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Executives

Eileen Osborn - Vice President of Investor Relations

Karl Lopker - Chief Executive Officer

Daniel Lender - Chief Financial Officer

Gordon Fleming - Chief Marketing Officer

Pam Lopker - President

Analysts

Peter Goldmacher - Cowen & Company

Mark Schappel - Benchmark

David Bayer - Cantor Fitzgerald

QAD Inc. (QADI) Q2 2009 Earnings Call August 21, 2008 5:00 PM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the QAD Fiscal 2009 Second Quarter Financial Results Conference Call. At this time all phone lines are in a listen-only mode. Later, there will be an opportunity for your questions, and instructions will be given to you at that time. (Operator Instructions). As a reminder, today's conference call is being recorded.

And with that being said, I would now much introduce your opening speaker for today, Eileen Osborne. Please go ahead.

Eileen Osborn - Vice President of Investor Relations

Hello everyone. I am Eileen Osborn, QID’s Vice President in charge of Investor Relations.

Earlier today we issued a press release announcing QAD’s financial results for fiscal 2009 second quarter ended January 31, 2008. The press release and associated financial statements are available on the investor relations section of our website at www.qad.com. Additionally, please be advised that this call is being webcast live at our website.

Before I begin, I want to assure 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 today, August 21, 2008. 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 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 filings for the period ending January 31, 2008.

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

Karl Lopker - Chief Executive Officer

Good afternoon and thank you for joining us. With me today is Daniel Lender, Chief Financial Officer; and Gordon Fleming, Chief Marketing Officer. Pam Lopker, President, is traveling and will not join the call.

We're pleased to report that our second quarter produced record revenue for our second quarter, driven by our services organization. However, license revenue and profitability were not where we wanted them to be. You may also have seen in the announcement that Daniel Lender will be leaving QAD.

We think Daniel for his efforts over the last five years. These have been challenging years in software due to the regulatory environment and the business consolidations. We all hope for the best in his future endeavors. Daniel will go over the numbers one last time.

Daniel Lender – Chief Financial Officer

Thank you, Karl. Before I begin, I would like to say thank you to my colleagues at QAD for all of the hard work and support. I would also like to say thank you to our investors and analysts.

I have greatly enjoyed getting to know you over the last several years and believe I am leaving you in great hands. Total revenue continued to grow in the second quarter of fiscal 2009 with improvements in both our maintenance and services businesses. At the same time, license sales were impacted by some weakness in our US business, where sales cycles are lengthening as a result of the current economic environment.

Total revenue for the quarter was up 8% to $69.5 million compared with $64.2 million last year. About half of the revenue growth was related to the impact of foreign currency. During fiscal 2009 second quarter, we received orders from 17 customers, representing more than $500,000 each in combined license, maintenance and services billings. Of these, six exceeded 1 million and one exceeded 2 million. License revenue in the second quarter of fiscal '09 was 11.4 million versus 14.8 million in the same period last year.

As I mentioned, slower business conditions negatively impacted license sales orders in our US business. Additionally, we also faced resourcing challenges related to the breadth of our product line. We did, however, build up our pipeline and signed a few large deals during the quarter, for which we did not recognize revenue. We expect to recognize that revenue over the next one or two years.

Maintenance and other revenue grew 9% to 34.5 million from 31.8 million a year ago. Services revenue rose 34% to 23.6 million compared with 17.6 million in the prior-year period. This is an important accomplishment because future revenue streams are created as we improve our engagement with customers and work on large implementations around the world.

Cost of revenue was $32.5 million or 47% of revenue in the second quarter of fiscal 2009 compared to $56.9 million or 42% of revenue in the second quarter of fiscal 2008. The increase in cost of revenue was related to changes in our revenue mix and roughly $1.5 million in unfavorable currency movement.

Gross margin was 63% of revenue in the second fiscal '09 quarter compared with 88% of revenue in the second quarter of fiscal '08. The change reflects our mix of revenue in each quarter.

Total operating expenses in the fiscal '09 second quarter were $40 million or 67% of total revenue versus $36.6 million or 57% of total revenue in the same period last year. Approximately half of the increase in total operating expenses was attributable to the impact of foreign currency, which affected all expense categories.

Total operating expenses were also impacted by higher personnel costs related primarily to a sales and marketing headcount increase compared with the prior year. We're investing in building our pre-sales infrastructure to support the more complex sales that have resulted from our broadened product line and are putting more effort into helping our customers improve their efficiency.

Although we did not see a return on these investments in the second quarter, we believe that our activities will yield future benefits. At the same time, we're closely watching our P&L to ensure that expense growth does not significantly outpace revenue growth. Operating loss in the fiscal 2009 second quarter was $2.9 million, including an overall negative foreign currency impact of approximately $500,000 compared with operating income of approximately $700,000 in the same period last year.

Other income for the most recent quarter totaled $45,000 versus approximately $200,000 for the second quarter fiscal '08. The decrease in other income between the periods was related to lower interest income. Net loss for the fiscal 2009 second quarter totaled $1.4 million or $0.05 per share compared with net income of $500,000 or $0.02 per diluted share in the same period last year. In the second quarter fiscal '09, stock compensation expense was $0.04 per diluted share net of tax compared with $0.03 per diluted share net of tax in last year's second quarter.

Now, very quickly, total revenue for the first six months of fiscal '09 increased 13% to $136.4 million from $120.8 million in the first six months of fiscal '058. Net loss for the first six months of fiscal '09 was $2.2 million or $0.07 per share including stock compensation expense of $0.07 per diluted share net of tax. This compares with a net loss of $1.3 million or $0.04 per share including stock compensation expense of $0.06 per diluted share net of tax in the first six months of fiscal '08.

Cash and cash equivalents at July 31 were 43.2 million compared with 45.6 million at January 31, '08. Day sales outstanding using the count-back method was 82 days in the second quarter of fiscal 2009 versus 72 days in last year's second quarter. Cash flow used in operations for the fiscal '09 second quarter was roughly 700,000 versus cash provided by operation of 6.3 million for the second quarter of fiscal '08.

For the first six months of fiscal '09 cash flow provided by operations was $7.1 million compared with $8.1 million in the first six months of fiscal '08.

Now for our third-quarter and full-year output. QAD expects revenue between $69 million and $73 million and earnings per diluted share of about breakeven to a small profit for the fiscal '09 third quarter ending October 31, 2008. This estimate includes stock compensation expense of $0.03 per diluted share net of tax.

For the full year our revenue guidance remains at the same at $280 million to $290 million. Earnings per diluted share is now expected to be in the range of $0.10 to $0.18 per share. This estimate includes stock compensation expense of $0.13 per diluted share net of tax. This guidance takes into account our first-half performance as well as previous foreign exchange rate movements. Our business outlook for both the third quarter of fiscal '09 and full year assumes an effective tax rate of approximately 47%. This is higher than the 35% previously presumed as a result of the change in the estimated level and mix of profitability by tax jurisdiction. The change in effective tax rate impacts full year earnings per diluted share by approximately $0.04 a share.

With that, I will turn the call back to you, Karl.

Karl Lopker - Chief Executive Officer

Okay. Thanks Daniel. As Daniel reported, our services revenue pushed our total revenue into record territory. However, licenses did fall short of last year's result. This was due in part to the general economic conditions and the deferral of certain license transactions that will be recognized in future periods. We do continue to focus on license growth even as our customers look to QAD for broader portfolio of services.

Services revenue, which grew 34% in the second quarter and the first half of this year, not only showed strong growth but also improved utilization in billing rates. This growth is due to solid demand for global implementations. We began to build up our global services capability a couple of years ago and now those activities are paying off with increased revenue.

In the maintenance area, as we mentioned last quarter, we did initiate a maintenance price increase of 5 or 6% that will start show effect later in the year. Our overall license pipeline is up about 10% from a year ago. This is partly due to the lengthening of certain sales cycles which we talked about last quarter.

Our sales personnel headcount increased 11% from the previous year, which we expect will lead to increased license revenue as well as services revenue in the future. Our overall headcount was up around 6% year-over-year, mostly from the hiring in sales and in services.

On a geographical basis, all regions grew in the first half with Asia Pacific leading the way out on a percentage basis, and all our vertical markets performed inline with previous periods.

In the product area, QAD 2008 Standard Edition is currently in general availability as a standard product ship to new customers. QAD 2008 Enterprise Edition, which includes the new Enterprise Financial is in limited release with a number of customers due to go-live after the summer. Our on-demand products produced new customers, and the pipeline has also grown.

I'll let Gordon talk about the Explorer user conference we held in June. Gordon?

Gordon Fleming - Chief Marketing Officer

Good afternoon, everyone. Well, certainly, Explorer we held in Orlando, Florida this June, and that's the third in the annual series of our global user conferences. It was a great event, and customers were particularly focused on understanding the latest additions to our product suite. We held over 60 sessions focused on elements of our solution, including our transportation management solutions, enterprise asset management, customer relationship management and the most recent addition to our product suite, product information management. In fact, the session introducing QAD's product information management, or PIM solution, was the most attended session of the conference with standing room only.

Our customers gave us really great positive feedback on the launch of QAD Enterprise Applications 2008, or QAD 2008 for short. We were also proud to unveil QAD 2008 Enterprise Edition, or EE for short, in which we are debuting our Enterprise Financials. Many customers have already engaged with us to investigate adoption of the Enterprise Edition; and, as Karl mentioned, the early adoptor program is pursuing well.

Through the balance of this year we'll be holding further conferences in the series with events in [Haiku] in the People's Republic of China, Sorrento in Italy, Johannesburg in the Republic of South Africa and expect to have engaged with over 3,000 members of our customer community through this series of events. These really are great community events, and we're always pleased to engage with our customer at them.

Also this month we were really pleased to see Aberdeen Group publish their third annual report on ERP in manufacturing. Through a survey of over 600 mid-sized companies, that's companies between $50 million and $1 billion in annual revenues, Aberdeen evaluated the ERP costs and benefits that they realize. QAD proved to have the lowest cost of ownership and, more importantly, our customers achieved the greatest improvement in business performance over the many competitors surveyed.

Performance was defined across five key operational metrics, and QAD's customers generated the best improvement in each of those five metrics. Taken together, QAD demonstrated the lowest total percentage point of improvement, a true measure of ROI, or return on investment. QAD showed 27% better than its nearest competitor and 36% better than the average of all mid-sized customers. So ERP sales, we believe, are not driven purely by customers' needs for software, but rather by a need for business improvement, and we feel that this survey shows that QAD customers are benefiting from receiving those results. So our passion truly is our customers' advantage, and we are really pleased with the results of that survey.

So let me pass back to you, Karl.

Karl Lopker - Chief Executive Officer

Okay, thanks, Gordon. Well, overall we're happy with our 13% year-to-date increase in revenue, which is almost completely organic growth, by the way. However, we would have preferred that license growth and profitability were stronger. We know the areas we need to work on for the remainder of the fiscal year. We're still positive about the general market, although we are watching the global economy for signs of difficulty or, hopefully, recovery.

That finishes our report for the quarter. Operator, can you give us the instructions for questions?

Question-and-Answer Session

Operator

Absolutely. (Operator Instructions). And our first question today comes from the line of Peter Goldmacher with Cowen & Company. Please go ahead.

Peter Goldmacher

Hey, guys. Some of your commentary on the shortfall was from macroeconomic weakness, and you said that was going to delaying some sales cycles. I'd love a little bit more detail on that. Specifically, was it specific verticals you are selling into? And was it delaying sales cycles, or were deal sizes getting scaled down? And, what is your perspective on where we are in a slower purchasing patterns, are we starting, midway through, near the end? And what are you all doing to make sure that you do maintain some level of profitability and continue to generate cash? Thanks.

Karl Lopker

Well, on the vertical side, one vertical is up one quarter and one vertical is up another. So we didn't really notice anything particularly in any one particular vertical. You would expect automotive to be a little bit rougher, but that is where we got some of our bigger license revenue from last quarter because we are strong in automotive.

On the deal size, we did notice that after the deals sizes have reduced a little, we actually did more transactions last quarter than we did a year ago quarter, not a lot, but we did some more, but generated less revenue. The customers are trying to buy in smaller and smaller increments, so that's definitely true. And we don't like to give the big, huge discounts in order to get more in.

On the profitability side, our expenses will pretty much remain leveled, we believe throughout the rest of the year. The first half of the year does have these conferences that we've been going to and other expenses that are a little bit abnormal. And certainly because of the results we've had so far we're going to be tightening up on those expenses.

Peter Goldmacher

Okay. Thank you.

Operator

(Operator Instructions). Our next question then comes from the line of Mark Schappel with Benchmark. Please go ahead.

Mark Schappel

Hi, good evening and I guess congratulations on your move, Daniel. Karl, to start off with you, if you could just provide us with an update on the move to on-demand and what you're seeing? Were the deals that were done in the quarter, were they on the supply chain visualization product, or are you seeing a kind of a breakout into some of the enterprise suite?

Karl Lopker

The on-demand is still starting out fairly slow for us. Certainly, most of the deals we're having on the Supply Visualization side, but we also took an order for the regular on-demand ERP side. We're offering it in probably about 40% of the deals that are out there, but the customers in ERP are still pretty much used to buying it on a permanent basis, especially in the manufacturing area. They like to see the box right there with all the bells and whistles going on. I think that will change their life. We still have a lot of faith that the on-demand market will be in the 20 or 30% of our revenue over the next, I'd say, three to four years.

Mark Schappel

Okay. And then Daniel, could you just give us a breakout of the international revenue as a percent of total revenue?

Daniel Lender

The international -- sure, international revenue by region, Mark, remained fairly constant. North America represented about 42%, so slightly down from last quarter; EMEA, steady at 32%; Asia-Pacific, as Karl mentioned, we did have good license performance there, and that grew to 19%; Latin American steady, at 7%.

Mark Schappel

7%, okay. Okay and that’s all from me.

Daniel Lender

Okay. Thanks Mark.

Operator

(Operator Instructions). And our next question is from the line of David Bayer with Cantor Fitzgerald. Please go ahead.

David Bayer

Hi, gentlemen. I'm new to the call, so please allow me to ask a question here. I'm wondering, if you could talk a little bit more about some of the slowdowns in terms of the sales cycles. What I'm interested in particularly is to what degree are competitors perhaps causing some of the slowdown by countering with lower-priced offerings or things of that nature? I mean in other words, is it really an economic issue, or is it also some new dynamics from the competition that needs to be thought about?

Karl Lopker

We don't really see much change in the competitor landscape. Certainly, pricing is a formidable weapon that's used out there these days and when we're doing pricing. A lot of our sales are actually new modules to our existing customers were, really, the competitor is more the return on investment than it is a different company that's selling them the product.

David Bayer

Thanks. So within the installed base, clearly the competition would not be as major of an issue. So do you think that in general the pipeline is just extended as opposed to canceled?

Karl Lopker

Yes, our win-loss rates haven't changed much over the last year.

David Bayer

Very good. Thank you.

Operator

(Operator Instructions). We have no further questions in the queue. Please continue.

Karl Lopker

Okay. Well, thank you, everyone, for your attendance. We look forward to updating you again in November, after the end of our third quarter. Goodbye.

Operator

Ladies and gentlemen, today's conference call is being made available for replay starting today at 4:00 PM in the Pacific Time zone, that's 7:00 PM Eastern time, and running for one week until Thursday, August 28. You can access our service at any time by dialing 1800-475-6701 or 320-365-3844 and at the voice prompt enter today's conference access code which is 924130. And that does conclude our conference call for today. Thank you for your participation. You may now disconnect.

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