10-K 1 qada20190131_10k.htm FORM 10-K qada20190131_10k.htm
 

 

 

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

 

FORM 10-K

 

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

 

For the fiscal year ended January 31, 2019

 

OR

 

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

 

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 and zip code)

 

Registrant’s telephone number, including area code (805) 566-6000

 

Securities registered pursuant to Section 12(g) of the Act:

 

Title of Each Security

Name of Each Exchange on Which Registered

Class A Common Stock, $.001 par value

The NASDAQ Stock Market LLC

Class B Common Stock, $.001 par value

(NASDAQ Global Select Market)

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ☐ YES ☒ NO

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ☐ YES ☒ NO

 

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 checkmark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or an amendment to this Form 10-K. ☒

 

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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer,  smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

☐ Large accelerated filer

☒ Accelerated filer

☐ Non-accelerated filer

☐ 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 July 31, 2018, the last business day of the Registrant’s most recently completed second fiscal quarter, there were 16,350,124 shares of the Registrant’s Class A common stock outstanding and 3,263,906 shares of the Registrant’s Class B common stock outstanding, and the aggregate market value of such shares held by non-affiliates of the Registrant (based on the closing sale price of such shares on the NASDAQ Global Market on July 31, 2018) was approximately $490 million. Shares of the Registrant’s common stock held by each executive officer and director and by each entity that owns 5% or more of the Registrant’s outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

As of March 31, 2019, there were 16,368,719 shares of the Registrant’s Class A common stock outstanding and 3,263,906 shares of the Registrant’s Class B common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Items 10 through 14 of Part III incorporate information by reference from the Definitive Proxy Statement for the Registrant’s Annual Meeting of Stockholders to be held on June 24, 2019.

 

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QAD INC.
FISCAL YEAR 2019
FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS

 

 

Page

PART I

 

ITEM 1. BUSINESS

 

4

     

ITEM 1A. RISK FACTORS

 

17

     

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

28

     

ITEM 2. PROPERTIES

 

28

     

ITEM 3. LEGAL PROCEEDINGS

 

28

     

ITEM 4. MINE SAFETY DISCLOSURES

 

28

     

PART II

     

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

29

     

ITEM 6. SELECTED FINANCIAL DATA

 

31

     

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

32

     

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

51

     

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

52

     

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

52

     

ITEM 9A. CONTROLS AND PROCEDURES

 

53

     

ITEM 9B. OTHER INFORMATION

 

54

 

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

54

     

ITEM 11. EXECUTIVE COMPENSATION

 

55

     

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

55

     

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

55

     

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

55

 

PART IV

 

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

56

     

ITEM 16. FORM 10-K SUMMARY

 

56

     

SIGNATURES

 

93

 

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NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

In addition to historical information, this Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. Any statements contained herein that are not statements of historical fact should be construed as forward-looking statements, including statements that are preceded or accompanied by such words as “may,” “believe,” “could,” “anticipate,” “projects,” “estimates,” “will likely result,” “should,” “would,” “might,” “plan,” “expect,” “intend” and words of similar meaning or the negative of these terms or other comparable terminology. Forward-looking statements are based on the Company’s current expectations and assumptions regarding its business, the economy and future conditions. A number of risks and uncertainties could cause actual results to differ materially from those expressed or implied in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in Item 1A entitled “Risk Factors” which are incorporated herein by reference, and as may be updated in filings we make from time to time with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions, expectations and projections only as of the date of this Annual Report on Form 10-K 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 this Annual Report on Form 10-K and the other documents we file from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q to be filed by QAD in fiscal year 2020.

 

PART I

 

ITEM 1. BUSINESS

 

QAD is a leader in cloud-based enterprise software solutions for global manufacturing companies across the automotive, life sciences, consumer products, food and beverage, high technology and industrial products industries. We offer full-featured, secure and flexible enterprise and supply chain solutions built for global manufacturing companies which can be delivered in the cloud, on-premises or via a blended deployment combination of cloud and on-premises. Our mission is to provide best-in-class software that enables our customers to operate as an effective enterprise where their business processes are running at peak efficiency and are perfectly aligned to their strategic goals. Our solutions, called QAD Enterprise Applications, enable measurement and control of key business processes that support operational requirements, including financials, manufacturing, demand and supply chain planning, customer management, business intelligence and business process management. Our architecture, called the QAD Enterprise Platform, provides manufacturers with the flexibility they need to achieve a greater fit between their optimal business processes and systems, which enables them to adjust to change in the markets they serve.

 

Over 2,000 manufacturing companies have deployed QAD solutions to run their businesses across approximately 4,000 sites globally. Today, our solutions are used by over 300,000 active users, of which our cloud and subscription users have grown to 43,000 from 33,000 in the prior year. We were founded in 1979 and our principal executive offices are located in Santa Barbara, California. Our principal website address is www.qad.com. Our office address is 100 Innovation Place, Santa Barbara, CA 93108. We employ 1,970 full-time employees throughout our direct operations in 24 countries across the North America, Europe, Middle East and Africa (“EMEA”), Asia Pacific and Latin America regions.

 

OUR TARGET VERTICAL MARKETS

 

We focus our efforts on delivering mission-critical software solutions to enterprise customers in six core vertical markets within global manufacturing – automotive, life sciences, consumer products, food and beverage, high technology and industrial products. Within these vertical markets, we focus on 26 segments where many of our existing customers operate and our solutions are a strong product fit. We offer solutions designed to overcome the business challenges within each segment, based on our in-depth knowledge of the segment and best practices. In addition, we participate in industry groups serving our target segments to ensure that we address regulatory compliance issues, evaluate new manufacturing practices and leverage advanced technologies to give our customers a maximum competitive advantage.

 

Automotive: Automotive suppliers are a key focus for QAD.  Automotive suppliers must meet critical industry standards such as the Materials Management Operations Guideline/Logistics Evaluation (“MMOG/LE”) and International Automotive Task Force (“IATF”) 16949:2016 (previously ISO/TS 16949). Disruptions to the supply chain can cause significant financial impact. QAD’s automotive-specific processes and built-in industry best practices help automotive suppliers reduce costs, mitigate supply chain risk and improve supply chain planning and visibility. Our customer base includes companies serving the global automotive marketplace, especially the tier-1 suppliers in the supply chains of automotive original equipment manufacturers. We deliver unique capabilities to support the collaboration requirements of the automotive suppliers, including the strict quality requirements of Advanced Product Quality Process (“APQP”) and Production Part Approval Process (“PPAP”). Many of our customers use QAD Cloud EDI because it provides a scalable solution which standardizes Electronic Data Interchange (“EDI”) across their global enterprise. QAD Supplier Portal, which allows for electronic communication with other suppliers, is another product commonly used by our automotive customers. QAD solutions are in use at many of the market-leading automotive parts companies throughout the world that manufacture a broad range of components used in interiors, electrical components, safety systems, bodies and drivetrains.

 

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Life Sciences: Life sciences manufacturers are dedicated to innovation, product quality and patient safety; however, a tightening regulatory environment, increasing cost pressures and greater supply chain complexities present challenges to the industry. Emerging markets, quality initiatives, and mergers and acquisitions activity also add to the complexity of life sciences manufacturing and distribution. QAD focuses on the following five segments in the life sciences industry: contract manufacturing; surgical devices; orthopedic devices; diagnostic devices; and pharmaceutical/biotechnology manufacturers. QAD solutions help global life sciences companies manufacture products in accordance with current Good Manufacturing Practices (“cGMP”) regulations and standards like ISO13485:2016 that are required by regulators around the world. In addition to cGMP, QAD solutions support many business and regulatory processes specific to the life sciences industry, such as automated quality management, supply chain planning and serialization in support of requirements for Unique Device Identification (“UDI”), the Drug Quality and Security Act (“DQSA”) and the Falsified Medicines Directive (“FMD”). QAD Cloud ERP for life sciences provides our customers with a qualified IT infrastructure as a key building block to help them ensure that they have a solid foundation for addressing life sciences regulatory requirements.

 

Consumer Products: Manufacturers of consumer products have the objective of delivering the right product, in the right quantities, to the right location at the right time to satisfy demand. To meet this goal, effective supply chain management is needed to synchronize critical activities and functions across the organization.  To gain market share and improve profitability, consumer products companies must anticipate and meet customer demand while managing their margins and complying with evolving safety and environmental regulations. QAD focuses on the following four segments in the consumer products industry: household and personal packaged products; consumer electronics; assembled and discrete products; and jewelry manufacturing. The manufacturing processes for these items vary and depend on the nature of the item; however, the fulfillment and distribution requirements have significant commonality. Major retailers manage complex supply chains and are typically very demanding of their suppliers as they strive to service growing demand from consumers for speed of delivery and variety of products. QAD solutions address the complex replenishment requirements of companies supplying the retail supply chain, including promotional pricing, demand planning, quality compliance and product configuration.

 

Food and Beverage: Food and beverage manufacturing is complex and requires regular updates to product, packaging and pricing. There is a lack of uniformity in the supply chain, which challenges food and beverage manufacturers to excel at supply chain management, as seasonal demand changes cause inefficiencies and increase manufacturing costs. At the same time, manufacturers must comply with requirements like field to fork traceability and record keeping. QAD focuses on the following six segments in the food and beverage industry: shelf-stable bottling, canning and packaging; distilleries, wineries and brewing; frozen foods; creameries and fresh foods; candy and confections; and meat and fish processing. Our solutions support regulatory and quality initiatives, such as the U.S. Food Safety Modernization Act (“FSMA”) and Hazard Analysis and Critical Control Point (“HACCP”) analysis, which address the management of biological, chemical and physical hazards. Our solutions support the product cycle of the food and beverage industry from raw material production, procurement and handling to manufacturing, distribution and consumption of the finished product.

 

High Technology: The success of manufacturers in the high technology industry relies on innovation and the ability to manage change. These manufacturers are subject to constant pressure on margins, challenges with cross border shipments, strains on material availability and cost control initiatives.  They require agile and effective global supply chains. All of these challenges need to be met while complying with standards and industry regulations. QAD solutions are used by many high-technology companies that manufacture a diverse range of products. QAD focuses on the following four segments in the high technology industry: standalone devices and test equipment; batteries, power supplies and lighting; cable, wiring and connectors; and industrial and high technology contract manufacturing. High-tech companies often face the challenges of very complex product structures with a need for traceability of parts and processes throughout their entire supply chain, as well as tight control of engineering changes. Many high-tech companies providing complex systems also face the challenge of managing installation and support of equipment after sale, in addition to managing field engineering resources. A high-technology manufacturer can use QAD’s solutions to configure product based on customers’ preference; manufacture and assemble product according to a customized specification; and schedule, install and support equipment throughout its lifecycle.

 

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Industrial Products: Today’s global customers are demanding more configure-to-order, make-to-order, and assemble-to-order products. As a result, the modern, agile industrial manufacturer must be responsive to demands while managing tight margins, operational challenges and rapid changes to product features. QAD customers manufacture products as diverse as machine tools; specialist ceramic materials used in aerospace and defense; and equipment used in the oil and gas industries. Fluctuating demand leads to significant challenges in managing the internal supply chain, coordinating the extended vendor ecosystem, controlling costs, ensuring quality, tracking production, and optimizing inventory levels. Companies in this broad vertical market have requirements to maintain many manufacturing methodologies, often within the same enterprise. QAD focuses on the following six segments in the industrial products industry: flexible packaging; engineered materials; contract manufacturing; standalone equipment; remanufacturing; and roll stock and wire cable. Our solutions support multiple manufacturing methodologies in parallel, including lean manufacturing. The need for traceability of materials from source through to the finished product is often important to our customers, and QAD’s capabilities in traceability and serialization support this feature.

 

Our focus on these six vertical markets gives us a competitive advantage by providing a solution developed specifically for our target customers, without the complexity and distraction of functionality they don’t want and don’t need. While some vendors provide broader solutions built for many industries, our targeted vertical focus allows our customers to implement our solutions with fewer configurations and customizations than our competitors require, enabling less complex and faster implementations. We leverage our vertical market expertise in research and development to meet specific industry needs: in sales, to understand our customer’s unique requirements; in presales, to demonstrate how these requirements are handled in the software; and in services, to apply best practices in the optimization of business processes and the implementation of the software. Our options to sell our product in the cloud or as on-premises licenses enable customers operating in multiple locations to choose a deployment option that best meets their unique needs.

 

QAD SOLUTIONS

 

QAD products and services support the business processes of global manufacturing companies in our target industries. We continually monitor emerging business requirements and practices as well as regulatory changes and incorporate them into our product and solutions strategies. Our development focus emphasizes user experience. We strive to deliver solutions that offer comprehensive capabilities while being easy to access, learn and use.

 

The Channel Islands program was designed to transform the architecture and user experience of QAD solutions. Channel Islands has two key components: Channel Islands User Experience (“UX”) and the QAD Enterprise Platform.

 

The Channel Islands User Experience (“UX”) provides access to QAD Enterprise Applications on any device with a modern web browser. It includes a new user interface (“UI”) written in HTML5 which seamless access across desktops and mobile devices and has the ability to co-exist with our current .NET UI. Mobile devices continue to play an ever-increasing role in our day-to-day lives, and our customers are using mobile computing to support their businesses. Channel Islands leverages a responsive HTML5 user interface that displays appropriately across screen sizes. As such, Channel Islands is available on any device with a modern web browser, including tablets and smartphones.  In addition, QAD provides some mobile specific applications purpose-built for the actions users are likely to take on their mobile devices. These include a requisition approval solution, a mobile business intelligence solution, mobile browse capability and mobile application monitoring tools to support system administrators.

 

The QAD Enterprise Platform is the architecture behind the Channel Islands project. The benefits it provides to customers make it the most significant part of the solution. Manufacturers need an Enterprise Resource Planning (“ERP”) system that will allow them to easily change their business processes to meet the demands of their changing market. The QAD Enterprise Platform provides five rapid response capabilities: Personalization; Embedded Analytics; Modularization; Extensibility; and New Apps. Most critically, these capabilities include the ability to extend current applications, to connect with external systems through micro services, and to develop entirely new applications on the QAD Enterprise Platform without the need to write or modify code in QAD Enterprise Applications. Extensions and new apps are non-intrusive to the enterprise applications and do not hinder future upgrades. Modularity provides the ability to upgrade the solution by components, rather than upgrading the entire solution at one time. This makes upgrades smaller, faster and easier; helping customers stay on the most current version of our software which reduces the gap between their business needs and what our enterprise applications provide. Modularity also allows us to improve the efficiency of our cloud operations using a simplified upgrade process. The architecture eases the adoption of new advanced technologies into the solution.

 

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In support of our focus on business process efficiency, we have integrated the ability to generate business process maps for common business processes into our software using the QAD Process Editor tool. This tool simplifies implementations, maps common business processes and facilitates navigation throughout the entire product suite. Within our suite, we have embedded business process management (“QAD BPM”). QAD BPM allows customers to visualize their business processes; monitor transactional throughput by user, role or stage; and modify those processes to make them more efficient. Using QAD BPM, companies can create business process models, assign task responsibilities, and monitor and re-direct workflow; all of which reduce process execution time, improve visibility of active processes, identify bottlenecks and support process improvement. QAD developed its solutions to allow simple integration with other systems our customers use within their organizations. For example, we enable seamless integration between QAD Enterprise Applications, common browser applications and spreadsheets. QAD solutions also integrate easily with other web applications and web services. Using our Q-Xtend toolset, customers can connect to different software, even when remote, and they can use industry-standard middleware products such as the IBM MQ™ series or standard connectors built on the Dell Boomi AtomSphere integration platform. Robust Application Program Interfaces (“APIs”) along with QAD Automation Solutions provide additional capabilities for integration.

 

QAD Cloud ERP and QAD Enterprise Applications

 

QAD Cloud ERP (delivered in the cloud) and QAD Enterprise Applications (delivered on-premises) are an integrated suite of software applications, which supports the core business processes of global manufacturing companies and provides specific functionality to support the requirements of our targeted industries and the geographies in which our customers conduct business. Both QAD Cloud ERP and QAD Enterprise Applications utilize the same underlying technology and therefore provide customers with the same functionality. QAD Cloud ERP and QAD Enterprise Applications allow customers to monitor, control and support their operations, whether operating a single plant or multiple sites located around the world.

 

QAD Cloud ERP provides customers with additional value and better experience than an on premises implementation.  QAD Cloud ERP allows customers to rapidly deploy, scale and extend their solutions in a highly-available, highly-secure environment.  QAD’s Cloud Operations group manages the end-to-end process of the deployment of the enterprise system, including the provisioning of the customer’s environments, performing continuous system performance tuning and monitoring to avoid disruptions, ensuring backup and disaster recovery processes are in place, applying software upgrades and patches, and ensuring industry best practice security processes are deployed.  Customer’s internal organizations can then focus on strategic initiatives while relying on QAD to provide their users with highly-secured and highly-reliable systems that support their ability to navigate through complexity and increasing disruption in their markets. 

 

QAD Cloud ERP and QAD Enterprise Applications are available in a blended model combining both deployment alternatives. Blended deployment enables users to transact more easily across business entities with a consistent interface and consistent functionality since our cloud and on-premises technology is the same. Companies that have chosen the cloud as a strategic direction but who cannot, or do not want to, move all locations at one time, find the blended deployment model allows them to transition to the cloud with less risk. The finance function can view individual business unit results and run consolidations that cross both cloud and on-premises sites seamlessly, while other users can transact and view inventory in multiple locations irrespective of whether any specific business entity is operating in the cloud or on-premises.

 

QAD Cloud ERP and QAD Enterprise Applications are comprised of the following software solutions:

 

QAD Financials

 

QAD Financials provides comprehensive capabilities to manage and control finance and accounting processes at a local, regional and global level. The suite supports multi-company, multi-currency, multi-language and multi-tax jurisdictions, as well as consolidated reporting and budgeting controls. These capabilities give cross-functional stakeholders access to financial results; enabling faster, more informed decision making while providing robust internal controls. Enterprise Financials includes multi-GAAP support, such as International Financial Reporting Standards (“IFRS”), as well as extensive local tax, reporting and segregation of duties controls.

 

QAD Customer Management

 

QAD Customer Management enables global manufacturing companies to acquire new customers efficiently, grow revenue through multiple channels and retain customers through superior service and support. QAD Customer Management helps our customers measure marketing campaign effectiveness, manage the sales opportunity lifecycle and optimize order and fulfillment processes. QAD Configurator has the ability to create unique products specified to customer requirements, enabling simple and cost effective controls for mass customization of products. The suite includes the ability to centralize sales order entry, including orders for configured items, and to ship the items from any facility or business entity. QAD Customer Self Service provides a web storefront for our customers to transact sales, which is fully and securely integrated with the rest of QAD Enterprise Applications.

 

QAD Manufacturing

 

QAD Manufacturing delivers comprehensive capabilities to support manufacturing business processes, from planning through execution, and provides visibility and control of materials and labor. The suite has capabilities in the areas of planning and scheduling, cost management, material control, shop floor control, quality management and reporting in various mixed-mode manufacturing environments. The manufacturing models supported include Discrete, Repetitive, Kanban (particularly relevant in lean manufacturing practices), Flow, Batch/Formula, Process, Co-products/By-products and Configured Products. The system also includes flexible item attributes that customers can use to track lot characteristics or test results. The Lot Trace Workbench provides insight into any products component genealogy and greatly simplifies product recalls. QAD Manufacturing supports companies’ deployment of business processes consistent with their industry’s best practices. The integration between scheduling, planning, execution, quality and materials allows tight control and simple management of processes.

 

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QAD Automation Solutions

 

QAD Automation Solutions improves manufacturers’ material transaction processing accuracy and efficiency by aligning QAD Enterprise Applications with material and production processes. There are two primary components to QAD Automation Solutions:

 

 

Data Collection captures material and production data through simplified transactions using mobile devices such as a radio frequency (“RF”) scanner, tablet or shop floor computer or other machine.

 

Label Printing Services routs and prints labels associated with material and production transactions based on manufacturer, supplier, customer and industry specified formats and rules.

 

These capabilities help manufacturers better align their material logistics processes in a timely fashion while ensuring inventory accuracy through process compliance.

 

QAD Demand and Supply Chain Planning

 

QAD Demand and Supply Chain Planning (“QAD DSCP”) is a comprehensive group of applications built on a single unified model to fulfill the materials planning and logistics requirements of global companies. QAD DSCP is supported and developed by our DynaSys operating division. This solution set delivers functionality and capabilities that help enterprises optimize their supply chains to enhance customer satisfaction through timely deliveries. Enterprises can align supply and demand to support the delivery of the right product, to the right place, at the right time and at the most efficient cost. The suite utilizes the DynaSys Single Click Collaborative platform, with the entire planning model running in a memory-resident database supporting real-time planning. The suite supports planning for demand, production, procurement, distribution and global sales and operations. Customers have used this solution with data sets that exceed a million SKUs. QAD Demand and Supply Chain Planning addresses both simple and complex networks, giving customers the ability to add more advanced functionality as their enterprise grows. Collaborative portals are available for both demand and supply sides to help ensure rapid communication of demand or supply fluctuations and to enable collaborative planning.

 

QAD Supply Chain Execution

 

QAD's Supply Chain Execution capabilities provide the tools required to make requisitions, and procure and purchase materials and parts needed for manufacturing. Purchasing readily integrates with inventory and warehouse management capabilities. Additionally, Supply Chain Execution manages consignment inventory for consignors and consignees, and distribution requirements planning to optimize and balance inventories at multiple distribution centers, enabling fast and cost-effective demand fulfillment. QAD also offers QAD Supplier Portal, a cloud-based, subscription supply chain insight and performance management solution that provides digital collaboration between suppliers and buyers to help optimize supply chains operations.

 

QAD Transportation Management

 

QAD markets transportation solutions directly to our existing customers as part of QAD Enterprise Applications, and to the general market through our Precision division. QAD Transportation Management facilitates correct documentation and control for moving shipments across borders. Transportation Management allows companies to manage and optimize outside carriers for shipments including parcel, less than truckload, full truckload and container shipments whether using land, sea or air carriers. Compliance and risk management enables companies to comply with regulations concerning denied parties and control of dangerous substances.

 

QAD Service and Support

 

QAD Service and Support enables exceptional after-sale customer service and support for companies who commission and support complex systems. The integration from customer demand through manufacturing to installation and support provides companies with great efficiencies when managing their business processes. QAD Service and Support handles service calls, manages service queues and organizes mobile field resources. It also provides extensive project management support, helping organizations track materials and labor against warranty and service work; compares actual costs to budget; and generates appropriate invoicing.

 

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QAD Enterprise Asset Management

 

QAD Enterprise Asset Management (“EAM”) helps companies manage maintenance and installation of capital equipment. The solution supports both planned and unplanned equipment maintenance based on elapsed time or completed quantities. It includes the ability to track calibrations, labor and required parts used for maintenance. In addition, it has project accounting capabilities to plan, track and control detailed project budget and spending data for capital expense projects such as refits or building and commissioning new plants. EAM includes functionality to manage rotable (renewable) inventory. EAM helps manufacturers achieve a balance between having the right equipment available and minimizing their equipment investment. It ensures critical spare parts are on hand as needed and monitors company expense and approval policies with regard to capital plant and equipment.

 

Action Centers with Embedded Analytics

 

Action Centers are designed to provide data and information users need in order to work efficiently in a straightforward visual format. Users can drill down into more detail or take quick action based on the insight the solution provides. Action Centers provide built-in analytics and operational metrics as well as more than 400 browses and nearly 450 reports. All information can be accessed from a mobile device to support users who are not at their desk or in the office.

 

QAD Analytics

 

QAD Enterprise Applications provides decision makers and company stakeholders with key data to measure performance against company and strategic goals. QAD Analytics helps customers perform complex analyses, make informed decisions and improve performance management by highlighting areas that need improvement and enabling drill down to source data. The QAD Analytics suite consists of multiple analysis and data extraction tools all working in harmony to provide user-defined analysis such as consolidated reporting or reporting by geography, product line or cost center.

 

The solution consists of QAD Reporting Framework, which provides powerful, yet simple, reporting and real-time visibility with ad hoc inquiries; Operational Metrics, which enables companies to define and monitor key performance indicators; and QAD Business Intelligence, which allows for dynamic analysis and trend reporting across multiple data sources. Customers can also access QAD Business Intelligence using mobile devices, which allows users to view, filter and sort all data accessible to QAD Browses using mobile devices.

 

QAD Enterprise Quality Management System

 

QAD provides enterprise quality management and regulatory compliance solutions to global companies in many market segments, including QAD’s target markets. The suite supports customers’ compliance with industry-specific quality standards. In the automotive vertical, QAD’s solution delivers automation of Advanced Product Quality Planning (“APQP”) methodologies, including Production Part Approval Process (“PPAP”), process flow and approvals. In the life sciences vertical, customers benefit from critical functionality supporting corrective and preventative action and non-conformance reporting. The suite also features manufacturing quality solutions for audit, risk management, document control, gage calibration, inspection and statistical process control. Our CEBOS division supports and develops QAD’s Enterprise Quality Management suite.

 

QAD Interoperability

 

QAD Cloud ERP and QAD Enterprise Applications use a service-oriented architecture, allowing customers to easily integrate with non-QAD business applications. Through the Q-Xtend integration toolset, QAD supports application interoperability using open standards, comprehensive APIs and event management. QAD Boomi AtomSphere, based on Dell Boomi, provides an integration platform for cloud and on-premises application, data and process integration. QAD Cloud EDI provides “as a service” EDI translation and communication services, ensuring manufacturers have a scalable solution that can be implemented rapidly and that standardizes EDI across the enterprise. QAD EDI eCommerce offers a complete on-premises EDI solution that simplifies electronic data interchange with trading partners across the value chain. Cloud-based QAD eInvoicing supports the exchange of digital invoices between supplier and customer, providing for paperless invoicing in 54 countries and helping manufacturing meet growing digital tax compliance requirements.

 

QAD Internationalization

 

QAD supports companies that manufacture and distribute their products around the world. When a global company expands its operations, it often needs to accommodate local languages, local accounting standards and local business practices. Operating in different countries also requires access to specific local software, such as that used to interface to banks in their country of operation. QAD supports the requirements of 60 different countries with its internationalization capabilities.

 

QAD Divisions

 

Over time QAD has acquired certain companies to enhance our product capabilities. We have chosen to keep some of our acquired companies operating as divisions because they may market their software outside of the industries our core QAD customers are in. Although the products marketed by these divisions have all been incorporated into QAD Enterprise Applications, these divisions also maintain their own websites, operate under their own names and may sell their products under their own names.

 

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The following divisions operate as part of QAD Inc.:

 

Precision Software

 

Precision markets our transportation management solutions and is a trusted source for global trade and transportation execution. Precision Transportation Management facilitates documentation and control for moving shipments across borders, including regulatory compliance, and allows companies to optimize outside carriers for shipments. From a single, comprehensive open architecture that is adaptable and extensible, the solution controls both domestic and international movement of inbound and outbound goods, regulatory compliance, documentation, carrier and delivery management. This enterprise-class solution can be found in the world's largest and most complex organizations that demand speed and centralized control of trade and shipping.

 

DynaSys

 

DynaSys markets our Demand and Supply Chain Planning (“DSCP”) solution. The DynaSys DSCP technology provides a comprehensive end-to-end solution that enables optimization, analysis, simulation, collaboration, and the ability to understand and efficiently plan supply chain activities. This solution helps enterprises improve customer satisfaction while reducing inventory levels and costs and provide instant visibility and intuitive decision support enabling companies to become more agile to make their supply chain a competitive business differentiation. The solution suite supports demand planning, inventory optimization, supply planning, manufacturing planning, financial planning, sales & operations planning, integrated business planning and Demand Driven Material Requirements Planning (“DDMRP”).

 

CEBOS

 

CEBOS provides our enterprise quality management and regulatory compliance solutions. This application suite features manufacturing quality solutions for audit, risk management, document control, gage calibration, inspection and statistical process control.

 

CEBOS provides a fully integrated end-to-end enterprise quality management solution (“EQMS”). The solution targets are manufacturing organizations that will utilize quality as a means to increase competitiveness as well as optimize the manufacturing operating margins. By reducing the cost of quality as well as optimizing throughput and reducing manufacturing interruption resulting from poor quality, significant margin impacts can be realized. In addition, the solution will target the cost of good quality by increasing the effectiveness of quality management and moving organizations from a containment approach to a preventative operating strategy. The CEBOS solution places intense focus on the early stages of new product introduction and expansion into the supplier ecosystem to insure quality issues are addressed in a proactive manner. The solution readily interoperates with all versions of the QAD ERP solution as well as non-QAD ERP solutions.

 

Customer Support and Product Updates Provided via Our Cloud and Maintenance Offerings

 

Customer support services and product enhancements are provided to our cloud customers as part of their monthly subscription fee and to on-premises customers via our maintenance offering. Customer support services include Internet and telephone access to technical support personnel located in our global support centers. Through our support services, we provide the resources, tools and expertise needed to maximize the use of QAD Enterprise Applications. Customers active on maintenance or the cloud are also entitled to receive product upgrades and enhancements on a when-and-if available basis.

 

As part of our maintenance and cloud offerings, our online support site also provides access to an extensive knowledge database, online training materials, a virtual training environment, remote diagnostics and our software download center, called QAD Store. Our support professionals in our global support centers focus on quickly resolving customers’ issues, maintaining optimal system performance and providing uninterrupted service for complete customer satisfaction. In addition, we provide other products, including operational metrics, workbenches and monitoring tools. Customers have access to these products at no additional fee, provided they have a current maintenance or cloud agreement in place with QAD.

 

Our cloud environment is managed by our Cloud Operations group with infrastructure operated by us, but located within third-party data center facilities or from cloud computing platform providers. The cloud operations group is dedicated to supporting our cloud solutions. Located primarily in the U.S. and India, they manage the day-to-day operations of our cloud computing solutions, act as the control point for activities related to elements of the cloud and maintain our cloud environment, conversions and upgrades to QAD Enterprise Applications.

 

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Generally, our on-premises customers purchase maintenance when they acquire new licenses and our maintenance retention rate is more than 90%. Our maintenance and other revenue represented 37%, 42% and 47% of our total revenues in fiscal 2019, 2018 and 2017, respectively. Our maintenance revenue is negatively impacted by customers on maintenance converting to our cloud solutions. When maintenance customers convert to the cloud, they no longer contract for maintenance as those support services and unspecified updates are included as a component of the subscription offering. Our subscription revenue represented approximately 28%, 23% and 19% of our total revenue in fiscal 2019, 2018 and 2017, respectively, and our cloud customer retention rate is also in excess of 90%. We track our retention rate of cloud and maintenance by calculating the annualized revenue of customer sites with contracts up for renewal during the period compared to the annualized revenue associated with the customer sites that have canceled during the period. The percentage of revenue not canceled is our retention rate. Conversions to the cloud are not considered cancellations for purposes of the maintenance retention rate calculation. Additional users and additional modules are not included in the annualized revenue for purposes of this calculation.

 

QAD Global Services

 

QAD offers professional services including consulting, deployment, training, technical, development and integration to facilitate adoption of our cloud Enterprise Applications solution and enable customer success. Through our agile “Easy On Boarding” (“EOB”) approach we can help customers response to business challenges in a rapid, agile and effective manner.

 

QAD Global Services engages with our customers across the entire enterprise application life cycle through planning, design, implementation and post go-live support. Whether in the cloud or on-premises, our Global Services group assists our customers with initial deployments, upgrades to more current product versions, migration of on-premises deployments to the cloud, conversion and transfer of historical data, ongoing system and process optimization, and user training and education. In addition, through its ecosystem of partners, QAD can offer our customers augmented resources to assist on typical site-based implementation activities such as data cleansing, functional support, training and user acceptance testing.

 

QAD Global Services comprises over 450 consultants located throughout the world, augmented by a growing global network of certified partners. Our consulting ecosystem spans 60 countries. QAD consultants and partners are trained on our best practice implementation methodologies and have obtained certifications of proficiency in many areas. We offer a complete portfolio of services, delivered to consistent standards across the globe. Working in tandem with our partners, we support national and global projects on behalf of QAD customers.

 

In support of QAD’s vision of all customers becoming Agile Effective Enterprises, QAD has developed a framework of Key Performance Indicators (“KPIs”) used by QAD Global Services to measure pre- and post-implementation performance of business processes and aid in the diagnosis of opportunities for continuous improvement. The QAD KPI framework is available to all customers and is monitored using the QAD analytics suite.

 

QAD’s principal methodology for deployment of solutions is called QAD Easy On Boarding (“EOB”). EOB has been designed to make deployment of QAD solutions on-premises or in the cloud standardized and efficient. EOB features predefined industry process models and work instructions built into the products themselves as well as implementation guides and scripts, all based on our experience with best practice standards, resulting in greater out of the box fit. With EOB, implementation can be faster than more traditional approaches.

   

QAD Global Services focuses on assisting customers with the following activities:

 

Implementations and Migrations – QAD Global Services supports customers with the initial implementation of QAD Enterprise Applications. QAD Global Services has expertise in global implementations, harnessing the entire QAD Global Services ecosystem to provide local or remote support to meet customer requirements. QAD Global Services deploys our applications both on-premises and in the cloud. In addition, QAD Global Services has the experience to assist new customers with migration from other enterprise application systems. This service includes data conversions as well as process design change management.

 

Upgrades – QAD Global Services assists customers in the process of upgrading their QAD Enterprise Applications to the latest version, accelerating time to benefit, increasing new functionality and applying usability best practices.

 

Conversions – QAD Global Services employs a standardized process for converting from on-premises solutions to the cloud.

 

Integration – QAD Global Services has the expertise and experience to quickly integrate QAD solutions with other systems.

 

Systems Management – QAD Global Services delivers a range of services to support the technical management of systems and performance monitoring for those customers who choose on-premises deployment.

 

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Training and Education – QAD Global Services offers a full range of services leveraging QAD’s learning management system. Users can access multimedia training on all QAD offerings and take advantage of pre-defined learning plans for all of the roles that QAD users typically perform. Global Services also provides customized courses that are taught on-site to meet specific customer needs and are available to end users, IT professionals, department managers, partners and consultants.

 

Extended Solution Support – QAD Global Services is available to support interfaces, Automation Solutions, any customer specific requests to tailor applications and EDI solutions through our Extended Solution Support Services.

 

Business Process Improvement – QAD has developed a range of predefined diagnostic offerings called Q-Scans. QAD Global Services utilizes Q-Scans to engage in highly efficient diagnosis of key business processes and functional areas to provide recommendations to customers for continuous improvement.

 

Pre-Defined Consulting Engagements – QAD Global Services performs diagnostic and prescriptive consultations that cover many areas including customization, analytics and various areas of compliance such as MMOG/LE and FDA requirements.

 

QAD Global Services’ network of employees, consultants and partners knows QAD software best. They diagnose issues preventing businesses from running efficiently and prescribe steps to maximize the benefits of QAD Enterprise Applications. These QAD experts offer what outside consultants cannot - a combination of a deep understanding of the industries in which our customers operate, in-depth knowledge of functionality of the QAD solution portfolio and the proven experience of helping customers leverage our software to become more Effective Enterprises. QAD Global Services offers a full range of program management, project management, industry consulting and technical services certified in our products and methodologies.

 

QAD GLOBAL PARTNER NETWORK

 

QAD establishes strategic relationships with our partners to expand our sales reach, improve our market impact, provide technological advantages and strengthen our strategic position in the industries that we serve. QAD and our partners are constantly evolving, broadening our expertise and our footprint in order to meet the diverse needs of our customers around the world. Today we have approximately 120 companies partnering with us to deliver innovative solutions, services and technology that help our customers build their Effective Enterprise.

 

OUR GROWTH STRATEGY

 

QAD believes there are substantial growth opportunities in its cloud business over the coming years. Global manufacturers are facing unprecedented levels of disruption driven by advances in digital technologies. Responding to these changes requires a level of agility that legacy ERP solutions fail to deliver. QAD's Cloud ERP offers unparalleled speed of deployment and the ongoing ability to easily adapt and extend business models to meet the challenge of accelerating change. As a market leading solution for agile ERP, we expect to see a growing number of manufacturers moving from their legacy providers and turning to QAD to help them thrive in the digital manufacturing era. Additionally, we also expect to see a continuing conversion of our on premises customers to QAD's Cloud ERP. 

 

Our strategy is to enhance our position as a leading provider of cloud-based enterprise applications for global manufacturing companies. The key elements of our strategy, which we believe will drive continued growth, are as follows:

 

Leverage disrupted markets for new cloud customer acquisitions. The accelerating pace of change in our customers’ markets has created a disconnect between their business requirements and what their systems are able to support. Legacy ERP systems simply were not designed to support today’s rapid pace of change. The QAD Enterprise Platform was designed to provide greater fit and flexibility to easily meet tomorrow’s requirements. As such, disruption in our customers’ markets becomes a compelling reason for changing their ERP systems and one that we are well positioned to address. We are targeting segments within our primary verticals with the greatest disruption and actively pursuing new customers where we can provide the best fit.  We are investing in sales and marketing to focus on new customer acquisitions.  Three areas of disruption that we are targeting are: Anything as a Service (“XaaS”), make to order at scale, and the digital transformation of manufacturing (also known as Industry 4.0).

 

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Grow our cloud business and expand our footprint within existing customers. We believe there is substantial opportunity to win new customers in the core vertical markets we serve and grow our cloud-based enterprise solutions within our global manufacturing customer base. Our cloud solutions allow our customers to focus on their products and services without the distraction of administering their enterprise applications or maintaining their infrastructure. With over 300,000 active users of our on-premises and cloud solutions, of which 43,000 are cloud users, we have many opportunities to increase cloud revenue across our existing installed base by converting our on-premises customers to our cloud-based solution and selling additional modules and users to our existing cloud customers

 

Continuous product development and rapid response to change.  Manufacturers are facing a swiftly changing business environment fueled by exponential growth in underlying Industry 4.0 technologies such as Internet of Things (“IoT”), Machine Learning (“ML”), Artificial Intelligence (“AI”), Additive Manufacturing (“3D Printing”), Blockchain, Augmented Reality, and Predictive Analytics. We believe delivering a focused, flexible ERP system will be increasingly attractive to pragmatic manufacturers seeking a long-term fit of their business systems in support of their strategy in changing markets. We are committed to continuous investment in product development and advanced technologies to ensure our products have the necessary capabilities to meet the needs of our global customers and enhance our competitive position in the vertical markets we serve.

 

 Focus on global manufacturing and leverage expertise within key vertical markets. Many manufacturers operate globally, requiring a provider that can tailor solutions to the unique needs of their markets, deliver local and global services resources and support local languages. Solutions must be cost effective and easy to implement and use. Our solutions offer many benefits to customers with global operations, including capabilities that support operations in multiple geographies with a variety of languages and currencies, as well as compliance with complex local regulations and business practices. Our existing global footprint is a key leverage point for meeting these needs by utilizing offices, personnel and partnerships in many countries around the world. We also employ staff with specific knowledge and experience in the industries in which our customers operate. We provide our solutions to 26 segments across six vertical manufacturing markets; and we actively participate in several leading industry associations. Our industry knowledge continues to deepen through regular interaction with our customers. This collective experience allows QAD to develop solutions with specific capabilities that address our customers’ needs in the industries they serve.

 

Enhance customer experience to deliver continuous value and maximize customer retention. Our goal is to renew the subscription or maintenance agreements of our customers every year.  We deliver a continuous improvement process to ensure our customers are maximizing their investment in QAD products and using our software to operate their business at peak efficiency.   We strive to deliver excellent customer support via our maintenance and cloud offerings. We also engage with every customer every year, frequently conducting reviews of their business processes and presenting opportunities for improvement. Our deep vertical segment focus and strong, ongoing customer relationships drive continuous development of industry-specific functionality. As a result, we have maintained retention rates in excess of 90% annually.

 

TECHNOLOGY

 

QAD Enterprise Applications was designed to achieve our vision for global manufacturing companies to effectively run their business processes at peak efficiency, in alignment with their strategic goals. We have chosen the best technologies to achieve our vision, focusing on user experience, integration, business services, analytics, databases and deployment flexibility. We embrace ‘openness’ as a core principle of our designs, aiming to allow customers freedom of choice of devices and open connectivity with other systems. The core of QAD Enterprise Applications is built on a service based architecture, which allows QAD Enterprise Applications’ components to communicate with one another through industry-standard messaging techniques like Representation State Transfer services. This allows customers to exploit the full benefit of QAD’s open architecture for their businesses.

 

QAD Enterprise Applications core systems are built upon the QAD Enterprise Platform. The QAD Enterprise Platform is a micro-services architecture with the technologies and development tools needed to build a world class user experience (“UX”) with comprehensive functionality for global manufacturing companies.  This functionality is encapsulated into Apps that can be upgraded independently of each other as well as extended by customers.  Apps can be accessed securely over the Internet via a web browser or mobile devices (iOS and Android). The platform provides many advanced services to Apps like an App builder, security, integration, cloud support, analytics, mobile, collaboration and a world-class UX.  The platform supports UX, code, data and cloud flexibility to adapt readily to the ever-changing world of technology.  The UX is built using the latest open web technologies to support a rich HTML5 user interface. Business logic can be implemented in JavaScript via the more structured Type Script, Oracle’s Java or Progress Software Corporation’s OpenEdge language. Databases include MySQL, Progress OpenEdge and Cassandra data lake.

 

QAD’s enterprise architecture provides significant flexibility for global companies in deploying QAD Enterprise Applications. Our enterprise architecture allows companies to separate the legal structure of their business from physical operating locations or to separate both of these from the software instances and computer hardware that support them. With QAD enterprise architecture, customers can choose which sites are a part of which companies, which sites are supported on any instance of the application, or which sites operate as one instance. Customers can also choose centralized, decentralized or hybrid computing architectures with parts of their enterprise running from both central resources and local resources.

 

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QAD combines our technologies to provide a comprehensive cloud solution for our customers. Our cloud architecture encompasses infrastructure provisioning and application deployment, management, monitoring and security; providing a world-class development operations practice built around Information Technology Infrastructure Library (“ITIL”) standards. QAD’s cloud infrastructure operates on a Cloud Management Platform. This enables QAD to seamlessly deploy customer systems to one of a number of global cloud infrastructure providers as part of the QAD Cloud offering.  Our cloud delivery centers are certified under the ISO 9001:2008 standard for quality management, the ISO 20000:2011 standard for service management (“SMS”), the ISO 27001:2013 standard for information security management (“ISMS”), the FDA 21 CFR Part 11 requirements for electronic records and signatures, and the SSAE 16 (SOC I-Type II) requirements for reporting and compliance controls.

 

Cloud deployments are designed to be delivered as single tenant deployments. This decision was made based on our customers’ requirements for a mission critical system that they control. Providing customers with control over when to apply patches and upgrades reduces downtime and aligns to their business cycles. It also reduces the substantial costs associated with validation requirements in Life Sciences.

 

QAD takes a pragmatic approach to technology that is use case focused. We engage with our customers through experimentation in the QAD Labs. QAD Labs is a virtual combination of people, technology and passion for addressing the challenges of manufacturing planning and operations. The guiding force behind QAD Labs is the collaboration between QAD and our customers. This collaboration involves experimenting with advanced technologies to address legacy or emerging challenges. The experimentation is not hindered by the large budgeting cycles of major projects. By design, the QAD Labs approach allows for rapid application, rapid evaluation and strategic pivots to build on success or investigate alternatives.

 

This experimentation can be aligned with initiatives like Industry 4.0 and associated technologies such as IoT, Machine Learning, Robotic Process Automation and Data Lakes. Alternatively, the initiative can be associated with innovation to solve long-term problems with the explosion of emerging new technologies. The pilot projects include machine learning, assisted planning and IoT integrated shop floor connectivity.

 

PRODUCT DEVELOPMENT

 

We continued to see our manufacturing customers’ businesses evolve during fiscal 2019 with a focus on connectivity to machines on the shop floor and data lakes to collect and analyze the rich information obtained from those machines. The products that our customers produce are becoming smarter and are now connected and participating in the IoT revolution. We are using Machine Learning and Predictive Analytics to streamline and make customers’ manufacturing processes smarter. We continue to maintain a global research and development organization that provides new product enhancements to the market on a semiannual basis in order to be responsive to industry and regulatory changes. We continue to support our customers as their operations move across the globe through our internationalization effort.

 

The enterprise software industry is continuing its transition from selling on-premises licenses to selling cloud-based solutions, which include flexible and adaptive integration, social media interaction, mobile computing and platform services capabilities. In fiscal 2019, we released a major upgrade to the Enterprise Edition software suite that was focused on supply chain efficiencies and flexible manufacturing. Our latest agile manufacturing module moved to general availability and gives our customers the ability to mix and match their manufacturing styles in one easy to use production process.

 

We continued the transition of our business model and product suite to cloud-based offerings as we moved our latest user experience and QAD Enterprise Platform to general availability for our cloud customers. We started an Early Adopter program for our on-premises customers. Our latest release supports mobile applications for decision making and provides insights into the health of our customers’ businesses through an Actionable Insights application. This offering is designed to give our customers even more value and flexibility when using our product suite with a secure browser from anywhere the user has connectivity. We continue to see more attempts of outside penetration or hacking with Internet facing applications which we take very seriously. We continue to have our software verified through an outside firm by scanning all the source code and performing penetration testing to preemptively identify and remove security flaws. With our web services, rich set of API’s and the QAD Enterprise Platform, our customers can more easily connect our product suite to other applications and extend our solution without customizing or writing code.

 

We dedicate considerable technical and financial resources to research and development to continually enhance and expand our product suite. For example, in fiscal 2019, we continued our internationalization program in support of our global customers. As we ended fiscal 2019, we were supporting our customers in over 70 countries with a single solution managed and maintained by QAD’s research and development organization. We continue to see a trend toward electronic invoicing and registration of shipments and invoices with government agencies to prevent falsification and tax avoidance. Spain, Mexico and Italy all introduced legislation in 2018 that requires all invoices to be registered with the government. We also see a continued tightening of tax legislation. India introduced a new Value Added Tax (“VAT”) process during 2018. We continue to support our customers through these changes without interruption to their business. Our goal is to continue to provide our customers with software that assists them in meeting the legal requirements of the countries in which they do business.

 

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We operate a global research and development (“R&D”) organization comprised of 430 R&D employees located in offices in the United States, India, China, Ireland, Australia, France, Belgium, Spain, Brazil, Great Britain and Poland. Our R&D expenses totaled $54.0 million, $47.7 million and $43.6 million in fiscal years 2019, 2018 and 2017, respectively. Our software is primarily developed internally; however, we also use independent firms and contractors to perform some of our product development activities when we require additional resources or specific skills or knowledge. All outside development is managed by our internal R&D organization. As needed, we acquire products or technology developed by others by purchasing or licensing products and technology from third parties. We continually review these investments in an effort to ensure that we are generating sufficient revenue or gaining enough competitive advantage to justify their costs. We routinely translate our product suite into fourteen languages and through our internationalization program we support mandatory governmental regulations and reporting requirements for over 70 countries. This is accomplished through a single offering for our customers in the cloud or on-premises, allowing them to run their businesses using a consistent core business model with the deployment model of their choice.

 

We plan to continue to manage significant product development operations globally over the next several years. We believe that our ability to conduct research and development at various locations throughout the world allows us to optimize product development at lower costs and integrate local market knowledge into our development activities. We continually assess the significant costs and challenges, including intellectual property protection, against the benefits of our international development activities. 

 

DIRECT AND INDIRECT SALES

 

QAD sells its products and services through direct and indirect sales channels located throughout the regions of North America, Latin America, EMEA and Asia Pacific. Each region leverages global standards and systems to enhance consistency when interacting with global customers. Additionally, we have a global strategic accounts team, which is responsible for managing QAD’s largest global customers across regions.

 

Our direct sales organization includes approximately 65 commissioned sales people. Incentive pay is a significant portion of the total compensation package for our sales staff. We continually align our sales organization and business strategies with market conditions to maintain an effective sales process. We cultivate the industries we serve within each territory through marketing, local product development and sales training.

 

Our indirect sales channel consists of approximately 40 distributors and sales agents worldwide. We do not grant exclusive rights to any of our distributors or sales agents. Our distributors and sales agents primarily sell independently to companies within their geographic territory, but may also work in conjunction with our direct sales organization. We also identify global sales opportunities through our relationships with implementation service providers, hardware vendors and other third parties.

 

MARKETING

 

Our marketing strategy is to differentiate our offering by focusing on our role in providing value by helping our customers achieve the vision of the Agile, Rapid and Effective Enterprise. We are targeting segments within our primary verticals with the greatest disruption and where we can provide the best fit.

 

Our main marketing objectives are to leverage the measurable success in business outcomes our customers have achieved and highlight hidden costs prospects may face to increase awareness and drive leads in these target segments. We do this by openly and consistently communicating with QAD customers, prospects, partners, investors and other key audiences. Our primary marketing activities include: account based marketing (“ABM”) for targeting, buying intent, and display advertising; press and industry analyst relations to garner third-party validation and generate positive coverage for our company, offerings and value proposition; user conferences and events, such as Explore, as well as participation in other industry events, to create customer and prospect awareness; content marketing and engagement on social channels like Facebook, Twitter, LinkedIn and YouTube; search engine optimization; web site development and gamification to engage and educate prospects and generate interest through product information and demonstrations; case studies, white papers, and marketing collateral; customer testimonials, references, and referrals; and sales tools and field marketing events to enable our sales organization to more effectively convert leads into customers.

 

We recognize the changing buying dynamics and are focused on engaging with prospects early in the sales cycle in order to help set the buying criteria and specifications in a way that uniquely leads to QAD. We seek to accelerate prospects through the buying journey by demonstrating the value of our products, answering questions, and removing roadblocks.

 

COMPETITION

 

Every aspect of our business is affected by strong competition from both enterprise software application vendors and cloud computing application services providers. The markets for our on-premises and cloud offerings are rapidly evolving; highly competitive; and subject to changing technology, shifting customer needs and frequent introductions of new applications. Our customers demand greater performance and reliability with lower complexity. Cost of implementation or conversion to the cloud and cost of ongoing maintenance and subscription are constant concerns when our customers make decisions about how best to deploy their resources.

 

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We compete with large, well-established enterprise application vendors, such as SAP, Oracle and Infor, who hold significant market share in the traditional ERP marketplace. These companies have considerable financial resources and name recognition; and have established broad market solutions by developing applications targeted at many industries, not just manufacturing. Internationally, we face competition from local companies, as well as the large enterprise application competitors, many of which have products tailored for those local markets.

 

Most enterprise application vendors today have some focus on cloud solutions, in addition to on-premises sales, which creates an environment in which we face competition from a variety of vendors that address one or more of our applications. As a result, our cloud solutions compete with both large enterprise software vendors and cloud computing application service providers. In addition, other vendors that provide services in different markets may develop solutions in our target markets and some potential customers may elect to develop their own internal solutions.

 

We believe the key competitive factors in our markets are:

 

 

Customer satisfaction

 

Speed and ease of deployment and use of applications

 

Total cost of ownership

 

Performance and reliability

 

Capability for configuration, integration, security and scalability

 

Solution breadth and functionality

 

Technological innovation and ability to respond to customer needs rapidly

 

Financial resources and

 

Reputation of the vendor.

  

We believe that we compete favorably on the basis of these factors. To further our market success, we must continue to respond promptly and effectively to technological change and competitors’ innovations. Our ability to remain competitive will depend on our efforts in the areas of product development and sales, services and support operations.

 

EMPLOYEES

 

As of January 31, 2019, we had approximately 1,970 full-time employees, including 965 in support, subscription and professional services, 430 in research and development, 345 in sales and marketing and 230 in administration. Generally, our employees are not represented by collective bargaining agreements. However, certain employees in our Netherlands, France and Italy subsidiaries are represented by statutory works councils as required under local law. Employees of our Brazilian subsidiary are represented by a collective bargaining agreement with the Data Processing Union.

 

INTELLECTUAL PROPERTY

 

We rely on a combination of trademark, copyright, trade secret and patent laws in the United States and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our proprietary technology and our brands and we maintain programs to protect and grow our rights. We also enter into confidentiality and proprietary rights agreements with our employees, consultants and other third parties and control access to software, services, documentation and other proprietary information.

 

SEASONALITY

 

Our fourth quarter has historically been our strongest quarter for new business and maintenance renewals. For a more detailed discussion, see the “Seasonal Nature of Deferred Revenue, Accounts Receivable and Operating Cash Flow” discussion in Management’s Discussion and Analysis.

 

SEGMENT REPORTING

 

We operate in a single reporting segment. Geographical financial information for fiscal years 2019, 2018 and 2017 is presented in Note 12 within the Notes to Consolidated Financial Statements included in Item 15 of this Annual Report on Form 10-K.

 

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AVAILABLE INFORMATION

 

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our website at www.qad.com, as soon as reasonably practicable after such reports have been electronically filed or otherwise furnished to the Securities and Exchange Commission. We are not including the information contained on our website as part of, or incorporating it by reference into, this annual report on Form 10-K.

 

ITEM 1A. RISK FACTORS

 

The environment in which we operate involves significant risks and is subject to factors beyond our control. You should consider the risk factors described below before investing in our stock as such risks may have a material adverse effect on our business, results of operations and financial condition and could cause the price of our stock to decline. Please note that the risk factors described below are not exhaustive.

 

Risks associated with our cloud service offerings

 

Defects and disruptions in our services could diminish demand for our services and subject us to liability.

 

Our cloud service offerings are complex and incorporate a variety of hardware, network infrastructure and proprietary and third-party software, and may have errors or defects that could result in unanticipated downtime and disruptions for our customers and harm to our reputation and our business. We have from time to time found defects in our services and new defects may be discovered in the future, especially in connection with the integration of new technologies and the introduction of new services. As a result, we could lose future sales and existing customers could elect to cancel or make warranty or other claims against us and potentially expose us to the expense and risk of litigation.

 

Our revenue and profitability will be adversely affected if we do not properly manage our cloud service offerings.

 

We expend significant resources to improve the reliability and security of our cloud offerings and the cost of these investments could reduce our revenue and profitability. The pricing and other terms of some of our cloud agreements require us to make estimates and assumptions at the time we enter into these contracts that could differ from actual results. Early termination, increased costs or unanticipated delays could have an adverse effect on our profit margin and generate negative cash flow. Further, if we experience delays in implementing new cloud customers (whether due to product defects, system complexities or other factors) then customers may delay the deployment of additional users and sites, which could adversely affect our revenue growth. If we fail to meet our system availability commitments or other customer obligations then we may be required to give credits or refund fees, and we may be subject to litigation and loss of customer business. For example, if we were to miss our system availability commitments then we are obligated under our standard customer contracts to issue one day’s credit against future fees for each hour of system unavailability.

 

Continued growth could strain our personnel resources and infrastructure, and if we are unable to scale our operations and increase productivity, we may not be able to successfully implement our business plan.

 

We continue to experience significant growth in our customer base and personnel, which has placed a strain on our management, administrative, operational and financial infrastructure. We anticipate that significant additional investments will be required to scale our operations and increase productivity, to address the needs of our customers, to further develop and enhance our services, and to scale with our overall growth. Our success will depend in part upon our ability to manage our projected growth effectively. To do so, we must continue to increase the productivity of our existing employees and to hire, train and manage new employees as needed, and continue to improve our operational, financial and management controls, our reporting systems and procedures. We may also experience a decline in our revenue growth rate as our revenues increase to higher levels. If we fail to successfully scale our operations and increase productivity, we may be unable to execute our business plan.

 

Our cloud retention rate is dependent upon a number of factors that may impact our ability to accurately predict growth in our cloud business.

 

Our cloud customers typically enter into subscription agreements with an initial term of 12 to 60 months. Our customers have no obligation to renew their subscriptions after the expiration of their initial subscription period, and some customers may elect (for a variety of reasons, including a business downturn) not to renew, or may elect to renew at a lower subscription level. Growth in our cloud business may be affected by our inability to maintain high retention rates and sell additional features and services to our current customers, which could depend on a number of factors, including customers’ satisfaction with our products and services, the prices of our offerings and general economic conditions. We cannot provide assurance that our subscriptions will be renewed at the same or higher levels of service, for the same number of users or for the same duration of time, if at all, or that we will be able to accurately predict future customer retention rates. If our customers do not renew their subscriptions or if they renew on terms less favorable to us, the rate at which our cloud business grows may decline and our revenue may be reduced.

  

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We rely on third-party hosting and other service providers.

 

We currently serve our cloud customers from third-party data center hosting facilities located in the United States and other countries. We do not control the operation of any of these facilities, and they may be subject to damage or interruption from earthquakes, floods, fires, power loss, telecommunications failures and similar events. They may also be subject to breaches of computer hardware and software security, break-ins, sabotage, intentional acts of vandalism and similar misconduct. And while we rely on service level agreements with these vendors, if they do not properly maintain their infrastructure or if they incur unplanned outages, our customers may experience performance issues or unexpected interruptions and we will not meet our service level agreement terms with our customers. Despite precautions taken at these facilities, the occurrence of a natural disaster or an act of terrorism, a decision to close the facilities without adequate notice or other unanticipated problems at these facilities could result in lengthy interruptions in our service. Even with our disaster recovery precautions, our services could be interrupted. Any loss or interruption of these services could result in us not meeting our service level agreements with our customers which would significantly increase our expenses, reduce our ability to generate revenue and/or result in errors or a failure of our services which could adversely affect our business. These vendor services may not continue to be available at reasonable prices or on commercially reasonable terms, or at all. Additionally, our service level agreements with our customers are not the same terms as our service level agreements with our hosting vendors. Our agreements with our customers are generally more restrictive and result in higher fees paid to customers for unplanned outages than credits we may receive from our hosting vendors.

 

We may be exposed to liability and loss from cyber security breaches.

 

Our cloud services involve the storage and transmission of customers’ proprietary information, and security breaches could expose us to a risk of loss of this information, resulting in litigation and possible liability. Security breaches may also include “denial-of-service” attacks, which can potentially disrupt our operations and our customers’ operations. Security measures may be breached in numerous ways, such as remote or on-site break-ins by computer hackers, disgruntled employees or employee error during transfer of data to additional data centers or at any time, and result in unauthorized access to our own and our customers’ data, intellectual property and other confidential business information. Additionally, third parties may attempt to induce employees or customers into disclosing sensitive information such as user names, passwords or other information in order to gain access to our own and our customers’ data, intellectual property and other confidential business information. Because the techniques used to obtain unauthorized access, or to sabotage systems, change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. A security breach could cause a loss of confidence in the security of our services, damage our reputation, disrupt our business, create legal liability and cause severe and potentially irreparable impact to our business. In the normal course of business, we are and have been the target of malicious cyber-attack attempts and have experienced other security incidents. To date, such identified security events have not had a material impact on our business operations or financial results, but there can be no assurance that future cyber-attacks will not have a material adverse impact.

 

Our solutions can be used to collect and store personal information of our customers’ employees or customers, and therefore privacy concerns and governmental regulations could result in additional cost and liability to us or inhibit sales of our solutions.

 

Regulatory focus on privacy issues continues to increase and worldwide laws and regulations concerning the handling of personal information are expanding and becoming more complex. Many federal, state and foreign government bodies and agencies have adopted, or are considering adopting, laws and regulations regarding the collection, use, disclosure and retention of personal information. The European Union (“EU”) and the United States entered into a new framework (known as the “Privacy Shield”) in July 2016 to provide a mechanism for companies to transfer data from EU member states to the U.S. The Privacy Shield and other data transfer mechanisms are subject to legal challenge, which generates uncertainty about the legal basis for data transfers to the U.S. or interruption of such transfers. In the event a court blocks transfers to or from a particular jurisdiction on the basis that transfer mechanisms are not legally adequate, this could cause operational interruptions, liabilities and reputational harm. These and other requirements could increase the cost of compliance for us and our customers, restrict our and our customers’ ability to store and process data, negatively impact our ability to offer our solutions in certain locations and limit our customers' ability to deploy our solutions globally. These consequences may be more significant in countries with legislation that requires data to remain localized “in country”, as this could require us or our customers to establish data storage in other jurisdictions or apply local operational processes that are difficult and costly to integrate with global processes.

 

If we fail to comply with such laws and regulations, we may be subject to significant fines, penalties or liabilities for noncompliance, thereby harming our business.  For example, in 2016, the European Union adopted the General Data Protection Regulation (“GDPR”), which establishes new requirements regarding the handling of personal data and which became effective in May 2018. Non-compliance with the GDPR may result in monetary penalties of up to 4% of worldwide revenue. In addition, domestic data privacy laws, such as the California Consumer Privacy Act (“CCPA”) which will take effect in January 2020, continue to evolve and could expose us to further regulatory burdens.

 

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Risks associated with rapid technological change and complexity

 

The market for our products and services is characterized by rapid technological change.

 

Customer requirements for products can change rapidly as a result of innovation or change within the computer hardware and software industries, the introduction of new products and technologies and changes to industry standards. Our future success, including our cloud service offerings, will depend upon our ability to continue to enhance our current product line and to develop and introduce new products and services that keep pace with technological developments, satisfy increasingly sophisticated customer requirements, keep pace with industry and compliance standards and achieve market acceptance. Our failure to successfully develop or acquire, and market, product enhancements or new products could have a material adverse effect on our business. Despite our significant investments in research and development, we may not realize significant new revenue from these investments for several years, if at all.

 

New software releases and enhancements may adversely affect our software sales.

 

The actual or anticipated introduction of new products, technologies and industry standards can render existing products obsolete or unmarketable or result in delays in the purchase of those products. Significant delays in launching new products may also jeopardize our ability to compete. If we fail to anticipate or respond to developments in technology or customer requirements, have significant delays in the introduction of new products or fail to maintain overall customer satisfaction, this could have a material adverse effect on our business.

 

Services engagements are complex and pose material risks.

 

Services engagements may involve complex technological challenges, including those related to customer customization requests and our cloud environments, and such challenges demand a significant number of specialized technical resources. Our failure to successfully address these issues could have a material adverse effect on our business.

 

Changes in laws and regulations related to the Internet may negatively impact our business.

 

Federal, state or foreign government bodies or agencies have in the past adopted, and may in the future adopt, laws or regulations relating to Internet usage. Changes in these laws or regulations could require us to modify our applications in order to comply with these laws or regulations. In addition, government agencies or private organizations may begin to impose taxes, fees or other charges for accessing the Internet or for commerce conducted via the Internet. These laws or charges could negatively impact our business.

 

Risks associated with our revenue, expenses and pricing

 

Our revenue and profits may fluctuate significantly.

 

Our quarterly and annual operating results have fluctuated in the past and may do so in the future. Such fluctuations have resulted from the seasonality of our customers’ manufacturing businesses and budget cycles and other factors. Moreover, there can be no assurance that our revenue will grow in future periods. As a result of fluctuating revenue or due to accelerated costs and deferred revenue resulting from cloud bookings there can be no assurance that we will be profitable on a quarterly or annual basis.  Furthermore, with the adoption of Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“Topic 606”) in fiscal 2019, revenue recognition has much greater reliance on management estimations.

 

Our financial forecasts are subject to uncertainty to the extent they are based on estimated sales forecasts.

 

Our revenues, and particularly our new software license revenue, are difficult to forecast, and, as a result, our financial forecasts are subject to uncertainty. Specifically, our sales forecasts are based on estimates that our sales personnel make regarding the likelihood of potential sales, including their expected closing date and fee amounts. If these estimates are inaccurate then our financial forecasts may also be inaccurate.

 

The margins in our services business may fluctuate.

 

Services revenue is dependent upon the timing and size of customer orders, as well as upon our related license and subscription sales. We may hire additional services staff in anticipation of customer orders and if we are unable to keep the services staff engaged on billable matters then our profit margins may suffer. In addition, certain engagements may involve fixed price arrangements and significant staffing which require us to make estimates and assumptions at the time we enter into these contracts as well as throughout the contract to determine percent completion and revenue recognition. Variances between these estimates and assumptions and actual results could have an adverse effect on our profit margin and generate negative cash flow and negative services margins. To the extent that we are not successful in securing orders from customers to provide services, or to the extent we are not successful in achieving the expected margin on such services, our results of operations may be adversely affected.

 

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The margins in our cloud service offerings may fluctuate.

 

Our cloud service offerings may involve fixed price arrangements, fixed and up-front costs and significant staffing which require us to make estimates and assumptions at the time we enter into these contracts. Variances between these estimates and assumptions and actual results could have an adverse effect on our profit margin and/or generate negative cash flow. To the extent that we are not successful in securing orders from customers to provide cloud services, or to the extent we are not successful in achieving the expected margin on such solutions, our results may be adversely affected.

 

Because we recognize revenue from cloud services over the term of the subscription, downturns or upturns in new business may not be immediately reflected in our operating results.

 

We generally recognize subscription revenue from customers ratably over the terms of their subscription agreements. As a result, most of the subscription revenue we report in each quarter is the result of subscription agreements entered into during prior quarters. Consequently, a decline in new or renewed subscriptions in any one quarter may not be reflected in our revenue results for that quarter. Any such decline, however, will negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in sales and market acceptance of our cloud services, and potential changes in our attrition rate, may not be fully reflected in our results of operations until future periods. Our subscription model also makes it difficult for us to rapidly increase our subscription revenue through additional sales in any period, as subscription revenue from new customers must be recognized over the applicable subscription term.

 

A significant portion of our revenue in any quarter may be derived from a limited number of large, non-recurring license sales.

 

We may experience large individual license sales, which may cause significant variations in license fees being reported on a quarterly basis. We also believe that the purchase of our products is discretionary and may involve a significant commitment of a customer’s capital resources. Therefore, a downturn in any significant customer’s business could have a significant adverse impact on our revenue and profit. Further, we have historically recognized a substantial portion of our license revenue from sales booked and shipped in the last month of a quarter and, as a result, the magnitude of quarterly fluctuations in license fees may not become evident until the end of a particular quarter. Our revenue from license fees in any quarter is substantially dependent on orders booked and shipped in that quarter. We are unlikely to be able to generate revenue from alternative sources if we discover a shortfall near the end of a quarter.

 

A significant portion of our revenue is derived from maintenance renewals with our existing installed base of customers.

 

Maintenance renewals are at the customer’s discretion, and customers may elect not to renew. Further, it is our strategy to convert existing customers to our cloud services offering, which, if successful, will reduce maintenance renewals. If our existing customers discontinue maintenance to a significant degree, our revenues and results of operations will be adversely affected.

 

Our maintenance retention rate is dependent upon a number of factors such as our ability to continue to develop and maintain our products, continue to recruit and retain qualified personnel to assist our customers, and promote the value of maintenance for our products to our customers.

 

Our maintenance retention rate is also dependent upon factors beyond our control such as technology changes and their adoption by our customers, budgeting decisions by our customers, changes in our customers’ strategy or ownership and plans by our customers to replace our products with competing products. If our maintenance retention rate decreases, our revenue and results of operations would be adversely affected.

 

We have risks regarding our pricing and pricing models.

 

We are occasionally obliged to offer deep discounts and other favorable terms in order to match or exceed the product and service offerings of our competitors. Furthermore, we may be faced with general downward pricing pressure from competitors and the market in the future. If we do not adapt our pricing models to reflect changes in customer demand resulting from rapid technological advances, such as those leading to alternative hosting and cloud service delivery offerings, our revenues could decrease. For example, if customer software usage evolves in ways that maintain or increase the value they derive from our products while decreasing traditional licensing metrics such as individual users, then if we do not adjust our pricing models accordingly then our revenues could decrease. Further, broad-based changes to our pricing models could adversely affect our revenues and operating results as our sales force implements, and our customers and accounting practices adjust to, the new pricing models.

 

We may have exposure to additional tax liabilities.

 

As a multinational organization, we are subject to income taxes as well as non-income taxes in the United States and in various foreign jurisdictions. Significant judgment is required in determining our worldwide income tax provision and other tax liabilities. Although we believe that our tax estimates are reasonable, the final determination of tax audits or tax disputes may differ from what is reflected in our historical income tax provisions and accruals.   

 

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Our tax rate could be adversely affected by several factors, many of which are outside of our control, including:

  

 

Changes in jurisdictional revenue mix;

 

 

Changing tax laws, regulations and interpretations thereof, including the changing landscape around Internet taxation and the new US Tax Reform laws;

 

 

Changes in tax rates;

 

 

Changes to the valuation allowance on deferred tax assets; and

 

 

Assessments and any related tax, interest or penalties.

 

If we are deemed to owe additional taxes, our results of operations may be adversely affected.

 

We report our results based on our calculations of the amount of taxes owed in the various tax jurisdictions in which we operate.

 

Periodically, we may receive notices that a tax authority in a particular jurisdiction believes that we owe a greater amount of income tax than we have reported, in which case we may engage in discussions or possible dispute resolutions with these tax authorities. If the ultimate determination of our income taxes owed in any of these jurisdictions is for an amount in excess of the tax provision we have recorded or reserved for, our operating results, cash flows, and financial condition could be adversely affected. We are also subject to non-income taxes, such as payroll, sales, use, value-added, net worth, property and goods and services taxes, in the United States and in various foreign jurisdictions. Audits or disputes relating to non-income taxes may result in additional liabilities that could negatively affect our operating results, cash flows and financial condition.

 

Risks associated with our sales cycle

 

Our products involve a long sales cycle and the timing of sales is difficult to predict. Because the licensing or subscription of our primary products generally involves a significant commitment of capital or a long-term commitment by our customers, the sales cycle associated with a purchase of our products is generally lengthy.

 

This cycle varies from customer to customer and is subject to a number of significant risks over which we have little or no control. The evaluation process that our customers follow generally involves many of their personnel and requires complex demonstrations and presentations to satisfy their needs. Significant effort is required by us to support this process, whether we are ultimately successful or not. If sales forecasted for a particular quarter are not realized in that quarter, then we are unlikely to be able to generate revenue from alternative sources in time to compensate for the shortfall. As a result, a lost or delayed sale could have a material adverse effect on our quarterly and annual operating results.

  

Risks associated with our solutions

 

We may experience defects in our solutions.

 

Our solutions, including licensed software, cloud services and other services, may contain defects, including security flaws, especially when first introduced or when new versions are released. The detection and correction of defects can be time consuming and costly. Defects in our solutions, including licensed third-party software, could affect the ability of our products to work with other hardware or software products. Defects could delay the development or release of new products or new versions of products and could adversely affect market acceptance of our products and our ability to conduct our cloud operations. Defects may also impair our ability to complete services implementations on time and within budget. Customers who rely on our solutions for applications that are critical to their businesses may have a greater sensitivity to such defects than customers for software products generally. Defects could expose us to product liability, performance and warranty claims as well as harm our reputation, which could adversely impact our future sales.

 

Dependence on third-party suppliers

 

We are dependent on Progress Software Corporation.

 

The majority of QAD Enterprise Applications are written in a programming language that is proprietary to Progress Software Corporation, or “Progress.” These QAD Enterprise Applications do not run within programming environments other than Progress and therefore our customers must acquire rights to Progress software in order to use these QAD Enterprise Applications. We have an agreement with Progress under which Progress licenses us to distribute and use Progress software related to our products. This agreement remains in effect unless terminated either by a written ten-year advance notice or due to a material breach that is not remedied. If Progress were to provide notice that it was terminating its agreement with us, this could have a material adverse effect on our business and prospects.

 

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Our success is also dependent upon Progress continuing to develop, support and enhance its programming language, its toolset and its database, as well as the continued market acceptance of Progress products. A change in Progress’ control, management or direction may adversely impact our relationship with Progress and our ability to rely on Progress products in our business. We have in the past, and may in the future, experience product release delays because of delays in the release of Progress products or product enhancements. Any of these delays could have a material adverse effect on our business.

 

We are dependent on other third-party suppliers.

 

We resell certain software which we license from third parties other than Progress. There can be no assurance that these third-party software arrangements and licenses will continue to be available to us on terms that provide us with the third-party software we require, provide adequate functionality in our products on terms that adequately protect our proprietary rights or are commercially favorable to us.

 

Certain QAD Enterprise Applications are developed using embedded programming tools from Microsoft and Sun Microsystems (owned by our competitor Oracle) for the Microsoft .NET framework and Java Programming environments, respectively. We rely on these environments’ continued compatibility with customers’ desktop and server operating systems. In the event that this compatibility is limited, some of our customers may not be able to easily upgrade their QAD software. If the present method of licensing the .NET framework as part of Microsoft’s Desktop Operating systems is changed and a separate price were applied to the .NET framework, our expenses could increase substantially. Similarly, if Oracle decided to charge fees or otherwise change the historical licensing terms for Java technology, our expenses could increase substantially. For both of the .Net and Java elements, we rely on market acceptance and maintenance of these environments and we may be adversely affected if these were withdrawn or superseded in the market.

 

Our partner agreements, including development, product acquisition and reseller agreements, contain confidentiality, indemnity and non-disclosure provisions for the third party and end user. Failure to establish or maintain successful relationships with these third parties or failure of these parties to develop and support their software, provide appropriate services and fulfill confidentiality, indemnity and non-disclosure obligations could have an adverse effect on us. We have been in the past, and expect to be in the future, party to disputes about ownership, license scope and royalty or fee terms with respect to intellectual property. Failure to prevail in any such dispute could have a material adverse effect on our business.

   

Risks associated with our proprietary rights and customer contracts

 

Our intellectual property may be at risk as a result of a variety of different factors.

 

We rely on a combination of protections provided by applicable copyright, trademark, patent and trade secret laws, as well as on confidentiality procedures and licensing arrangements, to establish and protect our rights in our software and related materials and information. We enter into licensing agreements with each of our on-premises customers and these agreements provide for the non-exclusive use of QAD Enterprise Applications. Our license contracts contain confidentiality and non-disclosure provisions, a limited warranty covering our applications and indemnification for the customer from infringement actions related to our applications. In addition, we generally license our software to end-users in both object code (machine-readable) and source code (human-readable) formats. While this practice facilitates customization, making software available in source code also makes it possible for others to copy or modify our software for impermissible purposes.

 

Despite our efforts, it may be possible for others to copy portions of our products, reverse engineer them or obtain and use information that we regard as proprietary, all of which could adversely affect our competitive position. Furthermore, there can be no assurance that our competitors will not independently develop technology similar to ours. In addition, the laws of certain countries do not protect our proprietary rights to the same extent as the laws of the United States.

 

The unauthorized use of our intellectual property rights may increase the cost of protecting these rights or reduce our revenues. We may initiate, or be subject to, claims or litigation for infringement of proprietary rights or to establish the validity of our proprietary rights, which could result in significant expense to us, cause product shipment delays, require us to enter royalty or licensing agreements and divert the efforts of our technical and management personnel from productive tasks, whether or not such litigation were determined in our favor.

 

We may be exposed to claims for infringement of intellectual property rights and breach of contract, and we may experience impairment of our own intellectual property rights.

 

Third parties may initiate proceedings against us claiming infringement or other misuse of their intellectual property rights and/or breach of our agreements with them. Further, while we actively monitor the adoption of open source software in our software development process, it is possible that our use of open source software may inadvertently subject our proprietary software to public disclosure and impairment of our intellectual property rights. The likelihood of such instances may increase as the use of open source and other third-party code becomes more prevalent in the industry. Any such instances, regardless of validity, may cause us to:

 

 

Pay license fees or monetary damages;

 

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Incur high legal fees in defense of such claims;

 

 

Alter or stop selling our products;

 

 

Satisfy indemnification obligations to our customers;

 

 

Release source code to third parties, possibly under open source license terms; and

 

 

Divert management’s time and attention from operating our business.

 

We may be exposed to product liability claims and other liabilities.

 

While our customer agreements typically contain provisions designed to limit our exposure to product liability claims and other liability, we may still be exposed to liability in the event such provisions may not apply.

 

We have an errors and omissions insurance policy which may not totally protect us.

 

The Company has an errors and omissions insurance policy. However, this insurance may not continue to be available to us on commercially reasonable terms or at all, or a claim otherwise covered by our insurance may exceed our coverage limits, or a claim may not be covered at all. We may be subject to product liability claims or errors or omissions claims that could have an adverse effect on us. Moreover, defending a suit, regardless of its merits, could entail substantial expense and require the time and attention of key management personnel.

  

Risks associated with our market and the economy

 

The market in which we participate is highly competitive and if we do not compete effectively our operating results could be harmed.

 

The market for enterprise software solutions is highly competitive and subject to changing technology, shifting customer needs and introductions of new products and services. Many of our current and potential competitors enjoy substantial competitive advantages, such as greater name recognition, larger marketing budgets and substantially greater financial, technical and other resources. In addition, many of our current and potential competitors have established marketing relationships and access to larger customer bases. A number of companies offer products that are similar to our products and target the same markets. Any of these competitors may be able to respond more quickly to new or changing opportunities, technologies and market trends, and devote greater resources to the development, promotion and sale of their products. Our competitors may also offer extended payment terms or price reductions for their products and services, either of which could materially and adversely affect our ability to compete successfully. There can be no assurance that we will be able to compete successfully against current and future competitors or that the competitive pressures that we may face will not materially adversely affect our business, revenue and results of operations.

 

We are dependent upon achieving success in certain concentrated markets.

 

We have made a strategic decision to concentrate our product development, as well as our sales and marketing efforts, in certain vertical manufacturing industry segments: automotive, life sciences, consumer products, food and beverage, high technology and industrial products. We also concentrate our efforts on certain geographies, where costs to expand our market or stay in compliance with local requirements could be extensive and require a large amount of resources. An important element of our strategy is the achievement of technological and market leadership recognition for our software products in these segments and geographies. The failure of our products to achieve or maintain substantial market acceptance in one or more of these segments or geographies could have an adverse effect on us. If any of these targeted industry segments or geographies experience a material slowdown or reduced growth, those conditions could adversely affect the demand for our products.

 

Unfavorable economic conditions may adversely impact our business, operating results and financial condition.

 

Our operations and performance are subject to the risks arising from worldwide economic conditions, which are themselves impacted by other events, such as financial crises, natural disasters and political turmoil. In particular, the negative impact of economic conditions on manufacturing companies could have a substantial adverse effect on our sales, because our products are focused on supporting manufacturing companies. Uncertainty about global economic conditions may result in reductions in sales of our products, longer sales cycles, slower adoption of new technologies and increased price competition as manufacturing companies may delay, reduce or forego spending in response to declining asset values, tight credit, high unemployment, natural disasters, political unrest and negative financial news. Such economic conditions may also result in our customers extending their payment periods or experiencing reduced ability to pay amounts owed to us. Uncertainty about global economic conditions could also increase the volatility of our stock price. If any of the foregoing occurs, our results of operations may be adversely affected.

 

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Risks associated with our third-party relationships

 

We are dependent upon the development and maintenance of sales, services and marketing channels.

 

We sell and support our products through direct and indirect sales, services and support organizations throughout the world. We also maintain relationships with a number of consulting and systems integration organizations that we believe are important to our worldwide sales, marketing, service and support activities and to the implementation of our products. We believe this strategy allows for additional flexibility in ensuring our customers’ needs for services are met in a cost effective, timely and high quality manner. Our services providers generally do not receive fees for the sale of our software products unless they participate actively in a sale as a sales agent or a distributor. We are aware that these third-party service providers do not work exclusively with our products and in many instances have similar, and often more established, relationships with our principal competitors. If these third parties exclusively pursue products or technology other than QAD software products or technology, or if these third parties fail to adequately support QAD software products and technology or increase support for competitive products or technology, we could be adversely affected.

  

Risks associated with acquisitions we may make

 

We may make acquisitions or investments in new businesses, products or technologies that involve additional risks.

 

As part of our business strategy, we have made, and expect to continue to make, acquisitions of businesses or investments in companies that offer complementary products, services and technologies or expand our geographical presence. Such acquisitions or investments involve a number of risks which could adversely affect our business or operating results, including:

 

 

Our business strategy may not be furthered by an acquisition as we planned;

  

 

We may be unable to retain customers, vendors, distributors, business partners or other relationships associated with the acquired business;

 

 

Our due diligence may not identify significant liabilities or deficiencies associated with the business, assets, products, financial condition or accounting practices of an acquired company;

 

 

We may have difficulty integrating an acquired business due to incompatible business cultures;

 

 

We may incur significant integration costs related to assimilating the operations and personnel of acquired companies;

 

 

Acquisition costs may result in charges in a particular quarter, increasing variability in our quarterly earnings;

 

 

We may not realize the anticipated revenue increase from an acquisition;

 

 

We may be unable to realize the value of the acquired assets relative to the acquisition cost; and

 

 

Acquisitions may distract management from our existing businesses.

 

These factors could have a material adverse effect on our business, financial condition and operating results. In addition such acquisitions may cause our future quarterly financial results to fluctuate due to costs related to an acquisition, such as the elimination of redundant expenses or write-offs of impaired assets recorded in connection with acquisitions. Also, consideration paid for any future acquisitions could include our stock. As a result, future acquisitions could cause dilution to existing stockholders and to earnings per share, though the likelihood of voting dilution is limited by the ability of the Company to use low-vote Class A common stock as consideration for potential acquisitions. Furthermore, we may incur significant debt to pay for future acquisitions or investments or our use of cash to pay for acquisitions may limit other potential uses of our cash, including stock repurchases, dividend payments and retirement of outstanding indebtedness.

 

Risks associated with our international operations

 

Our operations are international in scope, exposing us to additional risk.

 

We derive over half of our total revenue from sales outside the United States. A significant aspect of our strategy is to focus on developing business in emerging markets. Our operating results could be negatively impacted by a variety of factors affecting our foreign operations, many of which are beyond our control. These factors include currency fluctuations, economic, political or regulatory conditions in a specific country or region, trade protection measures and other regulatory requirements. Additional risks inherent in international business activities generally include, among others:

 

 

Longer accounts receivable collection cycles;

 

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Costs and difficulties of managing international operations and alliances;

 

 

Greater difficulty enforcing intellectual property rights;

 

 

Import or export requirements;

 

 

Uncertainty regarding regulation, currency, tax, and operations resulting from the Brexit vote that could disrupt the sale of our products and services and the movement of our people between the United Kingdom and the European Union;

 

 

Compliance with multiple, conflicting, ambiguous or evolving governmental laws and regulations, including employment, tax, privacy, anti-corruption, import/export, antitrust, data transfer, storage and protection, and industry-specific laws and regulations, including rules related to compliance by our third-party resellers and our ability to identify and respond timely to compliance issues when they occur; and

 

 

Operating in geographies with a higher inherent risk of corruption, which could adversely affect our ability to maintain compliance with domestic and international laws, including, but not limited to, the U.S. Foreign Corrupt Practices Act and other anti-corruption laws.

 

We may experience foreign currency gains and losses.

 

We conduct a portion of our business in currencies other than the United States dollar. Our revenues and operating results may be negatively affected by fluctuations in foreign currency exchange rates. Changes in the value of major foreign currencies, including the euro and Mexican peso, relative to the United States dollar can significantly and adversely affect our revenues, expenses and operating results.

 

Changes in accounting principles, or interpretations thereof, could have a significant impact on our financial position and results of operations.

 

We prepare our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). A change in these principles can have a significant impact on our reported results and may even retroactively affect previously reported transactions. The adoption of new or revised accounting principles may require that we make significant changes to our systems, processes and controls.

 

The U.S.-based Financial Accounting Standards Board (“FASB”) is currently working together with the International Accounting Standards Board (“IASB”) on several projects to further align accounting principles and facilitate more comparable financial reporting between companies who are required to follow GAAP under SEC regulations and those who are required to follow International Financial Reporting Standards outside of the United States. These efforts by the FASB and IASB may result in different accounting principles under GAAP that may result in materially different financial results for us. Additionally, significant changes to GAAP resulting from the FASB’s and IASB’s efforts may require that we change how we process, analyze and report financial information and that we change financial reporting controls.

 

We are exposed to fluctuations in the market values of our investments

 

Given the global nature of our business, we have investments both domestically and internationally. Credit ratings and market values of these investments can be negatively impacted by liquidity, credit deterioration or losses, financial results, foreign exchange rates, or other factors. As a result, the value or liquidity of our cash equivalents and short-term investments could decline, thus adversely affecting our financial condition and operating results.

 

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The market for our Class A and Class B common stock is volatile

 

Our stock price could become more volatile and investments could lose value.

 

The market price of our common stock and the number of shares of each class traded each day has experienced significant fluctuations and may continue to fluctuate significantly. The market price for our common stock may be affected by a number of factors, including, but not limited to:

 

 

Shortfalls in our expected net revenue, earnings or key performance metrics;

 

 

Changes in recommendations or estimates by securities analysts;

 

 

The announcement of new products by us or our competitors;

 

 

Quarterly variations in our or our competitors’ results of operations;

 

 

A change in our dividend or stock repurchase activities;

 

 

Developments in our industry or changes in the market for technology stocks;

 

 

Changes in rules or regulations applicable to our business; and

 

 

Other factors, including economic instability and changes in political or market conditions.

 

The dual class structure of our common stock as contained in our charter documents could adversely impact the market for our common stock.

 

Our dual-class stock structure could adversely impact the market for our stock. The liquidity of our common stock may be adversely impacted by our dual-class structure because each class has less of a public float than it would if we had a single class of common stock. In addition, there are fewer Class B shares than Class A shares and Class B shares may be less desirable to the public due to the 20% higher dividend on Class A shares. Also, the holding of lower voting Class A common stock may not be permitted by the investment policies of certain institutional investors or may be less attractive to managers of certain institutional investors.

  

If research analysts do not publish research about our business or if they issue unfavorable commentary or downgrade our common stock, our stock price and trading volume could decline.

 

The trading market for our common stock depends in part on the research and reports that research analysts publish about us and our business. If we do not maintain adequate research coverage, or if one or more analysts who covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, the price of our common stock could decline. If one or more of the research analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our common stock could decrease, which could cause our stock price or trading volume to decline.

 

We are obligated to maintain proper and effective internal control over financial reporting. We may not complete our analysis of our internal control over financial reporting in a timely manner, or this internal control may not be determined to be effective, which may adversely affect investor confidence in our company and, as a result, the value of our common stock.

 

We are required, pursuant to the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting. This assessment includes disclosure of any material weaknesses identified by our management in our internal control over financial reporting, as well as a statement that our auditors have issued an attestation report on our internal controls.

 

While we were able to determine in our management’s report for fiscal 2019 that our internal control over financial reporting is effective, as well as provide an unqualified attestation report from our independent registered public accounting firm to that effect, we may not be able to complete our evaluation, testing, and any required remediation in a timely fashion or our independent registered public accounting firm may not be able to formally attest to the effectiveness of our internal control over financial reporting in the future. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting that we are unable to remediate before the end of the same fiscal year in which the material weakness is identified, we will be unable to assert that our internal controls are effective. If we are unable to assert that our internal control over financial reporting is effective, or if our auditors are unable to attest to the effectiveness of our internal controls or determine we have a material weakness in our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which could cause the price of our common stock to decline.

 

26

 

 

If we are unable to pay quarterly dividends, our reputation and stock price may be harmed.

 

Our payment of dividends may require the use of a significant portion of our cash earnings. As a result, we may not retain a sufficient amount of cash to fund our operations or finance future growth opportunities, new product development initiatives and unanticipated capital expenditures which could adversely affect our financial performance. Additionally, our board of directors may, at its discretion, decrease or entirely discontinue the payment of dividends at any time. Our ability to pay dividends will depend on our ability to generate sufficient cash flows from operations in the future. This ability may be subject to certain economic, financial, competitive and other factors that are beyond our control. Any failure to pay dividends may negatively impact our reputation and investor confidence in us and may negatively impact the price of our common stock.

 

Our common stock ownership is concentrated

 

The dual class structure of our common stock as contained in our charter documents has the effect of concentrating voting control with certain stockholders, including Pamela Lopker, thus limiting our other stockholders’ ability to influence corporate matters.

 

Our Class B common stock has one vote per share and our Class A common stock has 1/20th vote per share. Stockholders who hold shares of our Class B common stock together held approximately 80% of the voting power of our outstanding capital stock as of January 31, 2019. As of January 31, 2019, Pamela Lopker beneficially owned approximately 40% of the outstanding shares of our Class A and Class B common stock, representing approximately 67% of the voting power of our outstanding capital stock. Currently she has sufficient voting control to determine the outcome of a stockholder vote concerning:

 

 

The election and removal of all members of our board of directors;

 

 

The merger, consolidation or sale of the Company or all of our assets; and

 

 

All other matters requiring stockholder approval, regardless of how our other stockholders vote their shares.

 

In addition, the holders of our Class B common stock collectively will continue to be able to control all matters submitted to our stockholders for approval even if their stock holdings represent less than 50% of the outstanding shares of our common stock. Because of the 20-to-1 voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively will continue to control a majority of the combined voting power of our common stock even when the shares of Class B common stock represent as little as 5% of all outstanding shares of our Class A common stock. This concentrated control will limit the ability of our Class A stockholders to influence corporate matters for the foreseeable future, and, as a result, the market price of our Class A common stock could be adversely affected.

 

This concentrated control limits the ability of our other stockholders to influence corporate matters and also limits the liquidity of the shares owned by other stockholders. Should the interests of Pamela Lopker differ from those of other stockholders, the other stockholders may not be afforded the protections of having a majority of directors on the board who are independent from our principal stockholders or our management. For example, Pamela Lopker’s concentrated control could discourage others from initiating potential merger, takeover or other change of control transactions; and, transactions could be pursued that our other stockholders do not view as beneficial. As a result, the market price of our Class A and Class B common stock could be adversely affected.

 

We are not required to comply with certain corporate governance rules of NASDAQ, that would otherwise apply to us as a company listed on NASDAQ, because we are a controlled company.

 

Specifically, we are not required to have a majority of independent directors or a compensation committee comprised solely of independent directors; select, or recommend for the board’s selection, director nominees by a majority of independent directors or a nominating committee comprised solely of independent directors; determine officer compensation by a compensation committee comprised solely of independent directors or by a majority of the board upon recommendation of a compensation committee comprised solely of independent directors; and satisfy certain responsibilities of the compensation committee prior to retaining or receiving advice from a compensation consultant, legal counsel or other advisor to the compensation committee.

 

Provisions in the Company's charter documents or Delaware law could discourage a takeover that stockholders may consider favorable.

 

Our Certificate of Incorporation contains certain other provisions that may have an “anti-takeover” effect. The Certificate of Incorporation contains authority for the Board to issue up to 5,000,000 shares of preferred stock without stockholder approval. Although the Company has no present intention to issue any such shares, we could issue such shares in a manner that deters or seeks to prevent an unsolicited bid for us. The Certificate of Incorporation also does not provide for cumulative voting and, accordingly, a significant minority stockholder could not necessarily elect any designee to the board of directors. In addition, Section 203 of the Delaware Corporation Law may discourage, delay, or prevent a change in control of us by imposing certain restrictions on various business combinations. Furthermore, our dual class structure concentrates the voting power of our stock in a small group of stockholders who would have the ability to control the outcome of a stockholder vote. As a result of these provisions in the Company's Certificate of Incorporation, including our dual class structure, and Delaware law, our stockholders may be deprived of an opportunity to sell their shares at a premium over prevailing market prices and it would be more difficult to replace our directors and management.

 

27

 

 

We are dependent upon highly skilled personnel

 

Our performance depends on the talents and efforts of highly skilled employees, including the continued service of a relatively small number of key technical and senior management personnel. In particular, our Chairman of the Board and President, Pamela Lopker, and Chief Executive Officer, Anton Chilton, are critical to overall management of QAD, maintenance of our culture and setting our strategic direction. All of our executive officers and key employees are at-will employees and we do not have key-person insurance covering any of our employees. Our future success depends on our continuing ability to attract and retain highly skilled personnel in all areas of our organization. Competition for such personnel is intense and many of our competitors are larger and have greater financial resources for attracting skilled personnel. The loss of key technical and senior management personnel or the inability to attract and retain additional qualified personnel could have an adverse effect on our continued ability to compete effectively.

 

We have hired personnel in countries where advanced technical expertise and other expertise are available at lower costs to improve our cost structure. We may experience competition for employees in these countries, which may negatively affect our employee retention efforts and increase our expenses in an effort to offer a competitive compensation program.

 

Catastrophic events may disrupt our business

 

Our corporate headquarters, including network infrastructure, internal technology systems and certain of our research and development activities, is located in Southern California, a region susceptible to fires, mudslides and seismic activity.  Additionally, certain of our other facilities and those of our suppliers and third-party data hosting services, may be located in regions affected by natural disasters.  Our corporate headquarters has been disrupted in the past, and any of the aforementioned facilities, suppliers and hosting services may be disrupted in the future, by significant natural disasters.  Such a natural disaster, as well as a terrorist attack, cyber-attack, war or other catastrophic event, may result in power loss, telecommunications failure, loss of access to the Internet, software or hardware malfunction, or physical access restrictions that our disaster recovery plans do not adequately address.  This could result in system interruptions, loss of intellectual property, delays in our product development, interruptions in our customer services, breaches of data security and loss of critical data, which may have a material adverse effect on our business, operating results and financial condition, and negatively impact our reputation.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

QAD’s corporate headquarters are located in Santa Barbara, California. The corporate headquarters are owned by QAD and consist of approximately 120,000 square feet situated on 28 acres of land.

 

In addition to the corporate headquarters, QAD owns a facility in Dublin, Ireland and leases over 25 offices throughout the world with lease agreements ending on various dates through fiscal year 2028. QAD’s leased properties include offices in the United States, Belgium, France, Germany, Ireland, Italy, Poland, Spain, The Netherlands, United Kingdom, Australia, China, India, Indonesia, Japan, Singapore, Thailand, Brazil and Mexico. QAD will seek to review lease commitments in the future as may be required. QAD anticipates that its current domestic and international facilities are substantially sufficient to meet its needs for at least the next twelve months.

 

ITEM 3. LEGAL PROCEEDINGS

 

We are not party to any material legal proceedings. We are from time to time party, either as plaintiff or defendant, to various legal proceedings and claims which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on our consolidated financial position or results of operations.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

28

 

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

QAD Class A Common Stock and Class B Common Stock are traded on the NASDAQ under the symbols “QADA” and “QADB”, respectively. The following table reflects the range of high and low sale prices of our Common Stock as reported by NASDAQ:

 

   

QADA

   

QADB

 
   

Low Price

   

High Price

   

Low Price

   

High Price

 

Fiscal 2019:

                               

Fourth quarter

  $ 38.39     $ 48.04     $ 29.50     $ 35.00  

Third quarter

    40.91       61.80       28.35       49.40  

Second quarter

    44.45       55.35       32.07       44.24  

First quarter

    39.33       50.35       27.00       36.75  

 

   

QADA

   

QADB

 
   

Low Price

   

High Price

   

Low Price

   

High Price

 

Fiscal 2018:

                               

Fourth quarter

  $ 34.90     $ 43.40     $ 26.72     $ 34.00  

Third quarter

    30.25       38.10       21.58       30.80  

Second quarter

    29.40       33.40       24.21       27.13  

First quarter

    26.04       30.95       21.38       26.09  

 

Holders

 

As of March 31, 2019, there were approximately 144 shareholders of record of our Class A common stock and approximately 129 shareholders of record of our Class B common stock. Because many of our shares of common stock are held by brokers or other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by the record holders.

 

Dividends

 

We declared four quarterly cash dividends in fiscal 2019 of $0.072 and $0.06 per share of Class A and Class B stock, respectively. Continuing quarterly cash dividends are subject to profitability measures, liquidity requirements of QAD and Board discretion.

 

Recent Sales of Unregistered Securities

 

None.

 

Issuer Purchases of Equity Securities

 

None.

 

29

 

 

STOCKHOLDER RETURN PERFORMANCE GRAPH

 

The line graph below compares the annual percentage change in the cumulative total stockholder return on QAD’s common stock with the cumulative total return of the NASDAQ Composite Total Return Index and the NASDAQ Computer Index, on an annual basis, for the period beginning January 31, 2014 and ending January 31, 2019.

 

The graph assumes that $100 was invested in QAD common stock on January 31, 2014 and that all dividends were reinvested. Historic stock price performance should not be considered indicative of future stock price performance.

 

The following Share Performance Graph shall not be deemed to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filings under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing.

 

COMPARISON OF CUMULATIVE TOTAL RETURN
AMONG QAD INC., THE NASDAQ COMPOSITE TOTAL RETURN INDEX,
AND THE NASDAQ COMPUTER INDEX

 

 

Measurement Periods
(Annually from Fiscal
Year 2014 through
Fiscal Year 2019)

 

QADA

 

 

QADB

 

 

NASDAQ
Composite
Total Return
Index

 

 

NASDAQ
Computer
Index

 

01/31/14

 

 

100.00

     

100.00

     

100.00

     

100.00

 

01/31/15

 

 

107.90

     

109.70

     

112.95

     

118.31

 

01/31/16

 

 

104.51

     

102.68

     

112.43

     

123.63

 

01/31/17

 

 

165.27

     

162.47

     

136.82

     

152.88

 

01/31/18

 

 

248.58

     

217.58

     

180.60

     

216.12

 

01/31/19

   

244.65

     

205.23

     

177.44

     

211.53

 

 

30

 

 

ITEM 6.   SELECTED FINANCIAL DATA

 

   

Years Ended January 31,

 
     2019 (1)    

2018 (2)

   

2017 (3)

   

2016 (4)

   

2015 (5)

 
   

(in thousands, except per share data)

 

STATEMENTS OF OPERATIONS DATA:

                                       

Revenues:

                                       

Subscription Fees

  $ 91,861     $ 69,615     $ 52,167     $ 38,806     $ 28,217  

License fees

    25,568       25,807       23,633       29,891       40,917  

Maintenance and other

    122,936       128,142       130,406       132,962       141,295  

Professional services

    92,651       81,454       71,767       76,193       84,672  

Total revenue

    333,016       305,018       277,973       277,852       295,101  

Operating income (loss)

    9,573       (3,074

)

    3,364       10,171       15,985  

Net income (loss)

  $ 10,428     $ (9,065

)

  $ (15,450

)

  $ 8,912     $ 12,946  

Basic net income (loss) per share:

                                       

Class A

  $ 0.55     $ (0.49

)

  $ (0.84

)

  $ 0.49     $ 0.84  

Class B

  $ 0.46     $ (0.41

)

  $ (0.70

)

  $ 0.41     $ 0.70  

Diluted net income (loss) per share:

                                       

Class A

  $ 0.50     $ (0.49

)

  $ (0.84

)

  $ 0.47     $ 0.79  

Class B

  $ 0.44     $ (0.41

)

  $ (0.70

)

  $ 0.40     $ 0.68  

Dividends declared per common share:

                                       

Class A

  $ 0.29     $ 0.29     $ 0.29     $ 0.29     $ 0.29  

Class B

  $ 0.24     $ 0.24     $ 0.24     $ 0.24     $ 0.24  

BALANCE SHEET AND CASH FLOW DATA:

                                       

Cash and equivalents

    139,413       147,023       145,082       137,731       120,526  

Working capital

    78,350       70,960       80,351       86,791       69,757  

Total assets

    317,174       299,817       280,890       287,341       282,151  

Current portion of long-term debt

    487       466       446       422       406  

Long-term debt

    12,836       13,313       13,767       14,191       14,603  

Total stockholders’ equity

    133,247       105,628       112,686       128,006       110,565  

Cash provided by operations

    19,007       10,418       18,680       24,057       23,963  

 


 

 

(1)

Fiscal year 2019 net income includes a $1.3 million reversal of the 2017 Tax Reform Act (the “Tax Act”) estimated tax liability recorded in fiscal year 2018. 

 

 

(2)

Fiscal year 2018 net loss includes a $2.0 million estimated tax liability, representing the Company’s best estimate of the impact of the Tax Act in accordance with QAD’s understanding of the Tax Act and the related guidance available.

 

 

(3)

Fiscal year 2017 includes placement of a valuation allowance of $16.3 million against U.S. federal and state net deferred tax assets.

 

 

(4)

Fiscal year 2016 includes an issuance of 450,000 shares of Class A common stock at $20.00 per share for net proceeds to the Company of $8.4 million after deduction of offering expenses as a result of an option to purchase additional shares exercised in full by the underwriters related to the stock issuance described in note (5) below.

 

 

(5)

Fiscal year 2015 includes an issuance of 2,000,000 shares of Class A common stock at $20.00 per share for net proceeds to the Company of $37.0 million after deducting offering expenses.

 

31

 

 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

INTRODUCTION

 

The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes to Consolidated Financial Statements included in Item 15 of this Annual Report on Form 10-K.

 

BUSINESS OVERVIEW

 

QAD (“QAD”, the “Company”, “we” or “us”) is a leading provider of flexible, cloud-based enterprise software and services for global manufacturing companies. QAD Enterprise Applications support operational requirements in the areas of financials, customer management, supply chain, manufacturing, service and support, analytics, business process management and integration. QAD's portfolio also includes related solutions for quality management software, supply chain management software, transportation management software and business-to-business interoperability. QAD solutions support customers in the automotive, consumer products, food and beverage, high technology, industrial manufacturing and life sciences industries to streamline processes, improve operational performance, comply with regulatory requirements and meet industry standards. 

 

We have four principal sources of revenue:

 

Subscription of Enterprise Applications through our cloud offering in a Software as a Service (“SaaS”) model as well as other hosted applications;

 

License purchases of Enterprise Applications;

 

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

 

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

 

We operate primarily in the following four geographic regions: North America, Latin America, EMEA and Asia Pacific. In fiscal 2019, approximately 48% of our total revenue was generated in North America, 30% in EMEA, 15% in Asia Pacific and 7% in Latin America. The majority of our revenue is generated from global customers who have operations in multiple countries throughout the world. A significant portion of our revenue and expenses are derived from international operations which are primarily conducted in foreign currencies. As a result, changes in the value of foreign currencies relative to the U.S. dollar have impacted our results of operations and may impact our future results of operations. At January 31, 2019, we employed approximately 1,970 employees worldwide, of which 650 employees were based in North America, 610 employees in EMEA, 600 employees in Asia Pacific and 110 employees in Latin America.

 

Our customer base and our target markets are primarily global manufacturing companies; therefore, our results are heavily influenced by the state of the manufacturing economy on a global basis. As a result, our management team monitors several economic indicators, with particular attention to the Global and Country Purchasing Managers’ Indexes (“PMI”). The PMI is a survey conducted on a monthly basis by polling businesses that represent the makeup of respective sectors. Since most of our customers are manufacturers, our revenue has historically correlated with fluctuations in the manufacturing PMI. Global macro-economic trends and manufacturing spending are important barometers for our business, and the health of the U.S., Western European and Asian economies have a meaningful impact on our financial results.

 

We are transitioning our business model from selling perpetual licenses to providing access to our software on a subscription basis as part of our cloud offering. During fiscal 2019, we closed most of our new customer deals in the cloud. In addition, we converted many of our existing customers from on-premises licenses to our cloud based solution. Recurring revenue, which we define as subscription revenue plus maintenance revenue, accounted for 65% of total revenue for fiscal 2019. By reducing our customers’ up-front costs and providing continuous application and infrastructure support, we expect our cloud business model will be more attractive than perpetual licenses. We expect recurring revenue to remain a majority of total revenue as our subscription revenue continues to grow.

 

32

 

 

RESULTS OF OPERATIONS

 

 

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

 

Revenue

 

   

Year Ended January 31,

   

Year Ended

January 31,

   

Change in
Constant

   

Change due
to Currency

   

Total Change
as Reported

 

(in thousands)

 

2019

   

2018

   

Currency

   

Fluctuations

   

$

   

%

 

Revenue

                                               

Subscription fees

  $ 91,861     $ 69,615     $ 22,398     $ (152

)

  $ 22,246       32

%

Percentage of total revenue

    28

%

    23

%

                               

License fees

    25,568       25,807       (293

)

    54       (239

)

    -1

%

Percentage of total revenue

    7

%

    8

%

                               

Maintenance and other

    122,936       128,142       (5,914

)

    708       (5,206

)

    -4

%

Percentage of total revenue

    37

%

    42

%

                               

Professional services

    92,651       81,454       11,349       (152

)

    11,197       14

%

Percentage of total revenue

    28

%

    27

%

                               

Total revenue

  $ 333,016     $ 305,018     $ 27,540     $ 458     $ 27,998       9

%

 

 

   

Year Ended

January 31,

   

Year Ended

January 31,

   

Change in
Constant

   

Change due
to Currency

   

Total Change
as Reported

 

(in thousands)

 

2018

   

2017

   

Currency

   

Fluctuations

   

$

   

%

 

Revenue

                                               

Subscription fees

  $ 69,615     $ 52,167     $ 17,060     $ 388     $ 17,448       33

%

Percentage of total revenue

    23

%

    19

%

                               

License fees

    25,807       23,633       1,746       428       2,174       9

%

Percentage of total revenue

    8

%

    8

%

                               

Maintenance and other

    128,142       130,406       (3,615

)

    1,351       (2,264

)

    -2

%

Percentage of total revenue

    42

%

    47

%

                               

Professional services

    81,454       71,767       8,927       760       9,687       13

%

Percentage of total revenue

    27

%

    26

%

                               

Total revenue

  $ 305,018     $ 277,973     $ 24,118     $ 2,927     $ 27,045       10

%

 

Total Revenue. On a constant currency basis, total revenue was $333.0 million for fiscal 2019, representing a $27.5 million, or 9%, increase from $305.5 million for fiscal 2018. When comparing categories within total revenue at constant rates, our results for fiscal 2019 included increases in subscription and professional services revenue partially offset by a decrease in license and maintenance and other revenue. In fiscal 2019, one customer accounted for 10% of total revenue and no other customer accounted for 10% or more of total revenue. In fiscal 2018 and 2017, no single customer accounted for more than 10% of total revenue. Revenue outside the North America region as a percentage of total revenue was 52% and 54% for fiscal 2019 and 2018, respectively. On a constant currency basis, total revenue increased across all regions during fiscal 2019 when compared to the prior year.  Our products are sold to manufacturing companies that operate mainly in the following six industries: automotive, consumer products, food and beverage, high technology, industrial products and life sciences. Given the similarities between consumer products and food and beverage as well as between high technology and industrial products, we aggregate them for management review. The following table presents revenue by industry for fiscal 2019, 2018 and 2017:

 

   

Years Ended January 31,

 
   

2019

   

2018

   

2017

 

Automotive

    39

%

    37

%

    35

%

Consumer products and food and beverage

    16

%

    16

%

    16

%

High technology and industrial products

    31

%

    33

%

    33

%

Life sciences and other

    14

%

    14

%

    16

%

Total revenue

    100

%

    100

%

    100

%

 

33

 

 

On a constant currency basis, total revenue was $305.0 million for fiscal 2018, representing a $24.1 million, or 9%, increase from $280.9 million for fiscal 2017. When comparing categories within total revenue at constant rates, our results for fiscal 2018 included increases in subscription, license and professional services revenue partially offset by a decrease in maintenance and other revenue. Revenue outside the North America region as a percentage of total revenue was 54% and 53% for fiscal 2018 and 2017, respectively. On a constant currency basis, total revenue increased across all regions during fiscal 2018 when compared to fiscal 2017.

 

Subscription Revenue. Subscription revenue consists of recurring fees from customers to access our products via the cloud and other subscription offerings. Our cloud offerings typically include access to QAD software, hosting, application support, maintenance support and product updates, if and when available. Included in subscription revenue are one-time set up fees for technical services such as configuration of the database and access to the environment.

 

On a constant currency basis, subscription revenue was $91.9 million for fiscal 2019, representing a $22.4 million, or 32%, increase from $69.5 million for fiscal 2018. Our subscription revenue represented 28% and 23% of our total revenue in fiscal 2019 and 2018, respectively. On a constant currency basis, subscription revenue increased across all regions during fiscal 2019 when compared to the prior year. One of the metrics that management uses to monitor subscription performance is the number of new cloud deals that have been signed in the period. In fiscal 2019 we closed 67 new cloud deals, including 41 new cloud customers and 26 conversions from existing customers who previously purchased on-premises licenses. This compared to fiscal 2018 when we closed 65 new cloud deals, including 37 new cloud customers and 28 conversions from existing customers who previously purchased on-premises licenses. The increase in subscription revenue consists of new customer sites; existing Enterprise Applications users converting from on-premises; and additional users and modules purchased by our existing cloud customers.

 

The following table presents subscription revenue by region for fiscal 2019, 2018 and 2017:

 

   

Years Ended January 31,

 
   

2019

   

2018

   

2017

 

North America

    56

%

    54

%

    60

%

EMEA

    27

%

    24

%

    17

%

Asia Pacific

    12

%

    14

%

    15

%

Latin America

    5

%

    8

%

    8

%

Total subscription revenue

    100

%

    100

%

    100

%

 

 

 The following table presents subscription revenue by industry for fiscal 2019, 2018 and 2017:

 

   

Years Ended January 31,

 
   

2019

   

2018

   

2017

 

Automotive

    33

%

    35

%

    39

%

Consumer products and food and beverage

    18

%

    15

%

    15

%

High technology and industrial products

    24

%

    23

%

    18

%

Life sciences and other

    25

%

    27

%

    28

%

Total subscription revenue

    100

%

    100

%

    100

%

 

 

On a constant currency basis, subscription revenue was $69.6 million for fiscal 2018, representing a $17.0 million, or 32%, increase from $52.6 million for fiscal 2017. On a constant currency basis, subscription revenue increased in our North America, EMEA and Asia Pacific regions and remained relatively flat in our Latin America region during fiscal 2018 when compared to the prior year.

 

We track our retention rate of subscription and maintenance by calculating the annualized revenue of customer sites with contracts up for renewal during the period compared to the annualized revenue associated with the customer sites that have canceled during the period. The percentage of revenue not canceled is our retention rate. Conversions to the cloud are not considered cancellations for purposes of this calculation. Our subscription customer retention rate is in excess of 90% in each of the fiscal years 2019, 2018 and 2017.

 

34

 

 

License Revenue. License revenue is derived from software license fees that customers pay for our core product, QAD Enterprise Applications, and any add-on modules they purchase. Our revenue mix has continued to shift from license to subscription revenue as a result of our business model transition as more new customers subscribe to our cloud based offerings rather than purchase perpetual licenses. While we expect license revenue to decline over time, we do continue to experience quarterly fluctuations.

 

On a constant currency basis, license revenue was $25.6 million for fiscal 2019, representing a $0.3 million, or 1%, decrease from $25.9 million for fiscal 2018. On a constant currency basis, license revenue decreased in our North America region and increased in our Latin America, Asia Pacific and EMEA regions during fiscal 2019 when compared to the prior year. During fiscal 2019, 14 customers placed license orders totaling more than $0.3 million, two of which exceeded $1.0 million. This compared to fiscal 2018 in which 15 customers placed license orders totaling more than $0.3 million, two of which exceeded $1.0 million. The majority of our license revenue has come from additional users and module purchases from our existing customers, which we believe is a result of a strong global manufacturing environment.

 

On a constant currency basis, license revenue was $25.8 million for fiscal 2018, representing a $1.7 million, or 7%, increase from $24.1 million for fiscal 2017. On a constant currency basis, license revenue increased in our North America and Asia Pacific regions, and decreased in our EMEA and Latin America regions during fiscal 2018 when compared to fiscal 2017. During fiscal 2018, 15 customers placed license orders totaling more than $0.3 million, two of which exceeded $1.0 million. This compared to fiscal 2017 in which 15 customers placed license orders totaling more than $0.3 million, two of which exceeded $1.0 million. 

  

Maintenance and Other Revenue. We offer support services 24 hours a day, seven days a week in addition to providing software upgrades, which include additional or improved functionality, when and if available.

 

On a constant currency basis, maintenance and other revenue was $122.9 million for fiscal 2019, representing a $6.0 million, or 5%, decrease from $128.9 million for fiscal 2018. On a constant currency basis, maintenance and other revenue decreased across all regions during fiscal 2019 when compared to the prior year. The decrease in maintenance and other revenue was primarily due to continued conversions of existing customers’ perpetual licenses to cloud subscription, in addition to our historical attrition rates. When customers convert to the cloud they no longer pay for maintenance as those support services are included as a component of the subscription offering. Though we continue to see renewal rates above 90%, conversions from on-premises to cloud have resulted in decreases in maintenance revenue and we expect this trend to continue in the future.

 

On a constant currency basis, maintenance and other revenue was $128.1 million for fiscal 2018, representing a $3.7 million, or 3%, decrease from $131.8 million for fiscal 2017. On a constant currency basis, maintenance and other revenue decreased in our North America, EMEA and Asia Pacific regions and increased in our Latin America region during fiscal 2018 when compared to the prior year. 

 

Over the last three years, our maintenance retention rate has remained in excess of 90%.

 

 Professional Services Revenue. Our professional services business includes technical and application consulting in addition to training, implementations, migrations and upgrades related to our solutions. Although our professional services are optional, our customers use these services when planning, implementing or upgrading our solutions whether in the cloud or on-premises. Professional services revenue growth is contingent upon subscription and license revenue growth and customer upgrade cycles, which are influenced by the strength of general economic and business conditions.

 

On a constant currency basis, professional services revenue was $92.7 million for fiscal 2019, representing an $11.4 million, or 14%, increase from $81.3 million for fiscal 2018. On a constant currency basis, professional services revenue increased in our North America, Latin America and EMEA regions and remained relatively flat in our Asia Pacific region during fiscal 2019 when compared to the prior year. The increase in professional services revenue period over period can be attributed to personnel augmentation services we performed for one of our cloud customers, mainly through third-party contractors at low margins. For fiscal 2019, personnel augmentation services revenue was $7.3 million, compared to $1.1 million for fiscal 2018. Augmentation services consists of providing our employees or third party contractors to assist the customer with the implementation tasks the customer needs performed by supplementing their workforce. In addition, fiscal 2019 results reflected a higher amount of revenue per customer and a higher number of engagements compared to the prior year.

 

35

 

 

On a constant currency basis, professional services revenue was $81.5 million for fiscal 2018, representing a $9.0 million, or 12%, increase from $72.5 million for fiscal 2017. On a constant currency basis, professional services revenue increased across all regions during fiscal 2018 when compared to the prior year. The increase in professional services revenue period over period can be attributed to a higher amount of professional services revenue per customer.

 

 

Total Cost of Revenue

 

   

Year Ended

January 31,

   

Year Ended

January 31,

   

Change in
Constant

   

Change due
to Currency

   

Total Change
as Reported

 

(in thousands)

 

2019

   

2018

   

Currency

   

Fluctuations

    $    

%

 

Cost of revenue

                                               

Cost of subscription

  $ 34,128     $ 30,563     $ (3,594

)

  $ 29     $ (3,565

)

    -12

%

Cost of license

    2,714       2,946       230       2       232       8

%

Cost of maintenance and other

    31,307       31,246       (173

)

    112       (61

)

    0

%

Cost of professional services

    87,735       84,670       (3,280

)

    215       (3,065

)

    -4

%

Total cost of revenue

  $ 155,884     $ 149,425     $ (6,817

)

  $ 358     $ (6,459

)

    -4

%

Percentage of revenue

    47

%

    49

%

                               

 

   

Year Ended

January 31,

   

Year Ended

January 31,

   

Change in
Constant

   

Change due
to Currency

   

Total Change
as Reported

 

(in thousands)

 

2018

   

2017

   

Currency

   

Fluctuations

    $    

%

 

Cost of revenue

                                               

Cost of subscription

  $ 30,563     $ 27,027     $ (3,449

)

  $ (87

)

  $ (3,536

)

    -13

%

Cost of license

    2,946       2,990       45       (1

)

    44       1

%

Cost of maintenance and other

    31,246       30,517       (452

)

    (277

)

    (729

)

    -2

%

Cost of professional services

    84,670       70,317       (13,500

)

    (853

)

    (14,353

)

    -20

%

Total cost of revenue

  $ 149,425     $ 130,851     $ (17,356

)

  $ (1,218

)

  $ (18,574

)

    -14

%

Percentage of revenue

    49

%

    47

%

                               

 

Total cost of revenue consists of cost of subscription, cost of license, cost of maintenance and other and cost of professional services. Cost of subscription includes salaries, benefits, bonuses and other personnel expenses of our cloud operations employees; stock-based compensation for those employees; third-party contractor expense, third-party hosting and hardware costs; royalties; professional fees; travel expense; and an allocation of information technology and facilities costs. Cost of license includes license royalties and amortization of capitalized software costs. Cost of maintenance and other includes salaries, benefits, bonuses and other personnel expenses of our support group, stock-based compensation for those employees, travel expense, professional fees and an allocation of information technology and facilities costs. Cost of professional services includes salaries, benefits, bonuses and other personnel expenses of our services employees, stock-based compensation for those employees, third-party contractor expense, travel expense and an allocation of information technology and facilities costs.

 

Total Cost of Revenue. On a constant currency basis, total cost of revenue was $155.9 million and $149.1 million for fiscal 2019 and 2018, respectively and as a percentage of total revenue was 47% for fiscal 2019 and 49% for fiscal 2018. The decrease in total cost of revenue as a percentage of total revenue was due to improved subscription and professional services margins. The non-currency related increase in cost of revenue of $6.8 million, or 5%, in fiscal 2019 compared to fiscal 2018 was primarily due to higher hosting and personnel costs associated with the increase in subscription revenue and higher third-party contractor costs, travel and personnel costs, associated with increased professional services revenue.

 

On a constant currency basis, total cost of revenue was $149.4 million and $132.1 million for fiscal 2018 and 2017, respectively and as a percentage of total revenue was 49% for fiscal 2018 and 47% for fiscal 2017. The increase in total cost of revenue as a percentage of total revenue was mainly due to lower professional services margins and the shift of our revenue mix from maintenance to subscription.  The non-currency related increase in cost of revenue of $17.3 million, or 13%, in fiscal 2018 compared to fiscal 2017 was primarily due to higher hosting and personnel costs associated with the increase in subscription revenue and higher third-party contractor, travel and personnel costs associated with increased professional services revenue. 

 

Cost of Subscription. On a constant currency basis, cost of subscription was $34.1 million for fiscal 2019, representing a $3.6 million, or 12%, increase from $30.5 million for fiscal 2018. The non-currency related increase in cost of subscription of $3.6 million in fiscal 2019 compared to fiscal 2018 was primarily due to higher hosting costs of $3.1 million and higher salaries and related costs of $0.6 million as a result of higher headcount of approximately 30 people. Cost of subscription as a percentage of subscription revenue was 37% and 44% in fiscal 2019 and 2018, respectively. We have continued to improve our subscription margins over time due to leveraging of ongoing economies of scale and implementing operational efficiencies. We have experienced and may experience in the future quarterly fluctuations in our subscription margins as we make investments in our data centers and cloud operations to support future growth. Our strategic investments in cloud growth may not match the timing of revenue increases.

 

36

 

 

On a constant currency basis, cost of subscription was $30.6 million for fiscal 2018, representing a $3.5 million, or 13%, increase from $27.1 million for fiscal 2017. The non-currency related increase in cost of subscription of $3.5 million in fiscal 2018 compared to fiscal 2017 was primarily due to higher hosting costs of $2.5 million, higher salaries and related costs of $0.8 million as a result of higher headcount of approximately 9 people and higher third-party contractor costs of $0.4 million. These costs were partially offset by $0.8 million of personnel costs cross charged to our services department to support conversion and upgrade projects. Cost of subscription as a percentage of subscription revenue was 44% and 52% in fiscal 2018 and 2017, respectively. 

 

Cost of License. On a constant currency basis, cost of license was $2.7 million for fiscal 2019, representing a $0.2 million, or 7%, decrease from $2.9 million for fiscal 2018. A majority of cost of license was royalty expense, which as a percent of license revenue, remained relatively consistent year over year.

 

On a constant currency basis, cost of license was $2.9 million for fiscal 2018, representing a $0.1 million, or 3%, decrease from $3.0 million for fiscal 2017. A majority of cost of license was royalty expense, which as a percent of license revenue, remained relatively consistent year over year.

 

Cost of Maintenance and Other. On a constant currency basis, cost of maintenance and other was $31.3 million for fiscal 2019, representing a $0.2 million, or 1%, increase from $31.1 million for fiscal 2018. The non-currency related increase in cost of maintenance and other of $0.2 million in fiscal 2019 compared to fiscal 2018 was primarily due to personnel costs. Cost of maintenance and other as a percentage of maintenance and other revenue was 25% and 24% in fiscal 2019 and 2018, respectively.

 

On a constant currency basis, cost of maintenance and other was $31.2 million for fiscal 2018, representing a $0.4 million, or 1%, increase from $30.8 million for fiscal 2017. The non-currency related increase in cost of maintenance and other of $0.4 million in fiscal 2018 compared to fiscal 2017 was due to higher personnel costs of $0.4 million. Cost of maintenance and other as a percentage of maintenance and other revenue was 24% and 23% in fiscal 2018 and 2017, respectively.

 

Cost of Professional Services. On a constant currency basis, cost of professional services was $87.7 million for fiscal 2019, representing a $3.2 million, or 4%, increase from $84.5 million for fiscal 2018. The non-currency related increase in cost of professional services of $3.2 million was primarily due to higher third-party contractor costs of $1.6 million, higher travel of $1.3 million and higher salaries and related costs of $1.1 million partially offset by lower bonuses of $0.5 million and lower severance of $0.3 million. The increase in salaries and related costs was the result of the addition of 40 services people hired in relation to the acquisition of our Indonesian distributor’s assets, partially offset by a reduction of 20 people in our existing business.

 

Cost of professional services as a percentage of professional services revenue was 95% for fiscal 2019 and 104% for fiscal 2018. We increased our services capacity by adding headcount and partners in fiscal 2018 in order to fulfill additional projects. The investment in hiring and training additional services personnel negatively impacted our professional services margins in fiscal 2018, but as utilization of those additional resources has increased, our professional services margins has improved. Our professional services margins have historically ranged from about breakeven to 10%. We believe we offer competitive rates and view our professional services organization as a department supporting the implementation and deployment of our products which improves the overall customer experience.

 

On a constant currency basis, cost of professional services was $84.7 million for fiscal 2018, representing a $13.5 million, or 19%, increase from $71.2 million for fiscal 2017. The non-currency related increase in cost of professional services of $13.5 million was primarily due to higher salaries and related costs of $4.4 million, as a result of higher headcount of approximately 87 people, higher third-party contractor costs of $3.6 million, higher bonuses of $1.3 million, higher travel of $1.5 million and higher information technology and facilities allocated costs of $0.7 million. In addition, cost of professional services included higher personnel costs from other departments of $1.2 million related to employees who worked on services engagements. Cost of professional services as a percentage of professional services revenue was 104% for fiscal 2018 and 98% for fiscal 2017. 

 

Sales and Marketing

 

   

Year Ended

January 31,

   

Year Ended

January 31,

   

Change in
Constant

   

Change due
to Currency

   

Total Change
as Reported

 

(in thousands)

 

2019

   

2018

   

Currency

   

Fluctuations

   

$

   

%

 

Sales and marketing

  $ 78,207     $ 75,368     $ (2,709

)

  $ (130

)

  $ (2,839

)

    -4

%

Percentage of revenue

    23

%

    25

%

                               

 

   

Year Ended

January 31,

   

Year Ended

January 31,

   

Change in

Constant

   

Change due
to Currency

   

Total Change
as Reported

 

(in thousands)

 

2018

   

2017

   

Currency

   

Fluctuations

   

$

   

%

 

Sales and marketing

  $ 75,368     $ 67,194     $ (7,571

)

  $ (603

)

  $ (8,174

)

    -12

%

Percentage of revenue

    25

%

    24

%

                               

 

37

 

 

Sales and marketing expense includes salaries, benefits, commissions, bonuses, stock-based compensation, travel expense and other personnel costs of our sales and marketing employees in addition to costs of programs aimed at increasing revenue, such as trade shows, user group events, lead generation, advertising and various sales and promotional programs. Sales and marketing expense also includes personnel costs of order processing, sales agent fees and an allocation of information technology and facilities costs.

 

On a constant currency basis, sales and marketing expense was $78.2 million for fiscal 2019, representing a $2.7 million, or 4%, increase from $75.5 million for fiscal 2018. The non-currency related increase in sales and marketing expense of $2.7 million in fiscal 2019 compared to fiscal 2018 was primarily due to higher salaries and related costs of $3.4 million as a result of higher headcount of approximately 30 people, higher stock compensation of $0.8 million, higher severance of $0.6 million, higher information technology and facilities allocated costs of $0.4 million and higher travel of $0.3 million. These higher expenses were offset by lower commissions of $4.5 million, which is partly attributable to the capitalization of commission expense in fiscal 2019 as a result of the adoption of the new revenue standard, Topic 606. Commissions in fiscal 2018 was driven by stronger than anticipated new cloud business bookings in the fourth quarter and was expensed as incurred in fiscal 2018 whereas in fiscal 2019 commission expense related to new subscription and maintenance was capitalized and will be amortized over five years.

 

On a constant currency basis, sales and marketing expense was $75.4 million for fiscal 2018, representing a $7.6 million, or 11%, increase from $67.8 million for fiscal 2017. The non-currency related increase in sales and marketing expense of $7.6 million in fiscal 2018 compared to fiscal 2017 was primarily due to higher commissions of $3.2 million, higher salaries and related costs of $2.1 million as a result of higher headcount of approximately 16 people, higher bonuses of $1.6 million and higher travel of $0.5 million. Stronger than anticipated new cloud business closed in the fiscal 2018 fourth quarter resulted in higher bonuses and commissions without the associated revenue, as we recognized these expenses up front, while the revenue is recognized ratably over the contract period. 

 

Research and Development

 

   

Year Ended

January 31,

   

Year Ended

January 31,

   

Change in
Constant

   

Change due
to Currency

   

Total Change
as Reported

 

(in thousands)

 

2019

   

2018

   

Currency

   

Fluctuations

   

$

   

%

 

Research and development

  $ 53,993     $ 47,661     $ (6,265

)

  $ (67

)

  $ (6,332

)

    -13

%

Percentage of revenue

    16

%

    16

%

                               

 

   

Year Ended

January 31,

   

Year Ended

January 31,

   

Change in
Constant

   

Change due
to Currency

   

Total Change
as Reported

 

(in thousands)

 

2018

   

2017

   

Currency

   

Fluctuations

   

$

   

%

 

Research and development

  $ 47,661     $ 43,587     $ (3,700

)

  $ (374

)

  $ (4,074

)

    -9

%

Percentage of revenue

    16

%

    16

%

                               

 

Research and development is expensed as incurred and consists primarily of salaries, benefits, bonuses, stock-based compensation, travel expense and other personnel costs for research and development employees in addition to professional services, such as fees paid to software development firms and independent contractors. Research and development expense includes an allocation of information technology and facilities costs, and is reduced by capitalized localization and translation costs.

 

On a constant currency basis, research and development expense was $54.0 million for fiscal 2019, representing a $6.3 million, or 13%, increase from $47.7 million for fiscal 2018. The non-currency related increase in research and development expense of $6.3 million in fiscal 2019 compared to fiscal 2018 was primarily due to higher personnel costs of $2.7 million, due in part to higher headcount of approximately 12 people, higher contractor costs of $2.1 million, higher information technology and facilities allocated costs of $0.4 million and higher stock compensation of $0.4 million.  We continue to invest in our new platform and user interface in addition to developing other advanced technologies such as our automated solutions product.

 

On a constant currency basis, research and development expense was $47.7 million fiscal 2018, representing a $3.7 million, or 8%, increase from $44.0 million for fiscal 2017. The non-currency related increase in research and development expense of $3.7 million in fiscal 2018 compared to fiscal 2017 was primarily due to higher salaries and related costs of $2.2 million, as a result of higher headcount of approximately 35 people, higher bonuses of $0.9 million and higher contractor costs of $0.6 million. These costs were a result of our investment in our Channel Islands project, which included the development of a new platform and user interface.

 

38

 

 

General and Administrative

 

   

Year Ended

January 31,

   

Year Ended

January 31,

   

Change in
Constant

   

Change due
to Currency

   

Total Change
as Reported

 

(in thousands)

 

2019

   

2018

   

Currency

   

Fluctuations

   

$

   

%

 

General and Administrative

  $ 35,248     $ 35,222     $ 121     $ (147

)

  $ (26

)

    0

%

Percentage of revenue

    11

%

    11

%

                               

 

   

Year Ended

January 31,

   

Year Ended

January 31,

   

Change in
Constant

   

Change due
to Currency

   

Total Change
as Reported

 

(in thousands)

 

2018

   

2017

   

Currency

   

Fluctuations

   

$

   

%

 

General and Administrative

  $ 35,222     $ 32,318     $ (2,863

)

  $ (41

)

  $ (2,904

)

    -9

%

Percentage of revenue

    11

%

    12

%

                               

 

General and administrative expense includes salaries, benefits, bonuses, stock-based compensation, travel expense and other personnel costs related to our finance, human resources, legal and executive personnel, as well as professional fees for accounting and legal services, bad debt expense and an allocation of information technology and facilities costs.

 

On a constant currency basis, general and administrative expense was $35.2 million for fiscal 2019, representing a $0.2 million, or 1%, decrease from $35.4 million for fiscal 2018. The non-currency related decrease in general and administrative expense of $0.2 million in fiscal 2019 compared to fiscal 2018 was primarily due to lower bonuses of $0.8 million and lower stock compensation of $0.4 million partially offset by higher accounting fees of $0.4 million and higher payroll taxes of $0.2 million.

 

On a constant currency basis, general and administrative expense was $35.2 million for fiscal 2018, representing a $2.8 million, or 9%, increase from $32.4 million for fiscal 2017. The non-currency related increase in general and administrative expense of $2.8 million in fiscal 2018 compared to fiscal 2017 was primarily due to higher bonuses of $1.0 million, higher stock compensation of $0.8 million and higher legal and accounting fees of $0.8 million. 

 

Amortization of Intangibles from Acquisitions

 

Amortization of intangibles from acquisitions totaled $0.1 million, $0.4 million and $0.7 million for fiscal 2019, 2018 and 2017, respectively. Amortization expense for fiscal 2019 was due to intangible assets acquired during fiscal 2019. Amortization expense for fiscal 2018 and 2017 was due to intangible assets acquired from our fiscal 2013 acquisitions of DynaSys and CEBOS.

 

Total Other (Income) Expense

 

 

 

Year Ended

   

Increase (Decrease)
Compared
to Prior Period

   

Year Ended

   

Increase (Decrease)
Compared
to Prior Period

   

Year Ended

 
(in thousands)  

January 31,

2019

   

$

   

%

   

January 31,

2018

   

$

   

%

   

January 31,

2017

 

Other (income) expense

                                                       

Interest income

  $ (2,600

)

  $ (1,053

)

    -68

%

  $ (1,547

)

  $ (851

)

    -122

%

  $ (696

)

Interest expense

    643       (26

)

    -4

%

    669       (1

)

    0

%

    670  

Other (income) expense, net

    (387

)

    (2,399

)

    -119

%

    2,012       2,448       561

%

    (436

)

Total other (income) expense, net

  $ (2,344

)

  $ (3,478

)

    -307

%

  $ 1,134     $ 1,596       345

%

  $ (462

)

Percentage of revenue

    1

%

                    0

%

                    0

%

 

Total other (income) expense, net was $(2.3) million, $1.1 million and $(0.5) million for fiscal 2019, 2018 and 2017, respectively. When comparing fiscal 2019 to fiscal 2018, the favorable change is primarily related to higher foreign exchange gains of $2.7 million, as the U.S. dollar strengthened by approximately 10% against the euro, and higher interest income of $1.1 million due to interest rate increases. When comparing fiscal 2018 to fiscal 2017, the unfavorable change is primarily related to higher foreign exchange losses of $2.3 million, as the U.S. dollar declined approximately 10% against the euro and Mexican peso, partially offset by higher interest income of $0.9 million due to interest rate increases.

 

Interest rate swap valuations and foreign exchange gains and losses are subject to changes which are inherently unpredictable. Our interest rate swap is accounted for using mark-to-market accounting. Accordingly, changes in the fair value of the swap each reporting period are adjusted through earnings, subjecting us to non-cash volatility in our results of operations. The swap fixes the interest rate on our mortgage to 4.31% over the entire term of the mortgage. Although the agreement allows us to prepay the loan and exit the agreement early, we have no intention of doing so. As a result, we will have non-cash adjustments through earnings each reporting period. Over the term of the mortgage, however, the net impact of these mark-to-market adjustments on earnings will be zero.

  

39

 

 

Income Tax Expense

 

 

 

Year Ended

January 31,

   

Increase (Decrease)
Compared
to Prior Period

   

Year Ended

January 31,

   

Increase (Decrease)

Compared
to Prior Period

   

Year Ended

January 31,

 
(in thousands)  

2019

   

$

   

%

   

2018

   

$

   

%

   

2017

 

Income tax expense

  $ 1,489     $ (3,368 )     -69

%

  $ 4,857     $ (14,419

)

    -75

%

  $ 19,276  

Percentage of revenue

    1

%

                    2

%

                    7

%

Effective tax rate

    12

%

                    -115

%

                    504

%

 

We recorded income tax expense of $1.5 million, $4.9 million and $19.3 million for fiscal 2019, 2018, and 2017 respectively. QAD’s effective tax rate was 12%, -115%, and 504% for fiscal 2019, 2018, and 2017, respectively. We generated pre-tax income of $11.9 million in fiscal 2019 versus incurring a pre-tax loss of $(4.2) million in fiscal 2018. Income tax expense in fiscal 2018 included an accrual of $2.0 million to estimate a one-time mandatory repatriation tax owed related to the Tax Act. The calculation was further refined during fiscal 2019 and the final amount owed was $0.7 million. As a result, we recorded a tax benefit of $1.3 million in the fourth quarter of fiscal 2019. In addition, in fiscal 2019 we recorded increased deductions overseas from our equity compensation which lowered our tax expense.

 

In 2018, our effective tax rate was significantly impacted by the provisional effects of the Tax Act, our jurisdictional mix of income and equity compensation windfalls. In fiscal 2018, we recorded an accrual of $2.0 million to estimate a one-time mandatory repatriation tax related to the Tax Act. Our effective tax rate in fiscal 2017 was extraordinarily high due to a $16.3 million valuation allowance placed on U.S. federal and state deferred tax assets.

 

Our foreign earnings are primarily generated from China, India and Mexico. These countries have higher statutory tax rates and effective tax rates than the U.S. However, we benefit from operating in Ireland which has a lower statutory income tax rate and effective tax rate than the U.S.

 

For further information regarding income taxes, see Note 4 “Income Taxes” within the Notes to Consolidated Financial Statements included in Item 15 of this Annual Report on Form 10-K.

 

Non-GAAP Financial Measures

 

Regulation S-K Item 10(e), “Use of Non-GAAP Financial Measures in Commission Filings,” defines and prescribes the conditions for use of non-GAAP financial information. Our measures of non-GAAP adjusted EBITDA, non-GAAP adjusted EBITDA margins, non-GAAP pre-tax income and estimated cash taxes on GAAP earnings each meet the definition of a non-GAAP financial measure. We define the non-GAAP measures as follows: 

 

Non-GAAP adjusted EBITDA - EBITDA is GAAP net income before net interest expense, income tax expense, depreciation and  amortization. Non-GAAP adjusted EBITDA is EBITDA less stock-based compensation expense and the change in the fair value of our interest rate swap.

  

Non-GAAP adjusted EBITDA margins - Calculated by dividing non-GAAP adjusted EBITDA by total revenue.

 

Non-GAAP pre-tax income - GAAP income before income taxes not including the effects of stock-based compensation expense, amortization of purchased intangible assets and the change in fair value of our interest rate swap.

 

Estimated cash taxes on GAAP earnings – Defined as GAAP total tax expense excluding changes in reserves for unrecognized tax benefits.

 

QAD’s management uses non-GAAP measures internally to evaluate the business and believes that presenting non-GAAP measures provides useful information to investors regarding the underlying business trends and performance of our ongoing operations as well as useful metrics for monitoring our performance and evaluating it against industry peers. The non-GAAP financial measures presented should be used in addition to, and in conjunction with, results presented in accordance with GAAP, and should not be relied upon to the exclusion of GAAP financial measures. Management strongly encourages investors to review our consolidated financial statements in their entirety and not to rely on any single financial measure in evaluating the company.

 

40

 

 

QAD non-GAAP measures reflect adjustments based on the following items:

 

Stock-based compensation expense: We have excluded the effect of stock-based compensation expense from our non-GAAP adjusted EBITDA and non-GAAP pre-tax income calculations. Although stock-based compensation expense is calculated in accordance with current GAAP and constitutes an ongoing and recurring expense, such expense is excluded from non-GAAP results because it is not an expense which generally requires cash settlement by QAD, and therefore is not used by us to assess the profitability of our operations. We also believe the exclusion of stock-based compensation expense provides a more useful comparison of our operating results to the operating results of our peers.

 

Amortization of purchased intangible assets: We amortize purchased intangible assets in connection with our acquisitions. We have excluded the effect of amortization of purchased intangible assets, which include purchased technology, customer relationships, trade names and other intangible assets, from our non-GAAP pre-tax income calculation, because doing so makes internal comparisons to our historical operating results more consistent. In addition, we believe excluding amortization of purchased intangible assets provides a more useful comparison of our operating results to the operating results of our peers.

 

Change in fair value of the interest rate swap: We entered into an interest rate swap to mitigate our exposure to the variability of one-month LIBOR for our floating rate debt related to the mortgage of our headquarters. We have excluded the gain/loss adjustments to record the interest rate swap at fair value from our non-GAAP adjusted EBITDA and non-GAAP pre-tax income calculations. We believe that these fluctuations are not indicative of our operational costs or meaningful in evaluating comparative period results because we currently have no intention of exiting the debt agreement early; and therefore over the life of the debt the sum of the fair value adjustments will be zero.

 

The following table sets forth the reconciliation of the non-GAAP financial measures of adjusted EBITDA, adjusted EBITDA margins and non-GAAP pre-tax income to the most comparable GAAP measures for fiscal years 2019, 2018 and 2017 (in thousands):

 

   

Years Ended January 31,

 
   

2019

   

2018

   

2017

 
                         

Total revenue

  $ 333,016     $ 305,018     $ 277,973  
                         

Net income (loss)

    10,428       (9,065

)

    (15,450

)

Add back:

                       

Net interest (income) expense

    (1,957

)

    (878

)

    (26

)

Depreciation

    4,734       4,562       4,326  

Amortization

    772       1,199       1,710  

Income tax expense

    1,489       4,857       19,276  

EBITDA

  $ 15,466     $ 675     $ 9,836  

Add back:

                       

Stock based compensation expense

    10,122       8,924       7,323  

Change in fair value of interest rate swap

    51       (377

)

    (485

)

Adjusted EBITDA

  $ 25,639     $ 9,222     $ 16,674  

Adjusted EBITDA margin

    8

%

    3

%

    6

%

                         

Non-GAAP pre-tax income reconciliation

                       

Income (loss) before income tax expense

  $ 11,917     $ (4,208

)

  $ 3,826  

Add back

                       

Stock-based compensation expense

    10,122       8,924       7,323  

Amortization of purchased intangible assets

    125       842       1,377  

Change in fair value of interest rate swap

    51       (377

)

    (485

)

Non-GAAP income before income taxes

  $ 22,215     $ 5,181     $ 12,041  
                         

Estimated cash taxes on GAAP earnings

  $ 3,270     $ 2,812     $ 2,688  

 

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our primary source of cash is from the sale of subscription, licenses, maintenance and professional services to our customers. Our primary use of cash is payment of our operating expenses which mainly consist of employee-related expenses, such as compensation and benefits, as well as general operating expenses for facilities, third-party hosting providers, third party contractors and other overhead costs. In addition to operating expenses, we may also use cash for capital expenditures; payment of dividends, taxes on equity award exercises and stock repurchases; and to invest in our growth initiatives, which may include acquisitions of products, technologies and businesses. 

 

41

 

 

At January 31, 2019, our principal sources of liquidity were cash and equivalents totaling $139.4 million, short-term investments of $1.2 million and net accounts receivable of $81.6 million. Our cash and equivalents consisted of current bank accounts, registered money market funds and time delineated deposits. Approximately 85% of our cash and equivalents were held in U.S. dollar denominated accounts as of January 31, 2019.

 

Our primary commercial banking relationship is with Bank of America and its global affiliates. Our largest cash concentrations are in the United States and Ireland. The percentage of cash and equivalents held by foreign subsidiaries was 74% and 69% as of January 31, 2019 and January 31, 2018, respectively. The majority of our cash and equivalents are held in investment accounts which are predominantly placed in money market mutual funds, U.S. Treasury and government securities funds. The remaining cash and equivalents and short-term investments are held in deposit accounts and certificates of deposit. 

 

We are a U.S.-based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions.  In addition to providing for U.S. income taxes on earnings from the United States, we provide for U.S. income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered permanently reinvested outside the United States. We do not anticipate changing our intention regarding permanently reinvested earnings as of the balance sheet date.

 

In December 2017, the Tax Act was signed into law. The Tax Act includes a mandatory one-time tax on accumulated earnings of our foreign subsidiaries which resulted in $0.7 million of additional U.S. tax and will be paid in equal installments over eight years beginning in fiscal 2019. In spite of the U.S. taxation on these earnings, we intend to permanently reinvest the earnings in our foreign subsidiaries.  Should we decide to repatriate these earnings in the future, we would not expect to incur significant additional taxes; however, foreign withholding taxes, currency translation, state taxes and currency control laws must always be considered.

 

The following table summarizes our cash flows for the fiscal years ended January 31, 2019, 2018 and 2017, respectively.

 

   

Years Ended January 31,

 

(in thousands)

 

2019

   

2018

   

2017

 

Net cash provided by operating activities

  $ 19,007     $ 10,418     $ 18,680  

Net cash used in investing activities

    (9,258

)

    (4,669

)

    (3,406

)

Net cash used in financing activities

    (14,691

)

    (9,165

)

    (7,814

)

Effect of foreign exchange rates on cash and equivalents

    (2,668

)

    5,357       (109

)

Net (decrease) increase in cash and equivalents

  $ (7,610

)

  $ 1,941     $ 7,351  

 

Typical factors affecting our cash provided by operating activities include our level of revenue and earnings for the period; the timing and amount of employee related compensation payments, vendor payments and tax payments; and the timing and amount of billings and cash collections from our customers, which is our largest source of operating cash flow. Net cash flows provided by operating activities were $19.0 million and $10.4 million for fiscal 2019 and 2018, respectively. The increase in cash flows from operating activities was due primarily to an increase in net income of $19.5 million and the positive cash flow effect of changes in accounts receivable of $11.0 million partially offset by the negative cash flow effect of changes in accounts payable and other liabilities of $(17.4) million.

 

Net cash flows provided by operating activities were $10.4 million and $18.7 million for fiscal 2018 and 2017, respectively. The decrease in cash flow provided by operating activities from fiscal 2017 to fiscal 2018 was due to a decrease in pre-tax income of $8 million.  Although our revenue increased 10% year over year, our personnel expenses were significantly higher as a result of hiring 160 additional employees to support the growth in our subscription and services offerings.

 

Net cash used in investing activities consisted primarily of capital expenditures of $4.3 million, $3.7 million and $3.3 million for fiscal 2019, 2018 and 2017, respectively. We continue to monitor our capital spending and do not believe we are delaying critical capital expenditures required to run our business. During fiscal 2019, we made two acquisitions. We acquired the assets of one of our Indonesian software distributors and made another acquisition to add functionality to our product suite. The total purchase price of the two acquisitions was $2.7 million and funded entirely with cash on hand.

 

Net cash used in financing activities consisted primarily of payments of withholding taxes on settlement of stock-based compensation and payment of dividends. We paid withholding taxes of $8.7 million, $3.4 million and $2.1 million in fiscal 2019, 2018 and 2017, respectively, on vested restricted stock units and exercised stock appreciation rights. We made dividend payments of $5.5 million, $5.4 million and $5.3 million in fiscal 2019, 2018 and 2017, respectively. On a regular basis the Board of Directors evaluates our ability to continue to pay dividends as well as the structure of any potential dividend payments.

 

We have historically calculated accounts receivable days’ sales outstanding (“DSO”), using the countback, or last-in first-out, method. This method calculates the number of days of billed revenue represented by the accounts receivable balance as of period end. When reviewing the performance of our entities, DSO under the countback method is used by management. It is management’s belief that the countback method best reflects the relative health of our accounts receivable as of a given quarter-end or year-end because of the cyclical nature of our billings. Our billing cycle includes high annual maintenance renewal billings at year-end that will not be recognized as earned revenue until future periods.

 

DSO under the countback method was relatively consistent at 48 days and 51 days as of January 31, 2019 and 2018, respectively. DSO using the average method, which is calculated utilizing the accounts receivable balance and earned revenue for the most recent quarter, was 89 days and 93 days as of January 31, 2019 and 2018, respectively. The aging of our accounts receivable remained consistent when compared with the same period last year. We believe our reserve methodology is adequate, our reserves are properly stated as of January 31, 2019 and the quality of our receivables remains good.

 

42

 

 

There have been no material changes in our contractual obligations or commercial commitments outside the ordinary course of business. Cash requirements for items other than normal operating expenses are anticipated for capital expenditures, dividend payments and other equity transactions. We may require cash for acquisitions of new businesses, software products or technologies complementary to our business.

 

We believe that our cash on hand and net cash provided by operating activities will provide us with sufficient resources to meet our current and long-term working capital requirements, debt service, dividend payments and other cash needs for at least the next twelve months.

 

Our revenue, earnings, cash flows, receivables, and payables are subject to fluctuations due to changes in foreign currency exchange rates. See Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” for further discussion.

 

Seasonal Nature of Deferred Revenue, Accounts Receivable and Operating Cash Flow. Deferred revenue primarily consists of billings to customers for maintenance and subscription. When renewing maintenance we generally invoice our customers in annual cycles and when renewing subscription we generally invoice our customers quarterly or annually. We typically issue renewal invoices in advance of the renewal period. The invoice for initial maintenance and subsequent invoices for maintenance renewal may occur in different quarters of the relevant year. This may result in quarterly fluctuations in deferred revenue and accounts receivable. There is a disproportionate weighting towards annual billings in the fourth quarter, primarily as a result of large enterprise account buying patterns. Our fourth quarter has historically been our strongest quarter for new business and renewals. The year on year compounding effect of this seasonality in both billing patterns and overall new and renewal business causes the value of invoices that we generate in the fourth quarter for both new business and renewals to increase as a proportion of our total annual billings.

 

The sequential quarterly changes in accounts receivable, related deferred revenue and operating cash flow during the first three quarters of our fiscal year are not necessarily indicative of the billing activity that occurs in the fourth quarter as displayed below (in thousands):

 

   

January 31,
2019

   

October 31,
2018

   

July 31,
2018

   

April 30,
2018

 

Fiscal 2019

                               

Accounts receivable, net

  $ 81,577     $ 46,420     $ 54,258     $ 56,909  

Deferred revenue, current

    115,253       80,537       91,195       103,369  

Operating cash flow (1)

    3,890       5,971       5,361       3,785  

 

   

January 31,
2018

   

October 31,
2017

   

July 31,
2017

   

April 30,
2017

 

Fiscal 2018

                               

Accounts receivable, net

  $ 83,518     $ 50,753     $ 42,397     $ 46,381  

Deferred revenue, current

    116,693       83,117       89,661       97,235  

Operating cash flow (1)

    7,574       (4,794

)

    (244

)

    7,882  

 

   

January 31,
2017

   

October 31,
2016

   

July 31,
2016

   

April 30,
2016

 

Fiscal 2017

                               

Accounts receivable, net

  $ 69,441     $ 39,100     $ 45,468     $ 44,829  

Deferred revenue, current

    104,125       73,982       85,268       92,640  

Operating cash flow (1)

    13,209       3,451       663       1,357  

 


(1)

Operating cash flow represents net cash provided by (used in) operating activities for the three months ended in the periods stated above.

 

43

 

 

CONTRACTUAL OBLIGATIONS

 

The following table summarizes our significant contractual obligations at January 31, 2019 and the effect these contractual obligations are expected to have on our liquidity and cash flows in future periods.

 

   

Years Ended January 31,

                 
   

2020

   

2021

   

2022

   

2023

   

2024

   

Thereafter

   

Total

 
   

(In millions)

 

Notes payable

  $ 0.5     $ 0.5     $ 0.5     $ 11.8     $     $     $ 13.3  

Notes payable interest payments

    0.6       0.6       0.5       0.2                   1.9  

Lease obligations

    5.6       4.6       2.8       1.8       1.5       2.8       19.1  

Purchase obligations

    9.0       6.8       3.0       0.1                   18.9  

Total

  $ 15.7     $ 12.5     $ 6.8     $ 13.9     $ 1.5     $ 2.8     $ 53.2  

 

 

Purchase obligations are contractual obligations for the purchase of goods or services. They are defined as agreements that are enforceable and legally binding for QAD which specify all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase obligations relate primarily to information technology infrastructure costs, hosting services agreements and costs associated with our sales and marketing events.

 

We have omitted unrecognized tax benefits from this table due to the inherent uncertainty regarding the timing of potential issue resolution. Specifically, either (a) the underlying positions have not been fully enough developed under audit to quantify at this time, or (b) the years relating to the issues for certain jurisdictions are not currently under audit. As of January 31, 2019, we had $1.2 million of unrecognized tax benefits. This is before the netting required by ASU 2013-11 which requires the netting of unrecognized tax benefits against deferred tax assets for a loss or credit that would apply in settlement of the uncertain tax position. For further information regarding the unrecognized tax benefits see Note 4 “Income Taxes” within Notes to Consolidated Financial Statements.

 

Purchase orders or contracts for the purchase of supplies and other goods and services are not included in the table above. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. Our purchase orders are based on our current procurement or development needs and are fulfilled by our vendors within short time frames. We do not have significant agreements for the purchase of supplies or other goods specifying minimum quantities or set prices that exceed our expected requirements for three months.

 

We have certain royalty commitments associated with the licensing of certain products. Royalty expense is generally based on the number of licenses delivered or being used in the cloud environment; or a percentage of the underlying revenue. Royalty expense, included in cost of subscription, license and maintenance and other revenue, was $18.6 million, $17.1 million and $16.2 million in fiscal 2019, 2018 and 2017, respectively.

 

Note Payable

 

Effective May 30, 2012, QAD Ortega Hill, LLC entered into a variable rate credit agreement (the “2012 Mortgage”) with Rabobank, N.A., to refinance a pre-existing mortgage. The 2012 Mortgage has an original principal balance of $16.1 million and bears interest at the one month LIBOR rate plus 2.25%. One month LIBOR was 2.51% at January 31, 2019. The 2012 Mortgage matures in June 2022 and is secured by the Company’s headquarters located in Santa Barbara, California. In conjunction with the 2012 Mortgage, QAD Ortega Hill, LLC entered into an interest rate swap with Rabobank, N.A. The swap agreement has an initial notional amount of $16.1 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 January 31, 2019 was $13.4 million.

 

Lease Obligations

 

We lease certain office facilities, office equipment and automobiles under operating lease agreements. Although our office lease agreements end on various dates through fiscal year 2028, they typically include termination options at earlier dates. The contractual obligations table reflects future minimum rental payments under non-cancellable operating lease commitments with terms of more than one year. For further discussion of our leased office facilities, see Item 2 entitled “Properties” included elsewhere in this Annual Report on Form 10-K.

 

Off-Balance Sheet Arrangements

 

As of January 31, 2019, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. 

 

44

 

 

CRITICAL ACCOUNTING POLICIES

 

The SEC defines “critical accounting policies” as those that require application of management’s most difficult, subjective, or complex judgments. These policies often require us to make estimates about the effects of matters that are inherently uncertain and are subject to change in subsequent periods.

 

We consider the following policies to be critical because of the significance of these items to our operating results and the estimation processes and management judgment involved in each:

 

 

Revenue

 

 

Accounts receivable allowances for doubtful accounts

 

 

Goodwill and intangible assets – impairment assessments

 

 

Income taxes

 

 

Stock-based compensation

 

Our senior management has reviewed these critical accounting policies and related disclosures. Historically, estimates described in our critical accounting policies that have required significant judgment and estimation on the part of management have been reasonably accurate.

 

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

 

We generate revenue through sales of licenses and maintenance provided to our on-premises customers and through subscriptions of our cloud-based software. We offer professional services to both our on-premises and cloud customers to assist them with the design, testing and implementation of our software.

 

We determine revenue recognition through the following steps:

 

-

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, we satisfy 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. We identify and track the performance obligations at contract inception so that we can monitor and account for the performance obligations over the life of the contract.

 

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

 

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

 

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

 

45

 

 

Subscription

 

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

 

Software Licenses

 

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

 

Maintenance

 

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

 

Professional Services

 

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

 

 Indirect Sales Channels

 

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

 

Disaggregated Revenue

 

We disaggregate revenue from contracts with customers by geography and by the customers’ industry within manufacturing, as we believe it best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.

 

Our revenue by geography is as follows:

 

   

Years Ended January 31,