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QAD Inc. QADI

F2Q10 Earnings Call

August 25, 2009; 5:00 pm ET

Executives

John Neale - Vice President & Treasurer

Karl Lopker - Chief Executive Officer

Daniel Lender - Chief Financial Officer

Pam Lopker - President

Analysts

Mark Schappel - The Benchmark Co.

Joe Delcaar - Cowen & Co.

Jason Nelson - Rommel Asset Management

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the QAD fiscal 2010 second quarter financial results conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions)

Now, I’ll turn the conference over to Mr. John Neale, Vice President and Treasurer. Please go ahead.

John Neale

Hello everyone and welcome to today’s call. I’m John Neale, QAD’s Vice President and Treasurer. Earlier this afternoon, we issued a press release announcing QAD’s financial results for the fiscal 2010 second quarter ended July 31, 2009. The press release and associated financial statements are available through the Investor Relations section of our website at www.qad.com. Additionally, please be advised that this call is being webcast live on our website.

Before I begin I need to ensure that everyone on today’s call understands that our discussions might contain forward-looking statements that are based on certain expectations and analysis as of August 25, 2009. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated.

QAD takes no obligation to revise or update as forward-looking statements to reflect events or circumstances after the date of this call. For a complete description of risks and uncertainties, please refer to QAD’s 10-K and 10-Q filings with the Securities and Exchange Commission.

Now, I’d like to turn the call over to Karl Lopker, QAD’s Chief Executive Officer.

Karl Lopker

Good afternoon and thank you for joining us to discuss our second quarter results. With me today is Daniel Lender, Chief Financial Officer; and Pam Lopker, President. Our second quarter results were slightly below our expectation. However, we have been able to reduce expenses inline with revenue, maintain our financial health and position ourselves for the eventual turnaround and manufacturing. Daniel will give you the numbers for the quarter then I’ll discuss the details. Daniel.

Daniel Lender

Thank you, Karl. As the economy continues to affect our global customers, our financial results for the second fiscal quarter were slightly below our prior expectations. Total revenue was $61.3 million in the fiscal 2010 second quarter versus $69.5 million last year. License revenue came in at $6.7 million, which was up slightly on a sequential basis, but down from $11.4 million in fiscal 2009 second quarter.

The year-over-year decrease is not surprising, given the impact of the economy on our customers businesses. Maintenances and other revenue was $32.1 million in the second quarter of fiscal 2010, compared with $34.5 million in the second quarter of last year, primarily reflecting changes in foreign exchange rates and as more effect from a couple of customers who entered bankruptcy protection.

Although, we continue to see lengthy negotiation cycles with our maintenances renewal process. Our maintenances business is healthy with renewal rates remaining at our historical levels about 90%. Services revenue was $12.5 million versus $23.6 million in the second quarter of ‘09. The lower services revenue relates in part to lower licenses revenue over the last few quarters and its impact on implantations, as well as lower customers spending due to the economy.

At the same time, as we discuss last quarter, we felt the impacts of a large engagement in the automotive sector that recently it was scale back. In addition, we moved certain customers to a cash basis for revenue recognition purposes, delaying the recognition of some revenue during the quarter.

As the result, our services activity during Q2 was stronger than the revenues numbers would suggest. We are however, continuing to monitor our services business carefully to ensure that we’re making timely adjustments and managing our capacity and subcontractor utilization accordingly. As we done in the last few quarter.

Now, let me review our second fiscal quarter revenue results by our six vertical markets. Automotive represented approximately 25%, consumer product and food and beverage 27%, high-tech and industrial 35%, and life science is 13%.

During the quarter, we received orders from 10 customers representing more than $500,000 each in combined license, maintenance and services billings, including three exceeding $1 million. Gross margin grew to 57% in the second quarter compared with 53% in the same quarter of last year, primarily reflecting changes in revenue mix.

Sales and marketing expense decreased from $19.9 million to $12.7 million in the fiscal 2010 second quarter. The reduction relates to various cost cutting measures that were initiated in response to the recession, reducing headcount by 20%, travel and discretionary spending significantly down and the cancellation of our Explore event.

General and administrative cost increased to $9 million including bad debt expense during the quarter of approximately $1.1 million, compared with $8.6 million one year ago. The bad debt expense, we took this quarter relates to three specific customers across three regions that entered bankruptcy protection.

We do not believe it is a reflection of the overall health of receivables, as our DSOs have improved over the last quarter in last year and or aging has remained relatively consistent. As a special note, I would also like to point out there are professional fees for the quarter were unusually high and we expect them to reduce by about $500,000 next quarter.

As expected, R&D expense decline in Q2 of 2010 to $9.3 million from $11.3 million reported in last years second fiscal quarter. Total operating expenses in fiscal 2010 amounted to $31.2 million or 61% of total revenue compared with $40 million or 57% of total revenue in the fiscal ‘09 second quarter. Total operating expenses in the current second quarter included severance expense of approximately $1.5 million.

Operating loss in the fiscal 2010 second quarter was $2.1 million, including $1.3 million in stock compensation expense, compared with an operating loss of $2.9 million, including $1.6 million in stock compensation expense in the similar period last year. Other income was 170,000 versus 45,000 in second quarter of ‘09.

Our net loss for the second quarter amounted to $1.4 million or $0.05 a share compared with $1.4 million or $0.05 a share last year. A stock compensation expense, net of tax was $0.03 and $0.04 a share respectively in the second quarters of fiscal 2010 and 2009. I’ll also quickly review our year-to-date results. Total revenues for the first six months of fiscal 2010 were $106.3 million compared with $136.4 million in the first six months of last year.

License revenue for the year-to-date period was $12.9 million versus $23.4 million in the same period of last year. Maintenances and other revenue total $65 million compared with $68.7 million in the first half of 2009. Services revenue equaled $28.4 million versus $44.3 million in the same period of last year. Net loss for the fiscal 2010 six month period was $4.1 million or $0.13 per share versus $2.2 million or $0.07 per share.

Stock compensation expenses equaled $0.06 per share and $0.07 per share respectively in the first six months of fiscal 2010 and 2009. Capital expenditures were down again this quarter to approximately 150,000 from $1.3 million last year. As we continued to preserve cash by strategically deploying capital were most necessary. Year-to-date capital expenditures were $500,000 compared to $2.9 million in the first six months of last year.

Cash flow provided by operations from the second quarter of fiscal 2010 was $5 million compared with cash used in operations of 700,000 in the fiscal second quarter of last year. For the first six months of fiscal 2010 cash flow provided by operations was $12.3 million compared with $7.1 million in the first six months of last year. This last quarter we offered our shareholders the option of receiving the dividend payment in stock or cash.

72% of shares elected to receive our dividend in stock thus producing our cash payments from 770,000 to 217,000. Pam and Karl Lopker, our majority shareholders elected to receive their dividend in stock. Cash and equivalents increased to $40.6 million at July 31, 2009, compared with $31.5 million at January 31.

Days sales outstanding using the Countback Method was 73 days in the second quarter of 2010, and improvement over 82 days in last year’s second quarter and 91 days last quarter. While we’re continuing to closely monitor our receivables, we believe that currently are healthy reflecting good collection practices.

Before providing our third quarter outlook, I’d like to update you on the one-time Stock Option and Stock Appreciation Right Exchange Program, which we successfully completed on August, 12. 79% of our eligible underwater stock options and SARs based on the eligible grants at the beginning of the program or 85% based on the eligible grants at the time of the exchange were tendered and exchanged.

We are pleased with the success of this program, as it reduced the overhang by 1.8 million shares and improve the effectiveness of our long term incentive program for our employees. Moving onto our business outlook for the third quarter of fiscal 2010, the company currently expects total revenue of approximately $54 million and a small profit.

Back to you, Karl.

Karl Lopker

Okay, thanks, Daniel. As you can see, our revenue was off quite a bit from the previous year, inline with what many of our competitors are experiencing. However, you can also see that we’re able to adjust cost and have been able to actually increase our cash position through good collections practice, reduced expenses and reduced capital expenditures.

Bankruptcies and near bankruptcies have affected our customer base, since so many of them are dependent on the auto industry. We still have some exposure in this area, but the majority of risks are known and we believe are under control. We do see a pick-up in revenue for the second half of the year, which when combined with our cost reduction actions should result in our return to our profitability and put us in a great shape for next year.

While we will continue to monitor our revenue and cost closely, we believe we’re at bottom of the economic cycle and now have the ability to plan to take advantage of the coming recovery and manufacturing. However, we’re planning for a slow recovery, due to the lack of spending by consumers and the back-to-capital spending does lag in any recovery.

Sentiment our customer base, appears to be getting more positive, although a pick-up sustained improvement in automotive to really make a difference. Rising stock prices were also a positive, since 70% of our revenue comes from public companies, whose executives feel better and their stock prices improving.

Our employee headcount stands at 1390, a reduction of 15% from its peak last year. The reductions were mainly in sales and services as you would expect with a reduced activity in the manufacturing economy. Just after the end of the quarter, we completed the equity exchange program that Daniel mentioned were employees were able to exchange occupants at a high stock price were a lower number at a lower number price and an extension investing.

This was very positively received and resulted in 85% of the eligible options being exchanged. This indicates that most of our staff will remain committed to seeing us through the recovery. Our license funnel shows a slight increase from last quarter, but it’s down 25% from a year. This compares to a decrease and first half license as a 45%, indicating to us the customers are planning to increase spending for our products.

In our vertical markets, automotive continues to suffer and a consumer product continues to perform relatively better. On a geographical basis, for the first half of the year, all regions were down on license revenue, in a range from 42% to 60%, although, Asia-Pacific did relatively better than all the other regions. We continue to invest aggressively in development, so that we have the products our customers will need, once our businesses start to recover, but one particularly bright spot in the second quarter, was in sales of our products delivered On Demand.

We closed six new customer deals, mostly in North America. We believe, On Demand will become increasingly important to our customer base and our technology makes us a profitable business for QAD. So, Pam is going to give us some more details on what we’re doing in developments and our On Demand offerings. Pam.

Pam Lopker

Okay, Karl since your mentioned On Demand let me just talk about that a minute. Q2 was a good quarter for selling enterprise On Demand sales. As Karl mentioned, we have six new customers and we’re continuing to get good traction in the On Demand sales. The customers represented a good range of the type of customers that we’re seeing interested in On Demand. One customer also passion is a divestiture from a current QAD customer. Another customer Helix is a pre-revenue medical device startup.

Two companies were adding new facilities in China and wanted to go On Demand to minimize upfront expenses and resource requirements, between the six companies, while they were primarily, new five of them were U.S. headquartered and one of them was Australian headquartered, they represented implementations or users in six countries, Australia, Brazil, China, U.S., U.K., and Singapore and it represented three out of our six verticals that customers in life science, automotive and industrial. So I think that really goes to show with a strong offering QAD has both in our verticals as well as our ability to deploy worldwide and why we think that this will be a good long term growth area for QAD.

I’d also like to cover a bit on where we’re spending our R&D dollars. Enterprise financials is still getting a lot of attention. As many of you may know, we setoff a few years ago to build from bottom up the best-in-class financial capabilities for global manufacturing companies, all written in new technologies with a strong emphasis on ease-of-use and minimum overhead.

We’re currently live with six customers in various areas of the world and we project that will have 20 live customers by year end. We are slightly behind in terms of our internal goals for live implementation. This is mainly a result of delays due to resource constrains and reductions in funding due to the economy at our customer cites, which ended up elongating implementation time.

Although, we are still resolving some issues that are normal in new product release, our implementations are stable and customers are reporting important benefits from the advance technology and functionalities in the software. Across our installed based we’re seeing increased interest and really filling this funnel of both new customers, but primarily upgrades for existing customers wanting to take advantage of this new capability.

At the same time, we’re continuing our strategic direction of up lifting our entire product for usability, embedding KPIs, our operational metrics, and business intelligence. We’re building new workbenches, we released just a few months ago, a new reporting framework with data integration and we’ve released new capability and Easy On Boarding to quickly implement not only new sites, but upgrades our existing customer.

While QAD is already know for ease-of-use and quick to implement application, our goal is to reduce the time and takes to implement and train by a factor of two to three and eventually get to the point, that an experienced user can train themselves, really pushing the envelope where we already excel and continue to be best-in-class in that area and setting the bar.

Thank you Karl, back to you.

Karl Lopker

Okay, thanks Pam. So overall we’re seeing science of life and manufacturing and we’re ready to capitalize on the recovered. That finishes our report for the quarter. Operator, can you please give the instructions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Schappel - The Benchmark Co.

Mark Schappel - The Benchmark Co.

Daniel, with respect to your customers and bankruptcies, is it fair to assume that they’re in the automotive sector?

Daniel Lender

Actually it’s across a couple of different verticals Mark, and if mention there’s some in the U.S., but there’s some actually one in Europe and another one in Asia.

Mark Schappel - The Benchmark Co.

Could you give us any details on what sectors exactly?

Daniel Lender

One is automotive, I believe the one is in industrial and don’t recall what the third one is.

Mark Schappel - The Benchmark Co.

With respect to the six On Demand deals in the quarter, were they all for the enterprise ERP solution or were some of them for the supply chain visualization product?

Pam Lopker

Because you asked last time, Mark at this time I focused just on the enterprise solution. So there are six enterprise solutions and basically end-to-end product capabilities. So finance distribution manufacturing, the whole suite of enterprise application is fit that particular vertical.

Mark Schappel - The Benchmark Co.

Moving onto expenses here, but G&A was up a little more than normal. I know you some bad debt expense in there. Was there anything else that was in there as well?

Daniel Lender

The other thing that I mentioned, our professional fees, Mark, were unusually high this quarter. So those should comedown next quarter by at least $500,000.

Mark Schappel - The Benchmark Co.

So it’s fair to assume that G&A should get back on a normal track then?

Daniel Lender

Yes.

Operator

Your next question comes from Joe Delcaar - Cowen & Co.

Joe Delcaar - Cowen & Co.

So I got a several question, is the services revenue for next quarter expected to be more inline with 1Q than with 2Q, given that should be just like a one-time shift due to the move from the cash accounting?

Daniel Lender

It should be probably somewhere in between, Joe.

Joe Delcaar - Cowen & Co.

You’d mentioned that severance expense for this quarter was $1.5 million, correct?

Daniel Lender

Yes.

Joe Delcaar - Cowen & Co.

Would you be so kind to give us an update on the status of that joint venture that you guys had mentioned in the past and sort of its impact on R&D and when we can expect that impact on R&D?

Daniel Lender

We haven’t yet recorded any significant cost offset to that and we expect that we will be recording costs up at sometime in the future, it’s hard to say right now exactly, when that will be.

Operator

(Operator Instructions) Your final question comes from Jason Nelson - Rommel Asset Management.

Jason Nelson - Rommel Asset Management

Just quick question, what effect did currency have in the quarter?

Daniel Lender

The effects under revenue side was roughly $3 million negative, and on the gross margin side about or on the cost of revenue $1.5 million on the positive side. The operating expense is about $1.9 million on a positive side, so on a net basis, fairly negligible.

Jason Nelson - Rommel Asset Management

Just curious, can you breakout for me on the operating cash flow, either in the second quarter or year-to-date? Do you know, off the top of your head, how much of that just from changes in working capital?

Daniel Lender

I don’t have that right off the top of my head.

Operator

At this point, there are no further questions in queue. We’ll turn it back to Mr. Lopker, for any closing comments.

Karl Lopker

Okay, well let me summarize what you’ve heard today. There appears to be improvements in the economic picture and we are ready for the recession to end. So we can get on with growing the business. Thank you for your attendance. We’ll update you again in November. Good bye.

Operator

Ladies and gentlemen, this conference will be available for replay after 4.00 pm Pacific Time today, through midnight Pacific Time on September, 1. You may access the AT&T Executive Replay Service at any time by dialing 1800-475-6701 entering access code 106682. International participants dial 320-365-3844, access code 106682. That does conclude your conference for today. Thank you for participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: QAD Inc. F2Q10 (Qtr End 31/07/09) Earnings Call Transcript

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