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CTI GROUP HOLDINGS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) Overview The Company is comprised of two business segments: EIM and CAMRA. EIM designs, develops and provides electronic invoice presentment and analysis software that enables internet-based customer self-care for wireline, wireless and convergent providers of telecommunications services. EIM software and services are used primarily by telecommunications services providers to enhance their customer relationships while reducing the providers operational expenses related to paper-based invoice delivery and customer support relating to billing inquiries. CAMRA designs, develops and provides software and services used by enterprise, governmental, institutional end users and managed and hosted customers of service providers to manage their telecommunications service and equipment usage and to analyze voice, video, and data usage, record and monitor communications and perform administrative and back office functions such as cost allocation or client bill back. These applications are commonly available in the market as enterprise-grade products. Customers typically purchase the CAMRA products when upgrading or acquiring a new enterprise communications platform. The Company generates its revenues and cash from several sources: software sales, license fees, processing fees, implementation fees, and training and consulting services. The Company's software products and services are subject to changing technology and evolving customer needs which require the Company to continually invest in research and development in order to respond to such demands. The limited financial resources available to the Company require the Company to concentrate on those business segments and product lines which the Company believes will provide the greatest returns on investment. The EIM segment, as compared to the other business segment, provides the predominant share of income from operations and cash flow from operations. The majority of CAMRA segment revenues are derived from its United Kingdom operations but the Company believes that most of the growth in the CAMRA segment will occur in the United States. The Company reported revenue in the EIM segment of $2.6 million and $2.9 million for the three months ended March 31, 2013 and 2012, respectively. For the CAMRA segment, the Company recorded revenues of $1.3 million and $1.4 million for the three months ended March 31, 2013 and 2012, respectively. The Company believes that as voice and data services continue to commoditize, service providers will seek alternative business models to replace revenue lost as a result of pricing pressures. One such business model is the delivery of managed or hosted voice and video services. Traditionally, organizations that required advanced voice and video services would purchase enabling communications hardware and software, operate and maintain this equipment, and depreciate the associated capital expense over time. This approach had two major disadvantages for such organizations. The first being that organizations would experience significant capital and operational expenditures related to acquiring these advanced services. The second being that the capabilities of the acquired equipment would not materially improve as voice and video service technology evolved. Service providers recognized these challenges and began, as part of their next generation network ("NGN") strategies, to deliver managed and hosted service offerings that do not require the customer to purchase expensive equipment up-front and virtually eliminate the operational expenditures associated with managing and maintaining an enterprise-grade communications network. Service providers incrementally improve revenue by enabling competitive voice and video features while reducing costs by delivering these services on high-capacity, low-cost NGNs. Due to the profitability and average revenue per user advantage possible by delivering such managed and hosted service offerings, providers not only look at acquiring new customers but converting legacy customers onto the NGN platform. The Company believes that this conversion process is significant. Many legacy features and functions are not available on NGN platforms, primarily due to the immaturity of the service delivery model. The Company's CAMRA applications will help eliminate customer resistance to conversion to next generation platforms, while creating new revenue opportunities for service providers through the delivery of compelling value added services. In 2007, the Company marketed two applications, emPulse, a web-based communications traffic analysis solution, and SmartRecord ® IP, which enable service providers to selectively intercept communications on behalf of their hosted and managed service customers. These applications also enable managed and hosted service customers of service providers to analyze voice, video, and data usage, record and monitor communications, and perform administration and back office functions such as cost allocation or client bill back. These applications were released as enterprise-grade products. The Company anticipates that customers will purchase these products when upgrading or acquiring a new enterprise communications platform. The Company has taken the business benefits of these enterprise-grade applications and has delivered provider-grade managed and hosted service applications, enabling service providers to create a new recurring revenue stream, while ensuring that enterprise customers have the tools necessary and relevant to their particular line of business or vertical. 14-------------------------------------------------------------------------------- Table of Contents Financial Condition In the three months ended March 31, 2013, the stockholders' equity decreased $427,951 from $5,258,237 as of December 31, 2012 to $4,830,286 as of March 31, 2013 primarily as a result of the net loss of $552,391, partially off-set by other comprehensive gain, related to foreign currency translation adjustment, of $108,911, for the three months ended March 31, 2013. The Company realized a decrease in net current assets (current assets, less current liabilities) of $972,764 which was primarily attributable to a decrease in cash and accounts receivable in the three months ended March 31, 2013. At March 31, 2013, cash and cash equivalents were $1,764,197 compared to $2,345,390 at December 31, 2012, and such decrease was primarily attributable to cash used in investing activities of $348,699 along with cash used in operating activities for the three months ended March 31, 2013 of $95,697. The cash used in operating activities in the three months ended March 31, 2013 of $95,697 was primarily attributable to the net loss of $552,391 and a decrease in deferred revenue of $651,532 which was partially offset by depreciation and amortization of $503,986 and a decrease in receivables of $439,622. Cash utilized in investing activities of $348,699 related to additions to property, equipment and software. The Company generates approximately 79.6% of its revenues from operations in the United Kingdom where the functional currency, the United Kingdom pound, has weakened by 6.5% in relation to the United States dollar during the three month period ended March 31, 2013. Results of Operations (Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012) Revenues Revenues from operations for the three months ended March 31, 2013 decreased $482,511, or 11.0%, to $3,885,326 as compared to $4,367,837 for the three months ended March 31, 2012. Overall revenues decreased primarily as a result of decreased sales in the EIM segment. Revenues derived from the United Kingdom operations represented 79.6% and 77.3% of total revenues for the three months ended March 31, 2013 and 2012, respectively. The increase in the percentage of total revenues attributable to United Kingdom operations was primarily related to decreased sales in the United States CAMRA segment. The United States revenues decreased by $200,592, or 20.2%, to $792,157 for the three months ended March 31, 2013 compared to $992,749 for the three months ended March 31, 2012. Such decrease was primarily related to a decrease in revenue in the CAMRA segment sales in the United States due to fewer installations in 2013. The Company earns a substantial portion of its revenue from a single EIM customer in the United Kingdom. That customer represented approximately 24.9% of the total revenues for the three months ended March 31, 2013 and approximately 25.3% for the three months ended March 31, 2012. Cost of Products and Services Excluding Depreciation and Amortization Cost of products and services, excluding depreciation and amortization, for the three months ended March 31, 2013, decreased $112,584, or 9.7%, to $1,042,327, as compared to $1,154,911 for the three months ended March 31, 2012. The decrease was primarily related to costs associated with decreased revenue. The cost of products and services, excluding depreciation and amortization, related to the CAMRA segment decreased $15,728 to $539,312 for the three months ended March 31, 2013 from $555,040 for the three months ended March 31, 2012. The costs of products and services, excluding depreciation and amortization, related to the EIM segment decreased by $96,856 to $503,015 for the three months ended March 31, 2013 compared to $599,871 for the three months ended March 31, 2012. The cost of products and services, excluding depreciation and amortization, was 26.8% of revenue for the three months ended March 31, 2013, as compared to 26.4% of revenue for the three months ended March 31, 2012. Selling, General and Administrative Costs Selling, general and administrative expenses for the three months ended March 31, 2013 increased $26,822, or 1.5%, to $1,867,824 compared to $1,841,002 for the three months ended March 31, 2012. The increase was primarily due to professional fees incurred. Selling, general and administrative costs related to the CAMRA segment decreased by $86,441 to $647,708 for the three months ended March 31, 2013 compared to $734,149 for the three months ended March 31, 2012. Selling, general and administrative costs related to the EIM segment increased by $11,519 to $813,703 for the three months ended March 31, 2013 compared to $802,184 for the three months ended March 31, 2012. Selling, general and administrative costs related to the Corporate allocation increased by $101,744 to $406,413 for the three months ended March 31, 2013 compared to $304,669 for the three months ended March 31, 2012 which was primarily due to an increase in professional fees. 15 -------------------------------------------------------------------------------- Table of Contents Research and Development Expense Research and development expense for the three months ended March 31, 2013 increased $216,411, or 36.5%, to $808,979 as compared to $592,568 for the three months ended March 31, 2012. Research and development costs related to the CAMRA segment increased $105,776 to $387,176 for the three months ended March 31, 2013 compared to $281,400 for the three months ended March 31, 2012. Research and development expense related to the EIM segment increased $110,635 to $421,803 for the three months ended March 31, 2013 compared to $311,168 for the three months ended March 31, 2012. Research and development costs that were capitalized during the three months ended March 31, 2013 and March 31, 2012 amounted to $223,388 and $257,051, respectively. Research and development costs allocated to cost of goods sold during the three months ended March 31, 2013 and March 31, 2012 amounted to $137,442 and $219,966, respectively. Depreciation and Amortization Depreciation and amortization for the three months ended March 31, 2013 increased $58,436 to $503,986 from $445,550 in the three months ended March 31, 2012. Amortization expense of developed software, which relates to cost of sales, was presented as depreciation and amortization expense. Amortization expense of developed software which amounted to $259,498 and $186,878 for the three months ended March 31, 2013 and 2012, respectively. Other Income and Expense The Company realized interest income of $1,146 for the three months ended March 31, 2013 compared to interest income of $2,924 for the three months ended March 31, 2012. The reduction in interest income was primarily associated with a decrease in the amount of invested cash. Taxes The tax expense for the three months ended March 31, 2013 decreased $7,453, or 3.3%, to $215,747 as compared to $223,200 for the three months ended March 31, 2012. The tax expense for the three months ended March 31, 2013 and March 31, 2012 was due to the pre-tax income in the United Kingdom of $421,414 and $707,127, respectively. The increase in the effective tax rate in 2013 was caused by a true-up of the prior year provision. The Company records a valuation allowance against its net deferred tax asset to the extent management believes that it is more likely than not that the asset will not be realized. As of March 31, 2013, the Company's valuation allowance related to the net deferred tax assets in the United States. Net Income / (Loss) The Company realized a net loss for the three months ended March 31, 2013 of $552,391 compared to net income of $113,530 for the three months ended March 31, 2012. The change to a net loss was primarily associated with the reduction of revenue of $482,511 for the three months ended March 31, 2013 when compared to the three months ended March 31, 2012. Liquidity and Capital Resources Historically, the Company's principal needs for funds have been for operating activities (including costs of products and services, patent enforcement activities, selling, general and administrative expenses, research and development, and working capital needs) and capital expenditures, including software development. Cash flows from operations and existing cash and cash equivalents have been adequate to meet the Company's business objectives. Cash and cash equivalents decreased $581,193 to $1,764,197 as of March 31, 2013 compared to $2,345,390 as of December 31, 2012. The decrease in cash and cash equivalents, during the three months ended March 31, 2013 was predominately related to cash spent on property, equipment, and software of $348,699 along with cash flows used in operations of $95,697. The effect of foreign currency exchange rates on cash and cash equivalents was a loss of $136,797. Cash is generated from (or utilized in) the income/(loss) from operations for each segment (see Note 11 to the Consolidated Financial Statements (unaudited) of Part I, Item 1 of this Form 10-Q). The EIM and CAMRA segments represented income / (loss) from operations for the three months ended March 31, 2013 of $509,414 and $(439,692), respectively. The Corporate Allocation expense was $(407,512) for the three months ended March 31, 2013. The United States location generated a loss from operations for the three months ended March 31, 2013 of $(758,058), which was primarily associated with losses generated in the CAMRA segment and the Corporate Allocations expense. The United Kingdom location generated income from operations for the same period of $420,268. 16-------------------------------------------------------------------------------- Table of Contents The Company anticipates that its cash needs will be met during the next twelve months primarily through cash from operations of the Company's EIM segment and if necessary from the cash balance at March 31, 2013. As of March 31, 2013, the Company did not and as of the date of this Form 10-Q does not have an operating line credit facility in place. Off-Balance Sheet Arrangements The Company has no material off-balance sheet arrangements. Critical Accounting Policies and Estimates The discussion and analysis of the Company's financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, bad debts, depreciation and amortization, investments, income taxes, capitalized software, goodwill, restructuring costs, accrued compensation, contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. For the description of other critical accounting policies used by the Company, see Item 8. "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 1" in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. Income Taxes. The Company is required to estimate its income taxes. This process involves estimating the Company's actual current tax obligations together with assessing differences resulting from different treatment of items for tax and accounting purposes which result in deferred income tax assets and liabilities. The Company accounts for income taxes using the liability method. Under the liability method, a deferred tax asset or liability is determined based on the difference between the financial statement and tax bases of assets and liabilities, as measured by the enacted tax rates assumed to be in effect when these differences are expected to reverse. The Company's deferred tax assets are assessed for each reporting period as to whether it is more likely than not that they will be recovered from future taxable income, including assumptions regarding on-going tax planning strategies. To the extent the Company believes that recovery is uncertain, the Company has established a valuation allowance for assets not expected to be recovered. Changes to the valuation allowance are included as an expense or benefit within the tax provision in the statement of operations. As of March 31, 2013, the Company's valuation allowance related only to net deferred tax assets in the United States. As a result, the Company's tax expense relates to the United Kingdom operations and the Company does not anticipate recording significant tax charges or benefits related to operating gains or losses for the Company's United States operations. In addition, at March 31, 2013, the Company considered its cumulative earnings related to non-U.S. subsidiaries to be indefinitely reinvested. The Company recognizes a tax position as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of the state of Indiana and foreign income tax in the United Kingdom. The Company does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months. The Company recognizes interest and/or penalties related to income tax matters in income tax expense. The Company did not have any amounts accrued for interest and penalties at March 31, 2013. The Company's tax filings are subject periodically to regulatory review and audit. 17 -------------------------------------------------------------------------------- Table of Contents Research and Development and Software Development Costs. Research and development costs are charged to operations as incurred. Software Development Costs are considered for capitalization when technological feasibility is established. The Company bases its determination of when technological feasibility is established based on the development team's determination that the Company has completed all planning, designing, coding and testing activities that are necessary to establish that the product can be produced to meet its design specifications including, functions, features, and technical performance requirements. Goodwill and Intangible Assets. The Company considers the goodwill and related intangible assets related to CTI Billing Solutions Limited to be the premium the Company paid for CTI Billing Solutions Limited. For accounting purposes, these assets are maintained at the corporate level and the Company considers the functional currency with respect to these assets as the United States dollar. Goodwill is tested for impairment on an annual basis and between annual tests in certain circumstances, and written down when impaired. No impairment was identified in 2012. Purchased intangible assets other than goodwill are amortized over their useful lives unless these lives are determined to be indefinite. Purchased intangible assets are carried at cost, less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally 3-15 years. Intangible assets consist of patents, purchased technology, trademarks and trade names, and customer lists. The Company has allocated goodwill and a significant component of its intangible assets to CTI Billing Solutions Limited, as that entity is considered a separate reporting unit. The Company performed its last annual impairment analysis on goodwill as of October 1, 2012, to coincide with the calendar date set in past years for this analysis. The Company's analysis considered the projected cash flows of the reporting unit and gave consideration to appropriate factors in determining a discount rate to be applied to these cash flows. The results of this analysis indicated that there was no impairment as of the date of our annual impairment determination and that further impairment analysis was not required. The Company recognizes that the market for our stock can be below our book value which the Company attributes to a number of factors including very limited trading in the Company's Class A common stock, a significant portion of the Company's Class A common stock (approximately 67%) is beneficially owned by a majority stockholder, an overall "flight to quality" by investors in which many "penny stocks" such as CTI's have been significantly downgraded in terms of pricing and an overall lack of public awareness of its operations. While the Company cannot quantify the impacts of these factors in terms of how they impact the difference between book value and our stock's "market cap," the Company does not believe that the market in its Class A common stock is sufficiently sophisticated to make a proper determination of the value of the Company's Class A common stock. Because of the Company's continued relatively low "market cap", the Company reviewed the assumptions utilized in the impairment determination and again found that there existed no impairment. As of May 7, 2013, the Company's "market cap" was above the Company's book value. The Company's operations of the business unit are primarily based on recurring revenues and have not experienced an adverse change in anticipated performance considered in the impairment analysis. The business unit's operating performance subsequent to the goodwill impairment analysis has exceeded anticipated performance through the most recent period that information is available. The Company believes that the year-end analysis is sufficiently current and no formal analysis has been performed at March 31, 2013. The Company believes the year-end analysis is sufficiently current and no formal analysis has been performed at March 31, 2013. If the Company assesses market condition changes in our business, it may be required to reflect additional goodwill impairment in the future. Long-Lived Assets. The Company reviews the recoverability of the carrying value of its long-lived assets on an annual basis. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. When such events occur, the Company compares the carrying amount of the assets to the undiscounted expected future cash flows. If this comparison indicates there is impairment, the amount of the impairment is typically calculated using discounted expected future cash flows. Revenue Recognition and Accounts Receivable Reserves. The Company records revenue when it is realized, or realizable, and earned. Revenues from software licenses are recognized upon shipment, delivery or customer acceptance, based on the substance of the arrangement or as defined in the sales agreement provided there are no significant remaining vendor obligations to be fulfilled and collectability is reasonably assured. Software sales revenue is generated from licensing software to new customers and from licensing additional users and new applications to existing customers. 18-------------------------------------------------------------------------------- Table of Contents The Company's sales arrangements typically include services in addition to software. Service revenues are generated from support and maintenance, processing, training, consulting, and customization services. For sales arrangements that include bundled software and services, the Company accounts for any undelivered service offering as a separate element of a multiple-element arrangement. Amounts deferred for services are determined based upon vendor-specific objective evidence of the fair value of the elements. Support and maintenance revenues are recognized on a straight-line basis over the term of the agreement. Revenues from processing, training, consulting, and customization are recognized as provided to customers. If the services are essential to the functionality of the software, revenue from the software component is deferred until the essential service is complete. If an arrangement to deliver software or a software system, either alone or together with other products or services, requires significant production, modification, or customization of software, the service element does not meet the criteria for separate accounting set forth in the guidance related to software revenue recognition. If the criteria for separate accounting are not met, the entire arrangement is accounted for in conformity with guidance related to contract accounting. The Company carefully evaluates the circumstances surrounding the implementations to determine whether the percentage-of-completion method or the completed-contract method should be used. Most implementations relate to the Company's Telemanagement products and are completed in less than 30 days once the work begins. The Company uses the completed-contract method on contracts that will be completed within 30 days since it produces a result similar to the percentage-of-completion method. On contracts that will take over 30 days to complete, the Company uses the percentage-of-completion method of contract accounting. The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company continuously monitors collections and payments from its customers and the allowance for doubtful accounts is based on historical experience and any specific customer collection issues that the Company has identified. If the financial condition of its customers were to deteriorate resulting in an impairment of their ability to make payments, additional allowances may be required. Where an allowance for doubtful accounts has been established with respect to customer receivables, as payments are made on such receivables or if the customer goes out of business with no chance of collection, the allowances will decrease with a corresponding adjustment to accounts receivable as deemed appropriate. Stock Based Compensation. The Company recognizes the cost of employee services received in exchange for awards of equity instruments, such as stock options and restricted stock, based on the fair value of those awards at the date of grant. The Company uses the Black-Scholes-Merton formula to calculate the fair value of the stock options. The Company recognizes compensation cost net of a forfeiture rate and recognizes the compensation cost for only those awards expected to vest on a straight-line basis over the requisite service period of the award, which is generally the vesting term. The Company estimated the forfeiture rate based on its historical experience and its expectations about future forfeitures. Included within selling, general and administrative expense for the three months ended March 31, 2013 and March 31, 2012 was $15,529 and $10,081, respectively, of stock-based compensation. Stock-based compensation expenses are recorded in the Corporate Allocation segment as these amounts are not included in internal measures of segment operating performance. The Company estimates it will recognize approximately $62,000, $60,000, $31,000 and $0 for the fiscal years ending December 31, 2013, 2014, 2015 and 2016, respectively, of compensation costs for non-vested stock options previously granted to employees. New Accounting Pronouncements In January 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2013-01, Balance Sheet (Topic 210), Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. This update further clarified the guidance previously issued under ASU No. 2011-11, which required both gross and net presentation of offsetting assets and liabilities. The new requirements were effective retrospectively for fiscal years beginning on or after January 1, 2013, and for interim periods within those fiscal years. As the guidance impacted disclosure requirements only, the Company's adoption of the guidance on January 1, 2013 did not have an impact on its results of operations, financial position or cash flows. 19-------------------------------------------------------------------------------- Table of Contents In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220), Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The guidance was issued in response to ASU No. 2011-05 and required disclosure of the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items of net income, if the amounts reclassified are required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period. For other amounts not required to be reclassified to net income in their entirety in the same reporting period, or when a portion of the amount is reclassified to a balance sheet account instead of directly to income or expense, a cross reference to the related footnote disclosures for additional information should be provided. The new requirements were effective prospectively for fiscal years beginning on or after December 15, 2012, and for interim periods within those fiscal years. As the guidance impacted disclosure requirements only, the Company's adoption of the guidance on January 1, 2013 did not have an impact on its results of operations, financial position or cash flows. In February 2013, the FASB issued ASU No. 2013-04, Liabilities (Topic 405), Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date. This update provides guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this update is fixed at the reporting date, except for obligations addressed within existing U.S. GAAP. The guidance requires an entity to measure those obligations as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. The new requirements are effective for fiscal years that begin on or after December 15, 2013, and for interim periods within those fiscal years. Retrospective presentation for all comparative periods presented is required. The Company expects that the adoption of this guidance will not have a material impact on its results of operations, financial position or cash flows. In March 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2013-05, Foreign Currency Matters (Topic 830), Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity. This guidance clarifies the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity. The new requirements are effective prospectively for fiscal years beginning on or after December 15, 2013, and for interim periods within those fiscal years. The Company expects that the adoption of this guidance will not have a material impact on its results of operations, financial position or cash flows. 20-------------------------------------------------------------------------------- Table of Contents |