adjusted for discrete items recorded during both periods. The estimated annual tax rate for the year was used in the current period since the Company is forecasting profits for the full fiscal year 2019.

 

The Company recorded income tax expense of $0.6 million and $1.2 million in the third quarter of fiscal 2019 and 2018, respectively. The Company’s effective tax rate decreased to 17% during the third quarter of fiscal 2019 compared to 115% for the same period in the prior year. The difference in the effective tax rate is primarily due applying an annual effective tax rate to the forecasted profits in the third quarter of fiscal 2019 compared to calculating income tax expense based on actual quarterly results for the same period of fiscal 2018.

 

The Company recorded income tax expense of $3.3 million and $2.7 million for the first nine months of fiscal 2019 and 2018, respectively. The Company’s effective tax rate was 37% compared to (227%) for the same period in the prior year. The change in the effective tax rate is primarily due to forecasted profits for the first nine months of fiscal 2019 compared to the pre-tax loss for the same period of fiscal 2018.

 

When calculating income tax expense for the first nine months of fiscal 2019, the Company considered the U.S. Tax Cuts and Jobs Act (“Tax Act”) enacted December 22, 2017. The Tax Act imposed a deemed repatriation tax on accumulated earnings of foreign subsidiaries, reduced the U.S. corporate tax rate to 21% and introduced a new tax on global intangible low taxed income (“GILTI”). On August 1, 2018, the IRS and U.S. Department of Treasury issued proposed regulations on the one-time transition tax under Section 965.

 

20

 

 

As of October 31, 2018, the Company has not completed its accounting for all the tax effects of the 2017 Tax Act. However, the Company made what it believes to be a reasonable estimate of certain effects of the 2017 Tax Act. During the third quarter of fiscal 2019, the Company maintained its provisional estimate of the fiscal 2018 deemed repatriation tax of $10.0 million. This additional income tax expense was partially offset by net operating losses and tax credits. Subsequent to the close of the third quarter fiscal 2019, the Company completed its calculations of the Transition Tax and finalized its U.S. federal income tax return. The provisional tax expense for the Transition Tax is anticipated to be reduced from $2.0 million to $0.7 million. Due to the complexities of the calculations and the pending authoritative guidance the Company considers all tax reform related amounts as provisional. The Company expects final accounting related to the remeasurement of its existing deferred tax assets under SAB 118 to be complete during the fourth quarter of fiscal year 2019. The Company elected to pay the estimated repatriation tax liability over a period of eight years as permitted by the Tax Act. 

 

The Company included a provision for GILTI in the Company’s tax expense for the first nine months of fiscal 2019. The provisional GILTI estimate considered the proposed regulations released on September 13, 2018 by the U.S. Department of Treasury. Cash taxes and the Company’s effective tax rate were only slightly impacted by GILTI since the Company has sufficient tax credits to offset the additional liability. The Company has not recorded deferred taxes related to these GILTI provisions and has not yet determined its policy election with respect to whether it will treat GILTI as a current-period expense when incurred (the “period cost method”) or factor such amount into the measurement of deferred taxes (the “deferred method”). This decision will be made by year end as we evaluate the impact of proposed regulations and notices.

 

The Company adopted ASU 2016-16 Income taxes (Topic 740) Intra-entity Transfers of Assets Other Than Inventory during the three months ended April 30, 2018, which required all income tax effects of intra-entity transfers of assets other than inventory to be recognized in the Condensed Consolidated Statement of Operations and Comprehensive Income (Loss) when the transfer occurs. As a result of the adoption, the Company recorded $9.6 million to accumulated deficit and deferred tax asset at February 1, 2018 to account for the intra-entity sale of Intellectual Property that occurred in the fiscal year 2018.  

 

The gross amount of unrecognized tax benefits was $1.2 million at October 31, 2018, including interest and penalties. During the quarter the balance was reduced by $0.5 million after a tax dispute was resolved with the tax authority in one of our foreign jurisdictions. The unrecognized tax benefits were reduced by $0.9 million with an accompanying reduction of deferred tax assets, as a result of the netting required under ASU 2013-11. The entire amount of unrecognized tax benefits, if recognized, will impact the Company’s effective tax rate. This liability is classified as long-term unless the liability is expected to conclude within twelve months of the reporting date.

 

The Company’s policy is to recognize interest and penalties, if any, related to unrecognized tax benefits as a component of income tax expense. As of October 31, 2018, the Company has accrued approximately $0.1 million of interest and penalty expense relating to unrecognized tax benefits.

 

The Company reviews its net deferred tax assets by jurisdiction on a quarterly basis to determine whether a valuation allowance is necessary based on the more-likely-than-not standard. Management assesses historic, current and future financial projections by jurisdiction to draw its conclusion. During fiscal 2017, a valuation allowance for U.S. federal and state deferred tax assets was established.  For the quarter ended October 31, 2018, the Company continues to maintain a full valuation allowance on its U.S. federal and state deferred tax assets.  At October 31, 2018 and January 31, 2018, the valuation allowance attributable to deferred tax assets was $35.4 million and $33.7 million, respectively.

 

The Company files U.S. federal, state, and foreign tax returns that are subject to audit by various tax authorities. The Company is currently under audit in:

 

 

India for fiscal years ended March 31, 2010, 2013, 2014

 

 

 

 

Netherlands for fiscal year ended January 31, 2016

 

 

 

 

Germany for fiscal years ended January 31, 2015, 2016, 2017

 

 

Tennessee for fiscal years ended January 31, 2014, 2015, 2016, 2017

 

During fiscal 2019, the Company closed the following audits with no adjustment:

 

 

Iowa for fiscal year ended January 31, 2014

 

 

 

 

Kentucky for fiscal year ended  January 31, 2016

 

21

 

 

 

10.

STOCKHOLDERS’ EQUITY

 

Dividends

 

The following table sets forth the dividends that were declared by the Company during the first nine months of fiscal 2019:

 

Declaration

Date

Record Date

Payable

 

Dividend

Class A

 

 

Dividend

Class B

 

 

(in thousands)

 

9/11/2018

9/25/2018

10/2/2018

 

$

0.072

 

 

$

0.06

 

 

$

1,374

 

6/11/2018

6/25/2018

7/6/2018

 

$

0.072

 

 

$

0.06

 

 

$

1,372

 

4/10/2018

4/24/2018

5/1/2018

 

$

0.072

 

 

$

0.06

 

 

$

1,359

 

  

 

11.

STOCK-BASED COMPENSATION

 

The Company’s equity awards consist of RSUs and SARs. For a description of the Company’s stock-based compensation plans, see Note 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, 2018.

 

Stock-Based Compensation

 

The following table sets forth reported stock-based compensation expense for the three and nine months ended October 31, 2018 and 2017:

 

   

Three Months Ended

October 31,

   

Nine Months Ended

October 31,

 
   

2018

   

2017

   

2018

   

2017

 
   

(in thousands)

   

(in thousands)

 

Cost of subscription

  $ 65     $ 37     $ 182     $ 98  

Cost of maintenance and other revenue

    148       107       358       279  

Cost of professional services

    353       309       906       803  

Sales and marketing

    611       421       1,547       1,106  

Research and development

    442       338       1,170       895  

General and administrative

    529       1,099       3,455       3,490  

Total stock-based compensation expense

  $ 2,148     $ 2,311     $ 7,618     $ 6,671  

 

 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, 2018: 

 

   

RSUs

   

Weighted

Average

Grant Date

Fair Value

 
   

(in thousands)

         

Outstanding at January 31, 2018

    653     $ 25.10  

Granted

    276       52.75  

Released (1)

    (262

)

    25.82  

Forfeited

    (20

)

    29.67  

Outstanding at October 31, 2018

    647     $ 36.47  

_________________________

 

(1)

The number of RSUs released includes shares withheld on behalf of employees to satisfy the minimum statutory tax withholding requirements.

 

The Company withholds a portion of the released shares as consideration for the Company’s payment of applicable employee income taxes. During the three months ended October 31, 2018, the Company withheld 2,000 shares for payment of these taxes at a value of $0.1 million. During the nine months ended October 31, 2018, the Company withheld 80,000 shares for payment of these taxes at a value of $4.3 million.

  

22

 

 

Total unrecognized compensation cost related to RSUs was approximately $20.4 million as of October 31, 2018. This cost is expected to be recognized over a weighted-average period of approximately 3.0 years. 

 

SAR Information

 

The weighted average assumptions used to value SARs granted in the nine months ended October 31, 2018 and 2017 are shown in the following table:

 

   

Nine Months Ended

October 31,

 
   

2018

   

2017

 

Expected life in years (1)