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IPASS INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This section is organized as follows: Key Corporate Objectives Our overall strategy and goals Significant Trends and Events Operating, financial and other material highlights affecting our company Key Operating Metrics Discussion of key metrics and measures that we use to evaluate our operating performance Segment Financial Information Discussion of the two segments of our business: and Geographic Information Mobility Services and iPass Unity Critical Accounting Policies and Accounting policies and estimates that we Estimates believe are most important to understanding the assumptions and judgments incorporated in our reported financial results Results of Operations An analysis of our financial results comparing the years ended December 31, 2013, December 31, 2012 and December 31, 2011 An analysis of changes in our balance sheets and Liquidity and Capital cash flows, and discussion of our financial Resources condition and potential sources of liquidity Overview We provide global enterprises and telecommunication carriers with cloud-based mobility management and network connectivity services. As announced on February 12, 2014, we are exploring a potential sale or other strategic alternative for our Unity business. For a detailed discussion of our business, see "Item 1. Business." 16-------------------------------------------------------------------------------- Table of Contents Key Corporate Objectives We are focused on driving revenue growth and profitability by adding new customers through increased brand awareness, improving our customer activation rates, and increasing user demand in smartphone and tablets with optimized end user experience. Our plan is to continue to expand the strategic value of our business by leveraging our mobility assets to address both large and compelling market opportunities and to execute on key growth initiatives in our businesses. For a detailed discussion regarding our key corporate objectives, see section entitled "Our Strategy" under "Item 1. Business." Significant Trends and Events The following describes significant trends and events that impacted our financial condition, results of operations, and/or the direction of our business in 2013: Continued Focus on our Open Mobile Enterprise Business We have continued to show solid progress against two key metrics for our OME business: (i) the number of active Open Mobile Platform users; and (ii) the number of Open Mobile Wi-Fi Network users. During 2013, we steadily increased our percentage of Open Mobile Platform users as a percentage of total platform users from 55% for the fourth quarter of 2012 to 83% for the fourth quarter of 2013. In addition, we grew our percentage of Open Mobile Wi-Fi Network users as a percentage of total Wi-Fi network users from 43% for the fourth quarter of 2012 to 79% for the fourth quarter of 2013. Our Open Mobile growth has been driven by a combination of legacy platform customer migrations, migrated customer user and usage ramps, and new customer acquisition. We continue to release updates to our Open Mobile platform, creating enhanced user experiences on a variety of operating systems. We expect to grow Wi-Fi revenues in the future based on our ability to grow Open Mobile platform and Wi-Fi network users, primarily through the continued focus on the deployment of our Open Mobile platform on smartphone and tablet devices. See "Key Operating Metrics" below for a full discussion of our user metrics. Successful Deployments in our Open Mobile Exchange Business We are continuing to develop our OMX business, adding functionality and building-out the network of key partners including telecommunication carriers and service providers. During 2013, we began to see signs of successful deployments. In 2014, we expect these deployments to scale and begin to provide network user and platform user metrics consistent with how we describe the OME business. Total OMX revenue grew from $0.8 million in 2012 to $2.4 million in 2013, representing 2.1% of our total 2013 revenue. In addition, we expect to narrow the focus to our OM business as a whole and view the OME and OMX businesses together. Continued Decline in our Legacy Revenues We define our legacy revenue to include Dial-up and 3G network, our iPC platform, and related platform services, as well as iPC driven network usage, including iPC user driven Wi-Fi, and minimum commit shortfall. As we exit 2013 with roughly 85% of our platform and Wi-Fi network users on the OM platform, expect that we will discontinue discussions of our stand-alone legacy business in 2014, focusing most of our metrics on the OM business. We have continued to effectively manage the wind down of our legacy revenue streams, with legacy declining 55% year over year and representing less than 20% of revenue in the fourth quarter of 2013. We expect legacy revenue to represent a smaller percentage of mobility revenue in 2014. Key Operating Metrics Described below are key metrics that we use to evaluate our operating performance and our success in transforming our business and driving future growth. OM Wi-Fi Network Users OM Wi-Fi Network Users is the number of our platform users each month in a given quarter that paid for Wi-Fi network services from iPass. OM Platform Active Users OM Platform Active Users is the number of users who were billed Open Mobile platform fees and who have used or deployed Open Mobile. 17-------------------------------------------------------------------------------- Table of Contents The following table summarizes our key operating metrics in relation to the Average Number of Monthly Monetized Users(1) (in thousands): For the Quarter Ended December 31, September 30, June 30, March 31, December 31, 2013 2013 2013 2013 2012 Open Mobile Users: Wi-Fi Network Users(2) 67 59 56 46 35 Platform Users: Active 622 574 517 444 355 Gross(3) 1,017 1,019 1,019 955 822 Legacy Users: Wi-Fi Network Users(2) 18 21 31 40 46 Other Network Users(4) 19 20 23 26 28 Platform Users(5) 125 151 201 246 286 Total AMMU(1): Total Network Users 104 100 110 112 109 Open Mobile as a Percentage of Total Wi-Fi Network Users 79 % 74 % 64 % 53 % 43 % Open Mobile as Percentage of Total Network Users 64 % 59 % 51 % 41 % 32 % Total Platform Users 747 725 718 690 641 Open Mobile as Percentage of Total Platform Users 83 % 79 % 72 % 64 % 55 % (1) We have presented Average Monthly Monetized Users (referred to as "AMMU") as a metric that we use to track and evaluate the operating performance of our overall Mobility business. The AMMU metric is based on the number of active users of our network and platform services across both our Open Mobile Enterprise offering and legacy iPC offerings. Network users are billed for their use of our Wi-Fi, Dial-up or 3G network services. Platform users are billed for their use of our legacy iPC client or our Open Mobile client. AMMU is defined as the average number of users per month, during a given quarter, for which a fee was billed by us to a customer for such users. (2) Wi-Fi Network Users represent unique users of Wi-Fi network. (3) Open Mobile Platform Gross Users is the total number of unique Active and Paying-Undeployed monetized users on the OM platform. (4) Other Network Users represents unique users of Dial-up and 3G network. (5) Legacy Platform Users represents unique users of the legacy iPC platform. Smartphone and Tablet Users Smartphone and Tablet Users mean users who have deployed Open Mobile on their smartphone or tablet and used those devices to access Wi-Fi network services from iPass. Our focus is to increase the adoption of OM on smartphones and tablets to drive additional Wi-Fi network users and network usage. As we continue to focus on accelerating the adoption of smartphone and tablet users on our Open Mobile platform, we expect users of these devices to become an increasing percentage of our network users. Users grew as a percentage of total Open Mobile Wi-Fi Network Users from approximately 24% in December 2012 to 31% in 2013. Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA") Adjusted EBITDA is used by our management as a measure of operating efficiency, financial performance and as a benchmark against our peers and competitors. In addition, we also used this metric to determine a portion of our incentive compensation payouts. Management also believes that Adjusted EBITDA is useful to investors because it is frequently used by securities analysts, investors and other interested parties to understand our performance excluding the impact of items which may obscure trends in our core operating performance. Furthermore, the use of Adjusted EBITDA facilitates comparisons with other companies in our industry which may use similar financial measures to supplement their GAAP (accounting principles generally accepted in the United States) results. We defined Adjusted EBITDA as net loss adjusted for: interest, income taxes, depreciation and amortization, stock-based compensation, restructuring charges, and certain state sales and federal tax charges. We adjust for these excluded items because we believe that, in general, these items possess one or more of the following characteristics: their magnitude and timing is largely outside of our control; they are unrelated to the ongoing operation of the business in the ordinary course; they are unusual or infrequent and we do not expect them to occur in the ordinary course of business; or non-cash expenses involving stock option grants. Adjusted EBITDA is not a measure determined in accordance 18-------------------------------------------------------------------------------- Table of Contents with GAAP and should not be considered in isolation or as a substitute for operating income (loss), net income (loss) or any other measure determined in accordance with GAAP. The following table reconciles Adjusted EBITDA to GAAP net loss (in thousands): Year Ended December 31, 2013 2012 2011 Adjusted EBITDA income (loss) $ (5,143 ) $ 960 $ (196 ) Interest income (expense) (18 ) 19 112 Income tax expense (569 ) (642 ) (290 ) Depreciation of property and equipment (2,776 ) (2,110 ) (2,259 ) Amortization of intangible assets - (169 ) (239 ) Stock-based compensation (3,163 ) (2,418 ) (1,725 ) Restructuring (charges) benefit (653 ) (26 ) 151 Certain state sales tax and other discrete items 10 8 1,438 Net loss $ (12,312 ) $ (4,378 ) $ (3,008 ) Segment Financial Information and Geographic Information We operate our business and report under two segments: Mobility Services and iPass Unity. We allocate resources and assess the performance of each operating segment using information about its revenue and operating loss. The Mobility Services segment reflects our two primary areas of mobility services, (i) enterprise mobility services that consist of Open Mobile Enterprise services, our legacy enterprise mobility services and other ancillary services including professional consulting and other value-add services, and (ii) our Open Mobile Exchange services that were launched in 2011. Open Mobile Enterprise services have evolved from our Enterprise Mobility Services offerings as we focus on our Open Mobile business and migrate away from our legacy iPC services. For a more complete discussion of business risks that these segments face, both combined and individually, see the discussion that appears in Part I, "Item 1A. Risk Factors," of this Form 10-K. For further financial information on the Mobility Services and iPass Unity segments and geographic information, refer to the information contained in Note 14, "Segment and Geographic Information," in the Notes to the Consolidated Financial Statements included in Item 15. For risks attendant to foreign operations, see the risk entitled "Because a meaningful portion of our business is international, we encounter additional risks, which may impact our revenues and profitability" in "Item 1A. Risk Factors" of this Form 10-K. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on our historical experience, knowledge of current conditions and our belief of what could occur in the future considering available information, including assumptions that are believed to be reasonable under the circumstances. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results could differ materially from the amounts reported based on these policies. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition. We believe our most significant estimates, judgments and assumptions used in the preparation of our consolidated financial statements are used in the following critical accounting policies. Revenue Recognition Our revenue recognition policy requires us to make certain estimates and judgments, for example, in the recognition of monthly minimum commitment ("MMC") revenue and upfront fees for iPass Unity contracts. For customers that have agreed to a MMC fee in connection with network usage, such customer's monthly invoice reflects the greater of the customer's actual usage during the month or the customer's contractually committed monthly minimum for that month. If the MMC exceeds actual usage ("Shortfall"), we determine whether the Shortfall is fixed or determinable in accordance with the revenue recognition criteria. If we conclude that the Shortfall is fixed or determinable, 19-------------------------------------------------------------------------------- Table of Contents based upon customer specific collection history, and all other revenue recognition criteria have been met, we recognize as revenue the amount of the Shortfall which is invoiced. If the customer is in a Shortfall situation and it is determined that the Shortfall is not fixed or determinable, we recognize revenue only when the Shortfall is collected. iPass Unity contracts are monthly flat fee contracts combined with certain other upfront fees such as, one-time non-recurring fees, which include equipment fees, installation, management set up, and shipping fees. The monthly flat usage fee is recognized on a monthly basis, while other fees are recognized ratably over the estimated life of the end point. An end point represents a separate physical location, such as a branch office, retail office or virtual office. End point lives are estimated based on historical average end point life by product group. We periodically perform an analysis of estimated lives of the end points and revise the remaining term over which revenue will be recognized, if needed. As of December 31, 2013, the expected period of performance for end points approximates four years. Performance -Based Restricted Stock Awards Certain restricted stock awards have performance-based goals based on the the achievement of targeted quarterly revenue of Open Mobile, targeted EBITA or targeted number of active Open Mobile monetized users, which require an assessment of the probability and timing of vesting. We amortize stock-based compensation expense for performance-based awards on a graded vesting basis over the vesting period, after assessing probability of achieving the requisite performance criteria. Estimating the time in which we expect to achieve the requisite performance criteria requires judgment. If events or circumstances occur that cause us to revise our estimated vest dates, we recognize the unamortized expense prospectively over the revised estimated vesting period. Such a change in estimated vest dates could have a material impact on our financial statements. We believe vesting of all performance-based restricted stock awards is probable. Recently Issued Accounting Standards In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss carryforward, or similar tax loss or tax credit carryforward, rather than as a liability when (1) the uncertain tax position would reduce the net operating loss or other carryforward under the tax law of the applicable jurisdiction and (2) the entity intends to use the deferred tax asset for that purpose. This ASU is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. The Company will adopt ASU 2013-11 for its fiscal year, and interim periods within the year ending December 31, 2014. We do not expect that this guidance will materially impact our Consolidated Financial Statements. Results of Operations Sources of Revenues From a broad perspective, we report and analyze revenue under two primary offerings reflecting our operating segments: Mobility Services and iPass Unity. Within Mobility Services, we differentiate and analyze our Open Mobile and legacy generated revenues separately. Open Mobile generated revenues include: • Network-Wi-Fi and minimum customer commitments based on the number of network users sourced from the Open Mobile platform. • Platform-Fees based on the number of Active Open Mobile monetized platform users and fees for fully dedicated Open Mobile carrier arrangements. • Other Fees and Revenue-Fees specific to providing additional value add services to Open Mobile customers. • OMX-Revenues generated from our OMX customers. Legacy generated revenues include: • Network-Wi-Fi and minimum customer commitments based on the number of network users sourced from the legacy iPC platform. In addition, network revenues derived from our 3G and Dial-up products are categorized as legacy network revenues. • Platform-Fees based on the number of legacy iPC monetized platform users and fees related to legacy add-on platform products and related services. 20-------------------------------------------------------------------------------- Table of Contents • Other Fees and Revenue-Fees specific to providing additional value add service to legacy iPC customers. For the Year Ended December 31, 2013 2012 2011 (Dollars in thousands) Mobility Services $ 77,868 $ 92,674 $ 110,808 Operating Loss (1) (11,113 ) (2,750 ) (2,013 ) Open Mobile Enterprise: 45,692 26,271 8,206 Network 29,710 13,963 1,724 Platform 15,048 11,585 5,834 Other Fees 934 723 648 Open Mobile Exchange 2,362 786 678 Legacy iPC 29,814 65,617 101,924 Network 22,380 53,180 85,743 Platform 3,954 9,785 13,387 Other Fees 3,480 2,652 2,794 iPass Unity Network Services 33,247 33,404 29,953 Operating Income (Loss) (1) 556 (542 ) (1,753 ) Total Revenue 111,115 126,078 140,761 Service Offering Revenue as a Percentage of Total Revenue: Mobility Services 70 % 74 % 79 % Open Mobile Enterprise 41 % 21 % 6 % Open Mobile Exchange 2 % 1 % 1 % Legacy iPC 27 % 52 % 72 % iPass Unity Network Services 30 % 26 % 21 % Total Revenue 100 % 100 % 100 % (1) See Note 14 Segment and Geographic Information for reconciliation of segment operating loss. Mobility Services Revenue For the year ended December 31, 2013 compared to 2012, Mobility Service revenue decreased $14.8 million or 16% as the decrease in legacy iPC revenue of $35.8 million outpaced the increase in Open Mobile ("OM") revenue of $21.0 million. Legacy iPC declines were attributed to continued migrations to OM, customer terminations, and anticipated usage reductions in our 3G and Dial-up services. The net decline of $14.8 million for Mobility Services revenue was driven by a $5.0 million decline in Wi-Fi revenue, a $6.4 million decline in Dial-up and 3G revenue, a $3.6 million decline in MMC, and a $2.4 million decline in platform revenue offset by an increase in OMX and other revenues of $1.6 million and $1.0 million, respectively. The decrease in Wi-Fi, Dial-up and 3G revenues were driven by the continued and expected decline in usage and termination of legacy iPC customers. In addition, the ongoing pricing platform dynamics as user mix shifts away from laptops to less expensive smartphone and tablet pricing options also contributed to the platform revenue decline. For the year ended December 31, 2012 compared to 2011, Mobility Service revenue decreased $18.1 million or 16% as the decrease in legacy iPC revenue of $36.3 million outpaced the increase in Open Mobile Enterprise revenue of $18.1 million. Legacy iPC declines were attributed to migrations, customer terminations, and anticipated usage reductions in our 3G and Dial-up services. The net decline of $18.1 million for Mobility Services revenue was driven by a $11.8 million decline in Wi-Fi revenue, a $6.9 million decline in Dial-up and 3G revenue, and a $1.6 million decline in MMC offset by an increase in platform revenues of $2.2 million. The decrease in Wi-Fi revenues was primarily driven by legacy iPC customer terminations and ongoing usage pattern shifts from laptops to smartphones and tablets. Additionally, as we migrate customers from the iPC platform to the Open Mobile platform, we experience delays in fully deploying the agent to the customer user community which typically results in lagging Wi-Fi usage patterns. Mobility Service Operating Loss The increase in Mobility Services operating loss by $8.4 million for the year ended December 31, 2013, compared to 2012 was primarily due to the decrease in Mobility Service revenue of $14.8 million, partially offset by the decrease in mobility network access cost of $3.5 million and the decrease in mobility service operating expense of $2.9 million. 21-------------------------------------------------------------------------------- Table of Contents The increase in Mobility Services operating loss by $0.7 million or 37% for the year ended December 31, 2012 compared to 2011 was primarily due to the decrease in Mobility Service revenue of $18.1 million, partially offset by the decrease in mobility network access cost of $13.3 million and the decrease in mobility service operating expense of $2.6 million and non-recurring incremental benefit of $1.3 million in 2011 on collections of previously billed and accrued historical sales tax liabilities. iPass Unity Network Services Revenue iPass Unity Network Services revenues were relatively consistent for the year ended December 31, 2013 compared to 2012. For the year ended December 31, 2012 compared to 2011, iPass Unity revenue increased $3.5 million or 12% mainly due to growth in the number of installed customer endpoints. iPass Unity Network Services Operating Income and Loss The increase in iPass Unity operating income of $1.1 million for the year ended December 31, 2013 compared to 2012 was mainly due to ongoing cost reduction initiatives and a decrease in iPass Unity network access costs. The decrease in iPass Unity operating loss of $1.2 million for the year ended December 31, 2012 compared to 2011 was primarily due to the increase in iPass Unity revenue of $3.5 million, partially offset by an increase in iPass Unity network access cost of $1.3 million and $1.0 million in higher operating expenses. Network Gross Margin We use network gross margin as a metric to assist us in assessing the profitability of our various network services. Our overall network gross margin is defined as Mobility Services Network revenue plus iPass Unity revenue less network access costs divided by Mobility Services Network revenue plus iPass Unity revenue. Year Ended December 31, 2013 2012 2011 Network Gross Margin (%) 43.1 % 47.0 % 44.4 % The 3.9% decrease in network gross margin from 2012 to 2013 was primarily due to decreases in higher margin revenues products such as monthly minimum commitment revenue and Dial-up, and higher usage by customers on flat rate price plan. The 2.6% increase in network gross margin from 2011 to 2012 was primarily driven by favorable service mix as our declining 3G revenues, traditionally a lower margin offering, created less downward pressure on our overall network margin. Cost of Revenues and Operating Expenses Network Access Costs Network access costs ("NAC") consist of charges for network access which we pay to our network service providers and other direct cost of sales. Year Ended December 31, 2013 2012 2011 (In thousands, except percentages) Network access costs $ 49,490 $ 53,640 $ 65,766 As a percentage of revenue 44.5 % 42.5 % 46.7 % The decrease in NAC of approximately $4.2 million or 8% for 2013 compared to 2012 was primarily due to a combination of lower Wi-Fi, 3G and Dial-up network usage that decreased Mobility Services NAC by approximately $3.5 million, and a decrease in iPass Unity NAC of approximately $0.7 million. The decrease in NAC of approximately $12.1 million or 18% for 2012 compared to 2011 was primarily due to a combination of lower Wi-Fi, 3G and Dial-up network usage that decreased Mobility Services NAC by approximately $13.4 million, partially offset by an increase in iPass Unity NAC of approximately $1.3 million on more endpoints deployed. Network Operations 22-------------------------------------------------------------------------------- Table of Contents Network operations expenses consist of compensation and benefits for our network engineering, customer support and network access quality personnel, outside consultants, transaction center fees, network equipment depreciation, costs of 3G data cards and allocated overhead costs. Year Ended December 31, 2013 2012 2011 (In thousands, except percentages) Network operations expense $ 19,200 $ 20,806 $ 22,307 As a percentage of revenue 17.3 % 16.5 % 15.8 % The decrease in network operations expenses of approximately $1.6 million or 10% for 2013 compared to 2012 was primarily due to decreases in headcount and consulting related expense of approximately $1.0 million as we continue to manage our cost structure, 3G mobile data cards subsidized expense of approximately $0.5 million as we continue to phase out the legacy 3G offering, and lower network infrastructure spend. The decrease in network operations expenses of approximately $1.5 million or 7% for 2012 compared to 2011 was primarily due to a decrease in 3G mobile data cards subsidized expense of approximately $1.0 million. Research and Development Research and development expenses consist of compensation and benefits for our research and development personnel, consulting, and allocated overhead costs. Year Ended December 31, 2013 2012 2011 (In thousands, except percentages) Research and development expenses $ 13,317 $ 13,733 $ 14,368 As a percentage of revenue 12.0 % 10.9 % 10.2 % The decrease in research and development expenses of approximately $0.4 million or 4% for 2013 compared to 2012 was primarily due to lower headcount cost of approximately $0.5 million as we continue to manage our cost structure. The decrease in research and development expenses of approximately $0.6 million or 4% for 2012 compared to 2011 was primarily due to lower third party consulting expense of approximately $0.7 million, much of which was spent in 2011 on the acceleration of the OM platform development. Sales and Marketing Sales and marketing expenses consist of compensation, benefits, advertising and promotion costs, and allocated overhead costs. Year Ended December 31, 2013 2012 2011 (In thousands, except percentages) Sales and marketing expenses $ 18,315 $ 19,530 $ 20,702 As a percentage of revenue 16.5 % 15.5 % 14.7 % The decrease in sales and marketing expenses of approximately $1.2 million or 8% for 2013 compared to 2012 was primarily due to lower headcount and consulting expense of approximately $1.0 million and severance charges of $0.2 million as we looked to optimize our sales and marketing team to support our OM initiatives in 2014. The decrease in sales and marketing expenses of approximately $1.2 million or 6% for 2012 compared to 2011 was mainly due to lower severance charges and discretionary third party consulting expenses of $0.6 million and $0.4 million, respectively. General and Administrative General and administrative expenses consist primarily of compensation and benefits for general and administrative personnel, facilities, business information systems, legal and accounting expenses. 23-------------------------------------------------------------------------------- Table of Contents Year Ended December 31, 2013 2012 2011 (In thousands, except percentages) General and administrative expenses $ 21,340 $ 21,653 $ 20,009 As a percentage of revenue 19.2 % 17.2 % 14.2 % The decrease in general and administrative expenses of approximately $0.3 million or 2% for 2013 compared to 2012 was primarily due to a lower rent expense of $0.6 million, a decrease in headcount and consulting expense of $0.3 million, and a decrease in travel expense of $0.2 million, partially offset by an increase in expenses related to our going "live" with our new ERP system of $0.9 million. The increase in general and administrative expenses of approximately $1.6 million or 8% for 2012 compared to 2011 was primarily due to the non-recurring incremental benefit of $1.3 million in 2011 on collections of previously billed and accrued historical sales tax liabilities, and an increase in stock based compensation of $0.5 million in 2012. Restructuring Charges (Benefits) and Related Adjustments In the first quarter of 2013, we announced a restructuring plan (Q1 2013 Plan) to re-align our cost structure to focus investments, resources and operating expenses on our growing Open Mobile business, which resulted in a workforce reduction of 16 positions across all functional areas and termination of a lease contract. During the year ended December 31, 2009, we announced restructuring plans (2009 Plans) to reduce our operating costs and focus our resources on key strategic priorities, which resulted in a workforce reduction of 146 positions across all functional areas and abandonment of certain facilities and termination of a contract obligation. We completed all terminations by the first quarter of 2010. We incurred a restructuring charge of approximately $0.7 million for the year ended December 31, 2013 compared to the restructuring charge of $26,000 and restructuring benefits of $0.2 million for the years ended December 31, 2012, and 2011, respectively. These activities were related to our Q1 2013 Plan or the adjustment of prior estimates related to our 2009 Plans. Non-Operating Income and Expenses Foreign Exchange Gains (Losses) Foreign exchange gains (losses) primarily include realized and unrealized gains and losses on foreign currency transactions. Foreign currency exchange rate fluctuations impact the re-measurement of certain assets and liabilities denominated in currencies other than the U.S. Dollar and generate unrealized foreign exchange gains or losses. In addition, certain of our network access costs are invoiced in currencies other than the U.S. Dollar. The transactional settlement of these outstanding invoices and other cross-currency transactions generate realized foreign exchange gains or losses depending on the fluctuation of exchange rates between the date of invoicing and the date of payment. During the years ended December 31, 2013, 2012 and 2011, we did not enter into any hedging contracts and foreign exchange losses were $0.5 million, $0.3 million and $0.5 million, respectively. The foreign exchange loss in 2013 was mainly due to weakening of the U.S. dollar against Euro and British Pound at the time we settled certain non-U.S. Dollar denominated network access costs as well as the unfavorable re-measurement of foreign currency denominated assets and liabilities. The foreign exchange losses in 2012 and 2011 were primarily due to the unfavorable re-measurement of foreign currency denominated assets and liabilities during each of those years. Provision For (Benefit From) Income Taxes The effective tax rate was a tax expense of 5% for 2013 and a tax expense of 17% for 2012. The 2013 decrease of effective tax rate was due to a decrease in foreign taxes and an increase in the current net operating loss. The effective tax rate in 2011 was an expense of 11%. The higher tax rate in 2012 was due to higher foreign tax expense. Liquidity and Capital Resources 24-------------------------------------------------------------------------------- Table of Contents December 31, December 31, Increase/ 2013 2012 (Decrease) (dollars in thousands)Cash and cash equivalents $ 24,017 $ 26,822 $ (2,805 ) As a percentage of total assets 43.7 % 44.6 % Operating Activities. Net cash used in operating activities in 2013 was $2.4 million, compared to net cash provided by operating activities of $3.5 million in 2012 mainly due to an increase in net loss. Investing Activities. Net cash used in investing activities in 2013 was approximately $1.6 million, compared to net cash used in investing of $3.5 million in 2012, with the reduction mainly due to investment in our new ERP system in 2012 that went "live" in January 2013. Financing Activities. Net cash provided by financing activities in 2013 was $1.2 million, compared to net cash provided by financing activities of $1.4 million in 2012, with reduction mainly due to approximately $0.3 million of principal payments for vendor financed property and equipment in 2013. Sources of Cash and Future Cash Requirements We have historically relied on existing cash and cash equivalents and cash flow from operations for our liquidity needs. We use a professional investment management firm to manage a large portion of our cash which is invested primarily in money market accounts. We believe that based on our current business plan and revenue prospects and our anticipated cash flows from operations, our existing cash balances will be sufficient to meet our working capital and operating resource expenditure requirements for at least the next twelve months. The amount of cash and cash equivalents held by our foreign subsidiaries as of December 31, 2013 and 2012 was $0.9 million and $1.4 million, respectively. We currently do not intend to distribute any of our cumulative earnings by our foreign subsidiaries to the parent company in the U.S. Primary Uses of Cash Our principal use of cash in 2013 was for network access costs, payroll related expenses and general operating expenses including marketing, office rent, capital expenditures for IT infrastructure, and settlement of remaining restructuring obligations. During 2013, we acquired enterprise database software and infrastructure hardware (see "Note 8. Vendor Financed Property and Equipment") and made approximately $0.3 million of principle payment. We expect to make approximately $2.3 million of principal payments over the next three years related to this purchase. Off-Balance Sheet Arrangements As part of our ongoing business, we do not participate in transactions that generate material relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. We did not have any off-balance sheet arrangements at December 31, 2013 and December 31, 2012 as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. Contractual Obligations Less Than Total 1 Year 1-3 Years (In thousands)Operating Lease Obligations $ 4,900 $ 2,819 $ 2,081 Other Purchase Commitments(1) 3,467 2,122 1,345 Total Contractual Obligations $ 8,367 $ 4,941 $ 3,426 (1) In the normal course of our business, we have signed contracts with certain network service providers under which we have minimum purchase commitments. These commitments expire on various dates through 2017. In addition, during October 2013 the Company entered into a future minimum purchase commitment to acquire an additional enterprise infrastructure hardware of approximately $0.5 million and an annual support fee of approximately $0.7 million to be paid over the next three years. 25-------------------------------------------------------------------------------- Table of Contents In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of such agreements, services to be provided by us, or from intellectual property infringement claims made by third-parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers and employees that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. We maintain director and officer insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and certain of our officers and employees, in certain circumstances. iPass' product agreements typically include a limited indemnification provision for claims from third parties relating to breach of agreements, and iPass' intellectual property. Certain indemnification agreements may not be subject to maximum loss clauses. If the potential loss from any indemnification claim is considered probable and the amount or the range of the loss can be estimated, we accrue a liability for the estimated loss. To date, claims under such indemnification provisions have not been significant. |