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BRIDGELINE DIGITAL, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge)
This section contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in the forward-looking statements as a result of a variety of factors and risks
including risks described in our Annual Report on Form 10-K for the fiscal year
ended September 30, 2011 as well as in the other documents that we file with the
Securities and Exchange Commission. You can read these documents at www.sec.gov.
This section should be read in combination with the accompanying unaudited
consolidated financial statements and related notes prepared in accordance with
United States generally accepted accounting principles.
Overview
Bridgeline Digital is a developer of an award-winning Web Experience Management
(WEM) product suite named iAPPS® and award-winning interactive technology
solutions that help organizations optimize business processes. Bridgeline's
iAPPS product suite combined with its interactive development capabilities
assists customers in maximizing revenue, improving customer service and loyalty,
enhancing employee knowledge, and reducing operational costs by leveraging web
based technologies.
Bridgeline Digital's iAPPS product suite provides solutions that deeply
integrate web Content Management, eCommerce, eMarketing, deep within the
website, web applications, or on-line stores in which they reside; enabling
business users to enhance and optimize the value of their web
properties. Combined with award-winning interactive development capabilities,
Bridgeline helps customers cost-effectively accommodate the changing needs of
today's rapidly evolving web properties.
The iAPPS product suite is delivered through a Cloud-based SaaS ("Software as a
Service") business model, whose flexible architecture provides customers with
state of the art deployment providing maintenance, daily technical operation and
support; or via a traditional perpetual licensing business model, in which the
iAPPS software resides on a dedicated server in either the customer's facility
or Bridgeline's co-managed hosting facility.
KMWorld Magazine Editors selected iAPPS as a Trend Setting Product in both 2010
and 2011. iAPPS Content Manager won the 2010 Codie Award for Best Content
Management Solution globally, and was a finalist for the same award in 2011.
iAPPS Commerce was also selected as a finalist for the 2011 Codie Award for Best
Electronic Commerce Solution, globally. B2B Interactive has selected Bridgeline
Digital as one of the Top Interactive Technology companies in the United States
in 2009, 2010 and 2011.
Bridgeline's team of Microsoft ® Gold Certified developers specialize in
end-to-end interactive technology solutions which include digital strategy,
user-centered design, web application development, SharePoint development, rich
media development, search engine optimization and web application hosting
management.
Customer Information
We had approximately 640 customers at December 31, 2011 compared with
approximately 565 customers at December 31, 2010, an increase of 13%.
Approximately 465 of the Company's customers, or 73%, pay a monthly subscription
fee or a monthly managed service hosting fee.
For the three months ended December 31, 2011 and 2010, no customer represented
10% or more of total revenue.
Results of Operations for the Three Months Ended December 31, 2011 compared to
the Three Months Ended December 31, 2010
Total revenue for the three months ended December 31, 2011 remained flat at $6.5
million compared with three months ended December 31, 2010. We had a net loss of
($463) thousand for the three months ended December 31, 2011 compared with a net
loss of ($156) thousand for the three months ended December 31, 2010. Net loss
per share for the three months ended December 31, 2011 and 2010 was ($0.04) and
($0.01), respectively.
On October 3, 2011, the Company completed the acquisition of Magnetic
Corporation ("Magnetic"), a Tampa, Florida based web technology company. The
Company acquired all of the outstanding capital stock of Magnetic for
consideration consisting of (i) $150,000 in cash and (ii) contingent
consideration of up to $600,000 in cash and 166,666 shares of Bridgeline Digital
common stock valued at $150,000 ($0.90 per share). The contingent consideration
is payable quarterly over the 12 consecutive calendar quarters following the
acquisition, contingent upon the acquired business achieving certain quarterly
revenue and quarterly operating income targets during the period. The contingent
common stock has been issued and is being held in escrow pending satisfaction of
the applicable targets. To the extent that either the quarterly revenue target
or the quarterly operating income target is not met in a particular quarter, the
earn-out period will be extended for up to four additional quarters.
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The following table sets forth the percentages of revenue for items included in
our unaudited condensed consolidated statement of operations presented in our
Quarterly Reports on Form 10-Q for the periods presented.
Three Months Three Months
Ended Ended
December 31, December 31, $ %
Revenue: 2011 2010 Change Change
Web application development
services
iAPPS application development
services $ 3,015 $ 2,300 $ 715 31 %
% of total revenue 46 % 35 %
Other application development
services 2,293 3,244 (951 ) (29 %)
% of total revenue 35 % 50 %
Subtotal web application
development services 5,308 5,544 (236 ) (4 %)
% of total revenue 81 % 85 %
Managed service hosting 616 466 150 32 %
% of total revenue 9 % 7 %
Subscription and perpetual
licenses 593 519 74 14 %
% of total revenue 9 % 8 %
Total revenue 6,517 6,529 (12 ) -
Cost of revenue:
Web application development
services
iAPPS application development
cost 1,447 1,100 347 32 %
% of iAPPS application revenue 48 % 48 %
Other application development
cost 1,408 1,914 (506 ) (26 %)
% of other application
development revenue 61 % 59 %
Subtotal web application
development services 2,855 3,014 (159 ) (5 %)
% of web application development
services revenue 54 % 54 %
Managed service hosting 106 146 (40 ) (27 %)
% of managed service hosting
revenue 17 % 31 %
Subscription and perpetual
licenses 120 182 (62 ) (34 %)
% of subscription and perpetual
revenue 20 % 35 %
Total cost of revenue 3,081 3,342 (261 ) (8 %)
Gross profit 3,436 3,187 249 8 %
Gross profit margin 53 % 49 %
Operating expenses:
Sales and marketing 1,715 1,644 71 4 %
% of total revenue 26 % 25 %
General and administrative 1,000 897 103 11 %
% of total revenue 15 % 14 %
Research and development 403 382 21 6 %
% of total revenue 6 % 6 %
Depreciation and amortization 415 348 67 19 %
% of total revenue 6 % 5 %
Impairment of intangible asset 281 - 281 100 %
% of total revenue 4 % -
Total operating expenses 3,814 3,271 476 15 %
Loss from operations (378 ) (84 ) (227 ) 270 %
Interest income (expense) net (64 ) (51 ) (13 ) 25 %
Loss before income taxes (442 ) (135 ) (240 ) 178 %
Provision for income taxes 21 21 - -
Net loss $ (463 ) $ (156 ) $ (240 ) 154 %
Adjusted EBITDA $ 428 $ 485 (56 ) (12 %)
14--------------------------------------------------------------------------------Revenue
Our revenue is derived from three sources: (i) web application development
services (ii) managed service hosting and (iii) subscription and perpetual
licenses. Total revenue for the three months ended December 31, 2011 remained
flat at $6.5 million compared with the three months ended December 31, 2010.
Web Application Development Services
Revenue from web application development decreased $236 thousand, or 4% to $5.3
million from $5.5 million for the three months ended December 31, 2011 compared
to the three months ended December 31, 2010. Web application development
services revenue is comprised of iAPPS development related services and other
web development related services generated from non iAPPS related web
development engagements. Web application development revenue related to iAPPS
engagements increased $715 thousand or 31% while non-iAPPS related web
application development revenues decreased $951 thousand or 29%, as we continue
to focus on iAPPS engagements.
The decrease in total web application revenues is due to: (i) a stoppage in
non-iAPPS related development services from a customer due to a loss of
their funding and (ii) our decision to stop servicing low margin non-iAPPS
opportunities acquired from e.Magination IG, LLC. These decreases were offset by
a 31% increase in iAPPS development services and incremental revenues generated
from our acquisition of Magnetic.
Web application development services revenue as a percentage of total revenue
decreased to 81% from 85% for the three months ended December 31, 2011 compared
to the three months ended December 31, 2010. This was due to the increases in
license and hosting revenue as we continue to sell more iAPPS licenses.
Managed Service Hosting
Revenue from managed service hosting increased $150 thousand, or 32% to $616
thousand from $466 thousand for the three months ended December 31, 2011
compared to the three months ended December 31, 2010. Managed services revenue
as a percentage of total revenue increased to 9% from 7% the three months ended
December 31, 2011 compared to the three months ended December 31, 2010, as a
result of the increase in revenue. The increase is attributable to an increase
in iAPPS related hosting arrangements for perpetual licenses sold and
incremental revenues generated from our acquisition of Magnetic.
Subscription and Perpetual Licenses
Revenue from subscription and perpetual licenses increased $74 thousand, or 14%
to $593 thousand from $519 thousand for the three months ended December 31, 2011
compared to the three months ended December 31, 2010. Subscription and
perpetual license revenue as a percentage of total revenue increased to 9% from
8% for the three months ended December 31, 2011 compared to the three months
ended December 31, 2010. The increase is due primarily to a higher amount of
iAPPS SaaS subscription revenues, and to a lesser extent iAPPS perpetual license
revenue recognized in the three months ended December 31, 2011 compared to iAPPS
licenses and subscriptions recognized in the three months ended December 31,
2010.
Costs of Revenue
Total cost of revenue decreased $261 thousand, or 8% to $3.1 million from $3.3
million the three months ended December 31, 2011 compared to the three months
ended December 31, 2010.
Cost of Web Application Development Services
Cost of web application development services decreased $159 thousand, or 5% to
$2.9 million from $3.0 million for the three months ended December 31, 2011
compared to the three months ended December 31, 2010. The cost of web
application development services as a percentage of application development
services revenue remained flat at 54% for the both periods. The decrease in
cost of web application development services is attributable to the decrease in
personnel as a result of our decision to stop servicing low margin opportunities
related to our prior acquisition of e.Magination IG, LLC. Cost of iAPPS
application development services related to iAPPS engagements increased $347
thousand in proportion to the increases in iAPPS application development
services revenues. Cost of other application development services decreased $509
thousand driven by the decrease in staff previously supporting e.Magination IG,
LLC contracts.
Cost of Managed Service Hosting
Cost of managed service hosting decreased $40 thousand or 27% for the three
months ended December 31, 2011 compared to the three months ended December 31,
2010. The cost of managed services as a percentage of managed services revenue
decreased to 17% from 31% for the three months ended December 31, 2011 compared
to the three months ended December 31, 2010. The decrease in managed service
hosting costs is due to our continued efforts to streamline expenses.
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--------------------------------------------------------------------------------Cost of Subscription and Perpetual License
Cost of subscription and perpetual licenses decreased $62 thousand, or 34%, for
the three months ended December 31, 2011 compared to the three months ended
December 31, 2010. The cost of subscription and perpetual licenses as a
percentage of subscription and perpetual license revenue decreased to 20% from
35% for the three months ended December 31, 2011 compared to the three months
ended December 31, 2010. The decrease in subscription and perpetual license
costs and the improvement in margin is attributable to higher percentage of
revenues from iAPPS SaaS licenses and maintenance renewals on iAPPS perpetual
licenses.
Operating Expenses
Sales and Marketing Expenses
Sales and marketing expenses increased $71 thousand, or 4% to $1.7 million from
$1.6 million for the three months ended December 31, 2011 compared to the three
months ended December 31, 2010. Sales and marketing expenses represented 26% and
25% of total revenue for the three months ended December 31, 2011 and
2010, respectively. This increase is primarily attributable to additional sales
personnel added as a result of acquisition of Magnetic.
General and Administrative Expenses
General and administrative expenses increased $103 thousand, or 11% to $1
million from $897 thousand for the three months ended December 31, 2011 compared
to the three months ended December 31, 2010. General and administrative
expenses represented 15% and 14% of total revenue for the three months ended
December 31, 2011 and 2010, respectively. The increase in general and
administrative expenses is primarily due to personnel costs and increased
staffing.
Research and Development
Research and development expense increased by $21 thousand, or 6% to $403
thousand from $382 thousand for the three months ended December 31, 2011
compared to the three months ended December 31, 2010. No software costs were
capitalized in the three months ended December 31, 2011 or 2010. The increase
in research and development expense is primarily due to an increase in the
number of research and development employees as we continue to invest in
enhancements for our iAPPS Product Suite.
Depreciation and Amortization
Depreciation and amortization expense increased by $67 thousand, or 19% to $415
thousand from $348 thousand for three months ended December 31, 2011 compared to
the three months ended December 31, 2010. Depreciation and amortization
represented 6% and 5% of revenue for the three months ended December 31, 2011
and 2010, respectively. The increase is attributable to costs related to
investments in our cloud-based infrastructure and amortization of intangible
assets acquired through acquisitions.
Impairment of Intangible Assets
This increase is attributable to an impairment charge recorded in the three
months ended December 31, 2011. We incurred a charge to operations of $281
thousand for impairment charges related to an intangible asset assumed from our
fiscal 2010 acquisition of e.Magination and its wholly-owned subsidiary
eMagination IG, LLC. In the first quarter of fiscal 2012, the Company stopped
servicing low margin non-iAPPS opportunities acquired from e.Magination IG, LLC.
It was therefore determined that a portion of the customer list was impaired.
Income (Loss) from Operations
The loss from operations was ($378) thousand for the three months ended December
31, 2011, as compared to a loss from operations of ($84) thousand for the three
months ended December 31, 2010. The loss from operations for the three months
ended December 2011 is primarily attributable to the impairment charge of $281
thousand.
Income Taxes
The provision for income tax expense was $21 thousand for both the three months
ended December 31, 2011 and the three months ended December 31, 2010. Income tax
expense represents the estimated liability for Federal and state income taxes
owed by the Company, including the alternative minimum tax. The Company has net
operating loss carryforwards and other deferred tax benefits that are available
to offset future taxable income.
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--------------------------------------------------------------------------------Adjusted EBITDA
We also measure our performance based on a non-GAAP ("Generally Accepted
Accounting Principles") measurement of earnings before interest, taxes,
depreciation, and amortization and before stock-based compensation expense and
impairment of goodwill and intangible assets ("Adjusted EBITDA").
We believe this non-GAAP financial measure of Adjusted EBITDA is useful to
management and investors in evaluating our operating performance for the periods
presented and provides a tool for evaluating our ongoing operations.
Adjusted EBITDA, however, is not a measure of operating performance under GAAP
and should not be considered as an alternative or substitute for GAAP
profitability measures such as (i) income from operations and net income, or
(ii) cash flows from operating, investing and financing activities, both as
determined in accordance with GAAP. Adjusted EBITDA as an operating performance
measure has material limitations since it excludes the financial statement
impact of income taxes, net interest expense, amortization of intangibles,
depreciation, other amortization and stock-based compensation, and therefore
does not represent an accurate measure of profitability. As a result, Adjusted
EBITDA should be evaluated in conjunction with net income for a complete
analysis of our profitability, as net income includes the financial statement
impact of these items and is the most directly comparable GAAP operating
performance measure to Adjusted EBITDA. Our definition of Adjusted EBITDA may
also differ from and therefore may not be comparable with similarly titled
measures used by other companies, thereby limiting its usefulness as a
comparative measure. Because of the limitations that Adjusted EBITDA has as an
analytical tool, investors should not consider it in isolation, or as a
substitute for analysis of our operating results as reported under GAAP.
The following table reconciles net loss (which is the most directly comparable
GAAP operating performance measure) to EBITDA, and EBITDA to Adjusted EBITDA:
(in thousands) Three Months Ended
December 31,
2011 2010
Net loss $ (463 ) $ (156 )
Provision for income tax 21 21
Interest expense (income), net 64 51
Amortization of intangible assets 195 208
Impairment of intangible asset 281 --
Depreciation 220 162
EBITDA 318 286
Other amortization 50 84
Stock based compensation 60 115
Adjusted EBITDA $ 428 $ 485
The decrease in Adjusted EBITDA is primarily related to a larger net loss for
the current period and the impairment of intangible assets, partially offset by
decreases in other amortization for capitalized software and stock-based
compensation charges.
Liquidity and Capital Resources
Cash Flows
Operating Activities
Cash provided by operating activities was $95 thousand for the three months
ended December 31, 2011 compared to cash used in operating activities of $313
thousand for the three months ended December 31, 2010. The increase in cash from
operating activities is primarily attributable to an increase in deferred
revenues and collection of accounts receivable, offset by lower net income for
three months ended December 31, 2011 compared to the three months ended December
31, 2010.
17--------------------------------------------------------------------------------Investing Activities
Cash used by investing activities was $740 thousand for the three months ended
December 31, 2011 compared to $430 thousand for the three months ended December
31, 2010. This amount included expenditures for equipment and improvements of
$523 thousand for the three months ended December 31, 2011 compared with $122
thousand for the three months ended December 31, 2010. Costs for the acquisition
of Magnetic Corporation were $134 thousand and contingent acquisition payments
were $83 thousand for the three months ended December 31, 2011 compared with
costs related to acquisitions and contingent acquisition payments of $308
thousand for the three months ended December 31, 2010.
Financing Activities
Cash used in financing activities was $193 thousand for the three months ended
December 31, 2011 compared cash provided by financing activities of $668
thousand for the three months ended December 31, 2010. Cash used in financing
activities for the three months ended December 31, 2011 includes payments on
capital leases of $71 thousand, payments on subordinated debt of $42 thousand,
and payment on bank loans assumed from the acquisition of Magnetic Corporation
of $120 thousand.
Capital Resources and Liquidity Outlook
We believe that cash generated from operations and proceeds from the bank line
of credit will be sufficient to fund the company's working capital and capital
expenditure needs in the foreseeable future.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, financings or other
relationships with unconsolidated entities or other persons, other than our
operating leases and contingent acquisition payments.
We currently do not have any variable interest entities. We do not have any
relationships with unconsolidated entities or financial partnerships, such as
entities often referred to as structured finance or special purpose entities,
which would have been established for the purpose of facilitating off-balance
sheet arrangements or other contractually narrow or limited purposes. Therefore,
we are not materially exposed to any financing, liquidity, market or credit risk
that could arise if we had engaged in such relationships.
Contractual Obligations
We lease our facilities in the United States and India. During the quarter ended
December 31, 2011, the Company signed a new office lease for its Burlington, MA
corporate office location. The lease term expires in January 2019, with future
minimum lease payments totaling $1.8 million.
Other new contractual obligations as of December 31, 2011 include equipment
acquired under capitalized lease agreements valued at $76 thousand with payments
extending through December 2014.
As of December 31, 2011, we had an accrued contingent earnout liability of $1.7
million from acquisitions completed in prior fiscal years, which are scheduled
to be paid out through fiscal 2015. Contingent earnout payments related to
acquisitions are paid when and if certain revenue and earnings targets are
achieved. We also have potential contingent acquisition payments of $743
thousand due related to acquisitions completed prior to September 30, 2009,
which are not required to be accrued until earned.
Critical Accounting Policies
These critical accounting policies and estimates by our management should be
read in conjunction with Note 2 Summary of Significant Accounting Policies to
the Consolidated Financial Statements that were prepared in accordance with
accounting principles generally accepted in the United States of America ("US
GAAP") that are included in our Annual Report on Form 10-K and filed with the
Securities and Exchange Commission on December 29, 2011.
The preparation of financial statements in accordance US GAAP requires us to
make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenue and expenses in the reporting period. We regularly make estimates
and assumptions that affect the reported amounts of assets and liabilities. The
most significant estimates included in our financial statements are the
valuation of accounts receivable and long-term assets, including intangibles,
goodwill and deferred tax assets, stock-based compensation, amounts of revenue
to be recognized on service contracts in progress, unbilled receivables, and
deferred revenue. We base our estimates and assumptions on current
facts, historical experience and various other factors that we believe to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities and the
accrual of costs and expenses that are not readily apparent from other sources.
The actual results experienced by us may differ materially and adversely from
our estimates. To the extent there are material differences between our
estimates and the actual results, our future results of operations will be
affected.
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--------------------------------------------------------------------------------We consider the following accounting policies to be both those most important to
the portrayal of our financial condition and those that require the most
subjective judgment:
· Revenue recognition;
· Allowance for doubtful accounts;
· Accounting for cost of computer software to be sold, leased or otherwise
marketed;
· Accounting for goodwill and other intangible assets; and
· Accounting for stock-based compensation.
Revenue Recognition
Overview
We enter into arrangements to sell web application development services
(professional services), software licenses or combinations thereof. Revenue is
categorized into (i) Web Application Development Services (ii) Managed Service
Hosting, and (iii) Subscriptions and Perpetual Licenses.
We recognize revenue as required by the Revenue Recognition Topic of the
Codification. Revenue is generally recognized when all of the following
conditions are satisfied: (1) there is persuasive evidence of an arrangement;
(2) delivery has occurred or the services have been provided to the customer;
(3) the amount of fees to be paid by the customer is fixed or determinable; and
(4) the collection of the fees is reasonably assured. Billings made or payments
received in advance of providing services are deferred until the period these
services are provided.
During fiscal 2010, we began to develop a reseller channel to supplement our
direct sales force for our iAPPS Product Suite. We continued to develop this
reseller channel in fiscal 2012. Resellers are generally located in territories
where we do not have a direct sales force. Customers generally sign a license
agreement directly with us. Revenue from perpetual licenses sold through
resellers is recognized upon delivery to the end user as long as evidence of an
arrangement exists, collectability is probable, and the fee is fixed and
determinable. Revenue for subscription licenses is recognized monthly as the
services are delivered.
Web Application Development Services
Web application development services include professional services primarily
related to the Company's web development solutions that address specific
customer needs such as information architecture and usability engineering,
interface configuration, application development, rich media development, back
end integration, search engine optimization, and project management.
Web application development services are contracted for on either a fixed price
or time and materials basis. For its fixed price engagements, after assigning
the relative selling price to the elements of the arrangement, the Company
applies the proportional performance model (if not subject to contract
accounting) to recognize revenue based on cost incurred in relation to total
estimated cost at completion. The Company has determined that labor costs are
the most appropriate measure to allocate revenue among reporting periods, as
they are the primary input when providing application development services.
Customers are invoiced monthly or upon the completion of milestones. For
milestone based projects, since milestone pricing is based on expected hourly
costs and the duration of such engagements is relatively short, this input
approach principally mirrors an output approach under the proportional
performance model for revenue recognition on such fixed priced engagements. For
time and materials contracts, revenues are recognized as the services are
provided.
Web application development services also include retained professional services
contracted for on an "on call" basis or for a certain amount of hours each
month. Such arrangements generally provide for a guaranteed availability of a
number of professional services hours each month on a "use it or lose it"
basis. For retained professional services sold on a stand-alone basis we
recognize revenue as the services are delivered or over the term of the
contractual retainer period. These arrangements do not require formal customer
acceptance and do not grant any future right to labor hours contracted for but
not used.
19--------------------------------------------------------------------------------Managed Service Hosting
Managed service hosting includes hosting arrangements that provide for the use
of certain hardware and infrastructure for those customers who do not wish to
host our applications independently. Hosting agreements are either annual or
month-to-month arrangements that provide for termination for convenience by
either party generally upon 30-days notice. Revenue is recognized monthly as the
hosting services are delivered. Set up fees paid by customers in connection
with managed hosting services are deferred and recognized ratably over the
longer of the life of the hosting period or the expected lives of customer
relationships. We continue to evaluate the length of the amortization period of
the set up fees as we gain more experience with customer contract renewals.
Subscriptions and Perpetual Licenses
The Company licenses its software on either a perpetual or subscription basis.
Customers who license the software on a perpetual basis receive rights to use
the software for an indefinite time period and an option to purchase
post-customer support ("PCS"). For arrangements that consist of a perpetual
license and PCS, as long as Vendor Specific Objective Evidence ("VSOE") exists
for the PCS, then PCS revenue is recognized ratably on a straight-line basis
over the period of performance and the perpetual license is recognized on a
residual basis. Under the residual method, the fair value of the undelivered
elements are deferred and the remaining portion of the arrangement fee is
allocated to the delivered elements and recognized as revenue, assuming all
other revenue recognition criteria have been met.
Customers may also license the software on a subscription basis, which can be
described as "Software as a Service" or "SaaS". SaaS is a model of software
deployment where an application is hosted as a service provided to customers
across the Internet. Subscription agreements include access to the Company's
software application via an internet connection, the related hosting of the
application, and PCS. Customers receive automatic updates and upgrades, and new
releases of the products as soon as they become available. Customers cannot take
possession of the software. Subscription agreements are either annual or
month-to-month arrangements that provide for termination for convenience by
either party upon 90 days notice. Revenue is recognized monthly as the services
are delivered. Set up fees paid by customers in connection with subscription
services are deferred and recognized ratably over the longer of the life of
subscription period or the expected lives of customer relationships. We continue
to evaluate the length of the amortization period of the set up fees as we gain
more experience with customer contract renewals.
Multiple Element Arrangements
In accounting for multiple element arrangements, we follow either ASC Topic
605-985 Revenue Recognition Software or ASC Topic 605-25 Revenue Recognition
Multiple Element Arrangements, as applicable.
In October 2009, the FASB issued Accounting Standards Update No. 2009-13,
Revenue Recognition: Multiple-Deliverable RevenueArrangements ("ASU 2009-13").
ASU 2009-13 provides amendments to certain paragraphs of previously issued ASC
Subtopic 605-25 - Revenue Recognition: Multiple-Deliverable Revenue
Arrangements. In accordance with ASU 2009-13, each deliverable within a
multiple-deliverable revenue arrangement is accounted for as a separate unit of
accounting if both of the following criteria are met (1) the delivered item has
value to the customer on a standalone basis and (2) for an arrangement that
includes a right of return relative to the delivered item, delivery or
performance of the delivered item is considered probable and within our control.
If the deliverables do not meet the criteria for being a separate unit of
accounting then they are combined with a deliverable that does meet that
criterion. The accounting guidance also requires that arrangement consideration
be allocated at the inception of an arrangement to all deliverables using the
relative selling price method. The accounting guidance also establishes a
selling price hierarchy for determining the selling price of a deliverable. We
determine selling price using VSOE, if it exists; otherwise, we use Third-party
Evidence ("TPE"). If neither VSOE nor TPE of selling price exists for a unit of
accounting, we use Estimated Selling Price ("ESP").
VSOE is generally limited to the price at which we sell the element in a
separate stand-alone transaction. TPE is determined based on the prices charged
by our competitors for a similar deliverable when sold separately. It is
difficult for us to obtain sufficient information on competitor pricing, so we
may not be able to substantiate TPE. If we cannot establish selling price based
on VSOE or TPE then we will use ESP. ESP is derived by considering the selling
price for similar services and our ongoing pricing strategies. The selling
prices used in our allocations of arrangement consideration are analyzed at
minimum on an annual basis and more frequently if our business necessitates a
more timely review. We have determined that we have VSOE on our SaaS offerings,
certain application development services, managed hosting services, and PCS
because we have evidence of these elements sold on a stand-alone basis.
20
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When the Company licenses its software on a perpetual basis in a multiple
element arrangement that arrangement typically includes PCS and application
development services, we follow the guidance of ASC Topic 605-985. In assessing
the hierarchy of relative selling price for PCS, we have determined that VSOE is
established for PCS. VSOE for PCS is based on the price of PCS when sold
separately, which has been established via annual renewal rates. Similarly, when
the Company licenses its software on a perpetual basis in a multiple element
arrangement that also includes managed service hosting ("hosting"), we have
determined that VSOE is established for hosting based on the price of the
hosting when sold separately, which has been established based on renewal rates
of the hosting contract. Revenue recognition for perpetual licenses sold with
application development services are considered on a case by case basis. The
Company has not established VSOE for perpetual licenses or fixed price
development services and therefore in accordance with ASC Topic 605-985, when
perpetual licenses are sold in multiple element arrangements including
application development services where VSOE for the services has not been
established, the license revenue is deferred and recognized using contract
accounting. The Company has determined that services are not essential to the
functionality of the software and it has the ability to make estimates necessary
to apply percentage-of-completion accounting. In those cases where perpetual
licenses are sold in a multiple element arrangement that includes application
development services where VSOE for the services has been established, the
license revenue is recognized under the residual method and the application
services are recognized upon delivery.
In determining VSOE for the application development services element, the
separability of the application development services from the software license
and the value of the services when sold on a standalone basis are
considered. The Company also considers the categorization of the services, the
timing of when the services contract was signed in relation to the signing of
the perpetual license contract and delivery of the software, and whether the
services can be performed by others. The Company has concluded that its
application development services are not required for the customer to use the
product but, rather enhance the benefits that the software can bring to the
customer. In addition, the services provided do not result in significant
customization or modification of the software and are not essential to its
functionality, and can also be performed by the customer or a third party. If an
application development services arrangement does qualify for separate
accounting, the Company recognizes the perpetual license on a residual basis. If
an application development services arrangement does not qualify for separate
accounting, the Company recognizes the perpetual license under the proportional
performance model as described above.
When subscription arrangements are sold with application development services,
the Company uses its judgment as to whether the application development services
qualify as a separate unit of accounting. When subscription service arrangements
involve multiple elements that qualify as separate units of accounting, the
Company allocates arrangement consideration in multiple-deliverable arrangements
at the inception of an arrangement to all deliverables based on the relative
selling price model in accordance with the selling price hierarchy, which
includes: (i) VSOE when available; (ii) TPE if VSOE is not available; and (iii)
ESP if neither VSOE or TPE is available. For those subscription arrangements
sold with multiple elements whereby the application development services do not
qualify as a separate unit of accounting, the application services revenue is
recognized ratably over the subscription period. Subscriptions also include a
PCS component, and the Company has determined that the two elements cannot be
separated and must be recognized as one unit over the applicable service
period. Set up fees paid by customers in connection with subscription
arrangements are deferred and recognized ratably over the longer of the life of
the hosting period or the expected lives of customer relationships, which
generally range from two to three years. We continue to evaluate the length of
the amortization period of the set up fees as we gain more experience with
customer contract renewals and our newer product offerings.
Customer Payment Terms
Payment terms with customers typically require payment 30 days from invoice
date. Payment terms may vary by customer but generally do not exceed 45 days
from invoice date. Invoicing for web application development services are either
monthly or upon achievement of milestones and payment terms for such billings
are within the standard terms described above. Invoicing for subscriptions
and hosting are typically issued monthly and are generally due in the month of
service.
Our agreements with customers do not provide for any refunds for services or
products and therefore no specific reserve for such is maintained. In the
infrequent instances where customers raise concerns over delivered products or
services, we have endeavored to remedy the concern and all costs related to such
matters have been insignificant in all periods presented.
Warranty
Certain arrangements include a warranty period which is generally 30 days from
the completion of work. In hosting arrangements, we provide warranties of
up-time reliability. We continue to monitor the conditions that are subject to
the warranties to identify if a warranty claim may arise. If we determine that a
warranty claim is probable, then any related cost to satisfy the warranty
obligation is estimated and accrued. Warranty claims to date have been
immaterial.
Reimbursable Expenses
In connection with certain arrangements, reimbursable expenses are incurred and
billed to customers and such amounts are recognized as both revenue and cost of
revenue.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts which represents estimated losses
resulting from the inability, failure or refusal of our clients to make required
payments.
21--------------------------------------------------------------------------------
We analyze historical percentages of uncollectible accounts and changes in
payment history when evaluating the adequacy of the allowance for doubtful
accounts. We use an internal collection effort, which may include our sales and
services groups as we deem appropriate. Although we believe that our allowances
are adequate, if the financial condition of our clients deteriorates, resulting
in an impairment of their ability to make payments, or if we underestimate the
allowances required, additional allowances may be necessary, resulting in
increased expense in the period in which such determination is made.
Accounting for Cost of Computer Software to be Sold, Leased or Otherwise
Marketed
We charge research and development expenditures for technology development to
operations as incurred. However, in accordance with Codification 985-20 Costs
of Software to be Sold Leased or Otherwise Marketed, we capitalize certain
software development costs subsequent to the establishment of technological
feasibility. Based on our product development process, technological feasibility
is established upon completion of a working model. Certain costs incurred
between completion of a working model and the point at which the product is
ready for general release are capitalized if significant. Once the product is
available for general release, the capitalized costs are amortized in cost of
sales.
Accounting for Goodwill and Intangible Assets
Goodwill is tested for impairment annually during the fourth quarter of every
year and more frequently if events and circumstances indicate that the asset
might be impaired. Though the Company's stock price declined from $1.22 at
September 30, 2010 (the date of the fiscal 2010 annual test) to $0.53 at
September 30, 2011, the Company did not consider the decline in stock price a
triggering event as:
· The Company's performance since the last annual test has not deteriorated as
both revenue and gross profit have increased and loss from operations was
greater compared to fiscal 2010 due the Company's decision to invest in its
iAPPS product suite; and
· The significant decrease in stock price is relatively recent as the stock
price was $1.44 at December 31, 2010, $1.10 at March 31, 2011, and $0.95 at
June 30, 2011 and is not related to a change in the market conditions that
would affect the Company.
At September 30, 2011 (the date of the fiscal 2011 annual test), the fair value
exceeded the carrying value by $4.3 million. This margin was based on a
weighting applied to four different valuation methods which result in fair
values ranging from $24.6 million to $27.2 million before the weightings were
applied. Had the four methodologies been weighted differently, the percentage by
which the fair value exceeded the carrying value may have been larger.
The factors the Company considers important that could indicate impairment
include its stock price, significant under performance relative to prior
operating results, change in projections, significant changes in the manner of
the Company's use of assets or the strategy for the Company's overall business,
and significant negative industry or economic trends.
In evaluating goodwill impairment, the Company considers a number of factors
including discounted cash flow projections, guideline public company
comparisons, acquisition transactions of comparable third party companies and
capitalization value. Evaluating the potential impairment of goodwill is highly
subjective and requires the Company to make significant estimates and judgment
at many points during the analysis, especially with regard to the Company's
future cash flows.
For the fiscal 2010 annual test, the Company weighted the Market Approach-Direct
Market Capitalization Method 75% in its evaluation of the fair value of the
Company's one reporting unit, which was a decrease from the 90% weighting used
in fiscal 2009. For the fiscal 2011 annual test, the Company reduced the
weighting further to 25% as the low level of market activity and substantial
variation in price quotations based on the low activity of the Company's stock
support the view that the Company's stock is inactive. The key assumption
included in the Market Approach-Direct Market Capitalization Method was a
control premium of 150%. This control premium was primarily based on an analysis
of control premiums from a study of guideline merger and acquisition
transactions. Specifically, the implied revenue multiples (the most commonly
used valuation method for mergers and acquisitions in the technology industry)
from the guideline transactions averaged 2.4 times revenue. The control premium
of 150% implies a revenue multiple of 0.9 which the Company's management
believes is reasonable and conservative. The control premium assumption of 150%
was also corroborated by an analysis of potential synergies which could be
realized by a market participant in an acquisition transaction. Using this
control premium resulted in the fair value determined by the Market
Approach-Direct Market Capitalization Method exceeding carrying value by $2.5
million. The Company believes the most significant change in circumstances that
could affect the key assumptions in its valuation is a significant reduction in
the observed revenue multiples implied by future mergers and acquisitions.
22
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While there are inherent limitations in any valuation, the Company believes that
placing a significant weighting of 75% on the Discounted Cash Flow Method, the
Guideline Public Company Method, and the Guideline Transaction Method are more
indicative of the fair value, or the price, that the Company would be sold at in
an orderly transaction between market participants. The Company believes the
most significant change in circumstances that could affect the key assumptions
in our valuation are a significant reduction in the observed revenue multiples
implied by future mergers and acquisitions and/or a significant deterioration of
the Company's projected financial performance.
During the twelve month period ended September 30, 2011, the carrying value of
goodwill increased as a result of the acquisitions of TMX and e.Magination (both
of which included contingent earnout payments recorded at the time of the
transaction) and the accrual of contingent acquisition payments related to
acquisitions completed prior to September 30, 2009 (which are recorded as
increases to goodwill as they are earned but not currently recorded). The
Company is obligated to continue paying quarterly contingent acquisition
payments to former owners of acquired companies in the amount of $825 thousand
based on the achievement of certain predefined operating metrics. If such
payments are earned they will be recorded as an increase to goodwill. To the
extent goodwill continues to increase as a result of such payments and to the
extent there are unfavorable changes in assumptions used to determine the
Company's fair value (including a decline in the Company's market
capitalization), there can be no assurance that the Company will not have an
impairment charge in the future.
Accounting for Stock-Based Compensation
At December 31, 2011, we maintained two stock-based compensation plans more
fully described in Note 11 to the Consolidated Financial Statements of our
Annual Report on Form 10-K filed with the Securities and Exchange Commission on
December 29, 2011.
The Company accounts for stock compensation awards in accordance with the
Compensation-Stock Compensation Topic of the Codification. Share-based payments
(to the extent they are compensatory) are recognized in our consolidated
statements of operations based on their fair values.
We recognize stock-based compensation expense for share-based payments issued or
assumed after October 1, 2006 that are expected to vest on a straight-line basis
over the service period of the award, which is generally three years. We
recognize the fair value of the unvested portion of share-based payments granted
prior to October 1, 2006 over the remaining service period, net of estimated
forfeitures. In determining whether an award is expected to vest, we use an
estimated, forward-looking forfeiture rate based upon our historical forfeiture
rate and reduce the expense over the recognition period. Estimated forfeiture
rates are updated for actual forfeitures quarterly. We also consider, each
quarter, whether there have been any significant changes in facts and
circumstances that would affect our forfeiture rate. Although we estimate
forfeitures based on historical experience, actual forfeitures in the future may
differ. In addition, to the extent our actual forfeitures are different than
our estimates, we record a true-up for the difference in the period that the
awards vest, and such true-ups could materially affect our operating results.
We estimate the fair value of employee stock options using the
Black-Scholes-Merton option valuation model. The fair value of an award is
affected by our stock price on the date of grant as well as other assumptions
including the estimated volatility of our stock price over the term of the
awards and the estimated period of time that we expect employees to hold their
stock options. The risk-free interest rate assumption we use is based upon
United States treasury interest rates appropriate for the expected life of the
awards. We use the historical volatility of our publicly traded options in
order to estimate future stock price trends. In order to determine the
estimated period of time that we expect employees to hold their stock options,
we use historical trends of employee turnovers. Our expected dividend rate is
zero since we do not currently pay cash dividends on our common stock and do not
anticipate doing so in the foreseeable future. The aforementioned inputs entered
into the option valuation model we use to fair value our stock awards are
subjective estimates and changes to these estimates will cause the fair value of
our stock awards and related stock-based compensation expense we record to vary.
We record deferred tax assets for stock-based awards that result in deductions
on our income tax returns, based on the amount of stock-based compensation
recognized and the statutory tax rate in the jurisdiction in which we will
receive a tax deduction.
Stock Options Activity (Repricing Plans)
On October 28, 2011, the Company offered its employees the opportunity to have
certain outstanding options modified by (i) reducing the grant exercise price to
$0.67, the fair market value of the common stock as of the modification date and
(ii) starting a new three year vesting schedule. The aggregate fair value of the
modified options of approximately $90 thousand was calculated using the
difference in value between the original terms and the new terms as of the
modification date. The incremental cost of the modified option over the original
option will be recognized as additional compensation expense over the new three
year vesting period beginning on the date of modification. This opportunity was
generally limited to options issued subsequent to the October 2008 repricing
described above and in Note 11 to the Company's Annual Report on Form 10-K for
fiscal 2011.
23--------------------------------------------------------------------------------
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