XNAS:QADB QAD Inc Quarterly Report 10-Q Filing - 7/31/2012

Effective Date 7/31/2012

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

FORM 10-Q

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

For the quarterly period ended July 31, 2012

OR

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

As of August 31, 2012, there were 12,576,615 shares of the Registrant’s Class A common stock outstanding and 3,158,678 shares of the Registrant’s Class B common stock outstanding.
 


 
 

 
 
QAD INC.
 
PART I - FINANCIAL INFORMATION
Page
       
 
ITEM 1
 
       
   
1
       
   
2
       
   
3
       
   
4
       
 
ITEM 2
14
       
 
ITEM 3
26
       
 
ITEM 4
27
       
PART II - OTHER INFORMATION
 
       
 
ITEM 1
28
       
 
ITEM 1A 
28
       
 
ITEM 2
28
       
 
ITEM 6
29
       
  SIGNATURES
30

 
 

 
PART I
 
ITEM 1 –
FINANCIAL STATEMENTS

QAD INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)

   
July 31,
2012
   
January 31,
2012
 
Assets
           
Current assets:
           
Cash and equivalents
  $ 73,843     $ 76,927  
Accounts receivable, net
    36,343       64,757  
Deferred tax assets, net
    4,365       4,355  
Other current assets
    11,448       11,853  
Total current assets
    125,999       157,892  
Property and equipment, net
    33,106       33,139  
Capitalized software costs, net
    2,334       583  
Goodwill
    8,739       6,412  
Deferred tax assets, net
    17,427       17,285  
Other assets, net
    3,982       2,834  
Total assets
  $ 191,587     $ 218,145  
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Current portion of long-term debt
  $ 388     $ 321  
Accounts payable
    7,539       9,724  
Deferred revenue
    77,111       93,871  
Other current liabilities
    24,266       31,099  
Total current liabilities
    109,304       135,015  
Long-term debt
    15,659       15,813  
Other liabilities
    6,095       5,302  
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 14,147,996 shares and 14,146,418 shares at July 31, 2012 and January 31, 2012, respectively
    14       14  
Class B, $0.001 par value. Authorized 4,000,000 shares; issued 3,536,816 shares and 3,536,609 shares at July 31, 2012 and January 31, 2012, respectively
    4       4  
Additional paid-in capital
    148,601       148,993  
Treasury stock, at cost (1,901,186 shares and 1,804,137 shares at July 31, 2012 and January 31, 2012, respectively)
    (28,762 )     (27,968 )
Accumulated deficit
    (49,344 )     (48,974 )
Accumulated other comprehensive loss
    (9,984 )     (10,054 )
Total stockholders’ equity
    60,529       62,015  
Total liabilities and stockholders’ equity
  $ 191,587     $ 218,145  

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
 July 31,
   
Six Months Ended
 July 31,
 
   
2012
    2011    
2012
    2011  
Revenue:
                               
License fees
  $ 6,906     $ 8,550     $ 14,771     $ 14,894  
Maintenance and other
    33,886       35,393       68,406       69,731  
Subscription fees
    3,745       2,322       6,968       4,530  
Professional services
    16,432       15,692       34,532       32,205  
Total revenue
    60,969       61,957       124,677       121,360  
                                 
Costs of revenue:
                               
License fees
    832       1,004       1,713       2,035  
Maintenance, subscription and other
    10,341       9,067       20,341       17,842  
Professional services
    15,846       16,741       31,584       33,029  
Total cost of revenue
    27,019       26,812       53,638       52,906  
                                 
Gross profit
    33,950       35,145       71,039       68,454  
                                 
Operating expenses:
                               
Sales and marketing
    14,747       13,864       30,243       28,353  
Research and development
    9,210       9,237       18,744       17,720  
General and administrative
    8,435       7,397       16,540       15,110  
Total operating expenses
    32,392       30,498       65,527       61,183  
                                 
Operating income
    1,558       4,647       5,512       7,271  
                                 
Other (income) expense:
                               
Interest income
    (164 )     (146 )     (327 )     (282 )
Interest expense
    330       287       616       557  
Other (income) expense, net
    92       (356 )     538       462  
Total other (income) expense
    258       (215 )     827       737  
                                 
Income before income taxes
    1,300       4,862       4,685       6,534  
Income tax expense
    341       1,792       1,882       2,444  
                                 
Net income
  $ 959     $ 3,070     $ 2,803     $ 4,090  
                                 
Basic net income per share
                               
Class A
  $ 0.06     $ 0.20     $ 0.18     $ 0.26  
Class B
  $ 0.05     $ 0.16     $ 0.15     $ 0.22  
Diluted net income per share
                               
Class A
  $ 0.06     $ 0.19     $ 0.18     $ 0.26  
Class B
  $ 0.05     $ 0.16     $ 0.15     $ 0.21  
                                 
Comprehensive income:
                               
Foreign currency translation adjustment, net of tax
    (75 )     43       70       (527 )
Total comprehensive income
  $ 884     $ 3,113     $ 2,873     $ 3,563  

See Accompanying Notes to Condensed Consolidated Financial Statements.
 
 
2

 
QAD INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

   
Six Months Ended
 July 31,
 
   
2012
   
2011
 
             
Cash flows from operating activities:
           
Net income
  $ 2,803     $ 4,090  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    2,361       2,443  
Provision for doubtful accounts and sales adjustments
    64       150  
Change in fair value of interest rate swap
    857        
Stock compensation expense
    2,467       2,274  
Excess tax benefits from share-based payment arrangements
    (123 )     (11 )
Other, net
          (139 )
Changes in assets and liabilities:
               
Accounts receivable
    28,241       24,844  
Other assets
    267       2,197  
Accounts payable
    (2,517 )     (3,463 )
Deferred revenue
    (16,058 )     (13,827 )
Other liabilities
    (6,989 )     (5,251 )
Net cash provided by operating activities
    11,373       13,307  
Cash flows from investing activities:
               
Purchase of property and equipment
    (2,029 )     (1,969 )
Acquisition of business, net of cash acquired
    (4,713 )     (6 )
Capitalized software costs
    (199 )     (117 )
Other
    2       19  
Net cash used in investing activities
    (6,939 )     (2,073 )
Cash flows from financing activities:
               
Repayments of debt
    (111 )     (172 )
Tax payments, net of proceeds, related to stock awards
    (786 )     (356 )
Excess tax benefits from share-based payment arrangements
    123       11  
Repurchase of common stock
    (3,899 )      
Cash dividends paid
    (1,841 )     (645 )
Net cash used in financing activities
    (6,514 )     (1,162 )
                 
Effect of exchange rates on cash and equivalents
    (1,004 )     1,490  
                 
Net (decrease) increase in cash and equivalents
    (3,084 )     11,562  
                 
Cash and equivalents at beginning of period
    76,927       67,276  
                 
Cash and equivalents at end of period
  $ 73,843     $ 78,838  
                 
Supplemental disclosure of non-cash activities:
               
Future obligations associated with dividend declaration
  $ 1,115     $ 935  
Dividends paid in stock
    334       1,224  
 
See Accompanying Notes to Condensed Consolidated Financial Statements.
 
 
3

 
QAD INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. 
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, 2012. The Condensed Consolidated Financial Statements include the results of the Company and its wholly owned subsidiaries. The results of operations for the three and six months ended July 31, 2012 are not necessarily indicative of the results to be expected for the year ending January 31, 2013.
 
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
 July 31,
   
Six Months Ended
July 31,
 
   
2012
   
2011
   
2012
   
2011
 
   
(in thousands)
   
(in thousands)
 
Net income
  $ 959     $ 3,070     $ 2,803     $ 4,090  
Less: Dividends declared
    (1,110 )     (947 )     (2,187 )     (1,881 )
Undistributed net income (loss)
  $ (151 )   $ 2,123     $ 616     $ 2,209  
                                 
Net income per share – Class A Common Stock
                               
Dividends declared
  $ 920     $ 785     $ 1,810     $ 1,559  
Allocation of undistributed net income
    (125 )     1,759       509       1,830  
Net income attributable to Class A common stock
  $ 795     $ 2,544     $ 2,319     $ 3,389  
                                 
Weighted average shares of Class A common stock outstanding—basic
    12,649       12,900       12,671       12,849  
Weighted average potential shares of Class A common stock
    433       397       473       393  
Weighted average shares of Class A common stock and potential common shares outstanding—diluted
    13,082       13,297       13,144       13,242  
                                 
Basic net income per Class A common share
  $ 0.06     $ 0.20     $ 0.18     $ 0.26  
Diluted net income per Class A common share
  $ 0.06     $ 0.19     $ 0.18     $ 0.26  
                                 
Net income per share – Class B Common Stock
                               
Dividends declared
  $ 190     $ 162     $ 377     $ 322  
Allocation of undistributed net income
    (26 )     364       107       379  
Net income attributable to Class B common stock
  $ 164     $ 526     $ 484     $ 701  
                                 
Weighted average shares of Class B common stock outstanding—basic
    3,164       3,195       3,166       3,189  
Weighted average potential shares of Class B common stock
    100       99       108       99  
Weighted average shares of Class B common stock and potential common shares outstanding—diluted
    3,264       3,294       3,274       3,288  
                                 
Basic net income per Class B common share
  $ 0.05     $ 0.16     $ 0.15     $ 0.22  
Diluted net income per Class B common share
  $ 0.05     $ 0.16     $ 0.15     $ 0.21  

 
4


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 are not considered participating securities as they do not have rights to dividends or dividend equivalents prior to release. In addition, the Company’s unexercised stock options and SARs are not considered participating securities as they do not have rights to dividends or dividend equivalents prior to exercise. Class A common stock equivalents of approximately 2.3 million and 2.2 million for the three and six months ended July 31, 2012, respectively, were not included in the diluted calculation because their effects were anti-dilutive. Class B common stock equivalents of approximately 0.3 million and 0.4 million for the three and six months ended July 31, 2012, respectively, were not included in the diluted calculation because their effects were anti-dilutive. Class A common stock equivalents of approximately 2.2 million and 2.1 million for the three and six months ended July 31, 2011, respectively, were not included in the diluted calculation because their effects were anti-dilutive. Class B common stock equivalents of approximately 0.5 million for the three and six months ended July 31, 2011 were not included in the diluted calculation because their effects were anti-dilutive.

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. Money market mutual funds are recorded at fair value based upon quoted market prices and are therefore included in Level 1.  The 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, and is therefore included in Level 2.

The following table sets forth the financial assets and liabilites measured at fair value, as of July 31, 2012 and January 31, 2012:

   
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 July 31, 2012
  $ 50,180     $     $  
Money market mutual funds as of January 31, 2012
  $ 48,242     $     $  
Liability related to interest rate swap as of July 31, 2012
  $     $ (857 )   $  
 
 
5


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 included cash deposited with commercial banks of $23.7 million and $28.7 million as of July 31, 2012 and January 31, 2012, respectively.

There have been no transfers between fair value measurement levels during the six months ended July 31, 2012.

The carrying amounts of cash and equivalents, accounts receivable and accounts payable approximate fair value due to the short-term maturities of these instruments. The Company’s line of credit and note payable both bear a variable market interest rate, subject to certain minimum interest rates. Therefore, the carrying amounts outstanding under the line of credit and note payable reasonably approximate fair value.

Derivative Instruments

The Company entered into an interest rate swap in May 2012 to mitigate the exposure to the variability in 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 or liability in the Condensed Consolidated Balance Sheets and the change in fair value is reported in “Other (income) expense” 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.  A valuation statement is provided by the counterparty to the swap.

The fair values of the derivative instrument at July 31, 2012 and January 31, 2012 were as follows (in thousands):
 
 
Asset/(Liability) Derivative
 
     
Fair Value
 
 
Balance Sheet
Location
 
July 31,
2012
   
January 31,
2012
 
Derivative instrument:
                 
Interest rate swap
Other liabilities
 
$
(857
)
 
$
 
Total
 
 
$
(857
)
 
$
 
 
The change in fair value of the interest rate swap recognized in the Condensed Consolidated Statements of Income and Comprehensive Income for both the three and six months ended July 31, 2012 was $0.9 million.

4. 
BUSINESS COMBINATIONS

On June 6, 2012, the Company acquired all of the outstanding stock of DynaSys S.A. ("DynaSys"), a provider of supply chain planning software solutions.  DynaSys was founded in 1985 and is headquartered in Strasbourg, France. The total purchase price of $7.5 million was paid in cash on June 6, 2012. In connection with the acquisition, the Company placed $0.6 million of the purchase price into escrow to satisfy any claims for indemnification made in accordance with the terms of the stock purchase agreement. Any remaining funds will be disbursed to DynaSys’ former shareholders six months after the acquisition date.  The Company completed the acquisition for the purpose of expanding its product offerings and driving revenue growth.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date (in thousands):
 
Tangible assets, including cash acquired of $2.8 million
 
$
4,250
 
Goodwill
 
 
2,356
 
Other intangible assets
 
 
3,500
 
Total assets acquired
 
 
10,106
 
Liabilities assumed
 
 
(2,032
)
Deferred tax liability
   
(575
)
Net assets acquired
 
$
7,499
 
 
 
6

 
Identified intangible assets will be amortized to cost of license and operating expense based upon the nature of the asset ratably over the estimated useful life, as detailed in the table below (in thousands, except year amounts).
 
 
 
Estimated
useful life
(years)
 
 
Fair
value
 
 
Estimated
annual
amortization
 
 
Statement of operations
classification
 
Software technology
 
5
 
 
$
1,800
 
 
$
360
 
 
Cost of license
 
Customer relationships
 
5
 
 
 
1,400
 
 
 
280
 
 
General and administrative
 
Trade name
 
5
 
 
 
300
 
 
 
60
 
 
General and administrative
 
 
 
   
 
$
3,500
 
 
           

The Company has evaluated and continues to evaluate pre-acquisition contingencies relating to DynaSys that existed as of the acquisition date. The Company has preliminarily determined that certain of these pre-acquisition contingencies are probable in nature and estimable as of the acquisition date and, accordingly, has recorded its best estimates for these contingencies as a part of the purchase price allocation. The Company continues to gather information and evaluate pre-acquisition contingencies that it has assumed. If the Company makes changes to the amounts recorded or identifies additional pre-acquisition contingencies during the remainder of the measurement period, such amounts recorded will be included in the purchase price allocation.

The results of DynaSys operations are included in the Consolidated Financial Statements from the date of acquisition. The acquisition was not deemed material, thus pro forma supplemental information has not been provided.

5. 
CAPITALIZED SOFTWARE COSTS

Capitalized software costs and accumulated amortization at July 31, 2012 and January 31, 2012 were as follows:

   
July 31,
2012
   
January 31,
2012
 
   
(in thousands)
 
Capitalized software costs:
           
   Acquired software technology
  $ 1,800     $  
   Capitalized software development costs
    1,081       1,194  
      2,881       1,194  
   Less accumulated amortization
    (547 )     (611 )
   Capitalized software costs, net
  $ 2,334     $ 583  

Acquired software technology costs relate to technology purchased from the Company’s second quarter fiscal 2013 acquisition of DynaSys, as described in Note 4 “Business Combinations” within these Notes to Condensed Consolidated Financial Statements. In addition to the acquired software technology, the Company has capitalized costs related to translations and localizations of QAD Enterprise Applications.

It is the Company’s policy to write off capitalized software development costs once fully amortized. Accordingly, during the first six months of fiscal 2013, $0.3 million of costs and accumulated amortization was removed from the balance sheet. Amortization of capitalized software costs was $0.1 million and $0.2 million for the three and six months ended July 31, 2012, respectively. For the three and six months ended July 31, 2011, amortization of capitalized software costs was $0.1 million and $0.3 million, respectively. Amortization of capitalized software costs is included in “Cost of license fees” in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income.

 
7


The following table summarizes the estimated amortization expense relating to the Company’s capitalized software costs as of July 31, 2012:

Fiscal Years
 
(in thousands)
 
2013 remaining
 
$
343
 
2014
 
 
618
 
2015
 
 
489
 
2016
 
 
404
 
2017
 
 
360
 
Thereafter
 
 
120
 
 
 
$
2,334
 
 
6. 
GOODWILL AND INTANGIBLE ASSETS
 
Goodwill

The changes in the carrying amount of goodwill for the six months ended July 31, 2012, were as follows:
 
   
Gross Carrying
Amount
   
Accumulated
Impairment
   
Goodwill, Net
 
           
(in thousands)
         
Balance at January 31, 2012
  $ 22,020     $ (15,608 )   $ 6,412  
Impact of foreign currency translation
    (29 )           (29 )
Additions
    2,356             2,356  
Balance at July 31, 2012
  $ 24,347     $ (15,608 )   $ 8,739  

Additions to goodwill relate to the Company’s second quarter fiscal 2013 acquisition of DynaSys due to the excess purchase price over the estimated fair value of acquired net assets. For further explanation of acquisition related transactions, see Note 4 “Business Combinations” within these Notes to Condensed Consolidated Financial Statements.

The Company monitors the indicators for goodwill impairment testing between annual tests. No adverse events occurred during the six months ended July 31, 2012 that would cause the Company to test goodwill for impairment.
 
Intangible Assets
 
   
July 31,
2012
   
January 31,
2012
 
   
(in thousands)
 
Amortizable intangible assets
           
Customer relationships
  $ 1,400     $  
Trade name
    300        
      1,700        
Less: accumulated amortization
    (57 )      
Net amortizable intangible assets
  $ 1,643     $  

 
The Company’s intangible assets as of July 31, 2012 are related to the DynaSys acquisition completed in the second quarter of fiscal 2013. Intangible assets are included in “Other assets, net” in the accompanying Condensed Consolidated Balance Sheets. As of July 31, 2012, excluding goodwill, 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 $57,000 for the both the three and six months ended July 31, 2012. For the three and six months ended July 31, 2011, amortization of intangible assets was zero and $14,000, respectively. Amortization of intangible assets is included in “General and administrative” in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income. The following table summarizes the estimated amortization expense relating to the Company’s intangible assets as of July 31, 2012:

 
8


Fiscal Years
 
(in thousands)
 
2013 remaining
  $ 170  
2014
    340  
2015
    340  
2016
    340  
2017
    340  
Thereafter
    113  
 
  $ 1,643  

7. 
DEBT

   
July 31,
2012
   
January 31,
2012
 
   
(in thousands)
 
Note payable
  $ 16,047     $ 16,134  
Less current maturities
    (388 )     (321 )
Long-term debt
  $ 15,659     $ 15,813  

Note Payable

In July 2004, QAD Ortega Hill, LLC, a limited liability company wholly owned by QAD Inc. (“QAD Ortega Hill, LLC”), entered into a loan agreement (the “2004 Mortgage”) with Rabobank, N.A. The 2004 Mortgage had an original principal amount of $18.0 million and bore interest at a fixed rate of 6.5%. The 2004 Mortgage was secured by the Company’s headquarters located in Santa Barbara, California. The terms of the 2004 Mortgage provided for QAD Ortega Hill, LLC to make 119 monthly payments of $115,000 consisting of principal and interest and one final principal payment of $15.4 million. The 2004 Mortgage was scheduled to mature in July 2014. The 2004 Mortgage was refinanced on May 30, 2012 as described below. The unpaid balance as of the date of the refinance was $16.1 million.

Effective May 30, 2012, QAD Ortega Hill, LLC entered into a variable rate credit agreement (the “2012 Mortgage”) with Rabobank, N.A., to refinance the 2004 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 0.25% at July 31, 2012.  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 July 31, 2012 was $16.0 million.

Credit Facility

On July 8, 2011, the Company entered into an unsecured credit agreement with Rabobank, N.A. (the “Facility”). The Facility provided a one-year commitment through July 15, 2012 for a $20 million line of credit for working capital or other business needs. The Company paid 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 bore interest at a rate equal to one month LIBOR plus 0.75%. On July 13, 2012, the Company entered into an amendment to the Facility. The amendment extended the maturity of the Facility from July 15, 2012 to July 15, 2014. The amendment did not provide for any change in the variable rate of interest or debt covenants.
 
 
9


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. At July 31, 2012, the effective borrowing rate would have been 1.0%.

As of July 31, 2012, there were no borrowings under the Facility and the Company was in compliance with the financial covenants.

8. 
INCOME TAXES

The total amount of unrecognized tax benefits was $2.6 million at July 31, 2012. 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 both foreign and domestic tax authorities related to tax credits and deductions, an estimated $0.3 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 July 31, 2012, 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 fiscal years ended March 31, 1998, 1999, 2008, 2009, and 2010, and in California for fiscal years ended 2004 and 2005.

9. 
STOCKHOLDERS’ EQUITY

Dividends

The following table sets forth the dividends declared and/or paid by the Company during fiscal 2013:
 
Declaration
Date
 
Record Date
Payable
 
Dividend
Class A
   
Dividend
Class B
    Amount Paid
in Cash
    Class A
Shares Issued
    Fair Value of
Shares Issued
 
6/12/2012
8/28/2012
10/9/2012
  $ 0.072     $ 0.060    
 
   
 
   
 
 
3/20/2012
6/4/2012
7/16/2012
  $ 0.072     $ 0.060     $ 893,000       15,000     $ 206,000  
12/14/2011
3/13/2012
4/23/2012
  $ 0.072     $ 0.060     $ 948,000       12,000     $ 128,000  

Shares issued in payment of these dividends were issued out of treasury stock.

Stock Repurchase Activity

In September 2011, the Company’s Board of Directors approved a stock repurchase plan. A total of one million shares may be repurchased under the plan and it may be suspended or discontinued at any time. Repurchases may be effected from time to time through open market purchases or pursuant to the Company’s Rule 10b5-1 plan.

In fiscal 2013, the Company repurchased 266,000 shares and 30,000 shares of the Company’s Class A and Class B common stock, respectively. The average share price was $13.19 and $13.12 for Class A and Class B stock, respectively, for total cash consideration of $3.9 million including fees. A total of 328,000 shares remain available for purchase under the plan as of July 31, 2012.
 
10. 
STOCK-BASED COMPENSATION

The Company’s equity awards consist of stock options, SARs and RSUs. For a description of the Company’s stock-based compensation plans, see Note 9 “Stock-Based Compensation” in Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended January 31, 2012. On June 12, 2012, the Company’s stockholders approved an amendment to the 2006 Stock Incentive Program to provide for an increase in the number of shares of Class A Common Stock reserved for issuance by 2,000,000 shares.

 
10


Stock-Based Compensation

The following table sets forth reported stock-based compensation expense for the three and six months ended July 31, 2012 and 2011:

   
Three Months Ended
July 31,
   
Six Months Ended
July 31,
 
   
2012
   
2011
   
2012
   
2011
 
   
(in thousands)
   
(in thousands)
 
Cost of maintenance, subscription and other revenue
  $ 60     $ 59     $ 108     $ 111  
Cost of professional services
    139       170       250       295  
Sales and marketing
    249       227       436       437  
Research and development
    197       188       350       355  
General and administrative
    783       518       1,323       1,076  
Total stock-based compensation expense
  $ 1,428     $ 1,162     $ 2,467     $ 2,274  

Option/SAR Information

The weighted average assumptions used to value SARs granted in the six months ended July 31, 2012 and 2011 are shown in the following table:
 
   
Six Months Ended
July 31,
 
   
2012
   
2011
 
Expected life in years (1)
  4.62     3.81  
Risk free interest rate (2)
  0.69%     1.17%  
Volatility (3)
  61%     66%  
Dividend rate (4)
  2.25%     2.38%  
 

(1)
The expected life of SARs granted under the stock-based compensation plans is based on historical vested stock option and SAR exercise and post-vest forfeiture patterns and includes an estimate of the expected term for stock options and 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 three months ending on July 31, 2012.

 
11

 
The following table summarizes the activity for outstanding stock options and SARs for the fiscal year ended January 31, 2012 and the six months ended July 31, 2012:

 
 
 
 
Stock Options/
SARs
(in thousands)
   
Weighted
Average
Exercise
Price per
Share
   
Weighted Average
Remaining
Contractual
Term (years)
   
 
Aggregate
Intrinsic Value
(in thousands)
 
Outstanding at January 31, 2011
    2,653     $ 11.33          
 
 
Granted
    502       10.28              
Exercised
    (164 )     8.08              
Expired
    (46 )     14.28              
Forfeited
    (74 )     9.26              
Outstanding at January 31, 2012
    2,871     $ 11.34              
Granted
    564       12.90              
Exercised
    (196 )     8.21              
Expired
    (216 )     22.52              
Forfeited
    (19 )     9.54              
Outstanding at July 31, 2012
    3,004     $ 11.04       5.2     $ 9,308  
Vested and expected to vest at July 31, 2012 (1)
    2,924     $ 11.05       5.2     $ 9,054  
Vested and exercisable at July 31, 2012
    1,410     $ 11.33       3.4     $ 4,360  
 

(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 July 31, 2012 and the exercise price for in-the-money stock options and SARs) that would have been received by the holders if all stock options and SARs had been exercised on July 31, 2012. The total intrinsic value of stock options or SARs exercised in the three and six months ended July 31, 2012 was $0.3 million and $1.0 million, respectively. The total intrinsic value of stock options or SARs exercised in the three and six months ended July 31, 2011 was $0.1 million and $0.2 million, respectively. The weighted average grant date fair value per share of SARs granted in the three and six months ended July 31, 2012 was $5.38.  The weighted average grant date fair value per share of SARs granted in the three and six months ended July 31, 2011 was $4.15 and $4.14, respectively.

The number of SARs exercised includes shares withheld on behalf of employees to satisfy minimum statutory tax withholding requirements.  During the three months ended July 31, 2012, the Company withheld 7,000 shares for payment of these taxes at a value of $90,000. During the six months ended July 31, 2012, the Company withheld 26,000 shares for payment of these taxes at a value of $353,000.

At July 31, 2012, there was approximately $6.6 million of total unrecognized compensation cost related to unvested SARs. This cost is expected to be recognized over a weighted-average period of approximately 2.9 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 fiscal year ended January 31, 2012 and the six months ended July 31, 2012:

   
 
 
RSUs
   
Weighted
Average
Grant Date
Fair Value
 
 
 
(in thousands)
       
             
Restricted stock at January 31, 2011
    435     $ 10.02  
Granted
    174       9.32  
Vested (1)
    (178 )     11.02  
Forfeited
    (17 )     9.35  
Restricted stock at January 31, 2012
    414     $ 9.32  
Granted
    198       12.20  
Vested (1)
    (161 )     10.00  
Forfeited
    (3 )     10.46  
Restricted stock at July 31, 2012
    448     $ 10.34  
 

(1)
The number of RSUs vested includes shares withheld on behalf of employees to satisfy statutory tax withholding requirements.

 
12

 
The Company withholds, at the employee’s election, a portion of the vested shares as consideration for the Company’s payment of applicable employee income taxes. During the three months ended July 31, 2012, the Company withheld 30,000 shares for payment of these taxes at a value of $359,000. During the six months ended July 31, 2012, the Company withheld 35,000 shares for payment of these taxes at a value of $433,000.

Total unrecognized compensation cost related to RSUs was approximately $3.6 million as of July 31, 2012. This cost is expected to be recognized over a weighted-average period of approximately 3.0 years.

11. 
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.
 
12. 
BUSINESS SEGMENT INFORMATION

The Company markets its products and services worldwide, primarily to companies in the manufacturing industry, including the automotive, consumer products, food and beverage, high technology, industrial products and life sciences industries. The Company sells and licenses its products in four geographic regions: North America, Europe, Middle East and Africa (“EMEA”), Asia Pacific and Latin America. 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.

License and subscription revenues are assigned to the geographic regions based on the proportion of commissions earned by each region. 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
July 31,
   
Six Months Ended
July 31,
 
   
2012
   
2011
   
2012
   
2011
 
   
(in thousands)
   
(in thousands)
 
Revenue:
                       
North America (1)
  $ 26,211     $ 25,204     $ 54,729     $ 50,484  
EMEA
    18,809       18,601       37,358       37,051  
Asia Pacific
    11,851       13,140       23,610       23,767  
Latin America
    4,098       5,012       8,980       10,058  
    $ 60,969     $ 61,957     $ 124,677     $ 121,360  


(1)
Sales into Canada accounted for 3% of North America total revenue in the three and six months ended July 31, 2012 and for 3% of North America total revenue for the three and six months ended July 31, 2011.
 
 
13

 
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, 2012. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof and are subject to risks, uncertainties and assumptions about our business. We undertake no obligation to revise or update or publicly release the results of any revision or update to these forward-looking statements except as required by applicable securities laws. Readers should carefully review the risk factors and other information described in other documents we file from time to time with the Securities and Exchange Commission (“SEC”).

INTRODUCTION

The following discussion should be read in conjunction with the information included within our Annual Report on Form 10-K for the year ended January 31, 2012, and the Condensed Consolidated Financial Statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q.

OVERVIEW

QAD Inc. (“QAD”, the “Company”, “we” or “us”) is a global provider of enterprise software applications, and related services and support. QAD provides enterprise software applications to global manufacturing companies primarily in the automotive, consumer products, food and beverage, high technology, industrial products and life sciences industries. Over 2,500 global manufacturing companies use QAD software and we employ approximately 1,600 people worldwide. QAD was founded in 1979, incorporated in California in 1986 and reincorporated in Delaware in 1997.

QAD’s enterprise resource planning (“ERP”) suite is QAD Enterprise Applications, which is also known as MFG/PRO. QAD Enterprise Applications supports the core business processes of our global manufacturing customers and includes the following functional areas: financials, customer management, manufacturing, supply chain, service and support, enterprise asset management, transportation management and analytics.

QAD offers two deployment models: On Premise and On Demand. With the On Premise model, QAD sells a perpetual license for the software and our customers then deploy the software on their own computer servers. Under the perpetual licensing model, customers may separately purchase contracts for maintenance and additional services. With QAD’s On Demand deployment model, customers subscribe to a service and QAD provides access to the software as well as ongoing support services and management of the environment. The majority of QAD’s customers use the On Premise model, although On Demand is increasing in acceptance and, as a result, it is a deployment model we are focusing on expanding.

Despite continued global economic uncertainties and geopolitical concerns, we have continued to achieve profitability and positive cash flows from operations. Total revenue for the first six months of fiscal 2013 was $124.7 million, a $3.3 million, or 3%, increase from the first six months of fiscal 2012.  Cash flows from operations were $11.4 million for the first six months of fiscal 2013 compared to $13.3 million for the first six months of fiscal 2012.  Our headcount has increased 10% year over year due to hiring in the first quarter of fiscal 2013 and also due to our acquisition of DynaSys. Personnel expenses are the primary driver of our increase in expenses year over year. While our year-to-date financial metrics are positive, our revenue for the second quarter of fiscal 2013 was lower than our revenue for the first quarter of fiscal 2013. Due to the decrease in revenue in the second quarter compared to the first quarter of fiscal 2013, we have initiated cost containment measures across all discretionary spending categories and will monitor our costs in the second half of fiscal 2013.  Our business model and long-term results are not immune to a sustained economic downturn. The direction and relative strength of the global economy makes it difficult for us to forecast operating results and to make decisions about future investments.
 
 
14

 
Net income was $2.8 million for the first six months of fiscal 2013 compared to $4.1 million for the first six months of fiscal 2012.  Net income for the first six months of fiscal 2013 was negatively impacted by a noncash mark-to-market adjustment of $0.9 million from an interest rate swap associated with the mortgage on our corporate headquarters.  We believe it is prudent to hedge the expected volatility of our variable rate mortgage. The swap fixes the interest rate to 4.31% over the entire term of the mortgage and effectively lowers our interest rate on the mortgage from 6.5%.
 
During the second quarter of fiscal 2013 we acquired DynaSys S.A., a French company with 40 employees that provides a supply chain planning solution which is complementary to our software.  Included in our second quarter results is $1.1 million of revenue and $1.2 million of costs attributable to DynaSys. We believe the DynaSys product, combined with our own software, will benefit many of our global customers striving to improve their supply chain effectiveness.

We have consistently focused on maintaining financial strength by preserving a strong balance sheet and managing costs. We ended the second quarter of fiscal 2013 with $73.8 million in cash and equivalents, down from $76.9 million at January 31, 2012.  The decrease in cash and equivalents was primarily driven by our recent acquisition funded entirely through cash on hand. In addition, we continue to make share repurchases and issue quarterly dividends.

We derive a significant portion of our revenue 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.

CRITICAL ACCOUNTING POLICIES
 
Our condensed consolidated financial statements are prepared applying certain critical accounting policies. 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) valuation of deferred tax assets and tax contingency reserves; and d) stock-based compensation are further discussed in the Annual Report on Form 10-K for the fiscal year ended January 31, 2012. 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, 2012.

RESULTS OF OPERATIONS

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

 
15


Revenue
 
         
Increase (Decrease)
               
Increase (Decrease)
       
   
Three Months
Ended
   
Compared to Prior
Period
   
Three
Months Ended
   
Six Months
Ended
   
Compared to Prior
Period
   
Six Months
Ended
 
   
July 31, 2012
    $     %    
July 31, 2011
   
July 31, 2012
    $     %    
July 31, 2011
 
(in thousands)
                                                   
Revenue
                                                   
License fees
  $ 6,906     $ (1,644 )     -19 %   $ 8,550     $ 14,771     $ (123 )     -1 %   $ 14,894  
Percentage of total revenue
    11 %                     14 %     12 %                     12 %
Maintenance and other
    33,886       (1,507 )     -4 %     35,393       68,406       (1,325 )     -2 %     69,731  
Percentage of total revenue
    56 %                     57 %     55 %                     57 %
Subscription fees
    3,745       1,423       61 %     2,322       6,968       2,438       54 %     4,530  
Percentage of total revenue
    6 %                     4 %     5 %                     4 %
Professional services
    16,432       740       5 %     15,692       34,532       2,327       7 %     32,205  
Percentage of total revenue
    27 %                     25 %     28 %                     27 %
Total revenue
  $ 60,969     $ (988 )     -2 %   $ 61,957     $ 124,677     $ 3,317       3 %   $ 121,360  

Total Revenue. Total revenue was $61.0 million and $62.0 million for the second quarters of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, total revenue for the current quarter would have been approximately $63.6 million, representing a $1.6 million, or 3%, increase from the same period last year. When comparing categories within total revenue at constant rates, our current quarter results included an increase in our subscription and professional services revenue categories and a decrease in our license and maintenance and other revenue categories. Revenue outside the North America region as a percentage of total revenue was 57% for the second quarter of fiscal 2013, as compared to 59% in the second quarter of fiscal 2012.  Total revenue increased in our North America and EMEA regions offset by decreases in our Asia Pacific and Latin America regions during the second quarter of fiscal 2013 when compared to the same quarter last year. The acquisition of DynaSys added $1.1 million to total revenue in our EMEA region. 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 second quarter of fiscal 2013 was approximately 26% in automotive, 22% in consumer products and food and beverage, 35% in high technology and industrial products and 17% in life sciences. In comparison, revenue by industry for the second quarter of fiscal 2012 was approximately 31% in automotive, 23% in consumer products and food and beverage, 33% in high technology and industrial products and 13% in life sciences. The increase in life sciences was primarily due to increased services revenue as license revenue remained fairly consistent during the second quarter of fiscal 2013 when compared to the same quarter last year. Automotive decreased due to both a lower amount of license deals and fewer services engagements quarter over quarter.

Total revenue was $124.7 million and $121.4 million for the first six months of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, total revenue for the first six months of fiscal 2013 would have been approximately $128.3 million, representing a $6.9 million, or 6%, increase from the same period last year. When comparing categories within total revenue at constant rates, our first six months results included increases in all revenue categories. Revenue outside the North America region as a percentage of total revenue was 56% for the first six months of fiscal 2013, as compared to 58% in the same period of the prior fiscal year.  Total revenue increased in our North America region, remained relatively unchanged in our EMEA region and decreased in our Asia Pacific and Latin America regions during the first six months of fiscal 2013 when compared to the same six months last year.  Revenue by industry for the first six months of fiscal 2013 was approximately 28% in automotive, 22% in consumer products and food and beverage, 34% in high technology and industrial products and 16% in life sciences. In comparison, revenue by industry for the first six months of fiscal 2012 was approximately 30% in automotive, 23% in consumer products and food and beverage, 34% in high technology and industrial products and 13% in life sciences. The increase in life sciences was primarily due to increased services revenue as license revenue remained fairly consistent during the first six months of fiscal 2013 when compared to the same period last year. Automotive decreased due to both a lower amount of license deals and fewer services engagements period over period.

 
16


License Revenue.  License revenue was $6.9 million and $8.6 million for the second quarters of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, license revenue for the current quarter would have been approximately $7.1 million, representing a $1.5 million, or 17%, decrease from the same period last year. Excluding $0.5 million of revenue recognized related to our DynaSys acquisition, license revenue decreased across all geographic regions in which we operate during the second quarter of fiscal 2013 when compared to the same quarter last year, which we believe is primarily a result of the slowdown in the global manufacturing economy. 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 second quarter of fiscal 2013, two customers placed license orders totaling more than $0.3 million and no orders exceeded $1.0 million. This compared to the second quarter of fiscal 2012 when three customers placed license orders totaling more than $0.3 million and no orders exceeded $1.0 million.

License revenue was $14.8 million and $14.9 million for the first six months of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, license revenue for the first six months of fiscal 2013 would have been approximately $15.1 million, representing a $0.2 million, or 1%, increase from the same period last year. Excluding $0.5 million of revenue recognized related to our DynaSys acquisition, license revenue increased in our North America and Asia Pacific regions offset by decreases in our EMEA and Latin America regions during the first six months of fiscal 2013 when compared to the same period last year. During the first six months of fiscal 2013, five customers placed license orders totaling more than $0.3 million and no orders exceeded $1.0 million. This compared to the first six months of fiscal 2012 when six customers placed license orders totaling more than $0.3 million and no orders exceeded $1.0 million.

Maintenance and Other Revenue. Maintenance and other revenue was $33.9 million and $35.4 million for the second quarters of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, maintenance and other revenue for the current quarter would have been approximately $35.0 million, representing a $0.4 million, or 1%, decrease from the same period last year. Excluding $0.2 million of revenue recognized related to our DynaSys acquisition, maintenance and other revenue decreased across our North America, Asia Pacific and Latin America regions and increased in our EMEA region during the second quarter of fiscal 2013 when compared to the same quarter of the prior year. In the second quarter of fiscal 2012, we benefited from revenue recognized related to maintenance provided in previous periods where we had not met the required revenue recognition criteria until the period ended July 31, 2011.

Maintenance and other revenue was $68.4 million and $69.7 million for the first six months of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, maintenance and other revenue for the first six months of fiscal 2013 would have been approximately $69.9 million, representing a $0.2 million, or 0.3%, increase from the same period last year. Excluding $0.2 million of revenue recognized related to our DynaSys acquisition, maintenance and other revenue increased in our EMEA region, was relatively flat in our North America region and decreased in our Latin America and Asia Pacific regions during the first six months of fiscal 2013 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 comparing 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 for the second quarter and the first six months of both fiscal 2013 and 2012 was in excess of 90%.
 
Subscription Revenue. Subscription revenue was $3.7 million and $2.3 million for the second quarters of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, subscription revenue for the current quarter would have been $3.8 million, representing a $1.5 million, or 65%, increase from the same period last year.  Subscription revenue increased in our North America, EMEA and Asia Pacific regions and remained flat in our Latin America region during the second quarter of fiscal 2013 when compared to the same quarter last year. The increase in subscription revenue was due to additional revenue related to our On Demand product offering.  Currently, a majority of our On Demand sales are in the North America region. We expect the growth of subscription revenue in the future to be primarily attributable to growth in our On Demand product offering.
 
 
17

 
Subscription revenue was $7.0 million and $4.5 million for the first six months of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, subscription revenue for the current period would have been unchanged at $7.0 million, representing a $2.5 million, or 56%, increase from the same period last year.  Subscription revenue increased in our North America, EMEA and Asia Pacific regions and remained flat in our Latin America region during the first six months of fiscal 2013 when compared to the same period last year. The increase in subscription revenue was due to additional revenue related to our On Demand product offering.  Currently, a majority of our On Demand sales are in the North America region. We expect the growth of subscription revenue in the future to be primarily attributable to growth in our On Demand product offering.

Professional Services Revenue.  Professional services revenue was $16.4 million and $15.7 million for the second quarters of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, professional services revenue for the second quarter of fiscal 2013 would have been approximately $17.6 million, representing a $1.9 million, or 12%, increase from the same period last year. Excluding $0.4 million of revenue recognized related to our DynaSys acquisition, professional services revenue increased in our North America, EMEA and Latin America regions offset by a decrease in our Asia Pacific region during the second quarter of fiscal 2013 when compared to the same quarter last year.  The increase in professional services revenue quarter over quarter can be attributed to a higher number of engagements in the second quarter of fiscal 2013 when compared to the same quarter last year.

Professional services revenue was $34.5 million and $32.2 million for the first six months of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, professional services revenue for the first six months of fiscal 2013 would have been approximately $36.2 million, representing a $4.0 million, or 12%, increase from the same period last year. Excluding $0.4 million of revenue recognized related to our DynaSys acquisition, professional services revenue increased in our North America, EMEA and Latin America regions offset by a decrease in our Asia Pacific region during the first six months of fiscal 2013 when compared to the same period last year.  The increase in professional services revenue period over period can be attributed to a higher number of engagements in the first six months of fiscal 2013 when compared to the same period last year as well as the recognition of previously deferred revenue related to one customer contract of $1.3 million in the first quarter of fiscal 2013.  The costs related to this customer contract had been expensed in previous periods.

Total Cost of Revenue
 
   
Three Months
Ended
   
Increase (Decrease)
Compared
to Prior Period
   
Three Months
Ended
   
Six Months
Ended
    Increase (Decrease)
Compared
to Prior Period
   
Six Months
Ended
 
(in thousands)
  July 31, 2012     $     %     July 31, 2011     July 31, 2011     $     %     July 31, 2011  
Cost of revenue
                                                               
Cost of license fees
  $ 832     $ (172 )     -17 %   $ 1,004     $ 1,713     $ (322 )     -16 %   $ 2,035  
Cost of maintenance, subscription and other
    10,341       1,274       14 %     9,067       20,341       2,499       14 %     17,842  
Cost of professional services
    15,846       (895 )     -5 %     16,741       31,584       (1,445 )     -4 %     33,029  
Total cost revenue
  $ 27,019     $ 207       1 %   $ 26,812     $ 53,638     $ 732       1 %   $ 52,906  
                                                                 
Percentage of revenue
    44 %                     43 %     43 %                     44 %

Cost of license fees includes license royalties, amortization of capitalized software costs and shipping. Cost of maintenance, subscription and other includes personnel costs of fulfilling maintenance and subscription contracts, stock-based compensation for those employees, travel expense, professional fees, hosting costs, royalties, direct material and an allocation of information technology and facilities costs. Direct material charges include the cost of fulfilling maintenance and subscription contracts, hardware, costs associated with transferring our software to electronic media, printing of user manuals and packaging materials. Cost of professional services includes personnel costs of fulfilling service contracts, stock-based compensation for those employees, third-party contractor expense, travel expense for services employees and an allocation of information technology and facilities costs.

 
18


Total cost of revenue. Total cost of revenue (combined cost of license fees, cost of maintenance, subscription and other and cost of professional services) was $27.0 million for the second quarter of fiscal 2013 and $26.8 million for the second quarter of fiscal 2012, and as a percentage of total revenue was 44% and 43% for the second quarter of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, total cost of revenue for the second quarter of fiscal 2013 would have been approximately $28.6 million, representing an increase of $1.8 million, or 7%. The non-currency related increase in cost of revenue of $1.8 million for the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 was primarily due to higher hosting costs and higher personnel costs associated with higher subscription revenue, as well as higher third-party contractor costs associated with higher professional services revenues.

Total cost of revenue (combined cost of license fees, cost of maintenance, subscription and other and cost of professional services) was $53.6 million for the first six months of fiscal 2013 and $52.9 million for the first six months of fiscal 2012, and as a percentage of total revenue was 43% and 44% for the first six months of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, total cost of revenue for the first six months of fiscal 2012 would have been approximately $55.8 million, representing an increase of $2.9 million, or 5%. The non-currency related increase in cost of revenue of $2.9 million for the first six months of fiscal 2013 compared to the first six months of fiscal 2012 was primarily due to higher hosting costs and higher personnel costs associated with higher subscription revenue, as well as higher third-party contractor costs associated with higher professional services revenues.

Cost of License Fees.  Cost of license fees was $0.8 million and $1.0 million for the second quarters of fiscal 2013 and fiscal 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, cost of license fees for the second quarter of fiscal 2013 would have been $0.9 million, representing a decrease of $0.1 million, or 10%. The non-currency related decrease in cost of license fees of $0.1 million for the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 was due to lower license royalties associated with lower license revenue. Cost of license fees as a percentage of license revenue was consistent at 12% for each of the second quarters of fiscal 2013 and fiscal 2012.

Cost of license fees was $1.7 million and $2.0 million for the first six months of fiscal 2013 and 2012. Holding foreign currency exchange rates constant to fiscal 2012, cost of license fees for the first six months of fiscal 2013 would have been unchanged at $1.7 million, representing a decrease of $0.3 million, or 15%. The non-currency related decrease in cost of license fees of $0.3 million for the first six months of fiscal 2013 compared to the first six months of fiscal 2012 was due to lower license royalties and lower amortization of capitalized software costs.  Cost of license fees as a percentage of license revenue was 12% and 14% for the first six months of fiscal 2013 and fiscal 2012, respectively.

Cost of Maintenance, Subscription and Other.  Cost of maintenance, subscription and other was $10.3 million and $9.1 million for the second quarters of fiscal 2013 and fiscal 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, cost of maintenance, subscription and other for the second quarter of fiscal 2013 would have been approximately $10.7 million, representing an increase of $1.6 million, or 18%. The non-currency related increase in cost of maintenance, subscription and other of $1.6 million for the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 was primarily due to higher subscription costs, which included higher personnel costs of $0.9 million as a result of higher headcount of approximately 25 people and higher hosting costs of $0.3 million. Cost of maintenance, subscription and other as a percentage of maintenance, subscription and other revenues were 27% and 24% for the second quarters of fiscal 2013 and fiscal 2012, respectively.  The increase is attributable to subscription costs increasing at a higher rate than revenue primarily due to increased costs related to transitioning customers to On Demand.

Cost of maintenance, subscription and other was $20.3 million and $17.8 million for the first six months of fiscal 2013 and fiscal 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, cost of maintenance, subscription and other for the first six months of fiscal 2013 would have been approximately $20.9 million, representing an increase of $3.1 million, or 17%. The non-currency related increase in cost of maintenance, subscription and other of $3.1 million for the first six months of fiscal 2013 compared to the first six months of fiscal 2012 was primarily due to higher subscription costs, which included higher personnel costs of $1.6 million as a result of higher headcount of approximately 25 people and higher hosting costs of $0.4 million. Cost of maintenance, subscription and other as a percentage of maintenance and other and subscription fees revenues were 27% and 24% in the first six months of fiscal 2013 and fiscal 2012, respectively. The increase is attributable to subscription costs increasing at a higher rate than revenue primarily due to increased costs related to transitioning customers to On Demand.
 
 
19


Cost of Professional Services.  Cost of professional services was $15.8 million and $16.7 million for the second quarters of fiscal 2013 and fiscal 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, cost of professional services for the second quarter of fiscal 2013 would have been approximately $17.0 million, representing an increase of $0.3 million, or 2%. The non-currency related increase in cost of professional services of $0.3 million for the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 was due primarily to higher third-party contractor costs of $0.7 million partially offset by lower services personnel costs of $0.2 million and lower bonuses of $0.2 million.  Cost of professional services as a percentage of professional services revenues was 96% and 107% for the second quarters of fiscal 2013 and fiscal 2012, respectively.

Cost of professional services was $31.6 million and $33.0 million for the first six months of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, cost of professional services for the first six months of fiscal 2013 would have been approximately $33.1 million, representing an increase of $0.1 million, or 0.3%. The non-currency related increase in cost of professional services of $0.1 million in the first six months of fiscal 2013 compared to the first six months of fiscal 2012 was due primarily to higher third-party contractor costs of $1.0 million partially offset by lower services personnel costs of $0.5 million and lower severance of $0.2 million. Cost of professional services as a percentage of professional services revenues was 91% and 103% for the first six months of fiscal 2013 and fiscal 2012 respectively.

Sales and Marketing
 
   
Three Months
Ended
 
Increase (Decrease)
Compared
to Prior Period
   
Three Months
Ended
   
Six Months
Ended
    Increase (Decrease)
Compared
to Prior Period
   
Six Months
Ended
 
    July 31, 2012     $     %     July 31, 2011     July 31, 2011     $     %     July 31, 2011  
(in thousands)
                                                               
Sales and marketing
  $ 14,747     $ 883       6 %   $ 13,864     $ 30,243     $ 1,890       7 %   $ 28,353  
Percentage of revenue
    24 %                     22 %     25 %                     23 %

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.

Sales and marketing expense was $14.7 million and $13.9 million for the second quarters of fiscal 2013 and fiscal 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, sales and marketing expense for the second quarter of fiscal 2013 would have been approximately $15.5 million, representing an increase of $1.6 million, or 12%. The non-currency related increase in sales and marketing expense of $1.6 million for the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 was primarily due to higher personnel costs of $1.2 million as a result of higher headcount of approximately 40 people, higher travel costs of $0.3 million, higher commissions of $0.2 million and higher costs related to our annual Explore customer event of $0.2 million partially offset by lower bonuses of $0.3 million.

Sales and marketing expense was $30.2 million and $28.4 million for the first six months of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, sales and marketing expense for the first six months of fiscal 2013 would have been approximately $31.2 million, representing an increase of $2.8 million, or 10%. The non-currency related increase in sales and marketing expense of $2.8 million for the first six months of fiscal 2013 compared to the first six months of fiscal 2012 was primarily due to higher personnel costs of $1.4 million as a result of higher headcount of approximately 40 people, higher travel costs of $0.6 million, higher professional fees of $0.2 million, higher sales agent fees of $0.2 million and higher costs related to our annual Explore customer event of $0.2 million.

 
20


Research and Development
 
   
Three Months
Ended
    Increase (Decrease)
Compared
to Prior Period
   
Three Months
Ended
   
Six Months
Ended
    Increase (Decrease)
Compared
to Prior Period
   
Six Months
Ended
 
(in thousands)
  July 31, 2012     $     %     July 31, 2011     July 31, 2011     $     %     July 31, 2011  
Research and development
  $ 9,210     $ (27 )     0 %   $ 9,237     $ 18,744     $ 1,024       6 %   $ 17,720  
Percentage of revenue
    15 %                     15 %     15 %                     15 %

Research and development expense is expensed as incurred and consists primarily of salaries, benefits, bonuses, stock-based compensation and travel expense for research and development employees, professional services, such as fees paid to software development firms and independent contractors, and training for such personnel. Research and development expense also includes an allocation of information technology and facilities costs, and is reduced by income from joint development projects.

Research and development expense was consistent at $9.2 million for the second quarters of fiscal 2013 and fiscal 2012. Holding foreign currency exchange rates constant to fiscal 2012, research and development expense for the second quarter of fiscal 2013 would have been approximately $9.6 million, representing an increase of $0.4 million, or 4%. The non-currency related increase in research and development expense of $0.4 million for the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 was primarily due to higher personnel expenses of $0.6 million as a result of higher headcount of approximately 30 people, primarily due to increased internationalization efforts and the incremental increase in headcount as a result of the DynaSys acquisition.

Research and development expense was $18.7 million and $17.7 million for the first six months of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, research and development expense for the first six months of fiscal 2013 would have been approximately $19.2 million, representing an increase of $1.5 million, or 8%. The non-currency related increase in research and development expense of $1.5 million for the first six months of fiscal 2013 compared to the first six months of fiscal 2012 was primarily due to higher personnel expenses of $1.1 million as a result of higher headcount of approximately 30 people, primarily due to increased internationalization efforts and the incremental increase in headcount as a result of the DynaSys acquisition as well as lower joint development income of $0.5 million.  These increases were partially offset by lower bonuses of $0.2 million.

Included as a reduction of research and development expense for the first two quarters of fiscal 2013 was joint development income of $0.5 million per quarter related to a project which will conclude in the third quarter of fiscal 2013.  We expect to recognize $0.3 million of income from this project in the third quarter. As part of our vertical focus we regularly seek to engage in 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.

General and Administrative
 
   
Three Months
Ended
    Increase (Decrease)
Compared
to Prior Period
   
Three Months
Ended
   
Six Months
Ended
    Increase (Decrease)
Compared
to Prior Period
   
Six Months
Ended
 
    July 31, 2012     $     %     July 31, 2011     July 31, 2011     $     %     July 31, 2011  
(in thousands)
                                                               
General and administrative
  $ 8,435     $ 1,038       14 %   $ 7,397     $ 16,540     $ 1,430       9 %   $ 15,110  
Percentage of revenue
    14 %                     12 %     13 %                     12 %
 
 
21


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.

General and administrative expense was $8.4 million and $7.4 million for the second quarters of fiscal 2013 and fiscal 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, general and administrative expense for the second quarter of fiscal 2013 would have been approximately $8.7 million, representing an increase of $1.3 million, or 18%. The non-currency related increase in general and administrative expense of $1.3 million for the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 was primarily due to an internal system upgrade project of $0.4 million, higher stock compensation expense of $0.3 million and higher personnel expenses of $0.2 million. In addition, the second quarter of fiscal 2013 included professional fees of $0.2 million related to the DynaSys acquisition.

General and administrative expense was $16.5 million and $15.1 million for the first six months of fiscal 2013 and 2012, respectively. Holding foreign currency exchange rates constant to fiscal 2012, general and administrative expense for the first six months of fiscal 2013 would have been approximately $16.8 million, representing an increase of $1.7 million, or 11%. The non-currency related increase in general and administrative expense of $1.7 million for the first six months of fiscal 2013 compared to the first six months of fiscal 2012 was primarily due to an internal system upgrade project of $0.9 million, higher personnel expenses of $0.2 million and higher stock compensation expense of $0.2 million. Fiscal 2013 included professional fees of $0.2 million related to the DynaSys acquisition.

Other (Income) Expense

   
Three Months
Ended
   
Increase (Decrease)
Compared to
Prior Period
   
Three Months
Ended
   
Six Months
Ended
   
Increase (Decrease)
Compared to
Prior Period
   
Six Months
 Ended
 
(in thousands)
 
July 31, 2012
   
$
   
%
   
July 31, 2011
   
July 31, 2012
   
$
   
%
   
July 31, 2011
 
Other (income) expense
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
(164)
 
 
$
(18)
 
 
 
-12
%
 
$
(146
)
 
$
(327)
 
 
$
(45)
 
 
 
-16
%
 
$
(282
)
Interest expense
 
 
330
 
 
 
43
 
 
 
15
%
 
 
287
 
 
 
616
 
 
 
59
 
 
 
11
%
 
 
557
 
Other (income) expense, net
 
92
 
 
448
 
 
 
126
%
 
(356
)
 
538
 
 
76
 
 
 
16
%
 
462
 
Total other (income) expense
 
$
258
 
 
$
473
 
 
 
220
%
 
$
(215
)
 
$
827
 
 
$
90
 
 
 
12
%
 
$
737
 
Percentage of revenue
 
 
1
%
 
 
 
 
 
 
 
 
 
 
0
%
 
 
1
%