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DAEGIS INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of the financial condition and results of operations of the Company contains forward-looking statements that involve risks and uncertainties and should be read in conjunction with the cautionary language applicable to such forward-looking statements described above in "A Caution About Forward-Looking Statements" found before Item 1 of this Form 10-K. You should not place undue reliance on these forward-looking statements which speak only as of the date of this Annual Report on Form 10-K. The following discussion should also be read in conjunction with the Consolidated Financial Statements and Notes thereto in Item 8. The Company's actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, the Risk Factors discussed in this Annual Report and in the Company's other filings with the SEC. Overview Daegis Inc. (formerly Unify Corporation) (the "Company", "we", "us" or "our") is a global provider of eDiscovery, application development, data management, migration, and archiving software solutions. The Company sells its solutions through two segments. The segments are the eDiscovery segment and the database, archive, and migration segment. Our eDiscovery solutions include technology and services that address the full spectrum of eDiscovery needs for corporate counsel and law firms. Our eDiscovery platform delivers a comprehensive solution that helps clients lower costs in all phases of the eDiscovery lifecycle from information management through search and analysis to review and production. Our database, archive, and migration business includes application development, data management and application modernization. Our tools and database software help companies to maximize value and reduce cost in the development, deployment, management and retention of business applications and data. The Company's enterprise archiving software enables corporations to preserve, manage, and dispose of their ESI for regulatory compliance and information governance. On June 29, 2010, the Company purchased Strategic Office Solutions, Inc. dba Daegis for approximately $37.4 million. Payment was made in the form of $24.0 million in cash, $7.2 million in equity, and $6.2 million in convertible notes which were subsequently converted into equity on September 1, 2010. On June 30, 2009, the Company purchased AXS-One Inc. for approximately 3.1 million shares of common stock. Critical Accounting Policies The following discussion and analysis of the Company's financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. We base our estimates on historical experience and on various other assumptions that are believed 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. On an ongoing basis, management evaluates its estimates and judgments. Actual results may differ from these estimates under different assumptions or conditions. The areas that require significant judgment are as follows. Revenue Recognition The Company generates revenue from software license sales and related services, including maintenance and support, hosting, and consulting and implementation services. The Company licenses its products to end-user customers, including corporate legal and IT departments, law firms, independent software vendors ("ISVs"), international distributors and value-added resellers ("VARs"). The Company's products are generally sold with a perpetual license. The Company's contracts with ISVs, VARs and international distributors do not include special considerations such as rights of return, stock rotation, price protection or special acceptance. The Company exercises judgment in connection with the determination of the amount of revenue to be recognized in each accounting period. The nature of each contractual arrangement determines how revenues and related costs are recognized. 26 -------------------------------------------------------------------------------- For software license arrangements that do not require significant modification or customization of the underlying software, revenue is recognized when the software product or service has been shipped or electronically delivered, the license fees are fixed and determinable, uncertainties regarding customer acceptance are resolved, collectability is probable and persuasive evidence of an arrangement exists. For fixed price arrangements that require significant modification or customization of software, the Company uses the percentage-of-completion method for revenue recognition. Under the percentage-of-completion method, progress towards completion is generally measured by labor hours. The Company considers a signed non-cancelable license agreement, a customer purchase order, a customer purchase requisition, or a sales quotation signed by an authorized purchaser of the customer to be persuasive evidence that an arrangement exists such that revenue can be recognized. The Company's customer contracts may include multi-element arrangements that include a delivered element (a software license) and undelivered elements (such as maintenance and support and/or consulting). The value allocated to the undelivered elements is unbundled from the delivered element based on vendor-specific objective evidence ("VSOE") of the fair value of the maintenance and support and/or consulting, regardless of any separate prices stated within the contract. VSOE of fair value is defined as: (i) the price charged when the same element is sold separately, or (ii) if the element has not yet been sold separately, the price for the element established by management having the relevant authority when it is probable that the price will not change before the introduction of the element into the marketplace. The Company then allocates the remaining balance to the delivered element (a software license) regardless of any separate prices stated within the contract using the residual method as the VSOE of fair value of all undelivered elements is determinable. We defer revenue for any undelivered elements, and recognize revenue for delivered elements only when the VSOE of fair value of undelivered elements are known, uncertainties regarding customer acceptance are resolved, and there are no customer-negotiated refund or return rights affecting the revenue recognized for delivered elements. If we cannot objectively determine the fair value of any undelivered element included in bundled software and service arrangements, we defer revenue until all elements are delivered and services have been performed, or until fair value can objectively be determined for any remaining undelivered elements. An assessment of the ability of the Company's customers to pay is another consideration that affects revenue recognition. In some cases, the Company sells to undercapitalized customers. In those circumstances, revenue recognition is deferred until cash is received, the customer has established a history of making timely payments or the customer's financial condition has improved. Furthermore, once revenue has been recognized, the Company evaluates the related accounts receivable balance at each period end for amounts that we believe may no longer be collectible. This evaluation is largely done based on a review of the financial condition via credit agencies and historical experience with the customer. Any deterioration in credit worthiness of a customer may impact the Company's evaluation of accounts receivable in any given period. Revenue from support and maintenance activities, which consist of fees for ongoing support and unspecified product updates, are recognized ratably over the term of the maintenance contract, typically one year, and the associated costs are expensed as incurred. Consulting and implementation services are performed on a "best efforts" basis and may be billed under time-and-materials or fixed price arrangements. Revenues and expenses relating to providing consulting services are generally recognized as the services are performed. Revenue from hosting activities, which consist of fees for storing customer data, are recognized as the services are performed, and the associated costs are expensed as incurred. Taxes collected from customers and remitted to the government are presented on a gross basis on the consolidated balance sheet. At April 30, 2012 and 2011 the Company had $48,000 and $14,000 of sales taxes payable. 27 --------------------------------------------------------------------------------Goodwill and Intangible Assets Goodwill is the excess of cost of an acquired entity over the amounts assigned to assets acquired and liabilities assumed in a business combination. Goodwill is not amortized. Goodwill is tested for impairment on an annual basis as of April 30, and between annual tests if indicators of potential impairment exist, using a fair-value-based approach. Intangible assets are amortized using the straight-line method over their estimated period of benefit. We evaluate the recoverability of intangible assets periodically and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. All of our intangible assets are subject to amortization. As a result of the impairment test, the Company recorded $15.0 million for the impairment of goodwill and intangible assets of the eDiscovery business unit. The Unify and AXS-One business units were not at risk of failing step one of the impairment test. Refer to Item 15, Note 5 for additional discussion of the goodwill and intangible asset impairment test. Deferred Tax Asset Valuation Allowance Deferred taxes are recorded for the difference between the financial statement and tax basis of the Company's assets and liabilities and net operating loss carryforwards. A valuation allowance is recorded to reduce deferred tax assets to an amount whose realization is more likely than not. U.S. income taxes are not provided on the undistributed earnings of foreign subsidiaries as they are considered to be permanently reinvested. As of April 30, 2012, the Company had $19.2 million of deferred tax assets related principally to net operating loss and capital loss carryforwards, reserves and other accruals, and various tax credits. The Company's ability to utilize net operating loss carryforwards may not be fully realized because of certain limitations imposed by the tax law related to changes in ownership. In addition, the Company's ability to ultimately realize its deferred tax assets is contingent upon the Company achieving taxable income in the future. There is no assurance that this will occur in amounts sufficient to utilize the deferred tax assets. Accordingly, management concluded that a valuation allowance be recorded to offset these deferred tax assets. Should we determine that Daegis would be able to realize the deferred tax assets in the future in excess of the recorded amount, an adjustment to the valuation allowance would be recognized in the period such determination was made. Account Receivable and Allowance for Doubtful Accounts We record trade accounts receivable at the invoiced amount and they do not bear interest. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We make these estimates based on an analysis of accounts receivable using available information on our customers' financial status and payment histories as well as the age of the account receivable. Historically, bad debt losses have not differed materially from our estimates. Accounting for Stock-based Compensation For our share-based payment awards, we make estimates and assumptions to determine the underlying value of stock options, including volatility, expected term and forfeiture rates. Changes to these estimates and assumptions may have a significant impact on the value and timing of stock-based compensation expense recognized, which could have a material impact on our financial statements. Fair Value of Common Stock Warrant Liability The Company accounts for common stock warrants in accordance with applicable accounting guidance provided in Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 815, "Derivatives and Hedging - Contracts in Entity's Own Equity" ("ASC 815"). The Company values its warrants based on open form option pricing models which, based on the relevant inputs, render the fair value estimate Level 3. The Company bases its estimates of fair value for liabilities on the amount it would pay a third-party market participant to transfer the liability and incorporates inputs such as equity prices, historical and implied volatilities, dividend rates and prices of convertible securities issued by comparable companies maximizing the use of observable inputs when available. Changes in the fair value of the warrants are reflected in the consolidated statement of operations as "Gain (loss) from change in fair value of common stock warrant liability." 28 --------------------------------------------------------------------------------Results of Operations The following table sets forth our consolidated statement of operations expressed as a percentage of total revenues for the periods indicated: Years Ended April 30, 2012 2011 2010 Revenues: eDiscovery 46.0 % 49.2 % - % Database, archive, and migration 54.0 50.8 100.0 Total revenues 100.0 100.0 100.0 Operating expenses: Direct costs of eDiscovery revenue 21.6 14.5 - Direct costs of database, archive, and migration revenue 12.4 12.0 21.3 Product development 17.6 16.5 22.6 Selling, general and administrative 43.8 52.6 61.8 Impairments of goodwill and intangible assets 34.6 34.0 - Change in fair value of contingent consideration - (0.4 ) (7.3 ) Total operating expenses 130.0 129.2 98.4 Income (loss) from operations (30.0 ) (29.2 ) 1.6 Other income (expense): Loss on extinguishment of debt (5.0 ) - - Gain (loss) from change in fair value of common stock warrant liability 2.4 1.1 (0.7 ) Interest expense (5.2 ) (7.3 ) (0.9 ) Other, net (0.2 ) - (0.1 ) Total other income (expense) (8.0 ) (6.2 ) (1.7 ) Loss before income taxes (38.0 ) (35.4 ) (0.1 ) Provision (benefit) for income taxes 0.3 0.1 (0.5 ) Net income (loss) (38.3 ) (35.5 ) 0.4 Total Revenues The Company generates revenue from eDiscovery software and service sales. All of our eDiscovery software and services sales are sold by our direct sales force in the United States. The Company also generates database, archive, and migration revenue from software license sales and related services, including maintenance, support and consulting services. We sell our database, archive, and migration solutions through our direct sales force in the United States and Europe, and through indirect channels comprised of distributors, ISVs, VARs, and other partners worldwide. Revenues from our distributor, ISV and VAR indirect channels accounted for approximately 54%, 55%, and 45% of our software license revenues for fiscal 2012, 2011 and 2010, respectively. International revenues include all our software license and service revenues from customers located outside North America. International revenues accounted for 32%, 28%, and 50% of total revenues in fiscal years 2012, 2011 and 2010, respectively. Total revenues in fiscal 2012 were $43.5 million, a decrease of $3.5 million, or 7% from fiscal 2011 revenues of $47.0 million. Total eDiscovery revenues in fiscal 2012 were $20.0 million a decrease of $3.1 million or 14% from fiscal 2011 eDiscovery revenues of $23.1 million. The decrease is primarily related to having fewer large legal matters in process in fiscal 2012 compared to fiscal 2011. The decrease is partially offset by having twelve months of eDiscovery revenue in the fiscal 2012 and only ten months of eDiscovery revenue in fiscal 2011. Total database, archive, and migration revenues in fiscal 2012 were $23.5 million, a decrease of $0.4 million or 2% from fiscal 2011 database, archive, and migration revenues of $23.9 million. 29 -------------------------------------------------------------------------------- Total revenues in fiscal 2011 were $47.0 million, an increase of $18.4 million, or 64% from fiscal 2010 revenues of $28.6 million. Total eDiscovery revenues in fiscal 2011 were $23.1 million. As the acquisition of Daegis occurred in June, 2010, there was no eDiscovery revenue in fiscal 2010. Total database, archive, and migrations revenues in fiscal 2011 were $23.9 million, a decrease of $4.7 million or 16% from fiscal 2010 database, archive, and migration revenues of $28.6 million. The decrease is primarily due to a large archive license sale that occurred in 2010 that did not occur in 2011 as well as current year delays in large government migration projects. For fiscal 2012, 2011, and 2010, total revenues derived from the United States were 68%, 72%, and 50% of total revenues, respectively. Total revenue from the United States in absolute dollars was $29.4 million for fiscal 2012, $34.0 million for fiscal 2011, and $14.3 million for fiscal 2010. Total revenue derived from all other countries was $14.1 million for fiscal 2012, $13.0 million for fiscal 2011, and $14.3 million for fiscal 2010. On a percentage basis, revenue from other countries was 32% for fiscal 2012, 28% for fiscal 2011, and 50% for fiscal 2010. Operating Expenses Direct Costs of eDiscovery Revenue. Direct costs of eDiscovery revenue consist primarily of expenses related to employees, facilities, and third party assistance that were directly related to the generation of eDiscovery revenue. Direct costs of eDiscovery revenue were $9.4 million for fiscal 2012, $6.8 million for fiscal 2011, and $0 for fiscal 2010. The increase in fiscal 2012 is primarily related to the acquisition of Daegis that occurred in June, 2010, resulting in eDiscovery having twelve months of costs included in fiscal 2012, ten months of costs included in fiscal 2011, and no costs in fiscal 2010. Direct Costs of Database, Archive, and Migration Revenue. Direct costs of database, archive, and migration revenue consist primarily of expenses related to employees, facilities, third party assistance, royalty payments, and the amortization of purchased technology from third parties that were directly related to the generation of database, archive, and migration revenue. Direct costs of database, archive, and migration revenue were $5.4 million for fiscal 2012, $5.6 million for fiscal 2011, and $6.1 million for fiscal 2010. Product Development. Product development expenses consist primarily of employee and facilities costs incurred in the development and testing of new products and in the porting of new and existing products to additional hardware platforms and operating systems. Product development costs in fiscal 2012 were $7.7 million compared to $7.7 million in fiscal 2011 and $6.5 million in fiscal 2010. The increase in product development costs in fiscal 2011 compared to fiscal 2010 was primarily the result of expenses related to additional headcount resulting from our acquisition of Daegis in June 2010. Selling, General and Administrative. Selling, general and administrative ("SG&A") expenses consist primarily of salaries and benefits, marketing programs, travel expenses, professional services, facilities expenses and bad debt expense. SG&A expenses were $19.0 million in fiscal 2012, $24.7 million for 2011 and $17.7 million for 2010. The decrease in SG&A costs in fiscal 2012 was primarily the result of expenses related to our acquisition of Daegis in June 2010. During fiscal 2011, the Company incurred approximately $1.4 million related to the transaction costs for the Daegis acquisition that were not repeated in fiscal 2012. Additionally, due to the write-off of intangible assets in fiscal 2011, amortization of intangible assets decreased approximately $1.4 million in fiscal 2012. Additionally, the Company made various cost cutting measures to reduce SG&A costs on an entity wide level. As a percentage of total revenue, SG&A expenses were 44% in fiscal 2012, 53% in fiscal 2011 and 62% in fiscal 2010. The major components of SG&A for fiscal 2012 were sales expenses of $7.8 million, marketing expenses of $2.3 million and general and administrative expenses of $8.9 million. The major components of SG&A for fiscal 2011 were sales expenses of $7.9 million, marketing expenses of $2.6 million and general and administrative expenses of $14.2 million. The major components of SG&A for fiscal 2010 were sales expenses of $8.2 million, marketing expenses of $1.5 million and general and administrative expenses of $8.0 million. Impairments of Goodwill and Intangible Assets. In connection with the Company's annual impairment analysis, in fiscal 2012 the Company recorded impairment charges of $13.5 million for the goodwill related to the acquisition of Daegis, representing 69% of its carrying value. Additionally, the Company recorded impairment charges of $1.5 million for the intangible assets related to the acquisition of Daegis. 30 -------------------------------------------------------------------------------- During the fourth quarter of the fiscal year we identified certain indicators that the goodwill and intangibles assets in our eDiscovery Division could potentially be impaired. While eDiscovery revenues had declined some in previous quarters, a new version of our eDiscovery software was released late in the third quarter which we expected would result in an increase in revenue in the fourth quarter. However, these expected revenue improvements did not materialize during the fourth quarter. Also in the fourth quarter we experienced a decrease in the number of new matters being received from existing customers and we had limited success adding new customers. Further, our stock price dropped significantly in the fourth quarter which we anticipated would negatively impact the market capitalization reconciliation analysis which is a part of the impairment testing process. Because of these factors the Company determined it necessary to perform a comprehensive review of the eDiscovery segment. As a result of this review, our estimates of future projected revenue and cash flows for the eDiscovery segment were reduced. The decision to reduce our future estimates of projected revenue and cash flows, coupled with a significant drop in our stock price were the primary factors that led to our recording of the impairment charge in the fourth quarter of fiscal 2012. In connection with the Company's annual impairment analysis, in fiscal 2011 the Company recorded impairment charges of $1.1 million for the goodwill related to the acquisition of CipherSoft, representing 100% of its carrying value, and $11.2 million for the goodwill related to the acquisition of AXS-One, representing 100% of its carrying value. Additionally, the Company recorded impairment charges of $0.4 million for the intangible assets related to the acquisition of CipherSoft and $3.3 million for the intangible assets related to the acquisition of AXS-One. The primary reason for these impairment charges is the Company's fourth quarter of fiscal 2011 decision to redirect its business focus and allocate more resources into the eDiscovery business which caused us to reduce our estimates of projected revenue and cash flows for CipherSoft and AXS-One. Change in Fair Value of Contingent Consideration. In applying ASC 805, "Business Combinations," to the June 2009 acquisition of AXS-One, the Company calculated the fair value of contingent consideration related to net license revenue on a quarterly basis and recorded any change in the calculated amount as adjustments in the statement of operations. The contingent consideration arrangement was completed and paid in full in fiscal 2011. There were no contingent consideration arrangements related to the June 2010 acquisition of Daegis. Loss on Extinguishment of Debt. The loss on extinguishment of debt is the result of the refinancing of the Hercules Term Loan and Credit Facility on June 30, 2011. The Company expensed $1.8 million of unamortized loan costs and warrant discounts on notes payable that were associated with the borrowings under the Hercules Term Loan and Credit Facility. Additionally, the Company was assessed prepayment fees of $0.4 million. Gain (Loss) from Change in Fair Value of Common Stock Warrant Liability. The change in the fair value of common stock warrant liability for the year ended April 30, 2012 resulted in a gain of $1,054,000, due primarily to a decrease in the Company's common stock share price during the period. The change in the fair value of common stock warrant liability for the year ended April 30, 2011 resulted in a gain of $519,000, due primarily to a decrease in the Company's common stock share price during the period. The change in the fair value of common stock warrant liability for the year ended April 30, 2010 resulted in a loss of $192,000, due primarily to an increase in the Company's common stock share price during the period. Interest Expense. Interest expense is primarily the result of interest from outstanding debt and was $2.3 million, $3.4 million and $0.3 million in fiscal 2012, 2011 and 2010, respectively. Fiscal 2012 interest expense consists primarily of interest on the Wells Fargo Credit Agreement that was incurred from the refinancing of the Hercules Loan Agreement plus the amortization of related debt issuance costs. Fiscal 2011 interest expense consists primarily of interest incurred on the Hercules Loan Agreement resulting from the debt financing in conjunction with the June 2010 acquisition of Daegis, plus the amortization of related debt issuance costs and the amortization of the discount on notes payable. Other, Net. Other, net consists primarily of foreign exchange rate gains and losses and other income. Other, net was ($68,000), $8,000 and ($14,000) in fiscal 2012, 2011 and 2010, respectively. Provision (Benefit) for Income Taxes. For fiscal 2012, the Company recorded $74,000 in foreign tax benefit and $227,000 for state and federal tax expense. For fiscal 2011, the Company recorded $39,000 in foreign tax benefit and $94,000 for state and federal tax expense. For fiscal 2010, the Company recorded $65,000 in foreign tax benefit and $66,000 for state and federal tax benefit. 31 --------------------------------------------------------------------------------Liquidity and Capital Resources At April 30, 2012, the Company had cash and cash equivalents of $4.8 million, compared to $4.6 million at April 30, 2011. The Company had net accounts receivable of $11.0 million as of April 30, 2012 and $15.7 million as of April 30, 2011. In June 2011, the Company entered into a new Revolving Credit and Term Loan Agreement with Wells Fargo (the "Wells Fargo Credit Agreement"). In order to secure its obligations under the Wells Fargo Credit Agreement, the Company has granted the lender a first priority security interest in substantially all of its assets. The Wells Fargo Credit Agreement consists of two term notes and a revolving credit note agreement. Term Note A is for $12.0 million payable over four years with principal payments of $300,000 quarterly plus an additional annual payment based on the Company's free cash flow for the year with any remaining amount due at maturity, June 30, 2015. The additional annual payment based on the Company's free cash flow for fiscal year 2012 is $1.7 million. This will be paid in the first quarter of fiscal 2013. The Company incurs interest at the prevailing LIBOR rate plus 5.0% per annum with a minimum rate of 6.50% (6.50% at April 30, 2012). Term Note B is a four year note for $4.0 million payable in full at maturity, June 30, 2015. The Company incurs interest at the prevailing LIBOR rate plus 10% per annum with a minimum rate of 12.0% (12.0% at April 30, 2012). As of April 30, 2012 there is $15.1 million outstanding on the term notes of which $2.6 million is current. Under the terms of the revolver, the Company can borrow up to $8.0 million. The Company incurs interest expense on funds borrowed at the prevailing LIBOR rate plus 5.0% per annum with a minimum rate of 6.50% (6.50% at April 30, 2012). The revolver has a maturity date of June 30, 2015. The total amount that can be borrowed under the Term Note A and the revolver is based on a multiplier factor of the trailing twelve months of maintenance revenue. As of April 30, 2012, the Company was eligible to borrow the entire amount of $8.0 million. As of April 30, 2012 there is $5.5 million borrowed on the revolving line of credit, none of which is current. The Wells Fargo Credit Agreement requires ongoing compliance with certain affirmative and negative covenants. The affirmative covenants include, but are not limited to: (i) maintenance of existence and conduct of business; (ii) compliance with laws; (iii) use of proceeds; and (iv) books and records and inspection. The negative covenants set forth in the Wells Fargo Credit Agreement include, but are not limited to, restrictions on the ability of the Company (and the Company's subsidiaries): (i) with certain limited exceptions, to create, incur, assume or allow to exist indebtedness; (ii) with certain limited exceptions, to create, incur, assume or allow to exist liens on properties; (iii) with certain limited exceptions, to make certain payments, transfers of property, or investments; or (iv) with certain limited exceptions, to make acquisitions. The Company is obligated to maintain certain minimum consolidated adjusted EBITDA levels, certain total leverage ratios, and certain fixed charge coverage ratios, all as calculated in accordance with the terms and definitions determining such amounts as contained in the Wells Fargo Credit Agreement. The Wells Fargo Credit Agreement also contains various information and financial reporting requirements. The Company is in compliance with all such covenants and requirements at April 30, 2012. The Wells Fargo Credit Agreement also contains customary events of default, including without limitation events of default based on payment obligations, repudiation of guaranty obligations, material inaccuracies of representations and warranties, covenant defaults, insolvency proceedings, monetary judgments in excess of certain amounts, change in control, certain ERISA events, and defaults under certain other obligations. In June 2011, the Company issued through a private placement 1,666,667 shares of preferred stock to a group of related party institutional investors at a price of $2.40 per share for a total of $4.0 million. The preferred stock will automatically convert on a 1-for-1 basis into shares of common stock of the Company upon the earlier of the second anniversary of the financing, June 30, 2013, or the date on which the Company's common stock has an average closing price above $4.00 per share during the preceding 30 trading days. The preferred stock includes an annual dividend of 10% payable in cash or stock at the Company's option. The preferred stock has no other provisions or preferences. During fiscal year 2012, the Company paid $334,247 in preferred stock dividends. As of April 30, 2012, the Company had no accrued preferred stock dividends. Except for the Wells Fargo Credit Agreement, as of April 30, 2012 the Company had no other notes payable outstanding. As of April 30, 2012, the Company has $651,000 in capital leases payable, $345,000 of which is current. 32 -------------------------------------------------------------------------------- We believe that existing cash of $4.8 million as of April 30, 2012, along with forecasted operating cash flows and the credit facilities under the Wells Fargo Credit Agreement, will provide us with sufficient working capital for us to meet our operating plan for fiscal year 2013. Our operating plan assumes normal operations for the Company and the required debt service payments. Operating Cash Flows. In fiscal 2012, we had cash flows provided by operations of $5.4 million. This compares to cash provided by operations of $0.6 million in fiscal 2011 and cash used in operations of $1.4 million in fiscal 2010. Cash flows provided by operations for fiscal 2012 principally resulted from a $4.7 million decrease in accounts receivable, $0.1 million decrease in other assets, $0.2 million increase in deferred revenue, $2.1 million of amortization of intangible assets, $1.1 million of depreciation, $0.1 million of interest added to long term debt principal, $0.9 million of stock based expenses, a $2.2 million loss on extinguishment of debt, and $15.0 million of impairments of goodwill and intangible assets. Offsetting these amounts were a $16.7 million net loss, an increase of $0.7 million in prepaid expenses and other current assets, a decrease in accounts payable of $1.0 million, a decrease in accrued compensation and related expenses of $0.4 million, a decrease in other accrued liabilities of $1.3 million, and a $1.1 million gain from the change in fair value of common stock warrant liability. In fiscal 2011, we had cash flows provided by operations of $0.6 million. Cash flows provided by operations for fiscal 2011 principally resulted from a decrease in other assets of $0.2 million, an increase in accounts payable of $0.7 million, an increase in accrued compensation of $0.6 million, an increase in other accrued liabilities of $0.1 million, an increase in other long term liabilities of $0.4 million, $3.6 million of amortization of intangible assets, $0.8 million of depreciation, $0.2 million of amortization of discount on notes payable, $0.4 million of interest added to long term debt principal, $1.0 million of stock based expenses, and $16.0 million of impairments of goodwill and intangible assets. Offsetting these amounts were a $16.7 million net loss, a $4.0 million increase in accounts receivable, an increase of $0.2 million in prepaid expenses and other current assets, a $1.8 million decrease in deferred revenue, a change in fair value of contingent consideration of $0.2 million, and a $0.5 million gain from the change in fair value of common stock warrant liability. In fiscal 2010, we had cash flows used in operations of $1.4 million. Cash flows used in operations for fiscal 2010 principally resulted from a $1.2 million increase in accounts receivable, a decrease in the valuation allowance from acquisition of $0.2 million, a decrease in accounts payable of $1.8 million, a decrease in accrued compensation of $0.2 million, a decrease in accrued acquisition costs of $0.1 million, a decrease in other accrued liabilities of $2.4 million, a decrease in other long term liabilities of $0.5 million, and a change in fair value of contingent consideration of $2.1 million. Offsetting these amounts were $0.1 million of net income, a $2.7 million increase in deferred revenue, a decrease of $0.6 million in prepaid expenses and other current assets, $2.4 million of amortization of intangible assets, $0.2 million of depreciation, $0.6 million of stock based expenses, and a loss from change in fair value of common stock warrant liability of $0.2 million. Investing Cash Flows. Cash used in investing activities was $1.1 million for fiscal 2012. The cash used consisted of $1.1 million related to the purchase of property and equipment. Cash used in investing activities was $22.7 million for fiscal 2011. The cash used consisted of $21.8 million related to the acquisition of Daegis, net of acquired cash, and $0.9 million related to the purchase of property and equipment. Cash used in investing activities was $17,000 in fiscal 2010. Financing Cash Flows. Net cash used in financing activities in fiscal 2012 was $4.0 million. In fiscal 2012 uses of cash included $4.0 million of payments on the revolving line of credit, $25.0 million of principal payments under debt obligations, $0.4 million of principal payments on capital leases, $0.6 million of loan cost payments, a $0.4 million prepayment penalty on the extinguishment of debt, and $0.3 million of preferred stock dividend payments. Offsetting these amounts were borrowings on the term loan of $16.0 million, borrowings on the revolving line of credit of $6.5 million, proceeds from the issuance of common stock of $0.2 million, and proceeds from the issuance of preferred stock of $4.0 million. Net cash provided by financing activities in fiscal 2011 was $23.6 million. In fiscal 2011 sources of cash included $24.0 million from borrowings on the term loan and $4.5 million from borrowings on the revolving line of credit. These amounts were offset by $1.9 million of payments on the revolving line of credit, $1.4 million of principal payments under debt obligations, $0.4 million of principal payments on capital leases, and $1.2 million of loan cost payments. Net cash used in financing activities in fiscal 2010 was $1.6 million. In fiscal 2010 uses of cash included $1.9 million of principal payments under debt obligations. This amount was offset by proceeds of $0.4 million from borrowings on the revolving line of credit. 33 -------------------------------------------------------------------------------- A summary of certain contractual obligations as April 30, 2012 is as follows (in thousands): Payments Due by Period 1 year After Contractual Obligations Total or less 2-3 years 4-5 years 5 years Debt financing $ 20,600 $ 2,600 $ 2,400 $ 15,600 $ - Estimated interest expense 4,294 1,466 2,624 204 - Other liabilities 123 - - - 123 Capital lease obligations 651 345 274 32 - Operating leases 5,615 1,630 2,443 1,542 - Total contractual cash obligations $ 31,283 $ 6,041 $ 7,741 $ 17,378 $ 123 Other liabilities primarily include mandatory severance costs associated with a French statutory government regulated plan covering all France employees. Recently Issued Accounting Standards In October 2009, the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidence of selling price or third-party evidence of selling price cannot be determined for deliverables in an arrangement, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. The new guidance became effective for Daegis beginning May 1, 2011. This guidance was applied prospectively for revenue arrangements entered into or materially modified after May 1, 2011 and did not have an effect on our consolidated financial statements. In January 2010, the FASB issued authoritative guidance on disclosures about fair value measurements, which requires additional disclosures about transfers between Levels 1 and 2 of the fair value hierarchy and disclosures about purchases, sales, issuances, and settlements in the roll-forward of activity in Level 3 fair value measurements. The guidance also clarifies certain existing disclosures regarding the level of disaggregation at which fair value measurements are provided for each class of assets and liabilities (instead of major category) and disclosures about inputs and valuation techniques used to measure fair value for both recurring and non-recurring fair value measurements that fall in either Level 2 or Level 3. The new guidance became effective for Daegis beginning May 1, 2011. This did not have an effect on our consolidated financial statements. In December 2010, the FASB issued authoritative guidance on disclosure of supplementary pro forma information for business combinations. The new guidance specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period. The new guidance became effective for Daegis beginning May 1, 2011. The guidance will be applied prospectively for business combinations occurring after May 1, 2011. In December 2010, the FASB issued authoritative guidance on when to perform step two of the goodwill impairment test for reporting units with zero or negative carrying amounts. Under the new guidance, modifications are made to step one 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 two 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 new guidance became effective for Daegis beginning May 1, 2011. We have implemented this guidance in our fiscal 2012 goodwill impairment test. In May 2011, the FASB issued authoritative guidance to achieve common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards. This guidance clarifies the application of fair value measurement and disclosure requirements. The new guidance will be effective for Daegis beginning May 1, 2012. This guidance will not a have a material effect on the Company's consolidated financial statements. 34 -------------------------------------------------------------------------------- In September 2011, the FASB issued authoritative guidance on when to perform the two-step impairment test for goodwill. Under the new guidance, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. The new guidance includes examples of events and circumstances that an entity should consider in evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The new guidance was adopted by Daegis upon issuance. We have implemented this guidance in our fiscal 2012 goodwill impairment test. In June 2011, the FASB issued authoritative guidance on the presentation of other comprehensive income. Under the new guidance, an entity has the option 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. The new guidance will be effective for Daegis beginning May 1, 2012. This guidance will not have a have a material effect on the Company's consolidated financial statements. In December 2011, the FASB issued authoritative guidance on the disclosure of offsetting assets and liabilities. Under the new guidance, entities are required to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The new guidance will be effective for Daegis beginning May 1, 2013. This guidance is not expected to have a material effect on the Company's consolidated financial statements. 35-------------------------------------------------------------------------------- |