10-Q 1 a2089165z10-q.htm 10-Q
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended July 31, 2002

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

For the transition period from to

Commission file number 0-22823

QAD Inc.
(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		77-0105228 (I.R.S. Employer Identification No.)
6450 Via Real, Carpinteria, California 93013 (Address of principal executive offices)
(805) 684-6614 (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o.

The number of shares outstanding of the issuer's common stock as of the close of business on August 30, 2002, was 34,454,285.

QAD INC.

INDEX

			Page
PART I
	FINANCIAL INFORMATION
	ITEM 1	Financial Statements (unaudited)
		Condensed Consolidated Balance Sheets as of July 31, 2002 and January 31, 2002	1
		Condensed Consolidated Statements of Operations for the Three and Six Months Ended July 31, 2002 and 2001	2
		Condensed Consolidated Statements of Cash Flows for the Six Months Ended July 31, 2002 and 2001	3
		Notes to Condensed Consolidated Financial Statements	4
	ITEM 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	10
	ITEM 3	Quantitative and Qualitative Disclosures About Market Risk	16
PART II
	OTHER INFORMATION
	ITEM 4	Submission of Matters to a Vote of Security Holders	17
	ITEM 6	Exhibits and Reports on Form 8-K	17
	SIGNATURES		18
	CERTIFICATIONS		19

PART 1

ITEM 1—FINANCIAL STATEMENTS

QAD INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share data)

			July 31, 2002			January 31, 2002
Assets
Current assets:
	Cash and equivalents		$	53,251		$	50,782
	Accounts receivable, net			39,142			59,714
	Other current assets			12,893			11,535

		Total current assets		105,286			122,031
Property and equipment, net				21,055			20,512
Capitalized software development costs, net				2,664			2,963
Other assets, net				11,711			12,503

		Total assets	$	140,716		$	158,009

Liabilities and stockholders' equity
Current liabilities:
	Current portion of long-term debt		$	1,748		$	2,157
	Accounts payable			7,839			10,069
	Accrued expenses			25,502			28,299
	Deferred revenue and other			56,962			58,854

		Total current liabilities		92,051			99,379
Long-term debt				14,475			15,345
Other deferred liabilities				713			633
Minority interest				415			516
Stockholders' equity:
	Preferred stock, $0.001 par value. Authorized 5,000,000 shares; none issued and outstanding			—			—
	Common stock, $0.001 par value. Authorized 150,000,000 shares; issued and outstanding 34,440,785 and 34,253,314 shares at July 31, 2002 and January 31, 2002, respectively			34			34
	Additional paid-in-capital			115,395			114,911
	Accumulated deficit			(75,248	)		(65,595	)
	Accumulated other comprehensive loss			(7,119	)		(7,214	)

		Total stockholders' equity		33,062			42,136

		Total liabilities and stockholders' equity	$	140,716		$	158,009

See accompanying notes to condensed consolidated financial statements.

QAD INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

			Three Months Ended July 31,						Six Months Ended July 31,
			2002			2001			2002			2001
Revenue:
	License fees		$	11,204		$	13,729		$	23,153		$	28,837
	Maintenance and other			26,372			26,357			51,690			52,107
	Services			7,702			10,090			14,755			21,026

		Total revenue		45,278			50,176			89,598			101,970
Costs and expenses:
	Cost of license fees			1,756			2,550			3,720			5,496
	Other cost of revenue			15,586			19,744			31,630			39,695
	Sales and marketing			16,433			14,904			32,337			29,774
	Research and development			8,877			8,248			17,213			15,737
	General and administrative			5,503			5,681			11,106			11,497
	Amortization of intangibles from acquisitions			295			984			577			1,990

		Total costs and expenses		48,450			52,111			96,583			104,189

Operating loss				(3,172	)		(1,935	)		(6,985	)		(2,219	)
Other (income) expense:
	Interest income			(217	)		(456	)		(416	)		(827	)
	Interest expense			387			590			869			1,369
	Other (income) expense, net			316			(22	)		564			175

		Total other (income) expense		486			112			1,017			717

Loss before income taxes and cumulative effect of accounting change				(3,658	)		(2,047	)		(8,002	)		(2,936	)
Income tax expense				300			300			600			1,100

Loss before cumulative effect of accounting change				(3,958	)		(2,347	)		(8,602	)		(4,036	)
Cumulative effect of accounting change				—			—			1,051			—

Net loss			$	(3,958	)	$	(2,347	)	$	(9,653	)	$	(4,036	)

Basic and diluted net loss per share:
	Before cumulative effect of accounting change		$	(0.12	)	$	(0.07	)	$	(0.25	)	$	(0.12	)
	Cumulative effect of accounting change			—			—			(0.03	)		—

Basic and diluted net loss per share			$	(0.12	)	$	(0.07	)	$	(0.28	)	$	(0.12	)

See accompanying notes to condensed consolidated financial statements.

QAD INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

		Six Months Ended July 31,
		2002			2001
Net cash provided by operating activities		$	6,786		$	16,206
Cash flows from investing activities:
	Purchase of property and equipment		(3,766	)		(1,686	)
	Investment in software development		(885	)		(469	)
	Other, net		21			—

Net cash used in investing activities			(4,630	)		(2,155	)
Cash flows from financing activities:
	Reduction of notes payable		(1,279	)		(2,587	)
	Issuance of common stock for cash		484			470

Net cash used in financing activities			(795	)		(2,117	)
Effect of exchange rates on cash and equivalents			1,108			(202	)

	Net increase in cash and equivalents		2,469			11,732
Cash and equivalents at beginning of period			50,782			36,500

Cash and equivalents at end of period		$	53,251		$	48,232

See accompanying notes to condensed consolidated financial statements.

QAD INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments necessary to present fairly the financial information contained therein. These statements do not include all disclosures required by accounting principles generally accepted in the United States for annual financial statements and should be read in conjunction with the audited financial statements and related notes included in our Annual Report on Form 10-K for the year ended January 31, 2002. The results of operations for the three and six months ended July 31, 2002 are not necessarily indicative of the results to be expected for the year ending January 31, 2003.

Certain prior period balances have been reclassified to conform to current period presentation.

2. RECENT ACCOUNTING PRONOUNCEMENTS

On February 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). Among other things, SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with its provisions. SFAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives and reviewed for impairment in accordance with SFAS 144.

SFAS 142 also requires an assessment of whether there is an indication that goodwill is impaired as of the date of adoption. We have up to six months from that date to determine the fair value of each reporting unit and compare it to the reporting unit's carrying amount. If an indication exists that the reporting unit's goodwill may be impaired, the implied fair value of the reporting unit's goodwill must be compared to its carrying amount. This comparison is required to be completed as soon as possible, but no later than the end of the year of adoption. Any transitional impairment loss is to be recognized as the cumulative effect of a change in accounting principle in our consolidated statement of operations. Upon adoption of SFAS 142, we recognized a $1.1 million impairment charge related to goodwill that is reflected as a cumulative effect of accounting change in the Condensed Consolidated Statement of Operations for the six months ended July 31, 2002. For further discussion related to SFAS 142, see note 5 within these Notes to Condensed Consolidated Financial Statements.

Effective February 1, 2002, we adopted Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144). Among other things, SFAS 144 supersedes SFAS 121. However, SFAS 144 retains the fundamental provisions of SFAS 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with SFAS 121. Unlike SFAS 121, an impairment assessment under SFAS 144 will never result in a write-down of goodwill. Rather, goodwill is evaluated for impairment under SFAS 142. The adoption of SFAS 144 did not have a material impact on our financial statements.

Also effective February 1, 2002, we adopted Financial Accounting Standards Board Emerging Issues Task Force No. 01-14, "Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred" (EITF 01-14). EITF 01-14 requires companies to characterize reimbursements received for out-of-pocket expenses incurred as revenue in the statement of operations. Comparative financial statements for prior periods include reclassifications to comply with the guidance of this announcement. The adoption of this EITF does not affect net income or loss in any past or future period, but will increase both services revenue and other cost of revenue equally. Adoption of

EITF 01-14 did not have a material impact on our total gross margin percentage. In implementing EITF 01-14, we recharacterized reimbursements received for out-of-pocket expenses incurred as revenue in the amount of $0.3 million and $0.7 million for the three and six months ended July 31, 2002 and $0.6 million and $1.1 million for the three and six months ended July 31, 2001, respectively.

3. COMPREHENSIVE LOSS

Comprehensive loss includes changes in the balances of items that are reported directly in a separate component of stockholders' equity on the Condensed Consolidated Balance Sheets. The components of comprehensive loss are as follows:

	Three Months Ended July 31,						Six Months Ended July 31,
(In thousands)	Three Months Ended July 31,						Six Months Ended July 31,
(In thousands)	2002			2001			2002			2001
Net loss	$	(3,958	)	$	(2,347	)	$	(9,653	)	$	(4,036	)
Foreign currency translation adjustments		(170	)		(306	)		95			(2,347	)

Comprehensive loss	$	(4,128	)	$	(2,653	)	$	(9,558	)	$	(6,383	)

4. PER SHARE INFORMATION

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

	Three Months Ended July 31,						Six Months Ended July 31,
(In thousands, except per share data)	Three Months Ended July 31,						Six Months Ended July 31,
(In thousands, except per share data)	2002			2001			2002			2001
Net loss	$	(3,958	)	$	(2,347	)	$	(9,653	)	$	(4,036	)

Weighted average shares of common stock outstanding		34,400			34,024			34,353			33,947
Weighted average shares of common stock equivalents issued using the treasury stock method		—			—			—			—

Weighted average shares of common stock and common stock equivalents outstanding		34,400			34,024			34,353			33,947

Basic and diluted loss per share	$	(0.12	)	$	(0.07	)	$	(0.28	)	$	(0.12	)

Common stock equivalent shares consist of the shares issuable upon the exercise of stock options and warrants using the treasury stock method. Shares of common stock equivalents of approximately 181,000 and 333,000 for the three and six months ended July 31, 2002 and 363,000 and 315,000 for the three and six months ended July 31, 2001, respectively, were not included in the diluted calculation because they were anti-dilutive. Due to the net loss for the three and six months ended July 31, 2002 and 2001, basic and diluted per share amounts are the same for each respective period.

5. GOODWILL AND INTANGIBLE ASSETS

Acquired Intangible Assets

(In thousands)		July 31, 2002			January 31, 2002
Amortizable Intangible Assets (various, principally customer contracts)		$	9,255		$	8,684
Less: accumulated amortization			(7,817	)		(6,786	)

	Net amortizable intangible assets	$	1,438		$	1,898

The increase in amortizable intangible assets from January 31, 2002 to July 31, 2002 is due to the impact of foreign currency translation. As of January 31, 2002 and July 31, 2002, we had no intangible assets that were determined to have indefinite useful lives, and therefore were not subject to amortization. The aggregate amortization expense related to amortizable intangible assets was $0.3 million and $0.6 million for the three and six months ended July 31, 2002 and $0.7 million and $1.4 million for the three and six months ended July 31, 2001, respectively.

The estimated remaining amortization expense related to amortizable intangible assets for the years ended January 31, 2003, 2004 and 2005 is $0.5 million, $0.7 million and $0.2 million, respectively. No additional amortization is estimated in fiscal year 2006 and thereafter.

Goodwill

For the applicable reporting units, the changes in the carrying amount of goodwill for the six months ended July 31, 2002, were as follows (reporting unit regions are defined in note 7 within these Notes to Condensed Consolidated Financial Statements):

(In thousands)	EMEA		Asia Pacific			Latin America			Total
Balances, February 1, 2002	$	6,325	$	1,036		$	966		$	8,327
Impairment loss		—		(1,051	)		—			(1,051	)
Impact of foreign currency translation		716		15			(70	)		661

Balances, July 31, 2002	$	7,041	$	—		$	896		$	7,937

In connection with the adoption of SFAS 142 on February 1, 2002, all reporting units were valued and tested for impairment where applicable. The fair value of the Asia Pacific reporting unit was determined using a discounted cash flow approach. The impairment loss recorded for Asia Pacific relates to anticipated trends in this reporting unit as the recovery of the manufacturing sector tends to lag behind the other regions. In accordance with the transition provisions of SFAS 142, the 2003 fiscal first quarter $1.1 million impairment loss related to Asia Pacific goodwill was recorded as a cumulative effect of accounting change and is included in our Condensed Consolidated Statement of Operations for the six months ended July 31, 2002.

For comparability, the following table assumes that SFAS 142 was adopted on February 1, 2001. The table adjusts net loss before cumulative effect of accounting change for amortization expense related to goodwill.

				Three Months Ended July 31,						Six Months Ended July 31,
(In thousands, except per share data)				Three Months Ended July 31,						Six Months Ended July 31,
(In thousands, except per share data)				2002			2001			2002			2001
Loss before cumulative effect of accounting change				$	(3,958	)	$	(2,347	)	$	(8,602	)	$	(4,036	)
		Adjustments to net loss:
			Goodwill amortization		—			285			—			576

Adjusted net loss before cumulative effect of accounting change				$	(3,958	)	$	(2,062	)	$	(8,602	)	$	(3,460	)

Basic and diluted net loss per share:
	Net loss before cumulative effect of accounting change			$	(0.12	)	$	(0.07	)	$	(0.25	)	$	(0.12	)
	Goodwill amortization				—			0.01			—			0.02

	Adjusted net loss before cumulative effect of accounting change			$	(0.12	)	$	(0.06	)	$	(0.25	)	$	(0.10	)

6. RESTRUCTURING CHARGE

In the past, we have implemented restructuring programs designed to strengthen operations and financial performance. Applicable charges and adjustments related to restructurings are included in costs and expenses in our Condensed Consolidated Statements of Operations. Below is a discussion of the active restructuring programs as of July 31, 2002.

During fiscal year 2001, we undertook several initiatives to strengthen operating and financial performance by sharpening the focus of our e-business and business intelligence solutions for multi-national customers. The related actions resulted in a $5.1 million charge taken in the third quarter of fiscal year 2001 and included facility consolidations ($1.0 million), a reduction of approximately 150 employees, contractors and consultants across most regions and functions ($2.2 million) and associated asset write-downs ($1.9 million). As of July 31, 2002, $4.0 million of this charge was utilized and $1.0 million was adjusted downwards because employee termination costs were lower than originally estimated. We expect to pay the remaining balance of $0.1 million, primarily consisting of lease obligations, by the end of fiscal 2007.

During fiscal year 2002, we continued our fiscal year 2001 initiative resulting in a $0.7 million and $0.4 million charge in the second quarter and fourth quarter, respectively. These charges primarily related to the reduction of office space in three of our North American locations. In addition, during fiscal year 2002, we recorded adjustments of $0.7 million and $0.3 million to the Statement of Operations in the second quarter and third quarter, respectively. These adjustments, totaling $1.0 million, were to the fiscal year 2001 restructuring accrual noted above. As of July 31, 2002, of the combined $1.1 million fiscal year 2002 restructuring charges, $0.5 million had been utilized. The remaining balance of $0.6 million related to lease obligations is expected to be paid through fiscal year 2007.

The following table presents the restructuring activities through July 31, 2002, resulting from each of the aforementioned programs:

(In thousands)		Lease Obligations			Employee Termination Costs		Total Restructuring
Balances, January 31, 2002		$	984		$	31	$	1,015
Fiscal year 2003 activity:
	Utilization		(345	)		—		(345	)

Balances, July 31, 2002		$	639		$	31	$	670

7. BUSINESS SEGMENT INFORMATION

QAD operates in geographic regions. The North America region includes the United States and Canada. The EMEA region includes Europe, the Middle East and Africa. The Asia Pacific region includes Asia and Australia. The Latin America region includes South America, Central America and Mexico.

Operating income attributable to each business segment is based upon management's assignment of revenue and costs. Regional cost of revenue includes the cost of goods produced by QAD manufacturing operations at the price charged to the distribution operation. Income from manufacturing operations and research and development costs are included in the Corporate operating segment. Identifiable assets are assigned by region based upon the location of each legal entity.

Revenue for the three and six months ended July 31, 2001, has been restated to comply with the guidance of EITF 01-14 regarding the characterization of reimbursements received for out-of-pocket

expenses. For further discussion of EITF 01-14, see note 2 within these Notes to Condensed Consolidated Financial Statements.

		Three Months Ended July 31,						Six Months Ended July 31,
(In thousands)		Three Months Ended July 31,						Six Months Ended July 31,
(In thousands)		2002			2001			2002			2001
Revenue:
	North America	$	18,916		$	19,122		$	37,558		$	39,502
	EMEA		15,810			18,582			30,042			38,203
	Asia Pacific		7,518			9,816			15,776			18,887
	Latin America		3,034			2,656			6,222			5,378

		$	45,278		$	50,176		$	89,598		$	101,970

Operating income (loss):
	North America	$	2,565		$	3,095		$	4,844		$	5,685
	EMEA		(819	)		(569	)		(2,409	)		(1,025	)
	Asia Pacific		(1,382	)		(2,048	)		(2,556	)		(3,294	)
	Latin America		(501	)		(958	)		(1,026	)		(1,914	)
	Corporate		(3,035	)		(1,455	)		(5,838	)		(1,671	)

		$	(3,172	)	$	(1,935	)	$	(6,985	)	$	(2,219	)

		July 31, 2002		January 31, 2002
Identifiable assets:
	North America	$	67,557	$	72,889
	EMEA		44,694		53,888
	Asia Pacific		23,617		26,167
	Latin America		4,848		5,065

		$	140,716	$	158,009

8. SUBSEQUENT EVENT

In August 2002, we announced the implementation of a cost reduction program aimed at reducing annualized operating expenses in order to better align expenses with current business levels. In connection with this program, we expect to report a restructuring charge of approximately $2 to $3 million in the 2003 fiscal third quarter, consisting primarily of employee termination costs occurring across all regions and most functions.

ITEM 2—MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements. These statements typically are preceded or accompanied by words like "believe," "anticipate," "expect" and words of similar meaning. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in these forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as other factors detailed in our Annual Report on Form 10-K for the year ended January 31, 2002. These include, but are not limited to, evolving demand for the company's software products and products that operate with the company's products, the publication of opinions by industry analysts about the company, its products and technology, the entry of new competitors and their technological advances, delays in localizing the company's products for new markets, delays in sales as a result of lengthy sales cycles, changes in operating expenses, pricing, timing of new product releases, the method of product distribution or product mix and general economic factors. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date hereof. In addition, revenue and earnings in the enterprise resource planning (ERP), e-business and collaborative commerce software industries are subject to fluctuations. Investors should not use any one quarter's results as a benchmark for future growth. We undertake no obligation to revise, update or publicly release the results of any revision or update to these forward-looking statements. Readers should carefully review the risk factors described in other documents we file from time to time with the Securities and Exchange Commission.

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q.

CRITICAL ACCOUNTING POLICIES

We consider certain accounting policies related to revenue recognition, accounts receivable allowances, impairment of long-lived assets and valuation of deferred tax assets to be critical policies due to the estimation processes and management's judgment involved in each.

•: Revenue Recognition. QAD licenses its software under non-cancelable license agreements including third-party software sold in conjunction with QAD software, provides customer support and provides services including technical, implementation and training. Revenue is recognized in accordance with Statement of Position (SOP) No. 97-2, "Software Revenue Recognition," as modified by SOP No. 98-9, "Modification of SOP No. 97-2, Software Revenue Recognition with Respect to Certain Transactions" and Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements." Our revenue recognition policy is as follows:

License Revenue. We recognize revenue from license contracts when a non-cancelable, non-contingent license agreement has been signed, the software product has been delivered, no uncertainties exist surrounding product acceptance, fees from the agreement are fixed and determinable, and collection is probable. We use the residual method to recognize revenue when a license agreement includes one or more elements to be delivered at a future date if evidence of the fair value of all undelivered elements exists. If evidence of the fair value of the undelivered elements does not exist, revenue is deferred and recognized when delivery occurs. Certain judgments affect the application of our license revenue recognition policy, such as the assessment of collectibility for which we review a customer's credit worthiness and our historical experience with that customer, if applicable.

Maintenance Revenue. Revenue from ongoing customer support and product updates is recognized ratably over the term of the maintenance period, which in most instances is one year.

Services Revenue. Revenue from technical and implementation services is recognized as the services are performed for the time-and-materials contracts. Revenue from training services is recognized as the services are performed.

We believe that we are currently in compliance with SOP No. 97-2, SOP No. 98-9 and SAB No. 101. However, the accounting profession continues to discuss various provisions of these guidelines with the objective of providing additional guidance on their future application. These discussions and the issuance of new interpretations, once finalized, could lead to unanticipated changes in revenue recognition. They could also drive significant adjustments to our business practices that could result in increased administrative costs, lengthened sales cycles and other changes that could affect our results of operations.

•: Accounts Receivable Allowances. We review the collectibility of our accounts receivable each period by analyzing balances based on age and record specific allowances for any balances that we determine may not be fully collectible. We also provide an additional reserve based on historical data including analysis of credit memo data and other known factors. These determinations require management's judgment. Actual collection of these balances may differ due to global or regional economic factors, challenges faced by customers within our targeted vertical markets or specific financial difficulties of individual customers.
•: Impairment of Long-Lived Assets and Valuation of Deferred Tax Assets. Our long-lived assets include goodwill, intangibles, deferred taxes and other assets. At July 31, 2002, we had $9.4 million of goodwill and other intangible assets, and $0.3 million of net deferred tax assets, current and non-current, which when combined account for approximately 7% of our total assets. In assessing the recoverability of our intangibles, excluding goodwill, we must make assumptions regarding estimated future cash flows to support the carrying value of the respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets not previously recorded. Effective February 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142) which requires us to analyze goodwill for impairment issues during the first six months of fiscal year 2003, and then on a periodic basis thereafter. Upon adoption of SFAS 142, we recognized a $1.1 million impairment charge related to goodwill that is reflected as a cumulative effect of accounting change in the Condensed Consolidated Statements of Operations for the six months ended July 31, 2002. For a further discussion of SFAS 142, see note 2 within the Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.
Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", requires that the carrying value of our net deferred tax assets reflects an amount that is more likely than not to be realized. In assessing the likelihood of realizing tax benefits associated with deferred tax assets and the need for a valuation allowance, we consider estimated future taxable income and tax planning strategies that are both prudent and feasible. Should we determine that it is more likely than not that we would be able to realize deferred tax assets in the future in excess of the net recorded amount, an adjustment to deferred tax assets would decrease tax expense in the period such determination was made. Likewise, should we determine that it is more likely than not that we would not be able to realize all or part of the net deferred tax asset in the future, an adjustment to deferred tax assets would increase tax expense in the period such determination was made.

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the percentage of total revenue represented by certain items reflected in our statements of operations:

			Three Months Ended July 31,				Six Months Ended July 31,
			2002		2001		2002		2001
Revenue:
	License fees		25	%	27	%	26	%	28	%
	Maintenance and other		58		53		58		51
	Services		17		20		16		21

		Total revenue	100		100		100		100
Costs and expenses:
	Cost of license fees		4		5		4		5
	Other cost of revenue		34		39		35		39
	Sales and marketing		36		30		36		29
	Research and development		20		17		19		16
	General and administrative		12		11		13		11
	Amortization of intangibles from acquisitions		1		2		1		2

		Total costs and expenses	107		104		108		102

Operating loss			(7	)	(4	)	(8	)	(2	)
Other (income) expense			1		—		1		1

Loss before income taxes and cumulative effect of accounting change			(8	)	(4	)	(9	)	(3	)
Income tax expense			1		1		1		1

Loss before cumulative effect of accounting change			(9	)	(5	)	(10	)	(4	)
Cumulative effect of accounting change			—		—		1		—

Net loss			(9	)%	(5	)%	(11	)%	(4	)%

Total Revenue. Total revenue for the second quarter of fiscal year 2003 was $45.3 million, a decline of $4.9 million, or 10%, from $50.2 million in the second quarter of fiscal year 2002. Total revenue for the six months ended July 31, 2002, was $89.6 million, a decline of 12%, or $12.4 million, from $102.0 million in the comparable prior year period. This decrease in total revenue on both a quarter-to-quarter and year-to-year basis was driven by declines in license fees and services revenues while maintenance and other revenue was flat on a quarter-to-quarter basis and declined slightly on a year-to-year-basis.

License revenue decreased $2.5 million to $11.2 million for the second quarter of fiscal year 2003 from $13.7 million for the same period last year. For the six months ended July 31, 2002, license revenue was $23.2 million, a $5.7 million decline from the same period last year. These declines reflect the continued slowdown in corporate IT spending within our core customer base of manufacturers due to current economic conditions. Maintenance and other revenue was flat to the second quarter of last year at $26.4 million. Maintenance revenue increased due to growth in our installed base, but was offset by declines in hardware sales. On a year-to-date basis, maintenance and other revenue decreased $0.4 million to $51.7 million for the current quarter from $52.1 million for the first six months of fiscal year 2002 primarily due to declines in hardware revenue, partially offset by increases in maintenance revenue. Second quarter services revenue decreased $2.4 million when compared to the second quarter

of last year and declined $6.3 million for the six months ended July 31, 2002 when compared to the same period last year. The declines in services revenue correlate with the recent license revenue trend.

Total Cost of Revenue. Total cost of revenue (combined cost of license fees and other cost of revenue) as a percentage of total revenue decreased to 38% in the second quarter of fiscal year 2003 from 44% in the second quarter of fiscal year 2002 and on a year-to-date basis decreased to 39% in fiscal year 2003 from 44% in fiscal year 2002. These percentage decreases are primarily the result of the mix of revenues. Maintenance and other revenues increased to 58% of revenues from 53% in the year-ago quarter and to 58% from 51% on a year-to-date basis, offset by a lower proportion of services revenues, which carries a lesser gross margin than license and maintenance revenue. In addition, in the first quarter of fiscal year 2003, the company terminated a third party royalty contract, which resulted in a one-time benefit of approximately $600,000, which represents a less than 1% improvement to the gross margin percentage on a year-to-date basis.

Sales and Marketing. Sales and marketing expense increased 10% to $16.4 million for the second quarter of fiscal year 2003 from $14.9 million in the comparable prior year period. On a current year-to-date basis, sales and marketing expense increased $2.6 million or 9% to $32.3 million compared to the first six months of fiscal year 2002. The increase in spending was primarily due to increased personnel costs and marketing efforts including a higher level of net expense in the current year for our annual Explore User Conference.

Research and Development. Research and development expense was $8.9 million for the second quarter of fiscal year 2003, up from $8.2 million in the second quarter of fiscal year 2002. During the six months ended July 31, 2002, research and development expense increased $1.5 million to $17.2 million from $15.7 million in the same prior year period. These increases were primarily due to increased personnel expenses related to our continued investment in the development of our new and existing products.

General and Administrative. General and administrative expense remained relatively flat at $5.5 million and $5.7 million for the second quarter of fiscal year 2003 and 2002, respectively. In the six months ended July 31, 2002, general and administrative expense was also relatively flat at $11.1 million from $11.5 million in the same prior year period.

Amortization of Intangibles from Acquisitions. Amortization of intangibles from acquisitions was down $0.7 million at $0.3 million for the current quarter when compared to the same quarter last year and down $1.4 million from $2.0 million last year to $0.6 million on a current year-to-date basis, because certain intangibles are now fully amortized and due to the discontinued amortization of goodwill with our adoption of SFAS 142 last quarter.

Operating Expenses. Operating expenses include sales and marketing, research and development, general and administrative, and amortization of intangibles from acquisitions. In total, these expenses were up $1.3 million at $31.1 million for the current quarter when compared to last year for the reasons described above. During the six months ended July 31, 2002 operating expenses increased $2.2 million to $61.2 million from $59.0 million in the same prior year period. Payroll expenses, overall, were down from last year. While support, services and general and administrative payroll expenses have declined, sales and marketing, and research and development payroll expenses have increased. It should also be noted that during the first quarter of fiscal year 2003 we adjusted the discretionary component of the fiscal year 2002 bonus pool, resulting in a $0.6 million benefit, of which $0.5 million related to operating expenses and $0.1 million related to cost of revenue.

Income Taxes. We recorded income tax expense of $0.3 million for the second quarter of both fiscal years 2003 and 2002 and $0.6 million and $1.1 million for the six months ended July 31, 2002 and 2001, respectively. These amounts include taxes in jurisdictions that were profitable during these periods. We have not provided a benefit for the jurisdictions in loss positions due to management's determination regarding the uncertainty of the realization of these benefits.

Cumulative Effect of Accounting Change. In the first quarter of fiscal year 2003, we adopted SFAS 142 related to impairment tests for goodwill, resulting in the reporting of a cumulative effect of a change in accounting principle of $1.1 million. For further discussion of SFAS 142, see note 2 within the Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.

PRO FORMA FINANCIAL RESULTS

Pro forma information is provided below to assist in evaluating our performance on a more consistent year-to-year basis. However, pro forma information should not be considered in isolation or as a substitute for net loss or other information prepared in accordance with accounting principles generally accepted in the United States. Pro forma amounts have been adjusted to exclude amortization of intangibles from acquisitions and a cumulative effect of accounting change related to goodwill. Pro forma adjustments are detailed below in a reconciliation from net loss calculated in accordance with accounting principles generally accepted in the United States to pro forma net loss.

			Three Months Ended July 31,						Six Months Ended July 31,
(In thousands, except per share data)			Three Months Ended July 31,						Six Months Ended July 31,
(In thousands, except per share data)			2002			2001			2002			2001
Reconciliation of net loss to pro forma net loss:
Net loss			$	(3,958	)	$	(2,347	)	$	(9,653	)	$	(4,036	)
	Adjustments to net loss:
		Amortization of intangibles from acquisitions		295			984			577			1,990
		Cumulative effect of accounting change		—			—			1,051			—

Pro forma net loss			$	(3,663	)	$	(1,363	)	$	(8,025	)	$	(2,046	)

Pro forma basic and diluted net loss per share			$	(0.11	)	$	(0.04	)	$	(0.23	)		(0.06	)
Pro forma basic and diluted weighted shares				34,400			34,024			34,353			33,947

LIQUIDITY AND CAPITAL RESOURCES

We have historically financed our operations and met our capital expenditure requirements through cash flows from operations, sale of equity securities and borrowings. Cash and equivalents were $53.3 million and $50.8 million at July 31, 2002, and January 31, 2002, respectively. We had working capital of $13.2 million as of July 31, 2002, compared to $22.7 million as of January 31, 2002. The decline primarily relates to a reduction in accounts receivable, partially offset by an increase in cash and decreases in accounts payable and other accrued expenses.

Accounts receivable, net of allowances, declined to $39.1 million at July 31, 2002, from $59.7 million at January 31, 2002, primarily because collections have exceeded billings, due to the high volume of annual maintenance renewal billings processed in the fourth quarter and collected in the subsequent fiscal year. Accounts receivable days sales outstanding, using the countback method, increased to 85 days as of July 31, 2002, compared to 75 days at January 31, 2002, due to slower customer payments in this economic environment.

Net cash provided by operating activities was $6.8 million and $16.2 million for the six months ended July 31, 2002 and 2001, respectively. The year-over-year change relates mainly to a larger net loss in the current year and a continued decrease in other accrued expenses.

Net cash used in investing activities was $4.6 million and $2.2 million for the six months ended July 31, 2002 and 2001, respectively, and related primarily to the purchase of property and equipment. During the second quarter of fiscal year 2003, we commenced construction of a new company headquarters on property owned by QAD in Summerland, California, a neighboring community to our existing headquarters in Carpinteria, California. A primary motivation for this activity is to consolidate QAD Santa Barbara area operations. The current construction schedule is set to complete the effort so that it coincides with the lease termination of the existing company headquarters in nearby Carpinteria, California. Another significant motivation for this effort is that the current entitlement under the California Development Plan for the project will expire August 2003. However, we may be eligible to receive up to a one-year extension for this entitlement if substantial continuous construction is in progress. The Board of Directors has approved expenditures up to $3.5 million for the initial phases of these construction activities, including architectural design, demolition, excavation and grading.

The preliminary construction budget is approximately $20 million and would be funded through a combination of cash and additional debt financing. In July 2002, we obtained a commitment from Santa Barbara Bank and Trust to finance a maximum of $18 million, subject to usual and customary due diligence by the bank. QAD may cancel this commitment at any time prior to funding of the loan, subject to a non-refundable commitment fee of $45,000. Funding of the loan, if approved by the Board of Directors, is expected by the end of fiscal year 2003. This commitment would require QAD to guarantee the construction financing and to repay the existing loan of $4.4 million encumbering the site. In total, the conditions of the loan would require QAD to contribute approximately $7 million in cash based on the preliminary budget. We expect to generate a portion of our cash contribution from the sale of another parcel of property located in Carpinteria, California.

Net cash used in financing activities totaled $0.8 million and $2.1 million for the six months ended July 31, 2002 and 2001, respectively, and was comprised of repayments of borrowings and proceeds from the issuance of common stock.

We maintain a five-year senior credit facility with Foothill Capital Corporation (the Facility). The Facility provides that we will maintain certain financial and operating covenants which include, among other provisions, maintaining minimum 12 month trailing earnings before interest, taxes, depreciation and amortization (EBITDA) and minimum tangible net worth. These covenants were renegotiated during the second quarter of fiscal year 2003. At July 31, 2002, we were in compliance with the renegotiated covenants. The Facility currently provides that the term loan shall be repaid in quarterly principal installments ranging from $375,000 to $750,000 based on our aggregate unrestricted cash and equivalents balance at the end of each quarter.

We believe that the cash on hand, net cash provided by operating activities and the expected available borrowings under our credit facility and anticipated construction loan will provide us with

sufficient resources to meet our current and long-term working capital requirements, construction requirements, debt service and other cash needs.

RECENT ACCOUNTING STANDARDS

In July 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146). SFAS 146 nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." It requires that a liability be recognized for those costs only when the liability is incurred, that is, when it meets the definition of a liability in the FASB's conceptual framework. SFAS 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002, with earlier adoption encouraged. We do not expect that the adoption of SFAS 146 will have a material impact on our financial position or results from operations.

ITEM 3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Exchange. For the six months ended July 31, 2002 and 2001, approximately 30% and 35%, respectively, of our revenue was denominated in foreign currencies. We also incur a significant portion of our expenses in currencies other than the United States dollar. As a result, fluctuations in the values of the respective currencies relative to the currencies in which we generate revenue could adversely impact our results.

Fluctuations in currencies relative to the United States dollar have affected and will continue to affect period-to-period comparisons of our reported results of operations. For the six months ended July 31, 2002 and 2001, foreign currency transaction losses totaled $0.6 million and $0.4 million, respectively. Due to constantly changing currency exposures and the volatility of currency exchange rates, we may experience currency losses in the future, and we cannot predict the effect of exchange rate fluctuations upon future operating results. Although we do not currently undertake hedging transactions, we may choose to hedge a portion of our currency exposure in the future, as we deem appropriate.

Interest Rates. We invest our surplus cash in a variety of financial instruments, consisting principally of bank time deposits and short-term marketable securities with maturities of less than one year. Our investment securities are held for purposes other than trading. Cash balances held by subsidiaries are invested in short-term time deposits with the local operating banks. Additionally, our short-term and long-term debt bears interest at variable rates.

We prepared sensitivity analyses of our interest rate exposure and our exposure from anticipated investment and borrowing levels for fiscal year 2003 to assess the impact of hypothetical changes in interest rates. Based upon the results of these analyses, a 10% adverse change in interest rates from the 2002 fiscal year-end rates would not have a material adverse effect on the fair value of investments and would not materially impact our results of operations or financial condition for fiscal year 2003.

PART II

ITEM 4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the annual meeting of stockholders held on June 6, 2002, the following proposals were adopted:

(1): To elect two directors to hold office for a term of three years until the annual meeting of stockholders in the year 2005 (Class I Directors):

		Votes For		Votes Withheld
Jeffrey A. Lipkin		31,822,265		482,404
A.J. "Bert" Moyer		31,819,265		485,404

(2): To ratify the appointment of KPMG LLP as the Company's independent auditors for the Company's 2003 fiscal year:

Votes For		Votes Against		Abstentions
32,243,709		50,227		10,733

ITEM 6—EXHIBITS AND REPORTS ON FORM 8-K

a): Exhibits

10.1		Architectural Services Agreement between the Registrant and Lenvik & Minor Architects dated May 29, 2002.
10.2		Master Services Agreement between the Registrant and Equant, Inc. dated June 6, 2002. (†)
10.3		Consulting Agreement between the Registrant and Ove Arup & Partners California dated June 12, 2002.
10.4		Second Amendment to the Loan and Security Agreement between the Registrant and Foothill Capital Corporation dated July 31, 2002.
99.1		Certification by the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2		Certification by the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


	(†)	Certain portions of exhibit have been omitted based upon a request for confidential treatment. The omitted portions have been separately filed with the Securities and Exchange Commission.

b): Reports on Form 8-K

No reports on Form 8-K were filed during the six months ended July 31, 2002.

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	QAD Inc. (Registrant)


Date: September 13, 2002	By:	/s/ KATHLEEN M. FISHER Kathleen M. Fisher Chief Financial Officer (on behalf of the registrant)
	By:	/s/ VALERIE J. MILLER Valerie J. Miller Chief Accounting Officer (Principal Accounting Officer)

CERTIFICATIONS

I, Karl F. Lopker, certify that:

1.: I have reviewed this quarterly report on Form 10-Q of QAD Inc.;
2.: Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.: Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.

Date: September 13, 2002

/s/ KARL F. LOPKER

Karl F. Lopker
Chief Executive Officer
QAD Inc.

CERTIFICATIONS

I, Kathleen M. Fisher, certify that:

1.: I have reviewed this quarterly report on Form 10-Q of QAD Inc.;
2.: Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.: Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.

Date: September 13, 2002

/s/ KATHLEEN M. FISHER

Kathleen M. Fisher
Chief Financial Officer
QAD Inc.

QuickLinks

QAD INC. INDEX
PART 1
QAD INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands, except share data)
QAD INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share data)
QAD INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
QAD INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
PART II
Signatures
CERTIFICATIONS
CERTIFICATIONS