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SMITH MICRO SOFTWARE 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 our financial condition and results of operations
should be read in conjunction with our consolidated financial statements and the
related notes and other financial information appearing elsewhere in this Annual
Report. Readers are also urged to carefully review and consider the various
disclosures made by us which attempt to advise interested parties of the factors
which affect our business, including without limitation the disclosures made in
Item 1A of Part I of this Annual Report under the caption "Risk Factors."
Risk factors that could cause actual results to differ from those contained in
the forward-looking statements include but are not limited to: deriving revenues
from a small number of products; our dependence upon the large carrier customers
for a significant portion of our revenues; potential fluctuations in quarterly
results; potential further impairments of long-lived assets; our failure to
successfully compete; changes in technology; our entry into new markets; failure
of our customers to adopt new technologies; loss of key personnel; failure to
maintain strategic relationships with device manufacturers; failure of our
products to achieve broad acceptance; uncertainty and volatility of current
global economic conditions; our failure to successfully integrate acquisitions;
undetected software defects; our failure to protect intellectual property;
exposure to intellectual property claims; security and privacy breaches in our
systems or interruptions or delays in the services we provide which could damage
client relations; our inability to raise more funds to meet our capital needs;
being delisted from NASDAQ; and doing business internationally.
Introduction and Overview
Smith Micro Software, Inc. provides software and services that simplify, secure
and enhance the mobile experience. The Company's portfolio of wireless solutions
includes a wide range of client and server applications that manage voice, data,
video and connectivity over mobile broadband networks. Our primary customers are
the world's leading mobile network operators, mobile device manufacturers and
enterprise businesses. In addition to our wireless and mobility software, Smith
Micro offers personal productivity and graphics products distributed through a
variety of consumer channels worldwide.
The proliferation of mobile broadband technology continues to provide new
opportunities for Smith Micro on a global basis. Over the last decade, the
Company has developed extensive expertise in embedded software for networked
devices (both wireless and wired), and we have leveraged that expertise to solve
an unending tide of connectivity and mobile service challenges for our
customers. As network operators and businesses struggle to reduce costs and
complexity in a market that is characterized by rapid evolution and
fragmentation, Smith Micro answers with innovative solutions that increase
reliability, security, performance, efficiency, and usability of wireless
services over a wide variety of networks and device platforms.
The underlying philosophy driving our products and services is our desire to
improve the user experience and optimize resources for our customers. These
objectives are delivered through the combination of rigorous market analysis and
planning, technology innovation that leverages substantial intellectual
property, leadership in industry standards, quality engineering, and extensive
commercial deployment experience gained over 30 years. As technology, market
dynamics and consumer demands change, Smith Micro has proven its ability to
evolve and meet those demands again and again.
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During fiscal year 2011, we experienced a significant decrease in our revenues.
This was primarily due to the introduction and market acceptance of mobile
hotspot devices, Tablets and Smartphones capable of functioning as a WWAN
hotspot, resulting in lower demand in our North American marketplace for our
core connection management products. While we launched new wireless products
that addressed this technology shift, they are new to the market and their rate
of adoption and deployment is unknown at this time causing material uncertainty
regarding the timing of our future wireless revenues.
As a result of our decreased revenues, slow adoption of our new products,
operating losses and depressed stock prices, we recorded a goodwill and other
long-lived asset impairment charge of $112.9 million in fiscal year 2011. All
goodwill and intangible assets have been written off as of December 31, 2011.
For the year ended December 31, 2012, revenues to two customers and their
respective affiliates in the Wireless business segment accounted for 40.7% and
20.5% of the Company's total revenues and 78% of accounts receivable. For the
year ended December 31, 2011, revenues to three customers and their respective
affiliates in the Wireless business segment accounted for 24.8%, 18.4% and 11.7%
of the Company's total revenues and 63% of accounts receivable. For the year
ended December 31, 2010, revenues to three customers and their respective
affiliates in the Wireless business segment accounted for 40.1%, 13.9% and 12.3%
of the Company's total revenues and 78% of accounts receivable.
Results of Operations
The following table sets forth certain consolidated statement of comprehensive
income data as a percentage of total revenues for the periods indicated:
Year Ended December 31,
2012 2011 2010
Revenues 100.0 % 100.0 % 100.0 %
Cost of revenues 19.5 23.8 11.9
Gross profit 80.5 76.2 88.1
Operating expenses:
Selling and marketing 38.5 46.0 22.8
Research and development 57.2 72.2 32.8
General and administrative 46.6 43.8 18.4
Restructuring expenses 0.5 5.5 -
Goodwill and long-lived asset impairment - 195.5 -
Total operating expenses 142.8 363.0 74.0
Operating income (loss) (62.3 ) (286.8 ) 14.1
Non-operating income:
Change in fair value of contingent liability 2.8 - -
Interest and other income, net 0.2 0.2 0.1
Income (loss) before provision for income taxes (59.3 ) (286.6 ) 14.2
Provision for income tax expense (benefit) (0.5 ) (10.3 ) 4.7
Net income (loss) (58.8 )% (276.3 )% 9.5 %
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Revenues and Expense Components
The following is a description of the primary components of our revenues and
expenses:
Revenues. Revenues are net of sales returns and allowances. Our operations are
organized into two business segments:
• Wireless, which includes our QuickLink, NetWise and CommSuite
family of products; and
• Productivity & Graphics, which includes ourconsumer-based
products: Poser, Anime Studio, Manga Studio, MotionArtist and
StuffIt.
The following table shows the revenues generated by each business segment (in
thousands):
Year Ended December 31,
2012 2011 2010
Wireless $ 36,963 $ 48,711 $ 118,684
Productivity & Graphics 6,175 8,816 11,399
Corporate/Other 191 240 418
Total revenues 43,329 57,767 130,501
Cost of revenues 8,448 13,761 15,507
Gross profit $ 34,881 $ 44,006 $ 114,994
"Corporate/Other" refers to the consulting portion of our services sector which
has been de-emphasized and is not considered a strategic element of our future
plans.
Cost of revenues. Cost of revenues consists of direct product costs, royalties,
and the amortization of purchased intangibles and capitalized software.
Selling and marketing. Selling and marketing expenses consist primarily of
personnel costs, advertising costs, sales commissions, trade show expenses, and
the amortization of certain purchased intangibles. These expenses vary
significantly from quarter to quarter based on the timing of trade shows and
product introductions.
Research and development. Research and development expenses consist primarily of
personnel and equipment costs required to conduct our software development
efforts and the amortization of certain acquired intangibles.
General and administrative. General and administrative expenses consist
primarily of personnel costs, professional services and fees paid for external
service providers, space and occupancy costs, and legal and other public company
costs.
Restructuring expenses. Restructuring expenses consist primarily of one-time
employee termination benefits, lease and other contract terminations and costs
to consolidate facilities and relocate employees.
Goodwill and long-lived asset impairment. Goodwill and long-lived asset
impairment charges are a result of determining that the recoverability of the
carrying value of goodwill, intangible assets, and fixed assets will not be
realized.
Change in fair value of contingent liability. This is the return-to-profit of a
milestone payment accrual that we did not have to pay.
Interest and other income, net. Interest and other income, net is primarily
related to our average cash and short term investment balances during the period
and vary among periods. Our other excess cash is invested in short term
marketable equity and debt securities classified as cash equivalents.
Provision for income tax expense (benefit). The Company accounts for income
taxes as required by Financial Accounting Standards Board ("FASB") Accounting
Standards Codification ("ASC") Topic No. 740, Income Taxes. This statement
requires the recognition of deferred tax assets and liabilities for the future
consequences of events that have been recognized in the Company's financial
statements or tax returns. Measurement of the deferred items is based on enacted
tax laws. In the event the future
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consequences of differences between financial reporting bases and tax bases of
the Company's assets and liabilities result in a deferred tax asset, we are
required to evaluate the probability of being able to realize the future
benefits indicated by such asset. The deferred tax assets are reduced by a
valuation allowance if, based upon all available evidence, it is more likely
than not that some or all of the deferred tax assets will not be realized.
Establishing, reducing or increasing a valuation allowance in an accounting
period generally results in an increase or decrease in tax expense in the
statement of operations. We must make significant judgments to determine the
provision for income taxes, deferred tax assets and liabilities, unrecognized
tax benefits and any valuation allowance to be recorded against deferred tax
assets. After consideration of the Company's three year cumulative loss position
as of December 31, 2011 and sources of taxable income, the Company recorded a
valuation allowance related to its U.S.-based deferred tax amounts, with a
corresponding charge to income tax expense, of $53.2 million for the year ended
December 31, 2011.
Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011
Revenues. Revenues of $43.3 million for fiscal year 2012 decreased $14.5
million, or 25.0%, from $57.8 million for fiscal year 2011. Wireless revenues of
$36.9 million decreased $11.8 million, or 24.1%, primarily due to lower sales of
our base business connection manager products to our carrier customers of $15.5
million and PC OEM customers of $3.2 million, partially offset by higher sales
of our CommSuite products of $3.9 million and NetWise products of $3.0 million.
Productivity & Graphics sales decreased $2.6 million, or 30.0%, primarily due to
lower sell through at large retailers and lower overall demand. Corporate/Other
sales decreased $0.1 million as we continue to de-emphasize this business. Due
to the introduction and market acceptance of mobile hotspot devices, Tablets and
Smartphones capable of functioning as a WWAN hotspot, our core connection
management products continue to experience lower demand in our North American
marketplace. We have launched new wireless products and services, but they are
new to the market and their rate of adoption and deployment is unknown at this
time causing material uncertainty regarding the timing of our future wireless
revenues.
Cost of revenues. Cost of revenues of $8.4 million for fiscal year 2012
decreased $5.4 million, or 38.6%, from $13.8 million for fiscal year 2011.
Amortization of intangibles decreased $3.8 million due to the impairment charge
we recorded for these assets in fiscal year 2011. There was no amortization of
intangibles in fiscal year 2012. Direct product costs decreased $1.6 million
primarily due to cost reductions.
Gross profit. Gross profit of $34.9 million or 80.5% of revenues for fiscal year
2012 decreased $9.1 million, or 20.7%, from $44.0 million, or 76.2% of revenues
for fiscal year 2011. The 4.3 percentage point increase in gross profit was
primarily due to no amortization of intangibles in fiscal year 2012 of 6.5
points, partially offset by lower product margins of 2.2 points as a result of
the lower revenues not absorbing our fixed overhead costs.
Selling and marketing. Selling and marketing expenses of $16.7 million for
fiscal year 2012 decreased $9.9 million, or 37.3%, from $26.6 million for fiscal
year 2011. This decrease was primarily due to lower personnel related expenses
of $5.8 million and lower third party commissions and advertising costs of $0.8
million. Amortization of intangibles decreased $2.1 million due to the
impairment charge we recorded for these assets in fiscal year 2011. There was no
amortization of intangibles in fiscal year 2012. Stock-based compensation
decreased from $2.1 million to $0.9 million.
Research and development. Research and development expenses of $24.8 million for
fiscal year 2012 decreased $16.9 million, or 40.6%, from $41.7 million for
fiscal year 2011. Personnel related, travel and supplies and equipment expenses
decreased $16.1 million. Stock-based compensation decreased from $1.4 million to
$0.8 million, or $0.6 million. Amortization of purchased technologies decreased
$0.2 million due to the impairment charge we recorded for these assets in fiscal
year 2011. There was no amortization of purchased technologies in fiscal year
2012.
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General and administrative. General and administrative expenses of $20.2 million
for fiscal year 2012 decreased $5.0 million, or 20.0%, from $25.2 million for
fiscal year 2011. This decrease was primarily due to personnel related expenses
of $1.8 million, lower outside legal and accounting fees of $0.7 million, and
other cost reductions of $0.6 million. Stock-based compensation expense
decreased from $4.3 million to $2.4 million, or $1.9 million.
Restructuring expenses. Restructuring expenses of $0.2 million for fiscal year
2012 were related to one-time employee termination and other costs as a result
of headcount reductions. Restructuring expenses of $3.2 million for fiscal year
2011 were related to the Chicago facility shutdown of $0.8 million, the Sweden
facility shutdown of $0.8 million and other one-time employee termination and
other costs in the U.S. of $1.6 million
Goodwill and long-lived asset impairment. There were no impairment charges in
fiscal year 2012. Goodwill and long-lived asset impairment charges of $112.9
million for fiscal year 2011 were related to goodwill of $94.2 million,
intangible assets of $13.4 million, and fixed assets of $5.3 million.
Change in fair value of contingent liability. When we acquired Core Mobility in
October 2009, we established a pre-acquisition contingency made up of two
milestone payments that were part of the purchase price of the business. The
first milestone was met and $0.6 million was paid in March 2010. The second
milestone was not met and therefore not paid. The Core Mobility shareholders
disputed the second milestone in a lawsuit which was found in our favor in
August 2012. The plaintiffs chose not to appeal the decision. As a result, we
have reduced the contingent liability of $1.2 million to its fair value of $0 at
December 31, 2012.
Interest and other income, net. Interest and other income, net was $0.1 million
for both fiscal year 2012 and 2011.
Provision for income tax expense (benefit). We recorded an income tax benefit of
$0.2 million for fiscal year 2012 related to state R&D tax credits of $0.7
million, partially offset by state and foreign income taxes of $0.5 million. We
recorded an income tax benefit of $5.9 million for fiscal year 2011. The
effective tax rate for fiscal year 2011 was impacted by the valuation allowance
and carryback of losses to offset taxable income in prior years.
Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010
Revenues. Revenues of $57.8 million for fiscal year 2011 decreased $72.7
million, or 55.7%, from $130.5 million for fiscal year 2010. Wireless revenues
of $48.7 million decreased $70.0 million, or 59.0%, primarily due to lower sales
of our base business connection manager products to our carrier customers of
$58.3 million and PC OEM customers of $8.3 million and large device solutions
sales in fiscal 2010 that were not repeated in fiscal 2011 of $3.4 million.
Productivity & Graphics sales decreased $2.6 million, or 22.7%, primarily due to
low consumer spending and moving toward a more internal distribution model.
Corporate/Other sales decreased $0.1 million as we continue to de-emphasize this
business. Due to the introduction and market acceptance of mobile hotspot
devices, Tablets and Smartphones capable of functioning as a WWAN hotspot, our
core connection management products experienced lower demand in our North
American marketplace. While we have launched new wireless products that address
this technology shift, they are new to the market and their rate of adoption and
deployment is unknown at this time causing material uncertainty regarding the
timing of our future wireless revenues.
Cost of revenues. Cost of revenues of $13.8 million for fiscal year 2011
decreased $1.7 million, or 11.3%, from $15.5 million for fiscal year 2010.
Direct product costs increased $0.4 million primarily due to costs associated
with the start-up of our new backup and messaging services. Amortization of
intangibles decreased from $5.9 million to $3.8 million, or $2.1 million,
primarily due to the impairment charge we recorded for these assets in fiscal
year 2011. No future amortization of intangibles is anticipated as these assets
have been fully impaired.
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Gross profit. Gross profit of $44.0 million or 76.2% of revenues for fiscal year
2011 decreased $71.0 million, or 61.7%, from $115.0 million, or 88.1% of
revenues for fiscal year 2010. The 11.9 percentage point decrease in gross
profit was primarily due to lower product margins of 9.9 points as a result of
the lower revenues not absorbing our fixed costs and our datacenter and start-up
costs associated with our backup and messaging products. Amortization of
intangibles as a percentage of revenues decreased 2.0 points primarily due to
the lower revenues and the impairment charge we recorded in fiscal 2011.
Selling and marketing. Selling and marketing expenses of $26.6 million for
fiscal year 2011 decreased $3.1 million, or 10.5%, from $29.7 million for fiscal
year 2010. This decrease was primarily due to lower personnel related expenses
of $0.9 million, lower advertising costs of $0.2 million and lower travel costs
of $0.1 million. Stock-based compensation decreased from $3.1 million to $2.1
million, or $1.0 million. Amortization of intangibles decreased from $3.0
million to $2.1 million, or $0.9 million. No future amortization of intangibles
is anticipated as these assets have been fully impaired.
Research and development. Research and development expenses of $41.7 million for
fiscal year 2011 decreased $1.0 million, or 2.5%, from $42.7 million for fiscal
year 2010. Personnel, recruiting and travel expenses decreased $0.4 million as a
result of implementing our restructuring plans. This decrease was offset by
increases in software maintenance and other small equipment of $0.6 million
related to our new products. Stock-based compensation decreased from $2.7
million to $1.4 million, or $1.3 million. Amortization of purchased technologies
increased from $0.1 million to $0.2 million, or $0.1 million. No future
amortization of purchased technologies is anticipated as these assets have been
fully impaired.
General and administrative. General and administrative expenses of $25.2 million
for fiscal year 2011 increased $1.1 million, or 4.7%, from $24.1 million for
fiscal year 2010. This increase was primarily due to increased space and
occupancy costs and depreciation/amortization associated with facility and
datacenter expansions in Aliso Viejo and Pittsburgh of $2.7 million and legal
expenses of $0.8 million, partially offset by lower personnel related costs of
$0.8 million and other cost decreases of $0.2 million. Stock-based compensation
expense decreased from $5.7 million to $4.3 million, or $1.4 million.
Restructuring expenses. Restructuring expenses of $3.2 million for fiscal year
2011 were related to the Chicago facility shutdown of $0.8 million, the Sweden
facility shutdown of $0.8 million and other one-time employee termination and
other costs in the U.S. of $1.6 million. There were no restructuring expenses in
2010.
Goodwill and long-lived asset impairment. Goodwill and long-lived asset
impairment charges of $112.9 million for fiscal year 2011 were related to
goodwill of $94.2 million, intangible assets of $13.4 million, and fixed assets
of $5.3 million. There were no impairment charges in 2010.
Interest and other income, net. Interest and other income, net was $0.1 million
for both fiscal year 2011 and 2010.
Provision for income tax expense (benefit). We recorded an income tax benefit of
$5.9 million for fiscal year 2011 and a tax provision of $6.2 million for fiscal
year 2010. The effective tax rate for fiscal year 2011 was impacted by the
valuation allowance and carryback of losses to offset taxable income in prior
years.
Liquidity and Capital Resources
At December 31, 2012, we had $32.2 million in cash and cash equivalents and
short-term investments and $34.8 million of working capital.
In November 2011, the Company announced that its Board of Directors had approved
a program authorizing the repurchase of up to five million shares of the
Company's common stock over a period of up to two years. Under this program,
stock repurchases may be made from time to time and the actual amount
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expended will depend on a variety of factors including market conditions,
regulatory and legal requirements, corporate cash generation and other factors.
The stock repurchases may be made in both open market and privately negotiated
transactions, and may include the use of Rule 10b5-1 trading plans. The program
does not obligate Smith Micro to repurchase any particular amount of common
stock during any period and the program may be modified or suspended at any time
at the Company's discretion. During the fiscal year 2012 we repurchased 375,000
shares at a cost of $0.8 million.
Capital expenditures were only $0.3 million for the fiscal year 2012 versus
$13.4 million for the fiscal year 2011 as we expanded our Aliso Viejo datacenter
and built out our new Pittsburgh facility in 2011.
We believe that our existing cash, cash equivalents and short-term investment
balances will be sufficient to finance our working capital and capital
expenditure requirements through at least the next twelve months. We are hopeful
that our new products will gain market acceptance in order to increase our
revenues in upcoming quarters. If our new products do not gain market
acceptance, or market acceptance is slower than anticipated, then we anticipate
that it will be necessary to undertake additional restructuring to lower costs
to bring them more in line with actual revenues, thus slowing the use of
cash. We may require additional funds to support our working capital
requirements or for other purposes and may seek to raise additional funds
through public or private equity or debt financing or from other sources. If
additional financing is needed, we cannot assure that such financing will be
available to us at commercially reasonable terms or at all.
Operating Activities
In 2012, net cash used in operations was $12.8 million primarily due to our net
loss adjusted for depreciation, amortization, non-cash stock-based compensation,
and inventory and accounts receivable reserves of $17.0 million, a decrease of
accounts payable and accrued liabilities of $2.2 million, and an increase in
accounts receivable of $1.5 million. This usage was partially offset by a
decrease of income taxes receivable of $7.6 million and a decrease in prepaid
and other assets of $0.3 million.
In 2011, net cash used in operations was $13.5 million primarily due to our net
loss adjusted for goodwill and long-lived asset impairments, depreciation,
amortization, non-cash stock-based compensation, deferred income taxes and
inventory and accounts receivable reserves of $28.0 million, an increase of
income taxes receivable of $5.4 million and a decrease in accounts payable and
accrued liabilities of $2.3 million. This usage was partially offset by a
decrease in accounts receivable of $20.0 million and lease incentives of $2.2
million.
In 2010, net cash provided by operations was $24.7 million primarily due to our
net income adjusted for depreciation, amortization, non-cash stock-based
compensation, deferred income taxes and inventory and accounts receivable
reserves of $34.0 million and a decrease in prepaid expenses of $0.3 million.
These increases were partially offset by an increase of accounts receivable due
to our increased revenue of $6.5 million, an increase in income tax receivable
of $1.9 million and an increase of all other net assets of $1.2 million.
Investing Activities
In 2012, cash provided by investing activities of $24.9 million was due to the
sale of short-term investments of $25.2 million, partially offset by capital
expenditures of $0.3 million.
In 2011, cash provided by investing activities of $2.7 million was due to the
sale of short-term investments of $16.1 million, partially offset by capital
expenditures of $13.4 million which were primarily for leasehold improvements
and to expand our datacenters.
In 2010, we used cash of $30.3 million for investing activities to purchase
short-term investments of $23.4 million, capital expenditures which primarily
were for leasehold improvements and to expand our datacenter of $6.3 million,
and for the acquisition of Avot Media of $0.6 million.
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Financing Activities
In 2012, cash used in financing activities of $0.7 million was due to the
repurchase of our common stock of $0.8 million which was partially offset by
cash received from the sale of stock for our employee stock purchase plan of
$0.1 million.
In 2011, cash provided by financing activities of $0.4 million was from the sale
of stock for our employee stock purchase plan.
In 2010, cash provided by financing activities of $8.8 million was related to
the exercise of stock options of $7.3 million and tax benefits associated with
stock-based compensation of $1.5 million.
Contractual Obligations and Commercial Commitments
As of December 31, 2012, we had no debt. The following table summarizes our
contractual obligations as of December 31, 2012 (in thousands):
Payments due by period
Less than More than
Contractual obligations: Total 1 year 1-3 years 3-5 years 5 years
Operating lease obligations $ 17,870 $ 2,611 $ 5,030 $ 3,915 $ 6,314
Purchase obligations 778 778 - - -
Total $ 18,648 $ 3,389 $ 5,030 $ 3,915 $ 6,314
During our normal course of business, we have made certain indemnities,
commitments and guarantees under which we may be required to make payments in
relation to certain transactions. These include: intellectual property
indemnities to our customers and licensees in connection with the use, sale
and/or license of our products; indemnities to various lessors in connection
with facility leases for certain claims arising from such facility or lease;
indemnities to vendors and service providers pertaining to claims based on the
negligence or willful misconduct; indemnities involving the accuracy of
representations and warranties in certain contracts; and indemnities to
directors and officers of the Company to the maximum extent permitted under the
laws of the State of Delaware. We may also issue a guarantee in the form of a
standby letter of credit as security for contingent liabilities under certain
customer contracts. The duration of these indemnities, commitments and
guarantees varies, and in certain cases, may be indefinite. The majority of
these indemnities, commitments and guarantees may not provide for any limitation
of the maximum potential for future payments we could be obligated to make. We
have not recorded any liability for these indemnities, commitments and
guarantees in the accompanying consolidated balance sheets.
Real Property Leases
Our corporate headquarters, including our principal administrative, sales and
marketing, customer support and research and development facility, is located in
Aliso Viejo, California, where we currently lease and occupy approximately
52,700 square feet of space pursuant to leases that expire on May 31, 2016 and
January 31, 2022. We lease approximately 55,600 square feet in Pittsburgh,
Pennsylvania under a lease that expires December 31, 2021. We lease
approximately 16,000 square feet in Sunnyvale, California under a lease that
expires February 28, 2015. We lease approximately 15,300 square feet in
Watsonville, California under a lease that expires September 30, 2018.
Internationally, we lease space in Belgrade, Serbia that expires December 30,
2016 and Vancouver, Canada that expires March 31, 2014.
Off-Balance Sheet Arrangements
As of December 31, 2012, we did not have any off-balance sheet arrangements.
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Critical Accounting Policies and Estimates
Our discussion and analysis of results of operations, financial condition and
liquidity are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. We base our estimates on historical experience and
on various other assumptions that are believed to be reasonable under the
circumstances. Actual results may materially differ from these estimates under
different assumptions or conditions. On an on-going basis, we review our
estimates to ensure that they appropriately reflect changes in our business or
new information as it becomes available.
We believe the following critical accounting policies affect our more
significant estimates and assumptions used in the preparation of our
consolidated financial statements:
Revenue Recognition
We currently report our net revenues under two operating groups: Wireless and
Productivity & Graphics. Within each of these groups software revenue is
recognized based on the customer and contract type. We recognize revenue when
persuasive evidence of an arrangement exists, delivery has occurred, the price
is fixed and determinable, and collectability is probable as required by FASB
ASC Topic No. 985-605, Software-Revenue Recognition. We recognize revenues from
sales of our software to our customers or end users as completed products are
shipped and title passes; or from royalties generated as authorized customers
duplicate our software, if the other requirements are met. If the requirements
are not met at the date of shipment, revenue is not recognized until these
elements are known or resolved. For Wireless sales, returns from customers are
limited to defective goods or goods shipped in error. Historically, customer
returns have not exceeded the very nominal estimates and reserves. We also
provide some technical support to our customers. Such costs have historically
been insignificant.
We have a few multiple element agreements for which we have contracted to
provide a perpetual license for use of proprietary software, to provide
non-recurring engineering, and in some cases to provide software maintenance
(post contract support). For these software and software-related multiple
element arrangements, we must: (1) determine whether and when each element has
been delivered; (2) determine whether undelivered products or services are
essential to the functionality of the delivered products and services; (3)
determine the fair value of each undelivered element using vendor-specific
objective evidence ("VSOE"), and (4) allocate the total price among the various
elements. VSOE of fair value is used to allocate a portion of the price to the
undelivered elements and the residual method is used to allocate the remaining
portion to the delivered elements. Absent VSOE, revenue is deferred until the
earlier of the point at which VSOE of fair value exists for any undelivered
element or until all elements of the arrangement have been delivered. However,
if the only undelivered element is post contract support, the entire arrangement
fee is recognized ratably over the performance period. We determine VSOE for
each element based on historical stand-alone sales to third parties or from the
stated renewal rate for the elements contained in the initial arrangement. In
determining VSOE, we require that a substantial majority of the selling prices
for a product or service fall within a reasonably narrow pricing range. We have
established VSOE for our post contract support services and non-recurring
engineering.
For Productivity & Graphics sales, management reviews available retail channel
information and makes a determination of a return provision for sales made to
distributors and retailers based on current channel inventory levels and
historical return patterns. Certain sales to distributors or retailers are made
on a consignment basis. Revenue for consignment sales are not recognized until
sell through to the final customer is established. Certain revenues are booked
net of revenue sharing payments. Sales directly to end-users are recognized upon
shipment. End users have a thirty day right of return, but such returns are
reasonably estimable and have historically been immaterial. We also provide
technical support to our customers. Such costs have historically been
insignificant.
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Sales Incentives
For our Productivity & Graphics sales, the cost of sales incentives the Company
offers without charge to customers that can be used in, or that are exercisable
by a customer as a result of, a single exchange transaction is accounted for as
a reduction of revenue as required by FASB ASC Topic No. 985-605,
Software-Revenue Recognition. We use historical redemption rates to estimate the
cost of customer incentives. Total sales incentives were $0.9 million, $1.2
million, and $2.0 million for the years ended December 31, 2012, 2011 and 2010,
respectively.
Accounts Receivable and Allowance for Doubtful Accounts
We sell our products worldwide. We perform ongoing credit evaluations of our
customers and adjust credit limits based upon payment history, the customer's
current credit worthiness and various other factors, as determined by our review
of their current credit information. We continuously monitor collections and
payments from our customers. We estimate credit losses and maintain an allowance
for doubtful accounts reserve based upon these estimates. While such credit
losses have historically been within our estimated reserves, we cannot guarantee
that we will continue to experience the same credit loss rates that we have in
the past. If not, this could have an adverse effect on our consolidated
financial statements.
Internal Software Development Costs
Development costs incurred in the research and development of new software
products and enhancements to existing software products are expensed as incurred
until technological feasibility has been established. The Company considers
technological feasibility to be established when all planning, designing, coding
and testing has been completed according to design specifications. After
technological feasibility is established, any additional costs are capitalized.
Through December 31, 2012, software has been substantially completed
concurrently with the establishment of technological feasibility; accordingly,
no costs have been capitalized to date.
Impairment of Goodwill and Long-Lived Assets
During the period ended September 30, 2011, the Company concluded that a decline
in its stock price and market capitalization was representative of the fair
value of the reporting unit as a whole.
The triggering events that led us to this conclusion were:
• Revenues - declined for the third consecutive quarter.
• New product launches - although we were in trials for several of
our new products, as of September 30, 2011 we had not realized any
revenues from these new products.
• Profitability - declined for the third consecutive quarter.
• Stock price - remained at depressed prices.
As such, the Company performed Step 1 of the goodwill impairment test which
failed, triggering Step 2. As a result of this analysis, the excess of the
carrying value of goodwill was compared to the implied fair value of goodwill
and resulted in an impairment loss of $94.2 million in the fiscal quarter ended
September 30, 2011.
As a result of the triggering events described above in our goodwill impairment
analysis, the Company reviewed its long-lived assets for recoverability. As a
result of this analysis, the Company recognized a long-lived asset impairment
charge of $18.7 million in the fiscal quarter ended September 30, 2011 which was
allocated pro-rata to the intangible assets of $13.4 million and $5.3 million to
equipment and improvements, primarily related to our leasehold improvements.
As a result of the $112.9 million goodwill and long-lived asset impairment
charge recorded in the fiscal quarter ended September 30, 2011, there were no
more goodwill or intangible assets on the balance sheet as of that date.
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Income Taxes
We account for income taxes as required by FASB ASC Topic No. 740, Income Taxes.
This Topic clarifies the accounting for uncertainty in income taxes recognized
in an enterprise's financial statements and prescribes a recognition threshold
and measurement process for financial statement recognition and measurement of a
tax position taken or expected to be taken in a tax return. The Topic also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. In the event the
future consequences of differences between financial reporting bases and the tax
bases of the Company's assets and liabilities result in a deferred tax asset, we
are required to evaluate the probability of being able to realize the future
benefits indicated by such asset. The Company records a valuation allowance to
reduce any deferred tax assets by the amount of any tax benefits that, based on
available evidence and judgment, are not expected to be realized.
The Company assesses whether a valuation allowance should be recorded against
its deferred tax assets based on the consideration of all available evidence,
using a "more likely than not" realization standard. The four sources of taxable
income that must be considered in determining whether deferred tax assets will
be realized are: (1) future reversals of existing taxable temporary differences
(i.e., offset of gross deferred tax assets against gross deferred tax
liabilities); (2) taxable income in prior carryback years, if carryback is
permitted under the applicable tax law; (3) tax planning strategies and
(4) future taxable income exclusive of reversing temporary differences and
carryforwards.
In assessing whether a valuation allowance is required, significant weight is to
be given to evidence that can be objectively verified. A significant factor in
the Company's assessment is that the Company was in a three-year historical
cumulative loss as of the end of fiscal 2011. This fact, combined with uncertain
near-term market and economic conditions, reduced the Company's ability to rely
on projections of future taxable income in assessing the realizability of its
deferred tax assets.
After a review of the four sources of taxable income as of December 31, 2011 (as
described above), and after consideration of the Company's three-year cumulative
loss position as of December 31, 2011, the Company recorded a valuation
allowance related to its U.S.-based deferred tax amounts, with a corresponding
charge to income tax expense, of $53.2 million during the year ended
December 31, 2011.
Stock-Based Compensation
The Company accounts for all stock-based payment awards made to employees and
directors based on their fair values and recognized as compensation expense over
the vesting period using the straight-line method over the requisite service
period for each award as required by FASB ASC Topic No. 718, Compensation-Stock
Compensation.
Recent Accounting Pronouncements
In December 2011, the FASB issued Accounting Standards Update ("ASU")
No. 2011-12, Comprehensive Income (Topic 220). The amendments in this Update
supersede certain pending paragraphs in ASU No. 2011-05, Comprehensive Income
(Topic 220): Presentation of Comprehensive Income, to effectively defer only
those changes in Update 2011-05 that relate to the presentation of
reclassification adjustments out of accumulated other comprehensive income. The
amendments will be temporary to allow the Board time to redeliberate the
presentation requirements for reclassifications out of accumulated other
comprehensive income for annual and interim financial statements for public,
private, and non-profit entities.
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In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220):
Presentation of Comprehensive Income. Under the amendments to this Update, 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 Company has implemented this guidance.
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurements and
Disclosures (Topic 820): Amendments to Achieve Common Fair Value Measurement and
Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update
result in common fair value measurement and disclosure requirements in U.S. GAAP
and IFRSs. Consequently, the amendments change the wording used to describe many
of the requirements in U.S. GAAP for measuring fair value and for disclosing
information about fair value measurements. The Company has implemented this
guidance and its adoption has not had an impact on its consolidated results of
operations and financial condition.
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