[November 14, 2011] ONVIA INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations Tweet (Edgar Glimpses Via Acquire Media NewsEdge) CAUTIONARY STATEMENT In addition to the historical information contained herein, the discussion and analysis in this report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding expected increases in clients, contracts and contract value, cash flow, profitability and stockholder value and expected stabilization of ACV. When used in this discussion, the words "believes," "anticipates," "may," "will," "should," "expects," "plans," "estimates," "predicts," "potential," "continue," "intends", "indicates" or the negative of these and similar expressions are intended to identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not a forward-looking statement. Forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions and are subject to risks and uncertainties that could cause actual results to differ materially from those expected or implied by these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the factors described under "Risk Factors," "Business," "Management's Discussion and Analysis of Financial Condition and Results of Operations," as applicable, in this report and in our Annual Report on Form 10-K for the year ended December 31, 2010. Onvia undertakes no obligation to publicly release any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of anticipated events. Readers are urged, however, to review the factors and risks described in reports Onvia files from time to time with the Securities and Exchange Commission. The following discussion should also be read in conjunction with the Consolidated Financial Statements and accompanying Notes thereto. In this Report, the words "we," "our," "us," "Onvia," or the "Company" refer to Onvia, Inc. and its wholly- owned subsidiary. Company Overview We are a leading provider of business information and research solutions that help companies plan, market and sell to targeted public sector buyers throughout the United States, or U.S. The government to business market place is defined as the market funded by federal, state and local government spending. Our products, proprietary databases and research tools, focus on federal, state, local and educational purchasing entities. Our information helps our clients proactively track which goods and services government agencies plan to purchase, when they plan to purchase, what they actually purchase, and from whom they purchase. This business intelligence allows clients to identify new market opportunities, analyze market trends, and obtain useful information about their competitors and channel partners. We believe our business solutions provide clients with a distinct competitive advantage, increased revenue opportunities, and strategic insight into the public sector market. Our business solutions leverage our proprietary databases, which have been compiled over more than eleven years, and include comprehensive, historical and real-time information on public sector activities unavailable elsewhere in the marketplace. Our databases provide information on over 9.0 million procurement-related records connected to over 378,000 companies from across approximately 89,000 government agencies and purchasing offices nationwide. Thousands of records are standardized, added, formatted and classified within our database each day. Most of our revenues are generated from sales to two customer types: end users, such as business development and sales and marketing executives, and businesses that license our content for redistribution. 18 -------------------------------------------------------------------------------- Onvia's solutions for end users include access to the Onvia Online Database, Spending Forecast Center, and the Onvia Guide. These services are sometimes bundled with management information reports in multiple-deliverable arrangements. Refer to the discussions below under "Products and Services" for a description of these products and services, and under "Critical Accounting Policies and Management Estimates" for a discussion of how sales price is allocated between the elements in a multi-deliverable arrangement and how revenue is recognized on each element. Subscriptions to the Onvia Online Database are typically prepaid, have a minimum term of one year and revenues are recognized ratably over the term of the subscription. Subscriptions are priced based upon the geographic range, nature of content purchased, and the number of users accessing the database. Revenue from businesses who license our content for resale to their own customers is classified as content license revenue. Content license contracts are generally multi-year arrangements that are invoiced on a monthly or quarterly basis, and these agreements typically have a higher annual contract value than our subscription-based services. Revenue from content license agreements is recognized ratably over the term of the agreement. Onvia was incorporated in January 2000 in the state of Delaware. Our principal corporate office is located in Seattle, Washington. Our securities trade on The NASDAQ Capital Market under the symbol ONVI. Industry Background With the passage of the American Recovery and Reinvestment Act ("ARRA") in 2009, government spending on goods and services accelerated dramatically and represented more than 40% of the gross domestic product of the United States. Two years later government spending is at crossroads. The remaining ARRA funding is being spent and federal, state and local agencies face looming budget deficits, which may result in freezes or cuts to some agencies' budgets. Smaller budgets and deficit reduction initiatives may lead to increased competition for contracts, and public sector vendors will be looking for a competitive advantage. Also, existing budgets may be reallocated to investments in emerging technologies, such as health care, clean water and renewable energy. Progressive enterprises are recognizing the substantial opportunity and the significant challenges presented by the government-to-business market and are developing their own strategies to penetrate this sector. A successful government-to-business strategy will require businesses to proactively identify new opportunities and changes in government spending behavior in this current landscape. Businesses may find that they are disadvantaged if they do not have insight about this market and their competitors. The government-to-business marketplace is highly competitive. Identifying relevant projects and partners can be difficult and companies spend a substantial amount of time and effort to locate and research new partners and opportunities to grow in this sector. The Internet provides short-term visibility into government contracting information for both government agencies and businesses alike, but does not provide the on-demand intelligence or context required to guide strategic decisions. When an opportunity is identified, more research must be performed to qualify the opportunity, including research on the agency, the decision maker, historical purchasing practices and pricing, and incumbent vendor relationships to name a few. A comprehensive view of the marketplace and of specific opportunities is necessary to prequalify opportunities, improve win rates, increase contract size and support a public sector strategic plan. Our comprehensive government procurement database contains much of the relevant decision making information required by businesses on both a historical and real-time basis. Through our solutions, we provide the market intelligence a business needs to design and manage a public sector strategy, build relationships with agency buyers and private sector contractors, and target more qualified revenue opportunities. The confluence of these activities should help clients create more winning proposals, increase close rates, increase contract size and, ultimately, increase public sector revenues. Products and Services Onvia's business solutions are tailored to the business objectives of each client, and support both strategic planning and sales and marketing activities. 19 -------------------------------------------------------------------------------- Strategic Planning Core to our business solution is the Onvia Online Database, which provides rich search functionality on our proprietary database of local, state and federal government agency purchasing information. Strategic users of the database can analyze purchasing trends to refine existing target markets, identify new geographic markets, and identify potential new agency buyers. Based upon the client's business objectives, we can help provide market intelligence needed for strategic planning such as: o Year-over-year growth rates by market or category to help understand buying trends; o Market growth rates to assist in business planning; o Distribution of state and local opportunities by sales territory to help allocate resources; o Competitive analysis; and o Seasonality and buying trends. To further enhance the value of our planning content, Onvia launched Spending Forecast Center in June 2010, which provides insight into budgets and capital improvement plans by agencies within the top 366 Metropolitan Statistical Areas in the United States. Spending Forecast Center provides valuable, strategic information on future capital spending used by larger corporations to execute their gBusiness strategies. Most governmental bodies, such as departments of transportation, city and county governments, and boards of education publish a plan that maps out their major initiatives and forecasts spending over the next 3-6 years. These spending forecasts generally include the name of the initiative or type of expense, project timing, the funding source and the budget amount. Businesses can use spending forecasts to inform business development, evaluate and target markets, as advance notices of projects, and for short to mid-term business planning. We collect plans from state, county and city government agencies, representing over 85% of all government spending. We add a powerful search tool that allows users to find plans based on keywords, as well as type of agency, location, spending focus, and other plan details. In September 2010, Onvia launched Agency Center, the newest module in the Onvia Online Database, which helps strategic users get a past, present and future view of potential agency targets. Agency Center provides users with agencies' procurements histories, current projects, and spending forecasts in a single application. This gives businesses an unprecedented view of agency buying patterns and plans, as well as the markets where their competitors are. Agency Center is included with standard access to the Onvia Online Database. In June 2011, we launched functionality to help clients analyze their search results more effectively. This new data visualization feature helps showcase the power of our database beyond just sales lead generation and notification. Our next product release is slated for early 2012 and is focused on improving and enhancing the client experience through an improved user interface intended to help clients unlock greater value from our database. The data visualization features are included with standard access to the Onvia Online Database. Sales and Marketing Access to comprehensive and timely agency and procurement information helps sales and marketing organizations effectively identify and qualify government agencies, agency buyers and procurement opportunities within their target markets. Sales and marketing users of the Onvia Online Database can research project histories, agency buyer contact information, agency relationships with existing vendors and contract awardees, and can evaluate pricing for goods and services. Comprehensive information on their target market helps businesses improve decision making, enhance proposal quality, and manage agency relationships, all of which should help our clients obtain new procurement awards. 20 -------------------------------------------------------------------------------- Sales and marketing users of the Agency Center application find it easier to identify and market to the government agencies that buy what they sell. Agency Center helps sales and marketing organizations to: · Identify government purchases that never go out to formal bid. Four out of five government purchases never go out to formal bid, because they fall below agencies' purchasing thresholds. Businesses can use Agency Center to identify these projects and then register with the agencies to get on the vendor list agencies use to award informal, unpublished projects. · Search for projects in their industry, then display the agencies involved with those projects. · Search for agencies to target based on location, purchasing history, annual budget, and area of focus. · Create a saved search of the agencies they have targeted and their daily Onvia Guide will track those agencies' buying activities, from pre-bid notices to bids and requests for proposal to contract awards. We also can provide our sales and marketing partners with management reports to help target upcoming contract renewals, identify agency buyers, and inform the proposal development process. These solutions include: · Term Contracts - Provide clients with actionable sales information on term or continuing service contracts pending renewal at public agencies. These reports identify what contracts exist, when they are coming up for renewal, who the incumbent is and who the buyers are. With this report, our clients are able to perform an early evaluation of the opportunity so they can be more competitive with their proposals to increase their public sector business. · Contact Lists - Provide clients a comprehensive list of decision makers, agency procurement officers and zoning officials that can be used to develop relationships and identify potential business partners. · Winning Proposals Library - Compare and contrast winning proposals submitted by competing firms in order to gain competitive insights. Provides insight into how other companies position their qualifications and personnel, structure and format persuasive proposals, incorporate supporting materials, price goods and services, and differentiate themselves from their competitors. Client Support Most clients are assigned a support team familiar with the client's specific industry. The support team is responsible for understanding the client's business objectives, setting up profiles and saved searches, delivering customized management reporting, and training the client to query the database effectively. The partnership between the client and its Onvia support team is important to deriving value from the Onvia business solution. Industries and Verticals Our business solutions support the largest industry verticals, with a focus on the infrastructure verticals, which include: · Architecture and Engineering · Construction and Building Supplies · IT / Telecommunications · Professional Services · Operations and Maintenance Services · Transportation · Healthcare · Water and Energy / Alternative Energy 21--------------------------------------------------------------------------------Within these verticals we provide hard-to-find content, which supports both strategic planning and sales and marketing activities. Comprehensive Procurement Content Our database presents sales and marketing with a comprehensive view of a project throughout the most critical phases of the procurement lifecycle including: · Advance Notices - alerts businesses of projects in the early stages of the development process, before the bid or request for proposal is released in its final form, or before final zoning and planning board approval; · Request for proposals, request for quotes, and related amendments; · Planholders and Bidders Lists - provides competitive intelligence by presenting a list of competitors that have acquired plans, specifications, bidding documents and/or proposals for specific projects in the active bid or proposal stage, and a list of competitors who submit bids for prime contracts with the owner of the project; · Bid Results and Awards Information - notifies businesses of awarded bids, providing information for use in their own sales and marketing activities; and · Grants - supplies federal grant information critical to businesses tracking or applying for publicly-funded projects. Strategy Our mission is to deliver essential, actionable business intelligence that our clients rely upon to compete more effectively in the government business marketplace. We intend to achieve this mission by delivering exceptional products that offer our customers significant value in maximizing their business in the public sector market. If we are able to effectively achieve this mission, we should see increased retention rates and, ultimately, increased stockholder value. Key elements of our strategy include: · Target prospects with high lifetime value: We intend to focus our sales and marketing efforts on the prospects that fit the profile of our most valuable clients. Using our own database we plan to identify companies that have a strategic, long-term interest in the public sector market based on the volume of their bidding activity and the geographical scope of their marketing program to the government. To address our target market, we are in the process of transforming our Small and Medium Business or "SMB" sales organization from a transactional team into a consultative sales force focused on this targeted market. The success of this transformation will be measured each quarter by our ability to increase the contract value of new customers acquired from our target market. In July 2011, we realigned our SMB sales management to separate responsibilities for SMB acquisition and SMB retention. We believe the new sales management structure, our maturing acquisition sales force, and the nurture marketing program we launched in July should accelerate pipeline growth through the balance of 2011 with a corresponding increase in contract value from new client acquisitions. Due to this transition, we believe new client acquisitions will begin to scale by early 2012. · Expand the distribution of our valuable content through channel sales programs and relationships: We intend to leverage our content and technology investment over a much wider market without losing focus on our target market. We believe there are a large number of businesses who leverage government procurement data but are not part of our target market. Through channel relationships, we believe we can serve this market more economically than through a direct sales model. Potential strategic partners include trade publishers, lead generation companies, database companies, franchises and business intelligence providers. 22 -------------------------------------------------------------------------------- Since December 2010, we have contracted with six new partners to resell derivatives of our content through their specific channels. We expect the contract value on these partnerships to slowly build over a six to twelve month period. We expect to increase the number of signed contracts in the fourth quarter of this year. We will continue to measure the success of this initiative by our ability to increase contract value with existing partners and to sign up new strategic relationships this year. · Develop and execute an enterprise sales and marketing program: We intend to develop and execute an enterprise sales program targeting the largest companies that offer the most business potential for Onvia. Our current enterprise clients derive the most value from our information services and this client segment has our highest retention rates. In the third quarter, we began to invest in our enterprise program, and began building a team of experienced sales professionals. Our new team should be productive by end of 2011. Once the team has matured and we have a reasonable basis for measurement, we intend to design success metrics for this initiative and report on these metrics each quarter. · Enhance the strategic application of our products and research tools: Today, many clients use Onvia for lead generation. Our target market has additional needs beyond lead generation to help them maximize their business with the public sector such as competitive analysis, market sizing and pricing analysis. Providing these additional applications in the future will strengthen our relationship with our customers and drive additional contract value per customer for Onvia in the future. We are building the foundation today to deliver these additional more strategic applications in the future by expanding our content and enhancing our platform. On the content side, we strive to cover 95% of all publicly available bids and RFPs and we add new sources daily. In the third quarter, we initiated coverage on 793 new agencies and also added 190 secondary sources to broaden coverage in existing agencies. Concurrently, we are expanding our comprehensive coverage of these agencies to include awards, plan holders lists, advance notices, and value added documents, such as plans and specifications in key regions. The expanding coverage and quality of our content should drive incremental value to our existing customers and power the additional new products to be launched over the next 2 years. Our next platform release is slated for early 2012 and is focused on enhancing the client experience. This release will provide customers with an improved user interface to improve client adoption and help clients unlock greater value from our database. The release includes significant navigation enhancements to increase the "findability" of information in our database. Improved information architecture will present search results in an intuitive way that supports informed decision making. The new user interface should help us more effectively demonstrate value to prospects to accelerate new client acquisitions, and increase product adoption across our entire client base to drive client satisfaction. Executive Summary of Results of Operations and Financial Position We service our clients through two separate business channels: client subscriptions and content licenses. Client subscriptions are sold directly to businesses for internal use. At September 30, 2011, we had approximately 4,700 subscribing clients. Client subscriptions contributed approximately 86% of our revenue in both the three and nine months ended September 30, 2011, compared to approximately 85% and 86% of our revenue in the three and nine months ended September 30, 2010. The annual contract value, or ACV, of client subscribers was approximately $19.0 million and $23.0 million at September 30, 2011 and 2010, respectively. The decline in ACV was primarily due to attrition of non-strategic clients and fewer new client acquisitions. ACV is expected to stabilize in early 2012 as first year client retention improves and client acquisitions begin to scale. ACV is defined further below. 23 --------------------------------------------------------------------------------Our second business channel, content licenses, represents clients who incorporate our data into their own products, or resell our business intelligence directly to their customers. These clients represented approximately 10% and 9% of our revenue in the three and nine months ended September 30, 2011, respectively, compared to 10% in the same periods of 2010. The annual contract value of our content license clients increased by $114,000 from the prior quarter and was approximately $2.2 million at September 30, 2011. We also generate revenue from fees charged for management information reports, document download services, and list rental services; these fees represented 4% and 5% of revenue in the three and nine months ended September 30, 2011, respectively, compared to 5% and 4%, respectively, in the same periods of 2010. We manage the business using the following key operating metrics: Annual Contract Value, or ACV Annual contract value is the aggregate annual revenue value of our client base. Growth in ACV demonstrates our success in increasing the number of high value clients and upgrading existing clients to new and higher valued products. Content licenses are excluded from ACV. Number of Clients Number of clients represents the number of individual businesses subscribing to our products. This excludes subscribers to the Company's entry level Metropolitan notification product. Annual Contract Value per Client, or ACVC Annual contract value per client is the annual contract value divided by the number of clients and indicates the average value of each of our subscriptions. Quarterly Contract Value per Client, or QCVC Quarterly contract value per client represents the average annual contract value of all new and renewing clients transacting during the quarter, and is a leading indicator of future annual contract value per client. Revenue for the third quarter of 2011 decreased 4% to $5.6 million from $5.8 million in the previous quarter and decreased 16% from $6.7 million in the same year-ago period. Consistent with our previously communicated turnaround plan, Onvia is focused on a small, targeted market of prospects which are committed long-term to the public sector. Under the previous transactional business model, our target market was extremely broad, and we acquired a large number of non-strategic clients which were not adequately profitable. We no longer invest in acquiring non-strategic clients, and our client base has declined as expected as we transition to our more profitable target market. Our declining year over year revenue is directly attributable to this planned decline in non-strategic clients. At the end of the third quarter, Onvia's total client base decreased 31% to 4,700 clients compared to 6,800 clients in the same year-ago period. Nearly 70% of our non-renewals over the last year were non-strategic clients under our new targeted account definition. ACVC grew 4% from the previous quarter and 19% from the same year-ago period to an average of $4,027 per client. ACVC improved in the third quarter, in part by targeting more strategic clients and because renewals were weighted toward strategic clients with higher contract values. Our ACVC from new SMB acquisition sales increased to $7,163, up 49% from $4,802 in the third quarter of 2010. In the third quarter of 2011, QCVC was $4,371, an increase of 8% compared to $4,030 in the third quarter of 2010. The year over year increase in QCVC is due to price increases that took effect in the fourth quarter of 2010, the elimination of low value product offers, and the elimination of low value lead sources. 24-------------------------------------------------------------------------------- Year-over-year, unearned revenue decreased by 17% to $8.5 million at September 30, 2011, compared to $10.3 million at September 30, 2010. The year-over-year decrease is due to a decrease in sales in the last four quarters, compared to the prior year periods, primarily due to the loss of non-strategic clients as discussed above. Unearned revenue consists of payments received for prepaid subscriptions whose terms extend into periods beyond the balance sheet date, as well as the invoiced portion of contracts whose terms extend into periods beyond the balance sheet date. Seasonality Our customer acquisition business is subject to some seasonal fluctuations. The second and third quarters are generally slower than the first and fourth quarters for customer acquisition. The construction industry is our single largest market and these prospects are typically engaged on projects during the spring and summer months, not prospecting for new work, which causes new customer acquisition to decline compared to the first and fourth quarters in the year. For this reason, comparisons of the performance of our business quarter to consecutive quarter may not provide the most relevant information, and our quarterly results and metrics should be considered on the basis of results for the whole year or by comparing results in a quarter with the results in the same quarter of the previous year. Results of Operations for the Three and Nine Months Ended September 30, 2011 Compared to the Three and Nine Months Ended September 30, 2010 Revenue and Cost of Revenue The following table provides a breakdown of revenue for the periods presented as a percentage of total revenue: Three Months Ended September 30, Nine Months Ended September 30, 2011 2010 2011 2010 Revenue $ 5,630 $ 6,705 $ 17,619 $ 20,533 Revenue: Subscription 86 % 85 % 86 % 86 % Content license 10 % 10 % 9 % 10 % Management information reports 2 % 4 % 3 % 3 % Other 2 % 1 % 2 % 1 % Total revenue 100 % 100 % 100 % 100 % Cost of revenue for the three and nine months ended September 30, 2011 and September 30, 2010 was as follows (in thousands of dollars): Increase / (Decrease) 2011 2010 Amount Percent Three months ended September 30, $ 889 $ 972 $ (83 ) (9 %) Percentage of Revenue 16 % 14 % Nine months ended September 30, $ 2,685 $ 3,126 $ (441 ) (14 %) Percentage of Revenue 15 % 15 % Our cost of revenue primarily represents payroll-related expenses associated with the research and aggregation of the data in our proprietary database and third-party content fees, and also includes credit card processing fees. The decrease for the comparable three and nine month periods was primarily due to decreases of $66,000 and $375,000, respectively, in third party content costs due to a strategic change in our production model. Weighted average headcount in our content team was 33 during the third quarter of 2011, compared to 38 in the same period of 2010. Headcount decreased as a result of higher utilization of third-party content providers. 25 --------------------------------------------------------------------------------Sales and Marketing Sales and marketing expenses for the three and nine months ended September 30, 2011 and September 30, 2010 were as follows (in thousands of dollars): Increase / (Decrease) 2011 2010 Amount Percent Three months ended September 30, $ 2,600 $ 3,394 $ (794 ) (23 %) Percentage of Revenue 46 % 51 % Nine months ended September 30, $ 7,892 $ 10,860 $ (2,968 ) (27 %) Percentage of Revenue 45 % 53 % The decrease in expenses for the comparable three month periods is primarily comprised of $624,000 in payroll-related expenses due to decreased headcount and lower commissionable sales, and $166,000 in marketing costs primarily as a result of our leveraging our proprietary database to identify prospects that align with our targeted account strategy. Weighted average headcount in our sales and marketing teams was 73 during the three months ended September 30, 2011, compared to 87 in the same period in 2010. The decrease in expenses for the comparable nine month periods is primarily comprised of $1.8 million in payroll-related expenses due to decreased headcount and lower commissionable sales, $657,000 in marketing costs for the reasons discussed above, $177,000 in travel and entertainment due to decreased travel, $152,000 in amortization expense, $115,000 in severance due to the departure of our Senior Vice President of Sales in the first quarter of 2010, and $104,000 in allocated facilities costs due to decreased headcount. These decreases were partially offset by a $70,000 increase in stock-based compensation due to an expense reversal in connection with the forfeiture of options upon the departure of our Senior Vice President of Sales in the second quarter of 2010. Weighted average headcount in our sales and marketing teams was 72 during the nine months ended September 30, 2011, compared to 97 in the same period in 2010. Technology and Development Technology and development expenses for the three and nine months ended September 30, 2011 and September 30, 2010 were as follows (in thousands of dollars): Increase / (Decrease) 2011 2010 Amount Percent Three months ended September 30, $ 989 $ 968 $ 21 2 % Percentage of Revenue 18 % 14 % Nine months ended September 30, $ 3,028 $ 2,753 $ 275 10 % Percentage of Revenue 17 % 13 % The increase in expenses for the comparable three month periods is primarily attributed to a $131,000 decrease in capitalized internal use software costs (primarily salaries and benefits) attributable to the nature of development efforts during the quarter. A larger percentage of development efforts in third quarter of 2011 were allocated to maintenance, which is not capitalizable pursuant to ASC 350-40, Intangibles - Goodwill and Other Subtopic Internal-Use Software. This change was offset by a $107,000 decrease in payroll related expenses due to lower headcount and lower vacation expense. Weighted average headcount in our technology and development teams was 15 during the three and nine months ended September 30, 2011, compared to 19 in the same periods in 2010. The increase in expenses for the comparable nine month periods is primarily attributed to a $429,000 decrease in capitalized internal use software costs and $164,000 increase in contract labor for the reasons discussed above. These changes were offset by a $239,000 decrease in payroll related expenses primarily due to lower headcount, a $92,000 decrease in facilities related costs, and other individually immaterial changes. 26 --------------------------------------------------------------------------------General and Administrative General and administrative expenses for the three and nine months ended September 30, 2011 and September 30, 2010 were as follows (in thousands of dollars): Increase / (Decrease) 2011 2010 Amount Percent Three months ended September 30, $ 912 $ 1,272 $ (360 ) (28 %) Percentage of Revenue 16 % 19 % Nine months ended September 30, $ 3,166 $ 4,831 $ (1,665 ) (34 %) Percentage of Revenue 18 % 24 % The decrease in expenses for the comparable three month periods is primarily related to a $239,000 decrease in business taxes, primarily due to an out of period adjustment as disclosed in Note 1 to the financial statements, a $133,000 decrease in contract labor and consultant expenses due in part to fees related to our CEO search, a $64,000 decrease in professional services and other individually immaterial items. These decreases were offset by a $124,000 increase in facilities costs primarily related to the idle lease accrual discussed below under "Critical Accounting Policies and Management Estimates". Weighted average headcount in this group was 17 during the three months ended September 30, 2011, compared to 18 in the same period in 2010. The decrease in expenses for the comparable nine month periods is primarily related to a $967,000 abandonment of internal use software in the second quarter of 2010, a $272,000 decrease in severance expenses primarily related to our former CEO's transition agreement, a $366,000 decrease in contract labor and consultant expenses in part due to fees related to the CEO search and reduced public relations costs, and a $156,000 decrease in bad debt expenses. These decreases were offset by an increase of $116,000 in facilities costs primarily related to the idle lease accrual. Weighted average headcount in this group was 17 during the nine months ended September 30, 2011, compared to 18 in the same periods in 2010. Interest and Other Income, Net Net interest and other income was $8,000 and $28,000 for the three and nine months ended September 30, 2011, respectively, compared to $10,000 and $81,000, respectively, for the same periods in 2010. Other income for the nine months ended September 30, 2010 includes a one-time refund of $39,000 from our credit card processor. The balance of the year over year decline is due to lower prevailing interest rates. We did not incur any interest expense in the three or nine months ended September 30, 2011, or in the three months ended September 30, 2011. Interest expense in the nine months ended September 30, 2010 was immaterial. Net Income and Net Income per Share Net income for the three and nine months ended September 30, 2011 was $248,000 and $876,000, respectively. We reported net income of $109,000 and net losses of $1.0 million for the three and nine months ended September 30, 2010, respectively. The increase in net income was primarily due to decreases in operating expenses as discussed above, partially offset by lower revenues. On a diluted per share basis, net income was $0.03 and $0.10 for the three and nine months ended September 30, 2011, compared to net income of $0.01 and net losses of $0.13 for the three and nine months ended September 30, 2010, respectively. Critical Accounting Policies and Management Estimates Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of commitments and contingencies. We base our estimates on historical experience and on various other assumptions 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 that are not readily apparent from other sources. Actual results may differ significantly from our estimates. In addition, any significant unanticipated changes in any of our assumptions could have a material adverse effect on our business, financial condition, and results of operations. Our critical accounting policies involve judgments associated with our accounting for revenue recognition, stock-based compensation, property and equipment, internal use software, income taxes, idle lease accrual, accounts receivable and allowance for doubtful accounts. 27 -------------------------------------------------------------------------------- Revenue Recognition Revenues from subscription services and content licenses are deferred and recognized over the subscription term and revenues from management information reports and onsite training is deferred and recognized as the product or service is delivered. These products and services may be sold individually or as bundled offerings ("multiple-deliverable arrangements"). When these products and services are bundled, we allocate revenue to each element in our multiple-deliverable arrangements based upon their relative selling prices. We determine the selling price for each deliverable based on a selling price hierarchy. The selling price for a deliverable is based on our vendor specific objective evidence ("VSOE") if available, third-party evidence ("TPE") if VSOE is not available, or estimated selling price ("ESP") if neither VSOE nor TPE is available. Revenue allocated to each element is then recognized when the basic revenue recognition criteria for that element have been met. The amount of revenue recognized is affected by our judgments as to whether an arrangement includes multiple elements. Changes to the elements in an arrangement could affect the timing of the revenue recognition. Unearned revenue consists of payments received for prepaid subscriptions whose terms extend into periods beyond the balance sheet date, as well as the invoiced portion of contracts whose terms extend into periods beyond the balance sheet date. Stock-Based Compensation We account for stock-based compensation according to the provisions of ASC 718, Compensation - Stock Compensation, which requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of stock-based compensation cost over the requisite service period for awards expected to vest. The fair value of our stock options is determined using the Black-Scholes valuation model and fair value for restricted stock units is determined using the fair market value of the underlying common stock on the date of grant. Such value is recognized as expense over the service period, net of estimated forfeitures. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including employee class and historical experience. There is also significant judgment required in the estimation of the valuation assumptions used to determine the fair value of options granted. Please refer to the discussion of valuation assumptions in Note 3 of the "Notes to Condensed Consolidated Financial Statements" of this Report for additional information on the estimation of these variables. Actual results, and future changes in estimates, may differ substantially from our current estimates. Property and Equipment Equipment and leasehold improvements are stated at cost, net of accumulated depreciation. Depreciation expense on software, furniture and equipment is recorded using the straight-line method over estimated useful lives of three to five years. Leasehold improvements are depreciated over the shorter of their useful lives or the term of the underlying lease. We periodically evaluate our long-lived assets for impairment in accordance with ASC 360-40, Property, Plant, and Equipment - Impairment or Disposal of Long-Lived Assets. ASC 360-40 requires that an impairment loss be recognized for assets to be disposed of or held-for-use when the carrying amount of an asset is deemed to not be recoverable. If events or circumstances indicate that any of our long-lived assets might be impaired, we will analyze the estimated undiscounted future cash flows to be generated from the applicable asset and will record an impairment loss to the extent that the carrying value of the asset exceeds the fair value of the asset. Fair value is generally determined using an estimate of undiscounted future net cash flows from operating activities or upon disposal of the asset. No property and equipment was impaired during the three and nine months ended September 30, 2011 or 2010. 28 -------------------------------------------------------------------------------- Internal Use Software We account for the costs to develop or obtain software for internal use in accordance with ASC 350-40, Intangibles - Goodwill and Other Subtopic Internal-Use Software. As a result, we capitalize qualifying computer software costs incurred during the "application development stage" and other costs as permitted by ASC 350-40. Amortization of these costs begins once the product is ready for its intended use. These costs are amortized on a straight-line basis over the estimated useful life of the product, typically 3 to 5 years. The amount of costs capitalized within any period is dependent on the nature of software development activities and projects in each period. We capitalized $309,000 and $1.1 million in internal use software costs during the three and nine months ended September 30, 2011, respectively, compared to $677,000 and $2.4 million, respectively, during the same periods in 2010. Amortization related to capitalized software was $447,000 and $1.3 million for the three and nine months ended September 30, 2011, compared to $413,000 and $1.5 million in the same periods in 2010. During the first nine months of 2011, assets that were nearly fully amortized related to aging search technology were replaced with a new platform. Onvia recorded an immaterial loss on this abandonment in operating expenses under the general and administrative category in the nine months ended September 30, 2011. During the second quarter of 2010, Onvia abandoned three internal use software projects. Pursuant with the guidance in ASC 360-35-47, Onvia recorded a loss on abandonment of approximately $967,000, representing the full unamortized balance as of September 2010 for these three assets. The loss is included in operating expenses under the general and administrative category in the nine months ended September 30, 2010. Onvia periodically evaluates the remaining useful lives and recoverability of internal use software and will record an impairment or abandonment if management determines that all or a portion of the asset will no longer be used or is no longer recoverable based on the estimated future cash flow, or will adjust the remaining useful life to reflect revised estimates in accordance with ASC 360-40 as described above under "Property and Equipment". Income taxes We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for net operating loss, or NOL, carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"), utilization of NOL carryforwards to offset future taxable income are subject to substantial annual limitations if we experience a cumulative change in ownership as defined by the Code. In general, an ownership change, as defined by the Code, results from transactions increasing the ownership of certain stockholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. As of December 31, 2010, we had tax NOL carryforwards of $255.2 million. During the first quarter of 2011, we completed a formal study (the "NOL Study") for the period of February 25, 1999 through December 31, 2010. The results of this study indicate that it is more likely than not that we experienced an ownership change under Section 382 on September 4, 2001. Accordingly, the NOLs incurred prior to the ownership change are limited based on the value of the Company on the date of the ownership change under Section 382 (the "Loss Limitation"). It is estimated that the Loss Limitation will result in the expiration of approximately $180.1 million in NOLs prior to utilization, leaving approximately $75.1 million available to offset future taxable income. The remaining NOLs expire in dates ranging from 2021 through 2029. On May 4, 2011 Onvia adopted a tax benefits preservation plan in the form of a Section 382 Rights Agreement, designed to preserve stockholder value and the value of certain income tax assets primarily associated with NOLs. 29 -------------------------------------------------------------------------------- The estimate of the Loss Limitation is based upon certain conclusions in the NOL study pertaining to the date of the ownership change and the value of the Company on the date of the ownership change. The overall determination of the Loss Limitation and the conclusions contained in the NOL Study are subject to interpretation, and therefore, the Loss Limitation could be subject to change. We currently have a full valuation allowance for our deferred tax assets as the future realization of the tax benefit is not more likely than not. Based on information currently available, we do not reasonably believe that the unrecognized tax benefit will change significantly within the next twelve months. Accounts Receivable and Allowance for Doubtful Accounts We record accounts receivable for the invoiced portion of our contracts once we have a signed agreement and amounts are billable under the contract. All of our subscription contracts are non-cancellable upon activation. We do not record an asset for the unbilled or unearned portion of our contracts. Accounts receivable are recorded at their net realizable value, after deducting an allowance for doubtful accounts. Such allowances are determined based on a review of an aging of accounts and reflect either specific accounts or estimates based on historical incurred losses. If the financial condition of our clients were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required, and our ability to recognize sales to certain clients may be affected. Idle Lease Accrual We have a non-cancellable operating lease for 35,000 square feet in our current corporate headquarters building, which expires in October 2015. 2,717 square feet has never been occupied and is still in shell condition. During the third quarter of 2011, we completed a revised staffing forecast for the period of time that covers the remaining term on our office lease. Based on this staffing forecast, we do not foresee a need to expand into this vacant space over the remaining term of the lease and no longer expect to derive any future economic benefit from this unused space. Pursuant to the guidance in ASC 420, Exit or Disposal Cost Obligations, a liability for costs that will continue to be incurred under a contract for its remaining term without economic benefit to the entity shall be recognized at the cease-use-date. Management has determined that the cease-use-date is September 1, 2011, which approximates the date that the staffing forecast was completed and when management began engaging outside real estate brokers to market the space. Accordingly, an accrual of approximately $150,000 was recorded in the three months ended September 30, 2011, representing the calculated fair value of our remaining obligation on the idle space from the cease-use-date through the lease expiration date, net of estimated future sublease income. We currently expect that the space will not be sublet until the fourth quarter of 2012. The accrual is recorded in the "General and administrative" category on the Consolidated Statements of Operations. Liquidity and Capital Resources Our principal sources of liquidity are cash, cash equivalents and short-term investments. Our combined cash and cash equivalents and short term investments were $10.4 million at September 30, 2011, and our working capital was $2.2 million. At September 30, 2011 we held $7.5 million in FDIC insured or U.S. government backed short-term investments. From December 31, 2010 to September 30, 2011, our cash, cash equivalents and short-term investments decreased by $474,000 for the reasons described below under operating, investing and financing activities. As we continue to transition our marketing and sales efforts to a consultative selling model concentrating on a focused target market, we may experience a decrease in sales and cash flow in the near term. However, we expect that, over the longer term, focusing on our target market will result in improved retention rates and ACV and, ultimately, increased sales, cash flow and operating income. Until such time as we are able to generate recurring positive cash flow and earnings, we will utilize our current cash, cash equivalents, short-term investments and current revenues to fund operations. 30 --------------------------------------------------------------------------------If the decline in the renewal rates of non-strategic clients continues, our operating cash flow may be adversely impacted in the near term; however, we believe that our current cash and cash equivalents are sufficient to fund current operations for the near-term foreseeable future. Operating Activities Net cash provided by operating activities was $1.6 million for the nine months ended September 30, 2011, compared to $1.2 million in the same period in the prior year. The increase in operating cash flow is due to an increase in vendor payments due to timing, and lower year over year sales offset by lower operating expenses. Investing Activities Net cash used by investing activities was $6.4 million in the nine months ended September 30, 2011, compared to net cash provided by investing activities of $3.2 million in the same period in 2010. The increase of $9.6 million in cash used is attributable to an increase of $4.6 million in purchases of investments, a reduction of $7.0 million in maturities and sales of investments, offset by a decrease of $2.0 million in additions to property and equipment and internal use software. Financing Activities Net cash provided by financing activities was $142,000 in the nine months ended September 30, 2011, compared to net cash used in financing activities of $386,000 in the same period of 2010. The increase is primarily due to there being no repurchase of common stock for minimum tax obligations on option exercises in 2011, while $427,000 was paid in the second quarter of 2010. Recent Accounting Pronouncements Except as noted below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2011, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, that are of significance, or potential significance to us. In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, which amends current comprehensive income guidance. ASU requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income, or in two separate but consecutive statements. This ASU will be effective for public companies during the interim and annual periods beginning after December 15, 2011 with early adoption permitted. The adoption of this ASU will not have an impact on our consolidated financial statements, except for the prescribed changes in presentation. The Company does not plan to early adopt this ASU. In May 2011, the "FASB" issued ASU No. 2011-04, "Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs." The amendments in this ASU generally represent clarification of Topic 820, but also include instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with GAAP and International Financial Reporting Standards ("IFRS"). The amendments are effective for interim and annual periods beginning after December 15, 2011 and are to be applied prospectively. Early application is not permitted. The adoption of this ASU will not have an impact on our consolidated financial statements. 31-------------------------------------------------------------------------------- [ Back To TMCnet.com's Homepage ]