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MATTERSIGHT CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge) Critical Accounting Policies and Estimates
Our management's discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States ("GAAP"). The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenue, and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, we evaluate our estimates, including those
related to the costs and timing of completion of client projects, our ability to
collect accounts receivable, the timing and amounts of expected payments
associated with cost reduction activities, and the ability to realize our net
deferred tax assets, contingencies, and litigation. We base our estimates on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances. Actual results may differ from these
estimates under different assumptions or conditions.
The fiscal year-end dates referenced herein for fiscal years 2011, 2010, and
2009 are December 31, 2011, January 1, 2011, and December 26, 2009,
respectively.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Discontinued Operations
ICS Business Unit Transaction
The sale by the Company of the ICS Business Unit and "eLoyalty" registered
trademark / trade name to Magellan Acquisition Sub, LLC, a Colorado limited
liability company and wholly-owned subsidiary of TeleTech Holdings, Inc., a
Delaware corporation, closed on May 28, 2011, and the Company changed its name
from eLoyalty Corporation to Mattersight Corporation effective May 31, 2011.
Therefore, the results of operations of the ICS Business Unit are reported as
discontinued operations for all periods presented. Additionally, certain
corporate and general costs that had historically been allocated to the ICS
Business Unit were reallocated to the Company and are reflected in all periods
presented.
Revenue Recognition
Continuing Operations
Behavioral Analytics Revenue
Behavioral Analytics revenue consists of Managed services revenue and Consulting
services revenue.
Managed services revenue consists of planning, deployment, training, and
subscription fees derived from Behavioral Analytics contracts. Planning,
deployment, and training fees, which are considered to be installation fees
related to long-term subscription contracts, are deferred until the installation
is complete and are then recognized over the term of the applicable subscription
contract. The terms of these subscription contracts generally range from three
to five years. Installation costs incurred are deferred up to an amount not to
exceed the amount of deferred installation revenue and additional amounts that
are recoverable based on the contractual arrangement. These costs are included
in Prepaid expenses and Other long-term assets. Such costs are amortized over
the term of the subscription contract. Costs in excess of the foregoing revenue
amount are expensed in the period incurred.
The amount of revenue generated from subscription fees is based on a number of
factors, such as the number of agents accessing the Behavioral Analytics System
and/or the number of hours of calls analyzed during the relevant month of the
term of the subscription contract. This revenue is recognized as the service is
performed for the client.
Consulting services revenue primarily consists of fees charged to the Company's
clients to provide post-deployment follow-on consulting services, which include
custom data analysis, the implementation of enhancements, and training. These
follow-on consulting services are generally performed for the Company's clients
on a fixed-fee basis. Revenue is recognized as the services are performed, with
performance generally assessed on the ratio of actual hours incurred to date
compared to the total estimated hours over the entire term of the contract.
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Other Revenue
Other revenue consists of Marketing Managed Services revenue and CRM Services
revenue.
Marketing Managed Services revenue is derived from marketing application
hosting. This revenue is generally in the form of fixed monthly fees received
from the Company's clients and is recognized as the services are performed for
each client. Any related setup fee would be recognized over the contract period
of the hosting arrangement.
CRM Services revenue consists of fees generated from the Company's operational
consulting services, which are provided to the Company's clients on a
time-and-materials or fixed-fee basis. The Company recognizes revenue as the
services are performed for time-and-materials projects. For fixed-fee projects,
revenue is recognized based on the ratio of hours incurred to date compared to
the total estimated hours over the entire term of the contract.
Reimbursed expenses revenue includes billable costs related to travel and other
out-of-pocket expenses incurred while performing services for our clients. The
cost of third-party product and support may be included within this category if
the transaction does not satisfy the requirements for gross reporting. An
equivalent amount of reimbursable expenses is included in Cost of revenue.
Payments received for Managed services contracts in excess of the amount of
revenue recognized for these contracts are recorded as unearned revenue until
revenue recognition criteria are met.
If the Company's estimates indicate that a contract loss will occur, then a loss
provision is recorded in the period in which the loss first becomes probable and
can be reasonably estimated.
The Company maintains allowances for doubtful accounts for estimated losses
resulting from clients not paying for unpaid or disputed invoices for
contractual services provided. Additional allowances may be required if the
financial condition of our clients deteriorates.
Discontinued Operations
ICS Business Unit
Managed services revenue included in the ICS Business Unit consisted of fees
generated from the Company's contact center support and monitoring services.
Support and monitoring services generally were contracted for a fixed fee, and
the revenue was recognized ratably over the term of the contract. Support fees
that were contracted on a time-and-materials basis were recognized as the
services were performed for the client.
For fixed fee Managed services contracts, where the Company provided support for
third-party software and hardware, revenue was recorded at the gross amount of
the sale. If the contract did not meet the requirements for gross reporting,
then Managed services revenue was recorded at the net amount of the sale.
Consulting services revenue included in the ICS Business Unit consisted of the
modeling, planning, configuring, or integrating of an Internet Protocol network
solution within the Company's clients' contact center environments. These
services were provided to clients on a time-and-materials or fixed-fee basis.
For the integration of a system, the Company recognized revenue as the services
were performed, with performance generally assessed on the ratio of hours
incurred to date compared to the total estimated hours over the entire term of
the contract. For all other consulting services, the Company recognized revenue
as the services were performed for the client.
Revenue from the sale of Product, which was generated primarily from the resale
of third-party software and hardware by the Company, was generally recorded at
the gross amount of the sale when it was delivered to the client.
In October 2009, the Financial Accounting Standards Board ("FASB") amended the
accounting standards for revenue recognition to remove tangible products
containing software components and non-software components that function
together to deliver the product's essential functionality from the scope of
industry-specific software revenue recognition guidance. In October 2009, the
FASB also amended the accounting standards for multiple deliverable revenue
arrangements to:
(i) provide updated guidance on whether multiple deliverables exist, how the
deliverables in an arrangement should be separated, and how the
consideration should be allocated;
(ii) require an entity to allocate revenue in an arrangement using estimated
selling prices ("ESP") of deliverables if a vendor does not have
vendor-specific objective evidence of selling price ("VSOE") or
third-party evidence of selling price ("TPE"); and
(iii) eliminate the use of the residual method and require an entity to
allocate revenue using the relative selling price method.
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The Company elected to adopt this accounting guidance at the beginning of its
first quarter of fiscal 2011 on a prospective basis. The adoption of this
guidance does not impact our revenue recognition with respect to Behavioral
Analytics because the implementation services sold with our hosting service are
not separated into multiple accounting units because there is no standalone fair
value for these services. We recognize these services revenues over the
anticipated term of the hosting services, currently the contract term. This
accounting guidance does not change the units of accounting for the Company's
revenue transactions or the methods used to allocate consideration to the units
of accounting. The revenue recognition for each of these offerings is discussed
below.
For the ICS Business Unit, the Company utilized VSOE to allocate revenue to
various elements in an arrangement. We determined VSOE based on our normal
pricing and discounting practices for the product or service when sold
separately. In determining VSOE, we required that a substantial majority of the
selling prices for a product or consulting services fall within a reasonably
narrow pricing range, generally evidenced by approximately 80% of such
historical standalone transactions falling within plus or minus 20% of the
median selling price. For the ICS Business Unit's managed services, we
established VSOE through the stated renewal approach. Previously, we were able
to establish VSOE for our product and service offerings except for software. If
we were not able to establish VSOE for an offering, we attempted to establish
fair value by utilizing TPE. TPE is established by obtaining evidence from
comparable offerings from a peer company. If the Company was unable to establish
fair value using VSOE or TPE, then the Company used ESP in its allocation of
revenue. To determine ESP, we applied significant judgment as we weighed a
variety of factors, based on the facts and circumstances of the arrangement.
These factors included internal costs, gross margin objectives, and existing
portfolio pricing and discounting.
Within discontinued operations, some of our sales arrangements had multiple
deliverables containing software and related software components. Such sale
arrangements were subject to the accounting guidance in ASC 985-605, Software
Revenue Recognition.
Stock-Based Compensation
Stock-based compensation cost is measured at the grant date based on the fair
value of the award and is recognized as expense over the vesting period.
Determining fair value of stock-based awards at the grant date requires certain
assumptions. The Company uses historical information as the primary basis for
the selection of expected life, expected volatility, expected dividend yield
assumptions, and anticipated forfeiture rates. The risk-free interest rate is
selected based on the yields from U.S. Treasury Strips with a remaining term
equal to the expected term of the options being valued.
Goodwill
In the fourth quarter of 2011, we early adopted ASU No. 2011-08,
Intangibles-Goodwill and Other (Topic 350) - Testing Goodwill for Impairment,
which allows an entity to use a qualitative approach to test goodwill for
impairment. As a result, in performing our annual impairment test, we first
perform a qualitative assessment to determine whether it is more-likely-than-not
that the fair value of a reporting unit is less than its carrying value,
including goodwill. If it is concluded that this is the case, we perform a
detailed quantitative assessment. Our annual impairment test of goodwill is
performed in the fourth quarter of each year. In 2011, after completing our
annual qualitative review, we concluded that it was not more likely than not
that the carrying value of any of our reporting units exceeded its fair value.
Accordingly, we concluded that further quantitative analysis and testing was not
required, and no goodwill impairment charge was required.
There has been no impairment identified as a result of the annual review of
goodwill as of December 31, 2011 and January 1, 2011. The carrying value of
goodwill was $1.0 million as of December 31, 2011 and January 1, 2011.
Intangible Assets
Intangible assets reflect costs related to patent and trademark applications,
Marketing Managed Services customer relationships acquired in 2004, and the 2003
purchase of a license for certain intellectual property. Patent and trademark
applications are amortized over 120 months. The other intangible assets are
fully amortized. The original cost of intangible assets as of December 31, 2011
and January 1, 2011 was $2.8 million and $2.7 million, respectively. Accumulated
amortization of intangible assets as of December 31, 2011 and January 1, 2011
was $2.6 million and $2.4 million, respectively. Currently, amortization expense
of intangible assets is expected to be $40 thousand annually.
Severance and Related Costs
We recorded accruals for severance and related costs associated with our
cost-reduction efforts undertaken during fiscal years 2007 through 2011. The
portion of the accruals relating to employee severance represents contractual
severance for identified employees and generally is not subject to a significant
revision. The portion of the accruals that related to office space reductions,
office closures, and associated contractual lease obligations are based in part
on assumptions and estimates of the timing and amount of sublease rentals, which
may be affected by overall economic and local market conditions. To the extent
estimates of the success of our sublease efforts changed, adjustments increasing
or decreasing the related accruals have been recognized.
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Income Taxes
We have recorded income tax valuation allowances on our net deferred tax assets
to account for the unpredictability surrounding the timing of realization of our
U.S. and non-U.S. net deferred tax assets due to uncertain economic conditions.
The valuation allowances may be reversed at a point in time when management
determines realization of these tax assets has become more likely than not,
based on a return to predictable levels of profitability.
The Company uses an asset and liability approach for financial accounting and
reporting of income taxes. Deferred income taxes are provided when tax laws and
financial accounting standards differ with respect to the amount of income for
the year, the basis of assets and liabilities and for tax loss carryforwards.
The Company does not provide U.S. deferred income taxes on earnings of U.S. or
foreign subsidiaries, which are expected to be indefinitely reinvested.
The Company may recognize the tax benefit from an uncertain tax position only if
it is more likely than not that the tax position will be sustained on
examination by the taxing authorities, based on the technical merits of the
position. The tax benefits recognized in the financial statements from such a
position should be measured based on the largest benefit that has a greater than
50% likelihood of being realized upon ultimate settlement. Significant judgment
is used to determine the likelihood of the benefit. There is additional guidance
on derecognition, classification, interest and penalties on income taxes,
accounting in interim periods, and disclosure requirements.
Intraperiod tax allocation requires that the provision for income taxes be
allocated between continuing operations and other categories of earnings (such
as discontinued operations or other comprehensive income) for each tax
jurisdiction. In periods in which there is a year-to-date pre-tax loss from
continuing operations and pre-tax income in other categories of earnings, the
tax provision is first allocated to the other categories of earnings. A related
tax benefit is then recorded in continuing operations. While intraperiod tax
allocation in general does not change the overall tax provision, it may result
in a gross-up of the individual components, thereby changing the amount of tax
provision included in each category. Included in our continuing operations
income tax provision is a tax benefit of $5.9 million for the year ended
December 31, 2011 and $1.7 million for the year ended January 1, 2011. Included
in our discontinued operations income tax provision is tax expense of $6.8
million for the year ended December 31, 2011 and $1.8 million for the year ended
January 1, 2011.
Other Significant Accounting Policies
For a description of the Company's other significant accounting policies, see
Note Two "Summary of Significant Accounting Policies" of the "Notes to
Consolidated Financial Statements" included in Part II Item 8 of this Form 10-K.
Forward-Looking Statements
Statements in this Form 10-K that are not historical facts are "forward-looking
statements" that are made pursuant to the safe harbor provisions of Section 27A
of the Securities Act of 1933, as amended (the "Securities Act"), and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). These forward-looking statements, which may be identified by use of words
such as "plan," "may," "might," "believe," "expect," "intend," "could," "would,"
"should," and other words and terms of similar meaning, in connection with any
discussion of our prospects, financial statements, business, financial
condition, revenues, results of operations, or liquidity, involve risks and
uncertainties that could cause actual results to differ materially from those
described in the forward-looking statements. In addition to other factors and
matters contained or incorporated in this document, important factors that could
cause actual results or events to differ materially from those indicated by such
forward-looking statements include, without limitation, those noted under "Risk
Factors" included in Part I Item 1A of this Form 10-K for the year ended
December 31, 2011, as well as the following:
• Changes by the FASB or the SEC of authoritative accounting principles
generally accepted in the United States or policies or changes in the
application or interpretation of those rules or regulations;
• Acts of war or terrorism, including, but not limited to, actions taken or
to be taken by the United States and other governments as a result of acts
or threats of terrorism, and the impact of these acts on economic,
financial, and social conditions in the countries where we operate; and
• The timing and occurrence (or non-occurrence) of transactions and events
which may be subject to circumstances beyond our control.
We cannot guarantee any future results, levels of activity, performance, or
achievements. The statements made in this Form 10-K represent our views as of
the date of this Form 10-K, and it should not be assumed that the statements
made in this Form 10-K remain accurate as of any future date. Moreover, we
assume no obligation to update forward-looking statements, except as may be
required by law.
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Business Outlook
Based upon Mattersight's business development efforts and third-party market
research, we believe there has been a fundamental shift in the way large
enterprises view data. The trends suggest that large enterprises today
appreciate that there is value in data that can be derived from their front and
back offices, but they have not yet established efficient and effective methods
to capture, analyze, and create value from this data. We seek to help large
enterprises capitalize on this data with our Behavioral Analytics solutions and,
as the leader in this rapidly growing market, we believe we are uniquely
positioned to capitalize on this opportunity. We estimate the market potential
in the United States for all of our current analytics offerings at over $10
billion per year. The market for enterprise analytics is very new and we
currently estimate it to be less than 5% penetrated.
Our business strategy to increase revenue, profitability, and capture market
share includes the following elements:
• Increase up-sell and cross-sell ratios by deepening and broadening our
relationships with existing clients;
• Win business with new clients, focusing on analyzing customer interactions
and back office activities in targeted industries;
• Continue to invest in innovative proprietary technology, new applications,
and delivery methods;
• Continue bookings growth and improve operating leverage;
• Expand our sales and marketing efforts with seasoned enterprise sales
agents and strategic marketing professionals; and
• Develop partnerships and strategic alliances to expand sales leverage,
improve brand awareness, and reach new industries while providing value to
our mutual clients.
Resulting from our delivery of measurable economic benefit to our clients, we
have seen increasing penetration within existing accounts, due to an increase in
adoption of our base Behavioral Analytics offerings across separate and distinct
business units, as well as the adoption of new applications within existing
business units. For this reason, we will continue to focus on further
penetrating what we estimate to be a large existing base market with a less
expensive cost of acquisition. In addition, our strategy to further invest in
sales and marketing, coinciding with the fundamental shift in enterprise data
utilization described above, has led to an increasing number of discussions with
potential new clients and strategic partners.
Managed Services Backlog
As a result of the strategic and long-term nature of Managed services revenue,
we believe it is appropriate to monitor the level of backlog associated with our
Managed services agreements. The Behavioral Analytics Managed services backlog
was $96.3 million as of December 31, 2011 and $84.5 million as of January 1,
2011. This increase in backlog is due to the value of the Managed services
contracts signed in fiscal year 2011 exceeding the amount of Managed services
revenue in fiscal year 2011. We expect Behavioral Analytics Managed service
backlog to increase in fiscal year 2012 based on the impact of anticipated
renewals of existing agreements and anticipated contract signings with clients
included in our current sales pipeline.
The Company uses the term "backlog" to reflect the estimated future amount of
Managed services revenue related to its Managed services contracts. The value of
these contracts is based on anticipated usage volumes over the anticipated term
of the agreement. The anticipated term of the agreement is based on the
contractually agreed fixed term of the contract, plus agreed upon, but optional
extension periods. Actual volumes may be greater or less than anticipated. In
addition, actual agreement terms may vary from the anticipated terms because
these contracts typically are cancellable without cause based on the customer
making a substantial early termination payment or forfeiture of prepaid contract
amounts. The reported Behavioral Analytics Managed service backlog is expected
to be recognized as follows: $34.2 million in 2012; $28.2 million in 2013; $17.8
million in 2014; and $16.1 million in 2015 and thereafter.
Year Ended December 31, 2011 Compared with the Year Ended January 1, 2011
Services Revenue
Services revenue is total revenue excluding reimbursable expenses that are
billed to our clients. Our services revenue decreased 5% to $28.8 million in
fiscal year 2011 from $30.3 million in fiscal year 2010.
Behavioral Analytics revenue was $27.3 million in fiscal year 2011 and was $25.2
million in fiscal year 2010. Behavioral Analytics revenue increased $2.1 million
in fiscal year 2011 due to increased subscription fees associated with the
conversion of several deployments to the subscription phase of the agreement.
Other revenue decreased by $3.5 million in fiscal year 2011 to $1.5 million,
from $5.0 million in fiscal year 2010, a decrease of 70%. The decrease in
revenue was mainly due to the completion of several contracts for Marketing
Managed Services and CRM Services performed for clients in fiscal year 2010 and
lower demand for CRM Services from existing clients who utilize these services.
The Company's top five clients accounted for 70% of total revenue in fiscal
years 2011 and 2010. The top 10 clients accounted for 90% of total revenue in
fiscal year 2011, compared to 86% in fiscal year 2010. In fiscal years 2011 and
2010, there were three and four clients, respectively, that accounted for 10% or
more of total revenue. In fiscal year 2011, Vangent, Inc., Allstate Insurance
Company, and Health Care Service Corporation accounted for 22%, 15%, and 14% of
total revenue, respectively. In fiscal year 2010, Vangent, Inc., United
HealthCare Services, Inc., Health Care Service Corporation, and Allstate
Insurance Company accounted for 20%, 15%, 14%, and 13% of total revenue,
respectively. Higher concentration of revenue with a single client or a limited
group of clients creates increased revenue risk if one of these clients
significantly reduces its demand for our services.
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Cost of Revenue Before Reimbursed Expenses, Exclusive of Depreciation and
Amortization
Cost of Services
Cost of services primarily consists of labor costs, including salaries, fringe
benefits, and incentive compensation, royalties, and other customer related
third-party outside services. Cost of services excludes depreciation and
amortization.
Cost of Behavioral Analytics revenue in fiscal year 2011 was $12.2 million, or
45% of Behavioral Analytics revenue, compared to $12.0 million, or 48% of
Behavioral Analytics revenue, in fiscal year 2010. The increase in cost was
primarily due to increased data center expenses of $0.2 million. The percentage
decrease in the Cost of Behavioral Analytics revenue was primarily due to
improved leverage of our cost structure resulting from higher revenue in fiscal
year 2011 compared to fiscal year 2010.
Cost of Other revenue in fiscal year 2011 was $1.0 million, or 67% of Other
revenue, compared to $3.5 million, or 70% of Other revenue, in fiscal year 2010.
The decrease in cost was largely due to lower compensation expense of $2.4
million, driven by the lower demand for our CRM services.
Sales, Marketing and Development
Sales, marketing and development expenses consist primarily of salaries,
incentive compensation, commissions, and employee benefits for business
development, account management, marketing, and product development
personnel. The personnel costs included here are net of any labor costs directly
related to the generation of revenue, which are represented in Cost of services.
Sales, marketing and development expenses increased $1.4 million, or 8%, to
$20.0 million in fiscal year 2011 from $18.6 million in fiscal year 2010. This
increase is due to the investment in our sales organization. During 2011, we
added 8 account executives to increase the total number of account executives to
17.
General and Administrative
General and administrative expenses consist primarily of salaries, incentive
compensation, and employee benefits for administrative personnel, as well as
facilities costs, a provision for uncollectible amounts, and costs for our
corporate technology infrastructure and applications.
General and administrative expenses decreased $1.0 million, or 10%, to $9.1
million in fiscal year 2011 from $10.1 million in fiscal year 2010. This
decrease is due to lower compensation expense of $0.9 million, primarily due to
the 30% reduction in our administrative staff as a result of the sale of the ICS
Business Unit.
Severance and Related Costs
In 2011 and 2010, a number of cost reduction activities were undertaken,
principally consisting of personnel reductions and an office consolidation. Cash
savings related to cost reduction actions for fiscal year 2011 are anticipated
to be $0.1 million annually. The cost reduction actions taken in fiscal year
2010 resulted in annual cash savings of $2.8 million. Costs related to office
space reductions and office closures were paid pursuant to contractual lease
terms through January 2012.
Severance and related costs were $0.3 million of income in fiscal year 2011 and
$0.5 million of expense in fiscal year 2010. In fiscal year 2011, the $0.3
million of income for continuing operations was related to the favorable
renegotiation of an office lease, partially offset by severance and related
costs for the elimination of one position and an office consolidation. In fiscal
year 2010, the Company recorded $0.5 million of expense, primarily related to
the elimination of 26 positions and an adjustment to sublease recoveries.
Depreciation
Depreciation decreased $0.1 million, or 3%, to $3.2 million in fiscal year 2011
compared to $3.3 million in fiscal year 2010. The decrease in depreciation is
primarily related to assets becoming fully amortized.
Amortization of Intangibles
Amortization of intangibles increased $0.1 million, or 100%, to $0.2 million in
fiscal year 2011 compared to $0.1 million in fiscal year 2010. The increase in
amortization is primarily related to a $0.1 million charge to write off patent
applications that the Company has determined it no longer wishes to pursue.
Operating Loss
Primarily as a result of the factors described above, we experienced an
operating loss of $16.6 million for fiscal year 2011, compared to an operating
loss of $17.9 million for fiscal year 2010.
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Interest and Other Income (Expense), Net
Non-operating interest and other income (expense) was $0.1 million of income in
fiscal year 2011 and was $0.1 million of expense in fiscal year 2010. In fiscal
year 2011, the $0.1 million of income was primarily related to favorable
exchange rates on intercompany settlements, partially offset by interest expense
on our capital lease obligation. In fiscal year 2010, the $0.1 million of
expense was primarily related to interest expense for our capital lease
obligations.
Income Tax Benefit
The income tax benefit was $5.9 million and $1.7 million in fiscal years 2011
and 2010, respectively. The $5.9 million tax benefit primarily related to the
tax accounting treatment of the gain on the sale of the ICS Business Unit. As of
December 31, 2011, total net deferred tax assets of $55.8 million were fully
offset by a valuation allowance. The level of uncertainty in predicting when we
will achieve profitability, sufficient to utilize our net U.S. and non-U.S.
operating losses and realize our remaining deferred tax assets, requires that an
income tax valuation allowance be recognized in the financial statements.
Income from Discontinued Operations
The income from discontinued operations in fiscal year 2011 was $28.9 million,
net of tax of $6.8 million and the income in fiscal year 2010 was $3.0 million,
net of tax of $1.8 million.
The income from discontinued operations of $28.9 million in fiscal year 2011 was
due to the impact of the results of the ICS Business Unit and the transaction
costs associated with the sale of the ICS Business Unit. The pretax gain from
the sale of assets included in discontinued operations in fiscal year 2011 was
$36.5 million. The income from discontinued operations of $3.0 million in fiscal
year 2010 was due to the impact of the results of the ICS Business Unit.
Net Income (Loss) Available to Common Stockholders
We reported net income available to common stockholders of $10.6 million in
fiscal year 2011 compared to a net loss available to common stockholders of
$14.6 million in fiscal year 2010. In fiscal year 2011, the Company paid $6.6
million on the Series B Stock fair value over stated value. Accrued dividends to
holders of our Series B Stock were $1.3 million in both fiscal years 2011 and
2010. In fiscal year 2011, there was net income of $0.74 per share on a basic
and diluted basis, compared to a net loss of $1.06 per share on a basic and
diluted basis in fiscal year 2010.
Year Ended January 1, 2011 Compared with the Year Ended December 26, 2009
Services Revenue
Services revenue is total revenue excluding reimbursable expenses that are
billed to our clients. Our services revenue decreased 5% to $30.3 million in
fiscal year 2010 from $31.8 million in fiscal year 2009.
Behavioral Analytics revenue was $25.2 million in fiscal year 2010 and was $19.6
million in fiscal year 2009. The first quarter of 2010 included the $0.7 million
impact of the cancellation of a Behavioral Analytics agreement. Behavioral
Analytics revenue increased $5.6 million in fiscal year 2010 due to increased
subscription fees associated with the conversion of several deployments to the
subscription phase of the agreement.
Other revenue decreased by $7.2 million in fiscal year 2010 to $5.0 million,
from $12.2 million in fiscal year 2009, a decrease of 60%. The decrease in
revenue was mainly due to the completion of several contracts for Marketing
Managed Services and CRM Services performed for clients in fiscal year 2010 and
lower demand for CRM Services from existing clients who utilize these services.
The Company's top five clients accounted for 70% of total revenue in fiscal year
2010, compared to 59% in fiscal year 2009. The top 10 clients accounted for 86%
of total revenue in fiscal year 2010, compared to 79% in fiscal year 2009. In
fiscal year 2010, there were four clients that accounted for 10% or more of
total revenue. In fiscal year 2010, Vangent, Inc., United HealthCare Services,
Inc., Health Care Service Corporation, and Allstate Insurance Company accounted
for 20%, 15%, 14%, and 13% of total revenue, respectively. In fiscal year 2009,
Blue Shield of California, United HealthCare Services, Inc., and Health Care
Service Corporation accounted for 16%, 14%, and 11% of total revenue,
respectively. Higher concentration of revenue with a single client or a limited
group of clients creates increased revenue risk if one of these clients
significantly reduces its demand for our services.
Cost of Revenue Before Reimbursed Expenses, Exclusive of Depreciation and
Amortization
Cost of Services
Cost of services primarily consists of labor costs, including salaries, fringe
benefits, and incentive compensation, royalties, and other customer related
third-party outside services. Cost of services excludes depreciation and
amortization.
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Cost of Behavioral Analytics revenue in fiscal year 2010 was $12.0 million, or
48% of Behavioral Analytics revenue, compared to $11.9 million, or 61% of
Behavioral Analytics revenue, in fiscal year 2009. The percentage decrease in
the Cost of Behavioral Analytics revenue was primarily due to improved leverage
of our cost structure resulting from higher revenue in fiscal year 2010 compared
to fiscal year 2009.
Cost of other revenue in fiscal year 2010 was $3.5 million, or 70% of Other
revenue, compared to $8.1 million, or 67% of Other revenue, in fiscal year 2009.
The decrease in cost was largely due to lower compensation expense of $4.0
million and lower travel costs of $0.4 million driven by lower demand for our
CRM services.
Sales, Marketing and Development
Sales, marketing and development expenses consist primarily of salaries,
incentive compensation, commissions, and employee benefits for business
development, account management, marketing, and product development
personnel. The personnel costs included here are net of any labor costs directly
related to the generation of revenue, which are represented in Cost of services.
Sales, marketing and development expenses increased $3.4 million, or 22%, to
$18.6 million in fiscal year 2010 from $15.2 million in fiscal year 2009. This
increase was due to higher commissions resulting from increased Behavioral
Analytics revenue and the continued investment in our product development.
General and Administrative
General and administrative expenses consist primarily of salaries, incentive
compensation, and employee benefits for administrative personnel, as well as
facilities costs, a provision for uncollectible amounts, and costs for our
corporate technology infrastructure and applications.
General and administrative expenses increased $0.3 million, or 3%, to $10.1
million in fiscal year 2010 from $9.8 million in fiscal year 2009. This increase
was due to higher compensation expense of $0.7 million, partially offset by
lower outside services of $0.3 million.
Severance and Related Costs
In 2010 and 2009, a number of cost reduction activities were undertaken,
principally consisting of personnel reductions and an office consolidation. Cash
savings related to cost reduction actions for fiscal years 2010 and 2009
resulted in annual cash savings of $2.8 million and $2.0 million, respectively.
Costs related to office space reductions and office closures were paid pursuant
to contractual lease terms through January 2012.
Severance and related costs were $0.5 million and $1.0 million in fiscal years
2010 and 2009, respectively. In fiscal year 2010, the $0.5 million of expense
for continuing operations was related to severance and related costs for the
elimination of 26 positions and an office consolidation. In fiscal year 2009,
the Company recorded $1.0 million of expense, primarily related to the
elimination of 19 positions and an adjustment to sublease recoveries.
Depreciation
Depreciation decreased $0.5 million, or 13%, to $3.3 million in fiscal year 2010
compared to $3.8 million in fiscal year 2009. The decrease in depreciation was
primarily related to assets becoming fully amortized.
Amortization of Intangibles
Amortization of intangibles decreased $0.1 million, or 50%, to $0.1 million in
fiscal year 2010 compared to $0.2 million in fiscal year 2009. The decrease in
amortization was primarily due to Marketing Managed Services customer contracts
becoming fully amortized.
Operating Loss
Primarily as a result of the factors described above, we experienced an
operating loss of $17.9 million for fiscal year 2010, compared to an operating
loss of $18.2 million for fiscal year 2009.
Interest and Other (Expense) Income, Net
Non-operating interest and other (expense) income was $0.1 million of expense in
fiscal year 2010 and was $0.1 million of income in fiscal year 2009. In fiscal
year 2010, the $0.1 million of expense was primarily related to interest expense
for our capital lease obligations. In fiscal year 2009, the $0.1 million of
income was primarily due to a gain on the sale of equity securities in a
publicly-traded company for $0.3 million, partially offset by $0.2 million of
interest expense for our capital lease obligations and lower average yields on
our investments.
Income Tax Benefit
The income tax benefit was $1.7 million in fiscal year 2010 and was $2.8 million
in fiscal year 2009. As of January 1, 2011, total net deferred tax assets of
$62.7 million were fully offset by a valuation allowance. The level of
uncertainty in predicting when we will achieve profitability, sufficient to
utilize our net U.S. and non-U.S. operating losses and realize our remaining
deferred tax assets, requires that an income tax valuation allowance be
recognized in the financial statements.
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Income from Discontinued Operations
The income from discontinued operations was $3.0 million, net of tax of $1.8
million in fiscal year 2010, and was $4.7 million, net of tax of $2.9 million,
in fiscal year 2009.
The income from discontinued operations of $3.0 million in fiscal year 2010 was
due to the impact of the results of the ICS Business Unit. The income from
discontinued operations of $4.7 million in fiscal year 2009 was due to the
impact of the results of the ICS Business Unit and the sale of a subsidiary in
Switzerland.
Net Loss Available to Common Stockholders
We reported a net loss available to common stockholders of $14.6 million in
fiscal year 2010 compared to a net loss available to common stockholders of
$11.9 million in fiscal year 2009. These losses include accrued dividends to
preferred stockholders of $1.3 million in both fiscal years 2010 and 2009. The
net loss was $1.06 per share on a basic and diluted basis in fiscal year 2010,
compared to a net loss of $0.90 per share on a basic and diluted basis in fiscal
year 2009.
Liquidity and Capital Resources
Introduction
Our principal capital requirements are to fund working capital needs, capital
expenditures for Behavioral Analytics and infrastructure requirements, and other
revenue generation and growth investments. As of December 31, 2011, our
principal capital resources consisted of (i) our cash and cash equivalents
balance of $29.4 million, which includes $0.3 million in foreign bank accounts,
(ii) restricted cash of $1.5 million, and (iii) the remaining $3.5 million under
the Facility, as defined below.
Our cash and cash equivalents position increased $8.5 million, or 41%, as of
December 31, 2011, from $20.9 million as of January 1, 2011. Our ICS Business
Unit, which was classified as discontinued operations in our consolidated
financial statements, did not include any cash or cash equivalents.
The increase in cash during fiscal year 2011 was primarily due to the proceeds
from the sale of the ICS Business Unit, net of transaction costs, and the
purchase by IGC Fund of the Shares of Common Stock pursuant to the terms of the
Purchase Agreement, which were largely offset by the Company's repurchase from
TCV of 1,872,805 shares of Series B Stock under the terms of the Settlement
Agreement, the net loss before non-cash items, capital expenditures, cash
dividend payments on Series B Stock, acquisition of treasury stock, capital
lease principal payments, and increased working capital requirements. Restricted
cash decreased by $1.0 million for fiscal year 2011 and remained constant for
fiscal year 2010. The restricted cash balance was primarily used as collateral
for letters of credit issued in support of future capital lease obligations. See
"Bank Facility" below for a description of the contractual requirements related
to restricted cash.
Cash Flows from Operating Activities
Net cash used in operating activities of continuing operations during fiscal
years 2011 and 2010 was $10.5 million and $11.4 million, respectively. During
fiscal year 2011, cash outflows of $10.5 million from operating activities
consisted primarily of the net loss before non-cash items of $7.7 million, and
an increase in prepaid costs of $2.3 million, which primarily consist of costs
associated with unearned revenue.
During fiscal year 2010, cash outflows of $11.4 million from operating
activities of continuing operations consisted primarily of the net loss before
depreciation, amortization, stock-based compensation, and a $1.6 million
decrease in unearned revenue reflecting the recognition of previously deferred
revenue, partially offset by accounts receivable collections of $1.4 million.
Net cash used in operating activities of discontinued operations during fiscal
year 2011 was $5.8 million. During fiscal year 2011, cash outflows of $5.8
million from discontinued operating activities consisted primarily of a
$5.1 million decrease in unearned revenue reflecting the recognition of
previously deferred revenue, partially offset by lower prepaid costs of
$1.1 million, due primarily to the amortization of costs associated with the
unearned revenue.
Net cash provided by operating activities of discontinued operations during
fiscal year 2010 was $8.4 million and consisted primarily of an increase in
unearned revenue of $11.8 million as a result of customer prepayments and income
before non-cash items, $6.4 million, partially offset by an increase in prepaid
costs of $7.3 million which primarily consist of deferred costs associated with
the deployment of our Behavioral Analytics services.
Days Sales Outstanding ("DSO") for continuing operations was 26 days at
December 31, 2011 compared to 23 days at January 1, 2011, an increase of three
days. This increase was primarily due to the impact of the completion of the
sale of the ICS Business Unit on our customer concentration. Because a high
percentage of our revenue is dependent on a relatively small number of clients,
delayed payments by a few of our larger clients could result in a reduction of
our available cash, which in turn may cause fluctuation in our DSO. We do not
expect any significant collection issues with our clients; see "Accounts
Receivable Customer Concentration" for additional information on cash
collections.
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As of December 31, 2011, there remains $46 thousand of costs for an office
closure for continuing operations and there were no unpaid severance and related
costs for discontinued operations. See Note Four "Severance and Related Costs"
of the "Notes to Consolidated Financial Statements" included in Part II Item 8
to this Form 10-K.
Cash Flows from Investing Activities
The Company used $0.8 million of cash in continuing investing activities during
each of fiscal years 2011 and 2010. Capital expenditures of $0.8 million and
$1.2 million were primarily used to purchase computer hardware and software
during fiscal years 2011 and 2010, respectively. We currently expect capital
investments to be between $4.0 million and $5.0 million for fiscal year 2012 and
plan on funding approximately $3.2 million to $4.2 million of these purchases
with capital leases.
Net cash provided by discontinued investing activities was $37.4 million during
fiscal year 2011 and a $1.6 million use of cash during fiscal year 2010.
Proceeds from sale of assets held for sale were $37.6 million during fiscal year
2011. The remaining cash usage in 2011 and 2010 is primarily due to capital
expenditures for the purchase of computer hardware and software.
Cash Flows from Financing Activities
The Company used $10.6 million and $2.4 million of cash in continuing financing
activities during fiscal years 2011 and 2010, respectively. Net cash outflows of
$10.6 million during fiscal year 2011 were primarily attributable to: $12.5
million of cash used to repurchase 1,872,805 shares of Series B Stock under the
terms of Settlement Agreement; $2.2 million for cash dividend payments on Series
B Stock, which included payment of previously accrued and unpaid dividends;
$1.9 million of principal payments under our capital lease obligations; and $1.0
million of cash used to acquire treasury stock, offset by proceeds of $6.0
million from the purchase by IGC Fund of the Shares pursuant to the terms of the
Purchase Agreement, and a decrease in restricted cash of $1.0 million.
Net cash outflows of $2.4 million in continuing financing activities during
fiscal year 2010 were primarily attributable to $1.6 million of principal
payments under our capital lease obligations, $1.3 million for cash dividend
payments on Series B Stock, and $1.0 million of cash used to acquire treasury
stock, offset by a decrease in restricted cash of $1.3 million. The treasury
stock acquired in each year reflects shares that were obtained to meet employee
tax obligations associated with stock award vestings.
Net cash used in discontinued financing activities was $0.7 million and $0.3
million during fiscal years 2011 and 2010, respectively. The usage in 2011 was
for $0.6 million of cash used to acquire treasury shares and in 2010 was for
principal payments under our capital lease obligations.
Historically, we have not paid cash dividends on our Common Stock, and we do not
expect to do so in the future. On July 1, 2011, a cash dividend of $1.9 million
was paid on the Series B Stock for the dividend periods January 1, 2011 through
June 30, 2011; July 1, 2010 through December 31, 2010; and July 1, 2008 through
December 31, 2008. Under the terms of the Settlement Agreement, the Company paid
$0.3 million to TCV, representing accrued and unpaid dividends on the Series B
Stock. On January 4, 2010 and July 1, 2010, a cash dividend of $1.4 million was
paid on the Series B Stock for the dividend periods July 1, 2009 through
December 31, 2009 and January 1, 2010 through June 30, 2010. Under the terms of
the Certificate of Designations for the Series B Stock, unpaid dividends are
cumulative and accrue at the rate of 7% per annum per year, payable
semi-annually in January and July. The amount of each dividend accrual will be
decreased by any conversions of the Series B Stock into Common Stock, as such
conversions require the Company to pay accrued but unpaid dividends at the time
of conversion. Conversions of Series B Stock became permissible at the option of
the holder after June 19, 2002. The Company expects to acquire between $0.5
million and $0.7 million of treasury stock during the first quarter of 2012 to
meet employee tax obligations associated with the various stock-based
compensation programs.
Liquidity
Our near-term capital resources consist of our current cash balance, together
with anticipated future cash flows and financing from capital leases. Our
balance of cash and cash equivalents was $29.4 million as of December 31, 2011.
In addition, our restricted cash of $1.5 million with Bank of America (the
"Bank") at December 31, 2011 is available to support letters of credit issued
under our credit facility (as described below) and collateral requirements for
our capital lease agreements.
We anticipate that our current unrestricted cash resources, together with
operating revenue and capital lease financing, should be sufficient to satisfy
our short-term working capital and capital expenditure needs for the next twelve
months. Management will continue to assess opportunities to maximize cash
resources by actively managing our cost structure and closely monitoring the
collection of our accounts receivable. If, however, our operating activities,
capital expenditure requirements, or net cash needs differ materially from
current expectations due to uncertainties surrounding the current capital
market, credit and general economic conditions, competition, or the suspension
or cancellation of a large project, then there is no assurance that we would
have access to additional external capital resources on acceptable terms.
Bank Facility
The Company is a party to a loan agreement with the Bank, which expires on
December 31, 2012. The maximum principal amount of the secured line of credit
under the agreement (the "Facility") is $5.0 million as of December 31, 2011.
The Facility requires the Company to maintain a minimum cash and cash equivalent
balance within a secured account at the Bank. The Facility provides that the
balance in the secured account cannot be less than the outstanding balance drawn
on the Facility and letter of credit obligations
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under the Facility. Available credit under the Facility has been reduced by $1.5
million due to letters of credit issued under the Facility to support our
capital lease obligations. As a result, $3.5 million remains available under the
Facility at December 31, 2011. Loans under the Facility bear interest at the
Bank's prime rate or, at the Company's election, an alternate rate of LIBOR
(London InterBank Offering Rate) plus 0.75%. We did not have any borrowings or
interest expense under the Facility during fiscal year 2011 or 2010. See Note
Eleven "Line of Credit" of the "Notes to Consolidated Financial Statements"
included in Part II Item 8 of this Form 10-K.
Accounts Receivable Customer Concentration
As of December 31, 2011, three clients, United HealthCare Services, Inc.,
Allstate Insurance Company, CVS Caremark Corporation accounted for 25%, 22%, and
14% of total gross accounts receivable, respectively. Of these amounts, we have
collected 100% from United HealthCare Services, Inc., 99% from Allstate
Insurance Company, and 100% from CVS Caremark Corporation, through March 12,
2012. Of the total December 31, 2011 gross accounts receivable, we have
collected 88% as of March 12, 2012. Because we have a high percentage of our
revenue dependent on a relatively small number of clients, delayed payments by a
few of our larger clients could result in a reduction of our available cash.
Capital Lease Obligations
Capital lease obligations as of December 31, 2011 and January 1, 2011 were $2.8
million and $2.3 million, respectively. We are a party to a capital lease
agreement with a lease company to lease hardware and software. Beginning in
2010, executed leases did not require an irrevocable letter of credit. Prior to
2010, the Company was required to issue an irrevocable letter of credit for a
portion of the lease amount as additional consideration for the duration of the
executed lease agreement. We expect capital lease obligations to increase
between $3.2 million to $4.2 million for fiscal year 2012 as we continue to
expand our investment in the infrastructure for Behavioral Analytics.
Contractual Obligations
Cash will also be required for operating leases and non-cancellable purchase
obligations as well as various commitments reflected as liabilities on our
balance sheet as of December 31, 2011. These commitments are as follows:
Continuing Operations
Less More
(In millions) Than 1 1 - 3 3 - 5 Than 5
Contractual Obligations Total Year Years Years Years
Letters of credit $ 1.5 $ 1.5 $ - $ - $ -
Operating leases 1.7 0.5 0.6 0.5 0.1
Capital leases 3.3 2.0 1.3 - -
Severance and related costs* - - - - -
Purchase obligations 1.6 1.6 - - -
Total $ 8.1 $ 5.6 $ 1.9 $ 0.5 $ 0.1
* Less than $0.1.
Due to the existence of the Company's net operating loss carryforward as
described in Note Eight "Income Taxes" of the "Notes to Consolidated Financial
Statements" included in Part II Item 8 of this Form 10-K, no net tax contractual
obligations exist as of December 31, 2011.
Letters of Credit
The amounts set forth in the chart above reflect standby letters of credit
issued as collateral for capital leases. The terms of the Facility require us to
deposit a like amount of cash into a restricted cash account at the Bank for the
duration of the letter of credit commitment period. The amounts set forth in the
chart above reflect the face amount of these letters of credit that expire in
each period presented. To the extent these letters of credit expire without a
claim being made, the cash deposited in the restricted cash account will be
transferred back to an unrestricted cash account.
Leases
The amounts set forth in the chart above reflect future principal, interest, and
executory costs of the leases entered into by the Company for technology and
office equipment, as well as office and data center space. Liabilities for the
principal portion of the capital lease obligations are reflected on our balance
sheet as of December 31, 2011 and January 1, 2011.
Severance and Related Costs
Severance and related costs reflect payments the Company is required to make in
future periods for severance and other related costs due to cost reduction
activities in fiscal year 2011 and prior periods. Liabilities for these required
payments are reflected on our balance sheet as of December 31, 2011 and
January 1, 2011.
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Purchase Obligations
Purchase obligations include $1.4 million of commitments reflected as
liabilities on our balance sheet as of December 31, 2011, as well as $0.4
million of non-cancellable obligations to purchase goods or services in the
future. Purchase obligations include $0.7 million of commitments reflected as
liabilities on our balance sheet as of January 1, 2011, as well as $0.2 million
of non-cancellable obligations to purchase goods or services in the future.
Recent Accounting Pronouncements
In October 2009, the FASB issued Accounting Standards Update ("ASU")
No. 2009-13, Revenue Recognition (ASC Topic 605) - Multiple-Deliverable Revenue
Arrangements, a consensus of the FASB Emerging Issues Task Force. This guidance
modifies the fair value requirements of ASC subtopic 605-25, Revenue
Recognition-Multiple Element Arrangements, by allowing the use of the "best
estimate of selling price" in addition to VSOE and vendor objective evidence
(now referred to as TPE, standing for third-party evidence) for determining the
selling price of a deliverable. A vendor is now required to use its best
estimate of the selling price when VSOE or TPE of the selling price cannot be
determined. In addition, the residual method of allocating arrangement
consideration is no longer permitted.
In October 2009, the FASB also issued ASU No. 2009-14, Software (ASC Topic 985)
- Certain Revenue Arrangements That Include Software Elements, a consensus of
the FASB Emerging Issues Task Force. This guidance modifies the scope of ASC
subtopic 965-605, Software-Revenue Recognition, to exclude from its requirements
(i) non-software components of tangible products and (ii) software components of
tangible products that are sold, licensed, or leased with tangible products when
the software components and non-software components of the tangible product
function together to deliver the tangible product's essential functionality.
ASU No. 2009-13 and ASU No. 2009-14 also required expanded qualitative and
quantitative disclosures and were effective for fiscal years beginning on or
after June 15, 2010. We elected to adopt these updates effective for our fiscal
year beginning January 2, 2011 and have applied them prospectively from that
date for new or materially modified arrangements. The adoption of this guidance
did not have a material effect on our consolidated financial statements.
In December 2010, the FASB issued ASU No. 2010-28, Intangibles-Goodwill and
Other (ASC 350), When to Perform Step 2 of the Goodwill Impairment Test for
Reporting Units with Zero or Negative Carrying Amounts ASU No. 2010-28, which
modifies Step 1 of the goodwill impairment test for reporting units with zero or
negative carrying amounts. For those reporting units, an entity is required to
perform Step 2 of the goodwill impairment test if it is more likely than not
that a goodwill impairment exists. In determining whether it is more likely than
not that a goodwill impairment exists, an entity should consider whether there
are any adverse qualitative factors indicating that an impairment may exist. The
adoption of ASU No. 2010-28 was effective for our fiscal year beginning
January 2, 2011. The adoption of this guidance did not have a material effect on
our consolidated financial statements.
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic220) -
Presentation of Comprehensive Income, which 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. ASU 2011-05
eliminates the option to present the components of other comprehensive income as
part of the Statement of Shareholders' Equity. The items that must be reported
in other comprehensive income or when an item of other comprehensive income must
be reclassified to net income were not changed. Additionally, no changes were
made to the calculation and presentation of earnings per share. In December
2011, the FASB issued ASU 2011-12, which deferred the effective date of guidance
pertaining to the reporting of reclassification adjustments out of accumulated
other comprehensive income in ASU 2011-05. ASU 2011-12 reinstated the
requirements for the presentation of reclassifications that were in place prior
to the issuance of ASU 2011-05. The Company will adopt ASU 2011-05 effective for
our fiscal year ending December 29, 2012 and will retrospectively apply the new
presentation of comprehensive income to prior periods presented. Other than the
change in presentation and disclosure, the update will not have an impact on our
consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and
Other (Topic 350) - Testing Goodwill for Impairment, which allows an entity to
use a qualitative approach to test goodwill for impairment. ASU 2011-08 permits
an entity to first perform a qualitative assessment to determine whether it is
more likely than not that the fair value of a reporting unit is less than its
carrying value. If it is concluded that a potential exposure exists, it is
necessary to perform the currently prescribed two-step goodwill impairment test.
Otherwise, the two-step goodwill impairment test is not required. We adopted ASU
2011-08 in connection with our annual impairment test performed in the fourth
quarter of 2011. The adoption of this update did not have a material effect on
our consolidated financial statements.
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