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ADVANT E CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) Forward looking statements This Form 10-K contains forward-looking statements, including statements regarding the expectations of future operations. For this purpose, any statements contained in this Form 10-K that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "estimate," or "continue" or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, and actual results may differ materially depending on a variety of factors, many of which are not within the Company's control. These factors include, but are not limited to, economic conditions generally and in the industries in which the Company may participate, competition within the chosen industry, including competition from much larger competitors, technological advances, and the failure to successfully develop business relationships. In light of these risks and uncertainties, you are cautioned not to place undue reliance on these forward-looking statements. The Company acknowledges that the safe harbor contained in the Litigation Reform Act of 1995 is not applicable to the disclosure in this Form 10-K. This item should be read in conjunction with "Item 8. Financial Statements and Supplementary Data" and other items contained elsewhere in this Form 10-K. 5-------------------------------------------------------------------------------- 2012 Results Compared to 2011 Executive Summary • Revenue in 2012 of $10,106,048 increased by $517,513, or 5%, compared to 2011 primarily from the sale by Edict Systems of Web EDI and EnterpiseEC products and services. • Net income in 2012 of $2,000,842 increased by $289,462, or 17%, due primarily to the additional gross margin earned on increased revenue from products sold by Edict Systems and reduced personnel-related expenses in sales and marketing. • The Company generated net cash flows from operating activities of $2,282,577 in 2012, compared to $1,961,435 in 2011, primarily on the strength of net income in both years. • The Company in 2012 declared and paid a special cash dividend of $.02 per share, totaling $1,235,405. • The Company in 2012 purchased 6,648,950 common shares for $1,683,648 pursuant to a $2,000,000 stock repurchase program. Revenue Revenue in 2012 increased by 5% compared to 2011. Revenue for Edict Systems increased by 6% and revenue for Merkur Group decreased by 1%. 2012 2011 Increase (Decrease) Amount % of Total Amount % of Total Amount % Edict Systems $ 8,778,374 87 8,244,583 86 533,791 6 Merkur Group 1,327,674 13 1,343,952 14 (16,278 ) (1 ) Revenue $ 10,106,048 100 9,588,535 100 517,513 5 Edict Systems Revenue Revenue from the sale of Internet-based Electronic Data Interchange (EDI) products and services sold by Edict Systems in 2012 and 2011 is summarized below: 2012 2011 Increase (Decrease) Amount % of Total Amount % of Total Amount % Web EDI GroceryEC $ 5,822,386 66 5,597,272 68 225,114 4 AutomotiveEC 780,047 9 705,569 9 74,478 11 Other Web EDI 180,544 2 183,002 2 (2,458 ) (1 ) EnterpriseEC 1,781,893 20 1,520,365 18 261,528 17 Other products and services 213,504 3 238,375 3 (24,871 ) (10 ) Total $ 8,778,374 100 8,244,583 100 533,791 6 • Revenue from GroceryEC increased 4% due to increased volume of transactions processed. • Revenue from AutomotiveEC increased 11% due to increased volume of transactions processed from existing customers and from new customers who are suppliers of a Canadian automotive company. • Revenue from EnterpriseEC, the Company's value added network (VAN), increased by 17% due to increased volume of EDI transactions processed for large grocery companies, increased revenue from the Company's integration solutions, and increased volume of transactions processed for small customers. Despite this increase, pricing pressures and the availability of alternate connectivity options continue to impact revenue growth for EnterpriseEC. • Revenue from other products and services decreased 10%, primarily due to decreased web-based testing and certification revenue. 6 -------------------------------------------------------------------------------- Merkur Group Revenue Revenue from the sale of software based products and services sold by Merkur Group in 2012 and 2011 is summarized below: 2012 2011 Increase (Decrease) Amount % of Total Amount % of Total Amount % Software $ 137,370 10 119,570 9 17,800 15 Hardware 28,251 2 61,701 5 (33,450 ) (54 ) Professional services 138,704 11 177,570 13 (38,866 ) (22 ) 304,325 23 358,841 27 (54,516 ) (15 ) Maintenance contracts 932,664 70 936,269 70 (3,605 ) - On-demand solutions 75,633 6 34,022 2 41,611 122 Other 15,052 1 14,820 1 232 2 1,023,349 77 985,111 73 38,238 4 Total $ 1,327,674 100 1,343,952 100 (16,278 ) (1 ) Revenue from the sale of software, hardware, and professional services decreased $54,516, as general economic conditions continue to exert a moderating effect on the sales of software and related products. This decrease was partially offset by revenue from the sale of on-demand services, which increased $41,611. Revenue from customers in foreign locations The Company has customers located in areas outside the United States, principally in Canada and to a lesser extent in Mexico, Europe, and Puerto Rico. The Company derived less than 4% of revenue from these customers in the years ended December 31, 2012 and 2011. The Company has no facilities or operations in foreign locations. Net Income Net income in 2012 compared to 2011 is summarized and discussed below: Increase 2012 2011 Amount % Edict Systems $ 1,828,146 1,596,895 231,251 14 Merkur Group 220,025 170,392 49,633 29 Amortization of intangible assets, net of income tax effects (47,329 ) (55,907 ) 8,578 15 Net Income $ 2,000,842 1,711,380 289,462 17 Net income increased due to the following: • Revenue increased by $517,513 primarily from the sale by Edict Systems of Web EDI and EnterpiseEC products and services. • Personnel-related marketing, general and administrative expenses decreased by $135,043 primarily in sales and marketing. Partially offsetting the above increases to net income were the following: • Technical personnel-related expenses increased by $165,045. • Rent-related expenses increased by $80,290 due to the relocation to a new corporate office in the fourth quarter of 2011. • Income tax expense increased by $148,058 due to increased income before income taxes. Gross margin and cost of revenue Gross margin, as a percent of revenue, was 61% in 2012 and 2011. The increased revenue of $517,513 was sufficient to cover the increased cost of revenue (primarily technical personnel-related expenses) and thereby maintain the 61% gross margin. Marketing, general and administrative expenses Marketing, general and administrative expenses decreased $101,760, or 3%, in 2012 compared to 2011 due primarily to reduced personnel-related and travel expenses in sales and marketing, partially offset by increased building rent and rent-related expenses. As a percent of sales, marketing, general and administrative expenses declined to 31% in 2012 from 34% in 2011. Liquidity and Capital Resources In 2012, the Company generated net cash flows from operating activities of $2,282,577 compared to $1,961,435 in 2011, primarily from net income adjusted for non-cash expenses. Also in 2012, the Company paid a special cash dividend of $1,235,405, made infrastructure improvements totaling $253,640, and purchased 6,648,950 common shares of its common stock at a cost of $1,683,648 pursuant to a $2,000,000 stock repurchase program announced in November 2012. 7-------------------------------------------------------------------------------- On December 13, 2012, the Company announced the abandonment of a previously announced reverse/forward stock split, which was expected to be executed in preparation for the Company's voluntary suspension of its obligation to file periodic reports with the SEC. Although the Company is committed to accomplishing this voluntary suspension, no action has been taken as of the filing of this Form 10-K. Management believes that the Company will have sufficient financial resources to meet business requirements for the next 12 months, to fund growth and other business and financial initiatives, and to achieve the Company's voluntary suspension of its obligation to file periodic reports with the SEC. The Company has available an unused line of credit in the amount of $1.5 million. Borrowings under the line of credit accrue interest at the bank's prime commercial rate, are collateralized by substantially all of the assets of the Company's subsidiaries, and are payable in full when the line of credit expires on May 25, 2013, when it is expected to be renewed. The line of credit is guaranteed by the Company's Chief Executive Officer and majority shareholder. Changes in Consolidated Balance Sheet from December 31, 2011 to December 31, 2012 Significant changes in the Consolidated Balance Sheet that occurred during 2012, and that are not described elsewhere in this Management's Discussion and Analysis of Financial Condition and Results of Operations are as follows: • Accounts receivable increased by $106,465 due primarily to a billing in December 2012 for $80,690 for software and related products. The billing was included in deferred revenue at December 31, 2012. • Accounts payable increased by $186,550 primarily due to costs of infrastructure improvements in the fourth quarter of 2012. • Deferred revenue increased by $143,654 due to the billing in December 2012 for $80,690 for software and related products described above, the timing of software maintenance billings, and increased billings for applications designed to meet specific customer specifications for services to be performed in future periods. Capitalized development costs The following table sets forth the cost and accumulated amortization of the products comprising the Software Development Costs asset at December 31, 2012: Accumulated Product Cost Amortization Net Web EDI, new version $ 579,459 433,848 145,611 The unamortized costs relate exclusively to internal use software and costs associated with website development and related enhancements. The ongoing assessment of recoverability of capitalized software development costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, anticipated future revenues, estimated economic life and changes in software and hardware technologies. Impairment of asset value is considered whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Fourth Quarter Results The Company's operating results in the fourth quarter of 2012 compared to the fourth quarter of 2011 are as follows: Fourth Fourth Quarter Quarter 2012 2011 Revenue $ 2,517,630 2,480,817 Cost of revenue 953,835 928,376 Gross margin 1,563,795 1,552,441 Marketing, general and administrative expenses 727,143 826,923 Operating income 836,652 725,518 Other income (expense), net 529 (403 ) Income before income taxes 837,181 725,115 Income tax expense 284,788 246,824 Net income $ 552,393 478,291 Earnings per share - basic and diluted $ 0.008 0.008 8 -------------------------------------------------------------------------------- Revenue Revenue in the fourth quarter of 2012 increased 1% compared to the fourth quarter of 2011. Revenue for Edict Systems increased 2% and revenue for Merkur Group decreased by 5%. Q4 2012 Q4 2011 Increase (Decrease) Amount % of Total Amount % of Total Amount % Edict Systems $ 2,205,267 88 2,152,624 87 52,643 2 Merkur Group 312,363 12 328,193 13 (15,830 ) (5 ) Revenue $ 2,517,630 100 2,480,817 100 36,813 1 Edict Systems Revenue Revenue from the sale of Internet based Electronic Data Interchange (EDI) products and services sold by Edict Systems in the fourth quarter of 2012 and 2011 is summarized below: Q4 2012 Q4 2011 Increase (Decrease) Amount % of Total Amount % of Total Amount % Web EDI GroceryEC $ 1,451,913 66 1,430,380 67 21,533 2 AutomotiveEC 193,025 9 202,082 9 (9,057 ) (4 ) Other Web EDI 53,272 2 41,392 2 11,880 29 EnterpriseEC 461,312 21 427,805 20 33,507 8 Other products and services 45,745 2 50,965 2 (5,220 ) (10 ) Total $ 2,205,267 100 2,152,624 100 52,643 2 • Revenue from GroceryEC increased by 2% due to increased volume of transactions processed. • Revenue from EnterpriseEC increased 8% due to increased volume of EDI transactions processed for large grocery companies, increased revenue from the Company's integration solutions, and increased volume of transactions processed for small customers. Merkur Group Revenue Revenue for Merkur Group decreased by $15,830, or 5%, in the fourth quarter of 2012 compared to the fourth quarter of 2011due primarily to reduced sales of software and related products. Revenue from customers in foreign locations The Company has customers located in areas outside the United States, principally in Canada and to a lesser extent in Mexico, Europe, and Puerto Rico. The Company derived less than 4% of revenue from these customers in the three-month periods ended December 31, 2012 and 2011. The Company has no facilities or operations in foreign locations. Net Income Net income in the fourth quarter of 2012 compared to the fourth quarter in 2011 is summarized and discussed below: Increase Q4 2012 Q4 2011 Amount % Edict Systems $ 517,251 455,042 62,209 14 Merkur Group 44,830 37,226 7,604 20 Amortization of intangible assets, net of income tax effects (9,688 ) (13,977 ) 4,289 31 Net Income $ 552,393 478,291 74,102 15 9 -------------------------------------------------------------------------------- Net income increased due to the following: • Revenue increased by $36,813 primarily from the sale by Edict Systems of Web EDI and EnterpriseEC products and services. • Personnel-related expenses decreased by $30,385 primarily in sales and marketing. • Rent, communications and other building expense decreased by $42,604 resulting from the closing in the fourth quarter of 2011 of an office used by Merkur Group. Partially offsetting the above increases to net income was increased income tax expenses of $37,964, due to increased income before income taxes. Gross margin and cost of revenue The Company's gross margin, as a percent of revenue, was 62% in the fourth quarter of 2012 compared to 63% in the fourth quarter of 2011. The increased revenue of $36,813 was sufficient to cover the increased technical personnel-related expenses, but not sufficient to maintain the gross margin. Marketing, general and administrative expenses Marketing, general and administrative expenses decreased $99,780, or 12%, in the fourth quarter of 2012 due primarily to reduced personnel-related and travel expenses in sales and marketing and decreased rent, communications and other building expenses from the closing of the Merkur Group office in the fourth quarter of 2011. As a result of these expenses reductions and the increased revenue described above, marketing, general and administrative expenses as a percent of sales declined to 29% in the fourth quarter of 2012 from 33% in the fourth quarter of 2011. Critical Accounting Policies and Estimates Revenue Recognition The Company recognizes revenues when, in addition to other criteria, delivery has occurred or services have been rendered. Revenue from Internet-based products and services are comprised of four components-account activation and trading partner set-up fees, monthly subscription fees, usage-based transactional fees and customer payments for the Company's development of applications designed to meet specific customer specifications. Revenue earned from account activation and trading partner set-up fees are recognized after the Company performs consultative work required in order to establish an electronic trading partnership between the customer and their desired trading partners. Trading partnerships, once established, require no ongoing effort on the part of the Company and customers are able to utilize the electronic trading partnerships either directly with their customers or via a service provider other than the Company. Revenue from monthly subscription fees is recognized over the period to which the subscription applies. Revenue from usage based transaction fees is recognized in the period in which the transactions are processed. Revenue from customer payments for the Company's development of applications designed to meet specific customer specifications is recognized over the contract period, generally twelve months. Revenue from the sale of software and related products contains multiple element arrangements, and is recognized in accordance with the provisions of Accounting Standards Codification (ASC) Topic 985-605, "Software Industry Revenue Recognition". The multiple elements include the sale of software, hardware, professional services and software maintenance contracts. The relative selling price of each element is based on vendor-specific objective evidence, and the elements in the arrangements qualify as separate units of accounting. Revenue from the sale of software and hardware is recognized when title and risk of loss are transferred, which generally occurs upon delivery. Revenue from the sale of professional services is recognized when the services are completed, which is generally soon after the delivery of the software and hardware. Even though customers have a 30-day period in which they can return the software, historically returns have not been significant. Revenue from maintenance contracts is recognized over the life of the maintenance and support contract period, generally twelve months. Revenue from the sale of software and related products are recorded at gross, and any related purchases are included in cost of revenue. Software Development Costs The Company accounts for the costs of computer software that it develops for internal use and costs associated with operation of its web sites in accordance with the ASC Topic 350, "Intangibles-Goodwill and Other" by capitalizing those costs. Such capitalized costs represent solely the salaries and benefits of employees working on the graphics and content development stages, or adding functionality or features. In accordance with ASC Topic 350, overhead, general and administrative and training costs are not capitalized. The Company accounts for the costs of computer software that it sells, leases and markets as a separate product in accordance with ASC Topic 985, "Software". Capitalized costs are amortized by the straight-line method over the remaining estimated economic lives of the software application, generally three years, and are reported at the lower of unamortized cost or net realizable value. 10 -------------------------------------------------------------------------------- The ongoing assessment of recoverability of capitalized software development costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, anticipated future revenues, estimated economic life and changes in software and hardware technologies. Impairment of asset value is considered whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Software Maintenance Costs Prepaid software maintenance costs represent amounts paid to the primary software supplier of Merkur Group, Inc. for providing program upgrades and software modifications to remediate programming errors during the lives of the related customer maintenance and support contracts. These costs are charged to expense over the lives of the maintenance and support contract periods, generally twelve months. Goodwill and Other Intangible Assets Goodwill represents the excess of the Company's purchase price over the fair value of the net identifiable assets of Merkur Group, Inc., acquired on July 2, 2007. Other intangible assets, which arose from the acquisition of Merkur Group, Inc., consist of contractual vendor relationships, customer relationships, and proprietary computer software, and were initially recorded at fair values using the income or cost approach. Other intangible assets are amortized on a straight-line basis over their estimated useful lives of five to seven years. Management assesses goodwill for impairment on an annual basis at year-end, and between annual tests if an event occurs or circumstances change that may more likely than not reduce the fair value of the reporting unit below its carrying value. Significant management judgment is required in assessing the impairment of goodwill, including the assignment of assets and liabilities and determination of fair value. Management uses the discounted cash flow method, which requires significant judgments and assumptions for estimates of future cash flows, growth rate, and useful life of the cash flows, and determination of the cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment, if any. Recently Issued Accounting Pronouncements For a description of recently issued accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on the Company's consolidated condensed financial statements, see Note 1: Recently Issued Accounting Pronouncements in the Notes to Consolidated Condensed Financial Statements of this Form 10-K. |