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INNOVARO, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Form 10-Q. This Form 10-Q contains forward-looking statements regarding the plans and objectives of management for future operations. These forward-looking statements may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by any forward-looking statements. Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words "may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend" or "project" or the negative of these words or other variations on these words or comparable terminology. These forward-looking statements are based on assumptions that may be incorrect, and we cannot assure you that the projections included in these forward-looking statements will come to pass. Our actual results could differ materially from those expressed or implied by the forward-looking statements as a result of various factors. Business Overview We are The Innovation Solutions Company focused on innovation management consulting and software. We are all about helping companies innovate and grow. We offer a comprehensive set of services and software to assure the success of any innovation project, regardless of the size or intent. Our unique combination of strategic consulting services provide innovation expertise, our new LaunchPad software product provides an integrated innovation environment, and our intelligence and insights services provide any business with the innovation support they need to drive success. These services are provided internationally from our offices in the United States and the United Kingdom. We have two business segments: Strategic Services and Intelligence and Insights Services. People are the key to providing innovation expertise through our strategic consulting services. Our people have defined and refined our methodology for over 15 years with more than 250 clients in over 750 engagements, which has created a proven effective process to get a company through the innovation cycle. This process has served to develop put Leading Edge Innovation Practices contained within our methodology. We provide strategic services to enable our clients to become more efficient by finding new avenues to grow, fighting commoditization, improving return on investment, transforming the organization, and removing barriers to innovation. Business value is delivered to clients through working with a team of seasoned and experienced professionals capable of unlocking an organization's capacity by: • Identifying and developing new segments and markets; • Creating and acting on game-changing strategies; • Building an enterprise-wide capability for innovation; • Accelerating and improving new product development processes; and • Assessing a company's innovation capability. Our intelligence and insights services business provides information to assist clients in gaining insights and making decisions. We offer expansive networks, experts in scouting, partner sourcing and licensing expertise, and world leading online marketplaces. We also provide an important foundation to successful licensing - understanding the true potential value of our clients' intellectual property "IP" and IP portfolio. We access that value and build a roadmap for our clients' use, and uncover opportunities and options to realize any latent value. We have an online information service, purpose-built for those who need it most - technology transfer, business development, intellectual property, competitive intelligence, and marketing professionals across the physical and life sciences. We also provide the insight and intelligence our clients require, applied to their markets today and into the future. From current market research to predictive intelligence, we help our clients find insights at the intersections affecting their business. Our research identifies and explains key consumer trends - including emerging trends not covered by other sources - and delivers insights about how these trends will shape the future operating environment. These services include: • Online marketplaces • Technology licensing • IP consulting • Global lifestyles and technology foresight Page 11 of 22 -------------------------------------------------------------------------------- Table of Contents Innovaro LaunchPad We are continuing the development of our innovation management software platform, Innovaro LaunchPad, which is designed to enhance and complement our innovation service offerings to clients. We have completed an external review by user clients of version one of the software, which is evolving based on their feedback, and are moving toward the launch of Innovaro LaunchPad in the marketplace. Financial Condition Our total assets were $20.2 million and $20.8 million as of March 31, 2012 and December 31, 2011, respectively. As of March 31, 2012, we had $162,000 in cash, $1.0 million in accounts receivable and contracts in process, $2.9 million in accounts payable, accrued expenses and accrued bonus, and $5.6 million in total debt outstanding. As of December 31, 2011, we had $268,000 in cash, $1.3 million in accounts receivable and contracts in process, $2.5 million in accounts payable, accrued expenses and accrued bonus, and $5.6 million in total debt outstanding. As of March 31, 2012, we had a working capital deficit of $2.2 million and an accumulated deficit of $77.8 million. Results of Operations Revenue Three Months Ended Percentage March 31, Change (in thousands, except percentages) 2012 2011 Strategic services $ 744 $ 3,028 (75 )% Intelligence and insights services 512 575 (11 )% Total revenue $ 1,256 $ 3,603 (65 )% Strategic Services Our strategic services revenue is derived from consulting services we provide to our clients. Our strategic services revenue decreased by $2.3 million for the three months ended March 31, 2012 in comparison to the three months ended March 31, 2011. This decrease is the result of the Company having a significantly lower number of contracts in the first quarter of 2012 than we had in the first quarter of 2011. We attribute the decreased contract level in 2012 to the departure of certain consulting professionals and a reduction in recurring customers. Our strategic services revenue in recent years has largely been dependent on the efforts of certain key consulting professionals whose employment contracts with us expired in April 2011. We expect that our strategic services revenue for the remainder of 2012 will increase over the first quarter of 2012, but will not reach 2011 levels. Intelligence and Insights Services Our intelligence and insights services revenue is derived from a combination of global technology licensing services, online marketplace fees, foresight and trend research revenue and IP consulting revenue. Our intelligence and insights services revenue decreased by $62,000 for the three months ended March 31, 2012 in comparison to the three months ended March 31, 2011. The decreased revenue is primarily a result of reductions of $65,000 in foresight and trend research revenue and $68,000 in online marketplace fees, partially offset by a $71,000 increase in our IP consulting revenue. The decreased revenue results from a reduction in the number of personnel selling and fulfilling projects, which has had a significant, direct impact on new sales for this line of business. Page 12 of 22 -------------------------------------------------------------------------------- Table of Contents We expect that our intelligence and insights services revenue will remain consistent with the first quarter of 2012 for the remainder of 2012. Direct Costs of Revenue Three Months Ended Percentage March 31, Change (in thousands, except percentages) 2012 2011 Direct costs of revenue - Strategic services $ 824 $ 1,682 (51 )% Direct costs of revenue - Intelligence and insights services 332 333 - % Direct costs of revenue - strategic services are comprised of salaries and related taxes, bonuses, certain outside services and other business development costs related to our strategic services business. The most significant portion of direct costs of revenue - strategic services is comprised of consulting personnel compensation, which includes bonuses. Direct costs of revenue - strategic services decreased by $858,000 for the three months ended March 31, 2012 in comparison to the three months ended March 31, 2011. The decrease is primarily related to a reduction in the use of outside consultants due to the lower number of jobs in process during the first quarter of 2012. In addition, we had a reduction in salaries expense related to the departure of certain consulting professionals in 2011. We expect that our direct costs of revenue - strategic services will increase over the first quarter of 2012 for the remainder of 2012 in anticipation of an increase in related revenue. Direct costs of revenue - intelligence and insights services are comprised of certain salaries and related taxes, commissions, certain outside services and other direct costs related to our intelligence and insights services business. Direct costs of revenue - intelligence and insights services remained consistent for the three months ended March 31, 2012 in comparison to the three months ended March 31, 2011. We expect that our direct costs of revenue - intelligence and insights services will remain consistent with the first quarter of 2012 for the remainder of 2012. Salaries and Wages Three Months Ended Percentage March 31, Change (in thousands, except percentages) 2012 2011 Salaries and wages $ 379 $ 325 17 % As a percent of revenue 30 % 9 % 21ppt * The abbreviation "ppt" denotes percentage points. Salaries and wages include non-sales employee and officer salaries and related benefits, including bonuses and stock-based compensation, that are not otherwise allocated to direct costs of revenue. Salaries and wages increased by $54,000 for the three months ended March 31, 2012 in comparison to the three months ended March 31, 2011. The increase is primarily related to a $66,000 increase in officer salaries and a $16,000 increase in stock compensation expense as a result of having hired our CEO in April 2011. These increases were partially offset by a $28,000 decrease in administrative and other staff. We expect that our salaries and wages will remain consistent with the first quarter of 2012 for the remainder of 2012. Professional Fees Three Months Ended Percentage March 31, Change (in thousands, except percentages) 2012 2011 Professional fees $ 79 $ 88 (11 )% As a percent of revenue 6 % 2 % 4ppt Professional fees include accounting fees, legal fees and valuation expenses for our investments. Professional fees decreased by $9,000 for the three months ended March 31, 2012 in comparison to the three months ended March 31, 2011, primarily as a result of a reduction in legal fees in the first quarter of 2012. We expect that our professional fees will remain consistent with the first quarter of 2012 for the remainder of 2012. Page 13 of 22 -------------------------------------------------------------------------------- Table of Contents Research and Development Three Months Ended Percentage March 31, Change (in thousands, except percentages) 2012 2011 Research and development $ 100 $ 304 (67 )% As a percent of revenue 8 % 8 % -ppt Research and development expense includes salaries, outside services, travel and other costs related to the development of our LaunchPad software platform, which is designed to enhance and complement our innovation services offerings to clients. Research and development costs decreased by $203,000 for the three months ended March 31, 2012 in comparison to the three months ended March 31, 2011. The decrease is partially related to the capitalization of $45,000 in software development costs in the first quarter of 2012 rather than the allocation of such costs to research and development expense. In addition, we scaled back the amount of resources allocated to the development of LaunchPad from $300,000 in the first quarter of 2011 to approximately $165,000 in total for the first quarter of 2012. We expect that our research and development expense will remain consistent with the first quarter of 2012 for the remainder of 2012. Sales and Marketing Three Months Ended Percentage March 31, Change (in thousands, except percentages) 2012 2011 Sales and marketing $ 66 $ 61 8 % As a percent of revenue 5 % 2 % 3ppt Sales and marketing expense includes advertising, marketing, commissions paid to outside service providers, certain travel and other business development expenses. Sales and marketing expense increased by $5,000 for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. The increase relates primarily to increased participation in conferences in the first quarter of 2012. We expect that our sales and marketing expense will increase over the first quarter of 2012 for the remainder of 2012. General and Administrative Three Months Ended Percentage March 31, Change (in thousands, except percentages) 2012 2011 General and administrative $ 478 $ 505 (5 )% As a percent of revenue 38 % 14 % 24ppt General and administrative expense decreased by $27,000 for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. The decrease relates to a $30,000 reduction in insurance and other employee related costs due to having fewer employees and a $32,000 decrease in outside services and travel expense as a result of having hired our CEO in the second quarter of 2011 as opposed to paying him as a consultant; partially offset by an increase in bad debt expense of $42,000. We expect that our general and administrative expense will remain consistent with the first quarter of 2012 for the remainder of 2012. Depreciation and Amortization Three Months Ended Percentage March 31, Change (in thousands, except percentages) 2012 2011 Depreciation and amortization $ 291 $ 341 (15 )% As a percent of revenue 23 % 9 % 14ppt Page 14 of 22 -------------------------------------------------------------------------------- Table of Contents Depreciation and amortization decreased by $50,000 for the three months ended March 31, 2012 in comparison to the three months ended March 31, 2011. Amortization expense decreased by $39,000 as a result of the impairment charges related to our intangible assets that were incurred in 2011. Depreciation expense decreased by $11,000. We expect that our depreciation and amortization will remain consistent with the first quarter of 2012 for the remainder of 2012. Other (Income) Expense Three Months Ended Percentage March 31, Change (in thousands, except percentages) 2012 2011 Other (income ) expense $ (121 ) $ 7 (1,904 )% Other (income) expense includes rental income, gains and losses related to adjusting our derivative liabilities to fair value, capital gains and losses and other miscellaneous income (losses). Other (income) expense increased by $128,000 for the three months ended March 31, 2012 in comparison to the three months ended March 31, 2011. The net other income of $121,000 for the three months ended March 31, 2012 is comprised primarily of rental income of $101,000 and miscellaneous income of $20,000. The net other expense of $6,700 for the three months ended March 31, 2011 is comprised primarily of a loss of $72,000 related to adjusting our derivative liabilities to fair value and miscellaneous other net losses of $5,300, partially offset by rental income of $71,000. Interest Expense, Net Three Months Ended Percentage March 31, Change (in thousands, except percentages) 2012 2011 Interest expense, net $ 135 $ 142 (5 )% Interest expense, net decreased by $7,000 for the three months ended March 31, 2012 in comparison to the three months ended March 31, 2011. The net interest expense of $135,000 for the three months ended March 31, 2012 is primarily comprised of interest expense on long-term debt of $128,000 and amortization of our debt discount of $33,000, partially offset by interest income on our note receivable of $26,000. The net interest expense of $142,000 for the three months ended March 31, 2011 is primarily comprised of interest expense on long-term debt of $109,000 and amortization of our debt discount of $33,000. Liquidity and Capital Resources Cash Flows Cash flows from operating activities of $31,000 for the three months ended March 31, 2012 decreased $660,000 from $692,000 for the three months ended March 31, 2011. Total cash flows from operations of $31,000 in the current period are primarily attributable to: • $324,000 in non-cash depreciation and amortization; • $98,000 in non-cash stock-based compensation expense related to vesting options; • $298,000 decrease in accounts receivable and contracts in process; • $138,000 increase in deferred revenue; and • $471,000 increase in accounts payable and accrued expenses. Partially offset by: • $1.3 million net operating loss. Cash flows from investing activities of $(30,000) for the three months ended March 31, 2012 decreased $7,000 from $(23,000) for the three months ended March 31, 2011. Total cash flows from investing activities of $(30,000) are primarily attributable to capitalization of software development costs. Cash flows from financing activities of $(101,000) for the three months ended March 31, 2012 increased $191,000 from $(292,000) for the three months ended March 31, 2011. Total cash flows from financing activities of $(101,000) are related to principal payments on long-term debt. Page 15 of 22 -------------------------------------------------------------------------------- Table of Contents Software Development Costs We are continuing the development of our LaunchPad software, which is designed to enhance and complement our innovation service offerings to clients. We will continue to incur costs related to the refinement of Version 1.0 while proceeding with the development of the next components of LaunchPad with Version 2.0. As of March 31, 2012, we had invested $2.2 million in this software platform. We expect to incur approximately $300,000 in additional expenditures for product development of Version 2.0 and refinement of Version 1.0 during 2012. Liquidity We have incurred recurring losses and negative cash flows from operations. We incurred a net loss of approximately $1.3 million and $4.9 million for the three months ended March 31, 2012 and the year ended December 31, 2011, respectively. In addition, we have a working capital deficit of approximately $2.2 million and an accumulated deficit of approximately $77.8 million as of March 31, 2012. These factors raise doubt about our ability to continue as a going concern. Our primary cash requirements include working capital, research and development expenditures, principal and interest payments on indebtedness, and employee salaries and bonuses. Our primary sources of funds are cash received from customers in connection with operations and, to a lesser extent, proceeds from the sale from time to time of our investments. We currently intend to fund our liquidity needs, including our software development costs, with existing cash balances, cash generated from operations, collections of our existing receivables and the potential sales of our investments. Given our cash position, working capital deficit and expected revenues in the near term, we do not expect that we will be able to fund our scheduled debt service payments of $1.6 million and our operating requirements for the next twelve months. We are exploring opportunities for obtaining a credit facility, as well as selling equity securities and certain other assets. In addition, we have the capability to delay all cash intensive activities, including our software development costs, and will look to reduce costs further. However, if such measures prove inadequate, we could face liquidity problems and might be required to reduce or delay planned capital expenditures and other initiatives and sell assets, and we may be unable to take any of these actions on satisfactory terms or in a timely manner. Further, any of these actions may not be sufficient to allow us to service our debt obligations or may have an adverse impact on our business. Our failure to generate sufficient cash from our operations could have a material adverse effect on us. Our future success depends on our ability to raise capital and ultimately generate revenue and attain profitability. We cannot be certain that additional capital, whether through selling additional debt or equity securities or obtaining a line of credit or other loan, will be available to us or, if available, will be on terms acceptable to us. If we issue additional securities to raise funds, these securities may have rights, preferences, or privileges senior to those of our common stock, and our current shareholders may experience dilution. If we are unable to obtain funds when needed or on acceptable terms, we may be required to curtail our current development programs, cut operating costs and forego future development and other opportunities. Without sufficient capital to fund our operations, we will be unable to continue as a going concern. Critical Accounting Estimates The preparation of financial statements in conformity with GAAP requires management to make assessments, estimates and assumptions that affect the amounts reported in the financial statements. We evaluate the accounting policies and estimates used to prepare the financial statements on an ongoing basis. Critical accounting estimates are those that require management's most difficult, complex, or subjective judgments and have the most potential to impact our financial position and operating results. For a detailed discussion of our critical accounting estimates, see our Annual Report on Form 10-K for the year ended December 31, 2011. There have been no material changes to our critical accounting estimates during the three months ended March 31, 2012. |