[March 08, 2013] NEULION, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations Tweet (Edgar Glimpses Via Acquire Media NewsEdge) Management's Discussion and Analysis of Financial Condition and Results of Operations This management's discussion and analysis ("MD&A") of the financial condition and results of operations of the Company should be read in conjunction with our audited consolidated financial statements and accompanying notes for the years ended December 31, 2012 and 2011, which have been prepared in accordance with United States generally accepted accounting principles ("U.S. GAAP"). All dollar amounts are in U.S. dollars ("US$" or "$") unless stated otherwise. As at March 4, 2013 the Bank of Canada noon rate for conversion of United States dollars to Canadian dollars ("CDN$") was US$1 to CDN$1.0298. Our MD&A is intended to enable readers to gain an understanding of our current results and financial position. To do so, we provide information and analysis comparing the results of operations and financial position for the current year to those of the preceding comparable year. We also provide analysis and commentary that we believe is required to assess our future prospects. Accordingly, certain sections of this report contain forward-looking statements that are based on current plans and expectations. These forward-looking statements are affected by risks and uncertainties that are discussed in Item 1A of this Annual Report on Form 10-K and below in the section titled "Cautions Regarding Forward-Looking Statements" and that could have a material impact on future prospects. Readers are cautioned that actual results could vary from those forecasted in this MD&A. Cautions Regarding Forward-Looking Statements This MD&A contains certain forward-looking statements that reflect management's expectations regarding our growth, results of operations, performance and business prospects and opportunities. Statements about our future plans and intentions, results, levels of activity, performance, goals, achievements or other future events constitute forward-looking statements. Wherever possible, words such as "may," "will," "should," "could," "expect," "plan," "intend," "anticipate," "believe," "estimate," "predict," or "potential" or the negative or other variations of these words, or similar words or phrases, have been used to identify these forward-looking statements. These statements reflect management's current beliefs and are based on information available to management as at the date of this Annual Report on Form 10-K. Forward-looking statements involve significant risk, uncertainties and assumptions. Although the forward-looking statements contained in this MD&A are based upon what management believes to be reasonable assumptions, we cannot assure readers that actual results will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this Annual Report on Form 10-K and we assume no obligation to update or revise them to reflect new events or circumstances, except as required by law. Many factors could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including: our ability to realize some or all of the anticipated benefits of our partnerships; our ability to increase revenue; general economic and market segment conditions; our customers' subscriber levels and financial health; our ability to pursue and consummate acquisitions in a timely manner; our continued relationships with our customers; our ability to negotiate favorable terms for contract renewals; competitor activity; product capability and acceptance rates; technology changes; regulatory changes; foreign exchange risk; interest rate risk; and credit risk. These factors should be considered carefully and readers should not place undue reliance on the forward-looking statements. A more detailed assessment of the risks that could cause actual results to materially differ from current expectations is contained in Item 1A, "Risk Factors." Overview NeuLion is a technology service provider that specializes in the digital video broadcasting, distribution and monetization of live and on-demand content to Internet-enabled devices. Through our cloud-based end-to-end solution, we build and manage interactive digital networks that enable our customers to provide a destination for their subscribers to view and interact with their content. We were incorporated on January 14, 2000 under the Canada Business Corporations Act and were domesticated under Delaware law on November 30, 2010. Our common stock is listed on the Toronto Stock Exchange ("TSX") under the symbol NLN. 22-------------------------------------------------------------------------------- Table of Contents Our core business and business model have evolved from being a provider of professional information technology services and international programming to a provider of customized, end-to-end interactive, video services for a wide range of professional and collegiate sports properties, cable networks and operators, content owners and distributors, and telecommunication companies. With a fundamental shift in the way media is now being consumed, technological advancements are affecting how, when and where consumers connect to content. NeuLion's technology empowers our customers to capitalize on the growing consumer demand for viewing video content on multiple types of Internet-enabled devices by enabling delivery to a range of equipment, including personal computers, laptops, mobile devices, gaming consoles, tablets, Internet-enabled TVs, third-party set top boxes ("STBs"), standard TV sets that have Internet-connected devices, and other similar consumer accessories. Our platform offers an end-to-end service, which includes content management, subscriber management, digital rights management, billing services, app creation, content delivery and advertising solutions. Key Developments in Fiscal 2012 Effective April 1, 2012, the Company amended its agreement with KyLin TV, such that, in addition to the services previously provided, KyLin TV was appointed the exclusive distributor of the Company's B2C IPTV interests. As exclusive distributor, KyLin TV obtains, advertises and markets all of the Company's B2C content, in accordance with the terms of the amendment. Accordingly, KyLin TV records the gross revenues from the Company's B2C content as well as the associated license fees, whereas the Company records revenues in accordance with the revised fee schedule in the amendment. On September 25, 2012, the Company completed a private placement for aggregate net proceeds of approximately $4.7 million, to be used for general working capital purposes. The Company sold an aggregate of 22,782,674 units at CDN$0.20 each (the "Units"), with each Unit consisting of one share of common stock and one-half of one common stock purchase warrant ("Warrant") with each full Warrant entitling the holder thereof to purchase one share of common stock at US$0.30 for thirty (30) months following closing (the "Offering"). The Vice Chairman of our Board of Directors purchased 1,745,000 Units in the Offering for CDN$349,000. The Chairman of our Board of Directors purchased 2,334,500 Units in the Offering for CDN$466,900 and loaned the Company CDN$533,100 (evidenced by a convertible note in the amount of $545,628). Upon receipt of stockholder approval, all outstanding principal and any accrued and unpaid interest owing on the convertible note will automatically convert into shares of common stock at a rate of US$0.20 per share (the "Conversion Shares") and the number of Warrants equal to one-half of the number of Conversion Shares. If stockholder approval is not received, all principal and interest (calculated (but not compounded) daily and payable in arrears at a rate of 6% per annum) will be paid on the maturity date, September 25, 2013. The agent for a portion of the subscriptions received from the Company a cash commission equal to 8% of the gross proceeds of the offering (excluding proceeds arising from Units purchased by the Chairman and Vice Chairman noted above) and broker warrants equal to 4% of the number of Units issued in the Offering. Each Broker Warrant is exercisable for one Unit at an exercise price of US$0.21 per Warrant ("Broker Unit") at any time prior to the 30 month anniversary of the closing date of the Offering. Each Broker Unit consists of one share of common stock and one-half of a Warrant, and each full Warrant entitles the holder thereof to purchase one share of common stock at US$0.30 for 30 months following the closing date of the Offering. Overall Performance Highlights † Non-GAAP Adjusted EBITDA loss (as defined below) improved by $3.6 million, or 52%, as compared to the prior year. † Cost of revenue, exclusive of depreciation and amortization, improved by 6%, as a percentage of revenue, as compared to the prior year. 23-------------------------------------------------------------------------------- Table of Contents Overview Total revenue for fiscal 2012 was $39.0 million, a decrease of $0.7 million, or 2%, from $39.7 million in fiscal 2011. The decrease in revenue was primarily attributable to the Company appointing KyLin TV as the exclusive distributor of the Company's B2C IPTV interests effective April 1, 2012 and a decrease in equipment revenue. Our net loss attributable to common stockholders for fiscal 2012 was $10.1 million, or a loss of $0.07 per basic and diluted share of common stock, compared with a net loss of $14.2 million, or a loss of $0.10 per basic and diluted share of common stock, in fiscal 2011. The improvement in net loss attributable to common stockholders of $4.1 million, or 29%, was due to the following: • a decrease in cost of revenue of $2.7 million; • a decrease in selling, general and administrative expenses, excluding stock-based compensation of $2.1 million; • a decrease in depreciation and amortization of $1.0 million (non-cash item); and • a loss on dissolution of majority-owned subsidiary of $0.2 million in fiscal 2011 (non-cash item). offset by the following: • a decrease in total revenue of $0.7 million; • an increase in research and development expenses of $0.5 million; • a $0.1 million foreign exchange loss in fiscal 2012 as compared to a nominal foreign exchange gain in 2011; • a discount on convertible note of $0.1 million in fiscal 2012 (non-cash item); • an increase in deferred income taxes of $0.3 million (non-cash item); and • an adjustment to the carrying amount of redeemable preferred stock of $0.2 million in fiscal 2011(non-cash item). Our non-GAAP Adjusted EBITDA loss (as defined below) was $3.3 million for the year ended December 31, 2012, compared with $6.9 million for the year ended December 31, 2011. The improvement in non-GAAP Adjusted EBITDA loss was due to the impact of the items noted in the net loss discussion above. We report non-GAAP Adjusted EBITDA loss because it is a key measure used by management to evaluate our results and make strategic decisions about the Company, including potential acquisitions. Non-GAAP Adjusted EBITDA loss represents net loss before interest, income taxes, depreciation and amortization, stock-based compensation, unrealized gain/loss on derivatives, investment income, non-controlling interests and foreign exchange gain/loss. This measure does not have any standardized meaning prescribed by U.S. GAAP and therefore is unlikely to be comparable to the calculation of similar measures used by other companies, and should not be viewed as an alternative to measures of financial performance or changes in cash flows calculated in accordance with U.S. GAAP. The reconciliation from net loss to non-GAAP Adjusted EBITDA loss is as follows: 24-------------------------------------------------------------------------------- Table of Contents Consolidated Statement of Operations Reconciliation: Years ended, December 31, 2012 2011 $ $ Consolidated net loss on a GAAP basis (10,078,764 ) (14,373,030 ) Depreciation and amortization 4,407,474 5,367,289 Stock-based compensation 1,627,231 1,647,422 Discount on convertible note 77,922 0 Loss on dissolution of majority-owned subsidiary 0 227,402 Deferred income taxes 612,884 299,094 Investment income and foreign exchange gain (loss) 54,918 (44,883 ) Non-GAAP Adjusted EBITDA loss (3,298,335 ) (6,876,706 ) OPERATIONS Revenue We earn revenue from four broad categories of customers: • Pro Sports This category contains all of our major, minor and junior sports league customers. These customers include the National Football League (NFL), the National Hockey League (NHL), the National Basketball Association (NBA), Ultimate Fighting Championship (UFC), Major League Soccer (MLS) and the American Hockey League (AHL). • College Sports This category contains all of our college and collegiate conference customers. We partner with many National Collegiate Athletic Association (NCAA) schools and conferences and have agreements in place with over 150 colleges, universities and related websites. These customers include the University of North Carolina, Louisiana State University, Texas A&M University and Duke University. • TV Everywhere This category contains all of our channel video distributors and operators, networks and programmers and studios and content aggregators. These customers include Independent Film Channel, Univision, China Network Television (a new media agency of China Central Television), Sky Angel, Rogers, Maple Leaf Sports and Entertainment, Outdoor Channel, TVG Network, CBC, Zon Multimedia, Cablevision MSG Varsity, Shaw Communications, Big Ten Network and KyLin TV. • Other Customers This category includes our B2C business, in which we market our own content directly to customers, and various consulting services. Effective April 1, 2012, the Company amended its agreement with KyLin TV, such that, in addition to the services previously provided, KyLin TV was appointed the exclusive distributor of the Company's B2C IPTV interests. As exclusive distributor, KyLin TV obtains, advertises and markets most of the Company's B2C content, in accordance with the terms of the amendment. Accordingly, KyLin TV records the gross revenues from the Company's B2C content as well as the associated license fees expense, whereas the Company records revenues in accordance with the revised fee schedule in the amendment. Within each of these four categories of customers, revenue is categorized as follows: 25 -------------------------------------------------------------------------------- Table of Contents • Services revenue, which consists of: • Setup fees - non-recurring and charged to customers for design, setup and implementation services. • Monthly/annual fees - recurring and charged to customers for ongoing hosting, support and maintenance. • Variable fees - recurring and earned through subscriptions, usage, advertising, support and eCommerce. † Subscription revenue consists of recurring revenue based on the number of subscribers. Revenue is typically generated on a monthly, quarterly or annual basis and can be either a fixed fee per user or a variable fee based on a percentage of the subscription price. † Usage fees are charged to customers for bandwidth and storage. † Advertising revenues are earned through the insertion of advertising impressions on websites and in streaming video at a cost per thousand impressions. † Support revenue consists of fees charged to our customers for providing customer support to their end users. † eCommerce revenues are earned through providing customers with ticketing and retail merchandising web solutions. • Equipment revenue, which is non-recurring, consists of the sale of STBs to content partners and/or end users and is recognized when title to a STB passes to our customer. Shipping revenue, STB rentals and computer hardware sales are also included in equipment revenue. Cost and Expenses Cost of services revenue Cost of services revenue primarily consists of: • revenue share payments; • broadcast operating costs (teleport fees, bandwidth usage fees, colocation fees); and • cost of advertising revenue, which is subject to revenue shares with the content provider. Cost of equipment revenue Cost of equipment revenue primarily consists of purchases of STB products and parts for resale to customers. Shipping costs are included in cost of equipment revenue. Selling, general and administrative expenses, including stock-based compensation Selling, general and administrative ("SG&A") expenses, including stock-based compensation, include: • Wages and benefits - represents compensation for our full-time and part-time employees as well as fees for consultants we use from time to time; • Stock-based compensation - represents the estimated fair value of our options, warrants and stock appreciation rights ("Convertible Securities") for financial accounting purposes, prepared using the Black-Scholes-Merton model, which requires a number of subjective assumptions, including assumptions about the expected life of the Convertible Securities, risk-free interest rates, dividend rates, forfeiture rates and the future volatility of the price of our shares of common stock. The estimated fair value of the Convertible Securities is expensed over the vesting period, which is normally four years, with the Convertible Securities vesting in equal amounts each year. However, our Board of Directors has the discretion to grant options with different vesting periods; 26-------------------------------------------------------------------------------- Table of Contents • Marketing - represents expenses for global and local marketing programs that focus on corporate marketing activities; • Professional fees - represents legal, accounting, and public and investor relations expenses; and • Other SG&A expenses - represents travel expenses, rent, office supplies, corporate IT services, credit card processing fees and other general operating expenses. Research and development Research and development costs ("R&D") primarily consist of wages and benefits for R&D department personnel. RESULTS OF OPERATIONS Fiscal 2012 to Fiscal 2011 Our consolidated financial statements for our fiscal years ended December 31, 2012 and 2011 have been prepared in accordance with U.S. GAAP. A comparison of our results of operations for those years is as follows: 2012 2011 Change $ $ % Revenue Services revenue 37,178,431 36,612,650 2 % Equipment revenue 1,804,495 3,053,732 -41 % Total Revenue 38,982,926 39,666,382 -2 % Costs and expenses Cost of services revenue, exclusive of depreciation and amortization shown separately below 12,280,658 13,985,258 -12 % Cost of equipment revenue 1,413,760 2,391,212 -41 % Selling, general and administrative, including stock-based compensation 23,541,296 25,612,668 -8 % Research and development 6,672,778 6,201,372 8 % Depreciation and amortization 4,407,474 5,367,289 -18 % 48,315,966 53,557,799 -10 % Operating loss (9,333,040 ) (13,891,417 ) -33 % Other income (expense) Gain (loss) on foreign exchange (56,244 ) 12,985 - Investment income, net 1,326 31,898 -96 % Discount on convertible note (77,922 ) - - Loss on dissolution of majority-owned subsidiary 0 (227,402 ) - (132,840 ) (182,519 ) -27 % Net and comprehensive loss before income taxes (9,465,880 ) (14,073,936 ) -33 % Deferred income taxes (612,884 ) (299,094 ) 105 % Net and comprehensive loss (10,078,764 ) (14,373,030 ) -30 % Net loss attributable to non-controlling interest - 21,485 - Net loss attributable to controlling interest (10,078,764 ) (14,351,545 ) -30 % Adjustment to the carrying amount of redeemable preferred stock - 153,233 - Net and comprehensive loss attributable to NeuLion, Inc. common stockholders (10,078,764 ) (14,198,312 ) -29 % 27-------------------------------------------------------------------------------- Table of Contents Revenue Services revenue Services revenue increased from $36.6 million for the year ended December 31, 2011 to $37.2 million for the year ended December 31, 2012. Services revenue includes revenue from TV Everywhere, pro sports, college sports and other customers and is comprised of set-up fees, annual/monthly fees and variable fees. Year-over-year variances in each sector are detailed below: Pro Sports Revenue from Pro Sports customers increased from $12.6 million for the year ended December 31, 2011 to $13.5 million for the year ended December 31, 2012. The $0.9 million improvement was the result of an increase in revenues from monthly/annual fees of $0.7 million and variable usage fees of $0.5 million offset by a decrease in revenues from setup fees of $0.3 million. College Sports Revenue from College Sports customers increased from $10.6 million for the year ended December 31, 2011 to $10.9 million for the year ended December 31, 2012. The $0.3 million increase was a result of an increase in variable subscription revenues. TV Everywhere Revenue from TV Everywhere customers increased from $9.1 million for the year ended December 31, 2011 to $10.6 million for the year ended December 31, 2012. The $1.5 million increase was a result of an increase in revenues from monthly/annual fees of $0.8 million and variable usage fees of $0.5 million. Other Customers Revenue from other customers decreased from $4.3 million for the year ended December 31, 2011 to $2.2 million for the year ended December 31, 2012. The decrease in revenue was primarily attributable to the Company appointing KyLin TV as the exclusive distributor of the Company's B2C IPTV interests effective April 1, 2012. Equipment revenue Equipment revenue decreased from $3.1 million for the year ended December 31, 2011 to $1.8 million for the year ended December 31, 2012. The $1.3 million change was due to a decrease in STB purchases by existing customers. Over 85% of our equipment revenue is generated from our TV Everywhere customers. Costs and Expenses Cost of services revenue Cost of services revenue decreased from $14.0 million for the year ended December 31, 2011 to $12.3 million for the year ended December 31, 2012. Cost of services revenue as a percentage of services revenue decreased from 38% for the year ended December 31, 2011 to 33% for the year ended December 31, 2012. The 5% improvement (as a percentage of services revenue) primarily resulted from the amendment we signed with KyLin TV discussed previously and our having negotiated lower rates on bandwidth costs. Cost of equipment revenue Cost of equipment revenue decreased from $2.4 million for the year ended December 31, 2011 to $1.4 million for the year ended December 31, 2012. Cost of equipment revenue as a percentage of equipment revenue was 78% for the year ended December 31, 2011 and 2012. 28-------------------------------------------------------------------------------- Table of Contents Selling, general and administrative expenses, including stock-based compensation Selling, general and administrative expenses, including stock-based compensation, decreased from $25.6 million for the year ended December 31, 2011 to $23.5 million for the year ended December 31, 2012. The individual variances are as follows: • Wages and benefits decreased from $17.0 million for the year ended December 31, 2011 to $16.1 million for the year ended December 31, 2012. The $0.9 million decrease was primarily a result of the amendment we signed with KyLinTV discussed previously. • Stock-based compensation expense was $1.7 million for the year ended December 31, 2011 and 2012. • Marketing expenses decreased from $0.7 million for the year ended December 31, 2011 to $0.4 million for the year ended December 31, 2012. The $0.3 million decrease as a result of the amendment we signed with KyLinTV discussed previously. • Professional fees decreased from $1.8 million for the year ended December 31, 2011 to $1.7 million for the year ended December 31, 2012. • Other SG&A expenses decreased from $4.4 million for the year ended December 31, 2011 to $3.6 million for the year ended December 31, 2012. The decrease of $0.8 million was primarily a result of a decrease in travel and bad debt expenses. Research and development Research and development costs increased from $6.2 million for the year ended December 31, 2011 to $6.7 million for the year ended December 31, 2012. The increase of $0.5 million was due to an increase in R&D employees. Depreciation and amortization Depreciation and amortization decreased from $5.4 million for the year ended December 31, 2011 to $4.4 million for the year ended December 31, 2012. The $1.0 million decrease was the result of certain fixed assets becoming fully depreciated subsequent to December 31, 2011. LIQUIDITY AND CAPITAL RESOURCES Our cash position was $11.1 million at December 31, 2012. In 2012, we used $4.9 million to fund operations, which included cash inflows from changes in operating assets and liabilities of $1.5 million. Additionally, we received $4.7 million (net) from a private placement and spent $1.1 million to purchase fixed assets. As of December 31, 2012, our principal sources of liquidity included cash and cash equivalents of $11.1 million and trade accounts receivable of $4.2 million. We closed a $4.7 million private placement on September 25, 2012; we are using the net proceeds from this private placement for general working capital purposes. We continue to closely monitor our cash balances to ensure that we have sufficient cash on hand to meet our operating needs. Management believes that we have sufficient liquidity to meet our working capital and capital expenditure requirements for at least the next twelve months. At December 31, 2012, approximately 90% of our cash and cash equivalents were held in accounts with U.S. banks that received a BBB+ rating from Standard and Poor's and an A3 rating from Moody's. The Company believes that these U.S. financial institutions are secure notwithstanding the current global economy and that we will be able to access the remaining balance of bank deposits. Our investment policy is to invest in low-risk short-term investments which are primarily term deposits. We have not had a history of any defaults on these term deposits, nor do we expect any in the future given the short term maturity of these investments. 29-------------------------------------------------------------------------------- Table of Contents We are still building out our current business. In 2006, our core business and business model evolved from providing professional information technology services and international programming to providing customized, end-to-end, interactive video services for a wide range of professional and collegiate sports properties, cable networks and operators, content owners and distributors, and telecommunication companies. From our inception, we have incurred substantial net losses and have an accumulated deficit of $85.3 million; however, our non-GAAP Adjusted EBITDA losses (as previously defined) have continuously improved year-over-year and management expects this trend to continue. We continue to review our operating structure in an attempt to maximize revenue opportunities, further reduce costs and achieve profitability. Based on our current business plan and internal forecasts, we believe that our cash on hand will be sufficient to meet our working capital and operating cash requirements for the next twelve months. However, we will require expenditures of significant funds for research and development, maintaining adequate video streaming and database software, and the construction and maintenance of our delivery infrastructure and office facilities. Cash from operations could be affected by various risks and uncertainties, including, but not limited to, the risks detailed in this Annual Report on Form 10-K. If our actual cash needs are greater than forecasted and if cash on hand is insufficient to meet our working capital and cash requirements for the next twelve months, we will require outside capital in addition to cash flow from operations in order to fund our business. Our short operating history and our current lack of profitability could each or all be factors that might negatively impact our ability to obtain outside capital on reasonable terms, or at all. If we were ever unable to obtain needed capital, we would reevaluate and reprioritize our planned capital expenditures and operating activities. We cannot assure you that we will ultimately be able to generate sufficient revenue or reduce our costs in the anticipated time frame to become profitable and have sustainable net positive cash flows. Working Capital Requirements Our net working capital at December 31, 2012 was $(2.5) million, an improvement of $0.2 million from the December 31, 2011 net working capital of $(2.7) million. Our working capital ratios at December 31, 2012 and 2011 were 0.88. Included in current liabilities at December 31, 2012 and 2011 are approximately $6.0 million and $6.6 million, respectively, of liabilities (deferred revenue and convertible note) that we do not anticipate settling in cash. Excluding these liabilities, our working capital ratios at December 31, 2012 and 2011 were 1.24 and 1.26, respectively. The change in working capital was primarily due to a decrease in current assets of $0.7 million and a decrease in current liabilities of $0.9 million. Current assets at December 31, 2012 were $18.2 million, a decrease of $0.7 million from the December 31, 2011 balance of $18.9 million. The change was primarily due to a decrease in accounts receivable. Current liabilities at December 31, 2012 were $20.6 million, a decrease of $0.9 million from the December 31, 2011 balance of $21.5 million. The change was due to a decrease in deferred revenue. 30-------------------------------------------------------------------------------- Table of Contents Cash Flows Summary balance sheet data: As at December 31, 2012 2011 $ $ Current Assets Cash and cash equivalents 11,108,107 12,346,882 Accounts receivable, net 4,193,949 3,494,077 Other receivables 348,891 309,764 Inventory 416,541 797,436 Prepaid expenses and deposits 1,185,051 1,189,311 Due from related parties 899,967 734,452 Total current assets 18,152,506 18,871,922 Current Liabilities Accounts payable 9,813,237 9,597,359 Accrued liabilities 4,766,668 5,314,308 Due to related parties 12,282 13,298 Deferred revenue 5,715,102 6,624,693 Convertible note, net of discount 320,560 - Total current liabilities 20,627,849 21,549,658 Working capital ratio 0.88 0.88 Comparative summarized cash flows: Year Ended December 31, 2012 2011 $ $ Cash used in operating activities (4,876,824 ) (3,556,164 ) Cash used in investing activities (1,106,700 ) (1,875,825 ) Cash provided by financing activities 4,744,749 4,849,546 Operating activities Cash used in operating activities for the year ended December 31, 2012 was $4.9 million. Changes in net cash used in operating activities reflect the consolidated net loss of $10.0 million for the year, less: • non-cash items in the amount of $6.6 million, which relates to stock-based compensation, depreciation and amortization, discount on convertible note and deferred income taxes; and • changes in operating assets and liabilities of $1.5 million. Investing activities Cash used in investing activities for the year ended December 31, 2012 was $1.1 million. These funds were used to purchase fixed assets. 31-------------------------------------------------------------------------------- Table of Contents Financing activities Cash provided by financing activities was $4.7 million for the year ended December 31, 2012. These funds were received from a $4.2 million private placement and a convertible note of $0.5 million. Off Balance Sheet Arrangements The Company did not have any off balance sheet arrangements as of December 31, 2012. Financial Instruments Our financial instruments are comprised of cash and cash equivalents, accounts receivable, other receivables, deposits, accounts payable, accrued liabilities, amounts due to/from related parties, and deferred revenue. Fair value of financial instruments Fair value of a financial instrument is defined as the amount for which the instrument could be exchanged in a current transaction between willing parties. The estimated fair value of our financial instruments approximates their carrying value due to the short maturity term of these financial instruments. Risks associated with financial instruments Foreign exchange risk We are exposed to foreign exchange risk as a result of transactions in currencies other than our functional currency of the United States dollar. The majority of our revenues are transacted in U.S. dollars, and the majority of our expenses are transacted in U.S. dollars. We do not use derivative instruments to hedge against foreign exchange risk. Interest rate risk We are exposed to interest rate risk on our invested cash and cash equivalents and our short-term investments. The interest rates on these instruments are based on bank rates and therefore are subject to change with the market. We do not use derivative financial instruments to reduce our interest rate risk. Credit risk We sell our services to a variety of customers under various payment terms and therefore are exposed to credit risk. We have adopted policies and procedures designed to limit this risk. The maximum exposure to credit risk at the reporting date is the carrying value of receivables. We establish an allowance for doubtful accounts that represents our estimate of incurred losses in respect of accounts receivable. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our consolidated financial statements are prepared in conformity with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. On an ongoing basis, management reviews its estimates to ensure they appropriately reflect changes in our business and new information as it becomes available. If historical results and other factors used by management to make these estimates do not reasonably predict future actual results, our consolidated financial position and results of operations could be materially impacted. We believe the following critical accounting policies involve the more significant judgments and estimates used in the preparation of our consolidated financial statements. 32 -------------------------------------------------------------------------------- Table of Contents Accounts receivable We maintain a provision for estimated losses resulting from the inability of our customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends and changes in customer payment terms. If the financial conditions of our customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. As of December 31, 2012 and 2011, the allowance for doubtful accounts was $85,882 and $64,132, respectively. Inventory We evaluate our ending inventories for estimated excess quantities and obsolescence. This evaluation includes analyses of sales levels and projections of future demand within specific time horizons. Inventories in excess of future demand are reserved. In addition, we assess the impact of changing technology and market conditions on our inventory on hand and write off inventories that are considered obsolete. Property, plant and equipment We review the carrying value of property, plant and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. If these future undiscounted cash flows are less than the carrying value of the asset, then the carrying amount of the asset is written down to its fair value, based on the related estimated discounted future cash flows. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the property, plant and equipment is used and the effects of obsolescence, demand, competition and other economic factors. Based on this assessment, no impairment was recorded for the years ended December 31, 2012 and 2011. Intangible assets We review the carrying value of our definite lived intangible assets for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. If these future undiscounted cash flows are less than the carrying value of the asset, then the carrying amount of the asset is written down to its fair value, based on the related estimated discounted future cash flows. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the intangible assets are used and the effects of obsolescence, demand, competition and other economic factors. Based on this assessment, no impairment was recorded for the years ended December 31, 2012 and 2011. Goodwill Goodwill is not amortized but is subject to an annual impairment test at the reporting unit level and between annual tests if changes in circumstances indicate a potential impairment. The Company performs this annual goodwill impairment test as of October 1 of each calendar year. Goodwill impairment is assessed based on a comparison of the fair value of each reporting unit to the underlying carrying value of the reporting unit's net assets, including goodwill. If the carrying value of the reporting unit exceeds its fair value, the Company performs the second step of the goodwill impairment test to determine the amount of the impairment loss. The second step of the impairment test involves comparing the implied fair value of the reporting unit's goodwill with its carrying amount to measure the amount of impairment loss, if any. The Company's impairment test is based on its single operating segment and reporting unit structure. For the years ended December 31, 2012 and 2011, there was no impairment loss. Stock-based compensation and other stock-based payments We account for all stock options and warrants using a fair value-based method. The fair value of each stock option and warrant granted is estimated on the date of the grant using the Black-Scholes-Merton option pricing model and the related stock-based compensation expense is recognized over the expected life of the stock option or warrant. The fair value of the warrants granted to non-employees is measured as the warrants vest. 33-------------------------------------------------------------------------------- Table of Contents Stock appreciation rights give the holder the right to elect one of three options: receive cash in an amount equal to the excess of the quoted market price over the stock appreciation right price; receive common stock in an amount equal to the fair value of the common stock less the exercise price divided by the market value of the common stock from treasury; or receive common stock by making a cash payment equal to the exercise price. Our Board of Directors has discretionary authority to accept or reject a cash payment request in whole or in part. Stock-based compensation expense is calculated as the fair value of the vested portion of the stock appreciation rights outstanding, with ongoing measurement of the outstanding liability at each reporting date. The liability is classified as a current liability on the consolidated balance sheets. If the holder elects to purchase common stock, the liability is reclassified to additional paid-in capital. Restricted share units give the holder the right to one share of common stock for each vested restricted share unit. These awards vest on a monthly basis over a four-year vesting period. Stock-based compensation expense related to restricted share unit awards is recorded based on the market value of the common stock when the common stock is issued, which generally coincides with the vesting period of these awards. Restricted stock awards give the holder the right to one share of common stock for each vested share of restricted stock. These awards vest on a yearly basis over a four year vesting period. Stock-based compensation expense is recorded based on the market value of the common stock on the grant date and recognized over the vesting period of these awards. Amortization policies and useful lives We amortize the cost of property, plant and equipment and intangible assets over the estimated useful service lives of these items. The determinations of estimated useful lives of these long-lived assets involve considerable judgment. In determining these estimates, we take into account industry trends and Company-specific factors, including changing technologies and expectations for the in-service period of these assets. On an annual basis, we reassess our existing estimates of useful lives to ensure they match the anticipated life of the technology from a revenue producing perspective. If technological change happens more quickly than anticipated, we might have to shorten our estimate of the useful life of certain equipment, which could result in higher amortization expense in future periods or an impairment charge to write down the value of this equipment. Taxes As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax expense, together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. The carrying value of our deferred tax assets is adjusted by a valuation allowance to recognize the extent to which the future tax benefits will be recognized on a more likely than not basis. Our net deferred tax liability consists primarily of indefinite lived intangibles. We record valuation allowances in order to reduce our deferred tax assets to the amount expected to be realized. In assessing the adequacy of recorded valuation allowances, we consider a variety of factors, including the scheduled reversal of deferred tax liabilities, future taxable income, and prudent and feasible tax planning strategies. Under the relevant accounting guidance, factors such as current and previous operating losses are given significantly greater weight than the outlook for future profitability in determining the deferred tax asset carrying value. Relevant accounting guidance addresses the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under such guidance, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such uncertain tax positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. 34-------------------------------------------------------------------------------- Table of Contents RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 2011, the FASB issued Accounting Standards Update No. 2011-05, "Presentation of Comprehensive Income" ("ASU No. 2011-05"), which improves the comparability, consistency, and transparency of financial reporting and increases the prominence of items reported in Other Comprehensive Income ("OCI") by eliminating the option to present components of OCI as part of the statement of changes in stockholders' equity. The amendments in this standard require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Subsequently in December 2011, the FASB issued Accounting Standards Update No. 2011-12, "Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income" ("ASU No. 2011-12"), which indefinitely defers the requirement in ASU No. 2011-05 to present on the face of the financial statements reclassification adjustments for items that are reclassified from OCI to net income in the statement(s) where the components of net income and the components of OCI are presented. The amendments in these standards do not change the items that must be reported in OCI, when an item of OCI must be reclassified to net income, or change the option for an entity to present components of OCI gross or net of the effect of income taxes. The amendments in ASU No. 2011-05 and ASU No. 2011-12 are effective for interim and annual periods beginning after December 15, 2011 and are to be applied retrospectively. We adopted ASU No. 2011-05 and ASU No. 2011-12 on January 1, 2012, and their application did not have a material impact on our consolidated financial position or results of operations. During the years presented, we did not have any amounts of comprehensive income other than net loss. In September 2011, the FASB issued Accounting Standards Update 2011-08, "Testing Goodwill for Impairment" ("ASU 2011-08"), which allows entities to use a qualitative approach to test goodwill for impairment. ASU 2011-08 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the currently prescribed two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We adopted ASU No. 2011-08 on January 1, 2012, and its application did not have a material impact on our consolidated financial position or results of operations. In July 2012, the FASB issued Accounting Standards Update ASU 2012-02, the amendments to ASC 350, "Intangibles-Goodwill and Other: Testing Indefinite-Lived Intangible Assets for Impairment" ("ASU 2012-02"). The amendments apply to all entities, both public and nonpublic, that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. In accordance with the amendments, an entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with ASC 350-30. An entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, and early adoption is permitted. We do not anticipate the adoption of the provisions of ASU 2012-02 will have a material impact on our consolidated financial position or results of operations. 35-------------------------------------------------------------------------------- Table of Contents [ Back To TMCnet.com's Homepage ]