I replied with the following, from which she kindly posted a summary tonight:

Companies pay dividends for a number of reasons. Two of the foremost are 1. To return retained earnings to shareholders when the company believes that it cannot find a better use for the capital, and 2. To raise the share price if the company thinks its market valuation is too low.

 

My guess is that QSI's circumstance is the former.

 

On the issue of investment in product development: A little-understood fact of the software business is that the incremental cost of adding each new feature increases exponentially as a function of software size, while the incremental benefit of each new feature increases at a much slower rate. Software systems eventually reach a point where the incremental cost of a new feature is greater than its incremental benefit, and it therefore makes no sense to "re-invest" in features. I have written about this phenomenon in detail. If QSI has come to the realization that continued software development might not make economic sense, they are smarter than the average software vendor.

 

You ask: "Does QSI just have that much cash on hand?" Yes, they do. If you read the 2006 10-K, you will note that they had net operating cash flows of $17MM, $21MM, and $30MM in 2004, 2005, and 2006. The balance sheet shows they had $56MM in cash on hand at the end of 2006. They're sitting on a pile of loot, and this dividend of $0.25/share on approximately 27 million outstanding shares — a total dividend payment of less than $7MM — will not hurt them. The dividend probably amounts to little more than their expected net increase in cash reserves for 2007.

 

Having a lot of cash on-hand creates what is called a moral hazard, an unfortunate propensity to make bad decisions when things start going well. People in general tend to compensate for a reduction in risk, in this case thanks to a fat wallet, by increasing their risk tolerance. Conversely, when risks abound we tend to operate more cautiously. So returning excess capital to shareholders may provide the added benefit of stronger incentives for the company management to make better investments with the capital that remains.

 

With that explanation out of the way, it is interesting to note that recent thinking on dividends is that they are a bit outmoded. Open-market stock repurchases have the same effect of returning capital to shareholders, though indirectly: The company bids up its own shares and rewards the shareholders with a capital gain instead of a cash payment. The question of tax effects can complicate the comparison of these two strategies somewhat, but in the end, stock repurchases are generally a more efficient way to return capital to shareholders.

 

Perhaps page 48 of the 10-K offers a clue as to why the company chose a dividend instead of a stock repurchase. Two insiders control 19% and 17% of the shares, respectively. Each stands to bank north of $1MM in dividends without the need to sell shares. A stock repurchase may have been considered, but these insiders would have to sell shares to benefit from the price increase that would result. And even if they didn't mind letting go of the shares, they would have to comply with the SEC's insider trading rules. A dividend will allow these insiders a handsome payday without diluting their ownership interests in the company or subjecting them to SEC scrutiny.