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NEULION, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Management's Discussion and Analysis of Financial Condition and Results of Operations This management's discussion and analysis ("MD&A") of the financial condition and results of operations of the Company should be read in conjunction with our audited consolidated financial statements and accompanying notes for the years ended December 31, 2013 and 2012, which have been prepared in accordance with United States generally accepted accounting principles ("U.S. GAAP"). All dollar amounts are in U.S. dollars ("US$" or "$") unless stated otherwise. As at March 7, 2014 the Bank of Canada noon rate for conversion of United States dollars to Canadian dollars ("CDN$") was US$1 to CDN$1.1089. Our MD&A is intended to enable readers to gain an understanding of our current results and financial position. To do so, we provide information and analysis comparing the results of operations and financial position for the current year to those of the preceding comparable year. We also provide analysis and commentary that we believe is required to assess our future prospects. Accordingly, certain sections of this report contain forward-looking statements that are based on current plans and expectations. These forward-looking statements are affected by risks and uncertainties that are discussed in Item 1A of this Annual Report on Form 10-K and below in the section titled "Cautions Regarding Forward-Looking Statements" and that could have a material impact on future prospects. Readers are cautioned that actual results could vary from those forecasted in this MD&A. Cautions Regarding Forward-Looking Statements This MD&A contains certain forward-looking statements that reflect management's expectations regarding our growth, results of operations, performance and business prospects and opportunities. Statements about our future plans and intentions, results, levels of activity, performance, goals, achievements or other future events constitute forward-looking statements. Wherever possible, words such as "may," "will," "should," "could," "expect," "plan," "intend," "anticipate," "believe," "estimate," "predict," or "potential" or the negative or other variations of these words, or similar words or phrases, have been used to identify these forward-looking statements. These statements reflect management's current beliefs and are based on information available to management as at the date of this Annual Report on Form 10-K. Forward-looking statements involve significant risk, uncertainties and assumptions. Although the forward-looking statements contained in this MD&A are based upon what management believes to be reasonable assumptions, we cannot assure readers that actual results will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this Annual Report on Form 10-K and we assume no obligation to update or revise them to reflect new events or circumstances, except as required by law. Many factors could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including: our ability to realize some or all of the anticipated benefits of our partnerships; our ability to increase revenue; general economic and market segment conditions; our customers' subscriber levels and financial health; our ability to pursue and consummate acquisitions in a timely manner; our continued relationships with our customers; our ability to negotiate favorable terms for contract renewals; competitor activity; product capability and acceptance rates; technology changes; regulatory changes; foreign exchange risk; interest rate risk; and credit risk. These factors should be considered carefully and readers should not place undue reliance on the forward-looking statements. A more detailed assessment of the risks that could cause actual results to materially differ from current expectations is contained in Item 1A, "Risk Factors." Overview NeuLion is a technology service provider that specializes in the digital video broadcasting, distribution and monetization of live and on-demand content to Internet-enabled devices. Through our cloud-based end-to-end solution, we build and manage interactive digital networks that enable our customers to provide a destination for their viewers to view and interact with their content. We were incorporated on January 14, 2000 under the Canada Business Corporations Act and were domesticated under Delaware law on November 30, 2010. Our common stock is listed on the Toronto Stock Exchange ("TSX") under the symbol NLN. Our core business and business model have evolved from being a provider of professional information technology services and international programming to a provider of customized, end-to-end, interactive content services for a wide range of professional and collegiate sports properties, cable networks and operators, content owners and distributors, and telecommunication companies. With a fundamental shift in the way media is now being consumed, technological advancements are affecting how, when and where consumers connect to content. Our technology enables our customers to capitalize on the growing consumer demand for viewing interactive content on multiple types of Internet-enabled devices by enabling the delivery of content to a range of these devices, such as PCs, smartphones and tablets, and by also providing our customers with a technology platform to manage their content. Our cloud-based technology platform offers a variety of digital technology and services, including content ingestion, live encoding, live video editing, advertising insertion and management, pay flow and premium content payment support, video player software development kits, multi-platform device delivery, content management, subscriber management, digital rights management, billing services, app development, website design, analytics and reporting. 18-------------------------------------------------------------------------------- Table of Contents Key Performance Indicators 2013 YE 2012 YE % Q4 2013 Q4 2012 % (million) (million) change (million) (million) change Financial Indicators Total Revenue $47.1 $39.0 21% $14.1 $10.5 34% Pro Sports (1) $20.9 $13.5 55% $6.8 $3.9 74% College Sports (1) $12.6 $10.9 16% $3.8 $3.2 19% TV Everywhere (1) $11.3 $10.6 7% $3.0 $2.9 3% Non-GAAP Adjusted Gross Margin % (2) 72% 65% 7% 72% 69% 3% Non-GAAP Adjusted EBITDA (3) $3.5 $(3.3) - $2.2 $0.8 175% Consolidated Net Income (Loss) $(2.3) $(10.1) - $1.1 $(0.8) - 2013 YE 2012 YE % change Non-Financial Indicator Video Streamed (4) 154.5 82.3 88% petabytes petabytes (1) Excludes equipment revenue. (2) We report non-GAAP Adjusted Gross Margin % because it is a key measure used by management to evaluate our results and make strategic decisions about the Company, including potential acquisitions. Non-GAAP Adjusted Gross Margin % represents consolidated operating income (loss) plus depreciation and amortization, research and development expenses and selling, general and administrative expenses divided by total revenue. This measure does not have any standardized meaning prescribed by U.S. GAAP and therefore is unlikely to be comparable to the calculation of similar measures used by other companies, and should not be viewed as an alternative to measures of financial performance or changes in cash flows calculated in accordance with U.S. GAAP. A reconciliation is provided below. (3) We report non-GAAP Adjusted EBITDA because it is a key measure used by management to evaluate our results and make strategic decisions about the Company, including potential acquisitions. Non-GAAP Adjusted EBITDA represents net income (loss) before interest, income taxes, depreciation and amortization, stock-based compensation, unrealized gain/loss on derivatives, investment income, non-controlling interests and foreign exchange gain/loss. This measure does not have any standardized meaning prescribed by U.S. GAAP and therefore is unlikely to be comparable to the calculation of similar measures used by other companies, and should not be viewed as an alternative to measures of financial performance or changes in cash flows calculated in accordance with U.S. GAAP. A reconciliation is provided below. (4) A petabyte is 1015 bytes of digital information. One petabyte is equivalent to 1000 terabytes. The figures shown in the table above represent the amount of video streamed on all of our business-to-business ("B2B") platforms (Pro Sports, College Sports and TV Everywhere). We believe the amount of video streamed is a key performance indicator because our contracts typically include a revenue share or usage fee component. 19-------------------------------------------------------------------------------- Table of Contents Overall Performance - Year-ended December 31, 2013 vs year-ended December 31, 2012 Total revenue for fiscal 2013 was $47.1 million, an increase of $8.1 million, or 21%, from $39.0 million in fiscal 2012. The increase of $8.1 million was due to an increase in services revenue of $9.1 million offset by a decrease in equipment revenue of $1.0 million. The $9.1 million increase in services revenue was primarily attributable to an increase in revenue in our Pro Sports category of customers. Our non-GAAP Adjusted Gross Margin % (as defined above and reconciled below) was 72% for the year ended December 31, 2013, compared with 65% for the year ended December 31, 2012. The 7% improvement in non-GAAP Adjusted Gross Margin % was primarily due to decreased bandwidth costs as well as a decrease in our equipment revenue and related cost of revenue. Our non-GAAP Adjusted EBITDA (as defined above and reconciled below) was $3.5 million for the year ended December 31, 2013, compared with $(3.3) million for the year ended December 31, 2012. The improvement in non-GAAP Adjusted EBITDA of $6.8 million was due to an increase in revenue of $8.1 million and a decrease in cost of revenue of $0.4 million offset by an increase of $1.7 million in selling, general and administrative expenses, excluding stock-based compensation, and research and development expenses. Our consolidated net loss for the year ended December 31, 2013 was $2.3 million, or a loss of $0.01 per basic and diluted share of common stock, compared with a net loss of $10.1 million, or a loss of $0.07 per basic and diluted share of common stock, for the year ended December 31, 2012. The improvement in consolidated net loss of $7.8 million was primarily attributable to the items discussed above relating to non-GAAP Adjusted EBITDA. The reconciliation from consolidated operating loss to non-GAAP Adjusted Gross Margin % is as follows: Consolidated Statement of Operations Reconciliation: Years ended December 31, 2013 2012 $ $ Consolidated operating loss on a GAAP basis (1,639,586 ) (9,333,040 ) Depreciation and amortization 3,755,054 4,407,474 Research and development 7,422,802 6,672,778 Selling, general and administrative, including stock-based compensation 24,289,845 23,541,296 Non-GAAP Adjusted Gross Margin 33,828,115 25,288,508 Non-GAAP Adjusted Gross Margin % (as a % of total revenue) 72% 65% The reconciliation from net loss to non-GAAP Adjusted EBITDA is as follows: Consolidated Statement of Operations Reconciliation: Years ended December 31, 2013 2012 $ $ Consolidated net loss on a GAAP basis (2,278,345 ) (10,078,764 ) Depreciation and amortization 3,755,054 4,407,474 Stock-based compensation 1,416,892 1,627,231 Discount on convertible note 233,769 77,922 Income taxes 276,846 612,884 Interest and foreign exchange loss 128,144 54,918 Non-GAAP Adjusted EBITDA 3,532,360 (3,298,335 ) 20-------------------------------------------------------------------------------- Table of Contents Overall Performance - Three months ended December 31, 2013 vs three months ended December 31, 2012 Total revenue for the three months ended December 31, 2013 was $14.1 million, an increase of $3.6 million, or 34%, from $10.5 million for the three months ended December 31, 2012. The $3.6 million increase in total revenue was primarily attributable to an increase in revenue in our Pro Sports category of customers. Our non-GAAP Adjusted Gross Margin % (as defined above and reconciled below) was 72% for the three months ended December 31, 2013, compared with 69% for the three months ended December 31, 2012. The 3% improvement in non-GAAP Adjusted Gross Margin % was primarily due to decreased bandwidth costs. Our non-GAAP Adjusted EBITDA (as defined above and reconciled below) was $2.2 million for the three months ended December 31, 2013, compared with $0.8 million for the year ended December 31, 2012. The improvement in non-GAAP Adjusted EBITDA of $1.4 million was due to an increase in revenue of $3.6 million offset by increases in cost of revenues of $0.8 million and selling, general and administrative expenses, excluding stock-based compensation and research and development expenses of $1.4 million. Our consolidated net income for the three months ended December 31, 2013 was $1.1 million, or income of $0.00 per basic and diluted share of common stock, compared with a net loss of $0.8 million, or a loss of $0.00 per basic and diluted share of common stock, for the three months ended December 31, 2012. The improvement of $1.9 million was primarily attributable to the items discussed above relating to non-GAAP Adjusted EBITDA. The reconciliation from consolidated operating income (loss) to non-GAAP Adjusted Gross Margin % is as follows: Consolidated Statement of Operations Reconciliation: Three months ended December 31, 2013 2012 $ $ Consolidated operating income (loss) on a GAAP basis 1,117,379 (433,242 ) Amortization and depreciation 767,782 842,614 Research and development 1,962,676 1,663,510 Selling, general and administrative, including stock-based compensation 6,300,462 5,244,689 Non-GAAP Adjusted Gross Margin 10,148,299 7,317,571 Non-GAAP Adjusted Gross Margin % (as a % of total revenue) 72% 69% The reconciliation from net income (loss) to non-GAAP Adjusted EBITDA is as follows: Consolidated Statement of Operations Reconciliation: Three months ended December 31, 2013 2012 $ $ Consolidated net income (loss) on a GAAP basis 1,071,979 (862,040 ) Depreciation and amortization 767,782 842,614 Stock-based compensation 344,291 361,497 Discount on convertible note - 77,922 Income taxes 11,556 333,884 Interest and foreign exchange loss 33,844 16,992 Non-GAAP Adjusted EBITDA 2,229,452 770,869 21-------------------------------------------------------------------------------- Table of Contents OPERATIONS Revenue We earn revenue from four broad categories of customers: • Professional Sports This category contains all of our professional sports programming customers. These customers include the National Football League (NFL), the National Hockey League (NHL), the National Basketball Association (NBA), Ultimate Fighting Championship (UFC), Major League Soccer (MLS), the American Hockey League (AHL), the Canadian Football League (CFL), the Western Hockey League (WHL), the Ontario Hockey League (OHL), and the Professional Bowlers Association (PBA). • College Sports This category contains all of our college and collegiate conference customers. We partner with many National Collegiate Athletic Association (NCAA) schools and conferences and have agreements in place with over 175 colleges, universities or related sites. These customers include the University of North Carolina, Duke University, the University of Oregon, Louisiana State University, Mississippi State University, Arkansas State University, the University of Nebraska, Texas A&M University, the Big 12 Conference and the Southern Conference, Pac 12 member schools, the University of Oklahoma, the Ivy League Digitial Network and the University of Maryland. • TV Everywhere This category contains all of our cable networks and operators, entertainment companies, content aggregators and MVPDs. These customers include ESPN, Univision, China Network Television (a new media agency of China Central Television), Sport TV, Rogers Media, Sportsnet, Outdoor Channel, TVG Network, CBC, Zon Multimedia, Independent Film Channel, Cablevision, MSG Varsity, Shaw Communications, the Big Ten Network, Participant Media and the Gospel Music Channel. • Other Customers This category includes our B2C business, in which we market our own content directly to customers, and various consulting services. Effective April 1, 2012, the Company amended its agreement with KyLin TV, such that, in addition to the services we previously provided, KyLin TV was appointed the exclusive distributor of the Company's B2C IPTV interests. As exclusive distributor, KyLin TV obtains, advertises and markets most of the Company's B2C content, in accordance with the terms of the amendment. Accordingly, KyLin TV records the gross revenues from the Company's B2C content as well as the associated license fees expense, whereas the Company records revenues in accordance with the revised fee schedule in the amendment. We record revenues from KyLin TV in our TV Everywhere category of customers. Within each of these four categories of customers, revenue is categorized as follows: • Services revenue, which consists of: • Setup fees - non-recurring and charged to customers for design, setup and implementation services. • Monthly/annual fees - recurring and charged to customers for ongoing hosting, support and maintenance. • Variable fees - recurring and earned through subscriptions, usage, advertising, support and eCommerce. † Subscription revenue consists of recurring revenue based on the number of subscribers. Revenue is typically generated on a monthly, quarterly or annual basis and can be either a fixed fee per user or a variable fee based on a percentage of the subscription price. † Usage fees are charged to customers for bandwidth and storage. † Advertising revenues are earned through the insertion of advertising impressions on websites and in streaming video at a cost per thousand impressions. † Support revenue consists of fees charged to our customers for providing customer support to their end users. † eCommerce revenues are earned through providing customers with ticketing and retail merchandising web solutions. • Equipment revenue, which is non-recurring, consists of the sale of STBs to content partners and/or end users and is recognized when title to an STB passes to our customer. Shipping revenue, STB rentals and computer hardware sales are also included in equipment revenue. 22-------------------------------------------------------------------------------- Table of Contents Cost and Expenses Cost of services revenue Cost of services revenue primarily consists of: • revenue share payments; • broadcast operating costs (teleport fees, bandwidth usage fees, colocation fees); and • cost of advertising revenue, which is subject to revenue shares with the content provider. Cost of equipment revenue Cost of equipment revenue primarily consists of purchases of STB products and parts for resale to customers. Shipping costs are included in cost of equipment revenue. Selling, general and administrative expenses, including stock-based compensation Selling, general and administrative ("SG&A") expenses, including stock-based compensation, include: • Wages and benefits - represents compensation for our full-time and part-time employees, excluding R&D employees shown below, as well as fees for consultants we use from time to time; • Stock-based compensation - represents the estimated fair value of our options, warrants and stock appreciation rights ("Convertible Securities") for financial accounting purposes, prepared using the Black-Scholes-Merton model, which requires a number of subjective assumptions, including assumptions about the expected life of the Convertible Securities, risk-free interest rates, dividend rates, forfeiture rates and the future volatility of the price of our shares of common stock. The estimated fair value of the Convertible Securities is expensed over the vesting period, which is normally four years, with the Convertible Securities vesting in equal amounts each year. However, our Board of Directors has the discretion to grant options with different vesting periods; • Marketing - represents expenses for global and local marketing programs that focus on corporate marketing activities; • Professional fees - represents legal, accounting, and public and investor relations expenses; and • Other SG&A expenses - represents travel expenses, rent, office supplies, corporate IT services, credit card processing fees and other general operating expenses. Research and development Research and development costs ("R&D") primarily consist of wages and benefits for R&D department personnel. 23-------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Comparison of Fiscal 2013 to Fiscal 2012 Our consolidated financial statements for our fiscal years ended December 31, 2013 and 2012 have been prepared in accordance with U.S. GAAP. A comparison of our results of operations for those years is as follows: 2013 2012 Change $ $ % Revenue Services revenue 46,257,712 37,178,431 24 % Equipment revenue 849,466 1,804,495 (53) % Total revenue 47,107,178 38,982,926 21 % Costs and expenses Cost of services revenue, exclusive of depreciation and amortization shown separately below 12,697,104 12,280,658 3 % Cost of equipment revenue 581,959 1,413,760 (59) % Selling, general and administrative, including stock-based compensation 24,289,845 23,541,296 3 % Research and development 7,422,802 6,672,778 11 % Depreciation and amortization 3,755,054 4,407,474 (15) % 48,746,764 48,315,966 1 % Operating loss (1,639,586 ) (9,333,040 ) - % Other income (expense) Loss on foreign exchange (125,657 ) (56,244) - % Interest, net (2,487) 1,326 - % Discount on convertible note (233,769 ) (77,922) - % (361,913 ) (132,840 ) - % Net and comprehensive loss before income taxes (2,001,499 ) (9,465,880 ) - % Deferred income taxes (276,846 ) (612,884 ) - % Net and comprehensive loss (2,278,345 ) (10,078,764 ) - % Revenue Services revenue Services revenue increased to $46.3 million for the year ended December 31, 2013 from $37.2 million for the year ended December 31, 2012. Services revenue includes revenue from Pro Sports, College Sports, TV Everywhere and Other Customers and is comprised of set-up fees, annual/monthly fees and variable fees. Year-over-year variances in each sector are detailed below: Pro Sports Revenue from Pro Sports customers increased to $20.9 million for the year ended December 31, 2013 from $13.5 million for the year ended December 31, 2012. The $7.4 million improvement was primarily the result of an increase in variable usage fees of $3.7 million, monthly/annual fees of $1.7 million and variable subscription fees of $1.3 million. The increase in revenue from variable usage fees was the result of an increase in end users, end users watching for longer periods of time and increased bandwidth consumption by end users due to advances in technology. College Sports Revenue from College Sports customers increased to $12.6 million for the year ended December 31, 2013 from $10.9 million for the year ended December 31, 2012. The $1.7 million increase was primarily a result of revenue earned from agreements signed with new colleges and conferences during the year and at the end of the prior year. The $1.7 million increase was the result an increase in monthly/annual fees of $0.5 million, variable subscription fees of $0.4 million, variable usage fees of $0.3 million, variable eCommerce fees of $0.3 million and variable advertising fees of $0.2 million. 24-------------------------------------------------------------------------------- Table of Contents TV Everywhere Revenue from TV Everywhere customers increased to $11.3 million for the year ended December 31, 2013 from $10.6 million for the year ended December 31, 2012. The $0.7 million increase was primarily a result of an increase in monthly/annual fees. Other - B2C Revenue from B2C customers decreased to $0.5 million for the year ended December 31, 2013 from $1.2 million for the year ended December 31, 2012. The decrease in revenue was primarily attributable to the Company's appointment of KyLin TV, a related party, as the exclusive distributor of the Company's B2C IPTV interests effective April 1, 2012. Other - Consulting Revenue from consulting customers was $1.0 million for the years ended December 31, 2012 and 2013. Equipment revenue Equipment revenue decreased to $0.8 million for the year ended December 31, 2013 from $1.8 million for the year ended December 31, 2012. The $1.0 million change was due to a decrease in STB purchases by existing customers. Over 85% of our equipment revenue is generated from our TV Everywhere customers. Costs and Expenses Cost of services revenue Cost of services revenue increased from $12.3 million for the year ended December 31, 2012 to $12.7 million for the year ended December 31, 2013. Cost of services revenue as a percentage of services revenue decreased from 33% for the year ended December 31, 2012 to 27% for the year ended December 31, 2013. The 6% improvement (as a percentage of services revenue) primarily resulted from the Company having negotiated lower rates on bandwidth costs. Cost of equipment revenue Cost of equipment revenue decreased from $1.4 million for the year ended December 31, 2012 to $0.6 million for the year ended December 31, 2013, primarily as a result of a decrease in equipment sold. Selling, general and administrative expenses, including stock-based compensation Selling, general and administrative expenses, including stock-based compensation, increased by 3%, from $23.5 million for the year ended December 31, 2012 to $24.3 million for the year ended December 31, 2013. The individual variances are as follows: • Wages and benefits increased from $16.1 million for the year ended December 31, 2012 to $17.2 million for the year ended December 31, 2013. The $1.1 million increase was primarily the result of the hire of new employees and related costs. • Stock-based compensation expense decreased from $1.6 million for the year ended December 31, 2012 to $1.4 million for the year ended December 31, 2013. The $0.2 million decrease was primarily the result of fully vested warrants being issued to a consulting firm during the three months ended December 31, 2012. There was no comparable charge during the three months ended December 31, 2013. • Marketing expenses decreased from $0.4 million for the year ended December 31, 2012 to $0.3 million for the year ended December 31, 2013. • Professional fees decreased from $1.6 million for the year ended December 31, 2012 to $1.3 million for the year ended December 31, 2013. The $0.3 million decrease was primarily the result of a decrease in legal fees and recruitment expenses. • Other SG&A expenses increased from $3.8 million for the year ended December 31, 2012 to $4.1 million for the year ended December 31, 2013. The $0.3 million increase was primarily due to an increase in bad debt expense due to a large recovery during the year ended December 31, 2012. 25-------------------------------------------------------------------------------- Table of Contents Research and development Research and development costs increased from $6.7 million for the year ended December 31, 2012 to $7.4 million for the year ended December 31, 2013. The increase of $0.7 million was primarily due to the hire of new R&D employees. Depreciation and amortization Depreciation and amortization decreased from $4.4 million for the year ended December 31, 2012 to $3.8 million for the year ended December 31, 2013. The $0.6 million decrease was the result of certain intangible assets becoming fully depreciated during the year ended December 31, 2013. RESULTS OF OPERATIONS Comparison of Three Months Ended December 31, 2013 to Three Months Ended December 31, 2012 Our consolidated financial statements for the three months ended December 31, 2013 and 2012 have been prepared in accordance with U.S. GAAP. A comparison of our results of operations for those periods is as follows: 2013 2012 Change $ $ % Revenue Services revenue 13,958,708 10,338,669 35 % Equipment revenue 185,425 200,096 (7) % Total revenue 14,144,133 10,538,765 34 % Costs and expenses Cost of services revenue, exclusive of depreciation and amortization shown separately below 3,852,390 3,116,829 24 % Cost of equipment revenue 143,444 104,365 37 % Selling, general and administrative, including stock-based compensation 6,300,462 5,244,689 20 % Research and development 1,962,676 1,663,510 18 % Depreciation and amortization 767,782 842,614 (9) % 13,026,754 10,972,007 19 % Operating income (loss) 1,117,379 (433,242 ) - % Other income (expense) Loss on foreign exchange (35,708 ) (12,493) - % Interest, net 1,864 (4,499) - % Discount on convertible note - (77,922) - % (33,844 ) (94,914 ) - % Net and comprehensive income (loss) before income taxes 1,083,535 (528,156 ) - % Deferred income taxes (11,556 ) (333,884 ) - % Net and comprehensive income (loss) 1,071,979 (862,040 ) - % Revenue Services revenue Services revenue increased to $13.9 million for the three months ended December 31, 2013 from $10.3 million for the three months ended December 31, 2012. Services revenue includes revenue from Pro Sports, College Sports, TV Everywhere and Other Customers and is comprised of set-up fees, annual/monthly fees and variable fees. Period-over-period variances in each sector are detailed below: Pro Sports Revenue from Pro Sports customers increased to $6.8 million for the three months ended December 31, 2013 from $3.9 million for the three months ended December 31, 2012. The $2.9 million improvement was primarily the result of an increase in variable usage fees of $1.3 million, monthly/annual fees of $1.1 million and variable subscription fees of $0.3 million. The increase in revenue from variable usage fees was the result of an increase in end users, end users watching for longer periods of time and increased bandwidth consumption by end users due to advances in technology. 26-------------------------------------------------------------------------------- Table of Contents College Sports Revenue from College Sports customers increased to $3.8 million for the three months ended December 31, 2013 from $3.2 million for the three months ended December 31, 2012. The $0.6 million increase was primarily a result of revenue earned from agreements signed with new colleges and conferences during the year and at the end of the prior year. The $0.6 million increase was the result an increase in monthly/annual fees of $0.2 million, variable usage fees of $0.2 million and variable advertising fees of $0.2 million. TV Everywhere Revenue from TV Everywhere customers increased to $3.0 million for the three months ended December 31, 2013 from $2.9 million for the three months ended December 31, 2012. Other - B2C Revenue from B2C customers was $0.1 million for the three months ended December 31, 2012 and 2013. Other - Consulting Revenue from consulting customers was $0.2 million for the three months ended December 31, 2012 and 2013. Equipment revenue Equipment revenue was $0.2 million for the three months ended December 31, 2012 and 2013. Over 85% of our equipment revenue is generated from our TV Everywhere customers. Costs and Expenses Cost of services revenue Cost of services revenue increased from $3.1 million for the three months ended December 31, 2012 to $3.8 million for the three months ended December 31, 2013. Cost of services revenue as a percentage of services revenue decreased from 31% for the year ended December 31, 2012 to 28% for the three months ended December 31, 2013. The 3% improvement (as a percentage of services revenue) primarily resulted from the Company having negotiated lower rates on bandwidth costs. Cost of equipment revenue Cost of equipment revenue was $0.1 million for the three months ended December 31, 2012 and 2013. Selling, general and administrative expenses, including stock-based compensation Selling, general and administrative expenses, including stock-based compensation, increased by 21%, from $5.2 million for the three months ended December 31, 2012 to $6.3 million for the three months ended December 31, 2013. The individual variances are as follows: • Wages and benefits increased from $3.6 million for the three months ended December 31, 2012 to $4.4 million for the three months ended December 31, 2013. The $0.8 million increase was primarily a result of the hire of new employees and consultants. • Stock-based compensation expense was $0.4 million for the three months ended December 31, 2012 and 2013. • Marketing expenses were $0.1 million for the three months ended December 31, 2012 and 2013. • Professional fees increased from $0.2 million for the three months ended December 31, 2012 to $0.4 million for the three months ended December 31, 2013. The $0.2 million increase was the result of an increase in legal fees. • Other SG&A expenses increased from $0.9 million for the three months ended December 31, 2012 to $1.0 million for the three months ended December 31, 2013. 27-------------------------------------------------------------------------------- Table of Contents Research and development Research and development costs increased from $1.7 million for the three months ended December 31, 2012 to $2.0 million for the three months ended December 31, 2013. The increase of $0.3 million was primarily due to the hire of new R&D employees. Depreciation and amortization Depreciation and amortization was $0.8 million for the three months ended December 31, 2012 and 2013. LIQUIDITY AND CAPITAL RESOURCES Our cash position was $19.6 million at December 31, 2013. In 2013, we generated $9.5 million from operations, which included cash of $6.9 million provided by operating assets. Additionally, cash provided by financing activities included $0.4 million from the exercise of stock options and broker units and cash used in investing activities included $1.3 million to purchase fixed assets. As of December 31, 2013, our principal sources of liquidity included cash and cash equivalents of $19.6 million and trade accounts receivable of $5.3 million offset by $13.0 million in accounts payable. We continue to closely monitor our cash balances to ensure that we have sufficient cash on hand to meet our operating needs. Management believes that we have sufficient liquidity to meet our working capital and capital expenditure requirements for at least the next twelve months. At December 31, 2013, approximately 92% of our cash and cash equivalents were held in accounts with U.S. banks that received a BBB+ rating from Standard and Poor's and an A3 rating from Moody's. The Company believes that these U.S. financial institutions are secure notwithstanding the current global economy and that we will be able to access the remaining balance of bank deposits. Our investment policy is to invest in low-risk short-term investments which are primarily term deposits. We have not had a history of any defaults on these term deposits, nor do we expect any in the future given the short term maturity of these investments. We are still building out our current business. In 2006, our core business and business model evolved from providing professional information technology services and international programming to providing customized, end-to-end, interactive video services for a wide range of professional and collegiate sports properties, cable networks and operators, content owners and distributors, and telecommunication companies. From our inception, we have incurred substantial net losses and have an accumulated deficit of $87.7 million; however, our non-GAAP Adjusted EBITDA (as previously defined) has continuously improved year-over-year and management expects this trend to continue. We continue to review our operating structure in an attempt to maximize revenue opportunities, further reduce costs and achieve profitability. Based on our current business plan and internal forecasts, we believe that our cash on hand will be sufficient to meet our working capital and operating cash requirements for the next twelve months. However, we will require expenditures of significant funds for research and development, maintaining adequate video streaming and database software, and the construction and maintenance of our delivery infrastructure and office facilities. Cash from operations could be affected by various risks and uncertainties, including, but not limited to, the risks detailed in this Annual Report on Form 10-K. If our actual cash needs are greater than forecasted and if cash on hand is insufficient to meet our working capital and cash requirements for the next twelve months, we will require outside capital in addition to cash flow from operations in order to fund our business. Our short operating history and our current lack of profitability could each or all be factors that might negatively impact our ability to obtain outside capital on reasonable terms, or at all. If we were ever unable to obtain needed capital, we would reevaluate and reprioritize our planned capital expenditures and operating activities. We cannot assure you that we will ultimately be able to generate sufficient revenue or reduce our costs in the anticipated time frame to become profitable and have sustainable net positive cash flows. Working Capital Requirements Our net working capital at December 31, 2013 was $(0.1) million, an improvement of $2.4 million from the December 31, 2012 net working capital of $(2.5) million. Our working capital ratios at December 31, 2013 and 2012 were 1.00 and 0.88, respectively. Included in current liabilities at December 31, 2013 and 2012 are approximately $8.9 million and $6.0 million, respectively, of liabilities (deferred revenue and convertible note) that we do not anticipate settling in cash. The change in working capital was primarily due to an increase in current assets of $9.0 million and an increase in current liabilities of $6.6 million. Current assets at December 31, 2013 were $27.2 million, an increase of $9.0 million from the December 31, 2012 balance of $18.2 million. The change was primarily due to an increase of $8.5 million in cash and cash equivalents. Current liabilities at December 31, 2013 were $27.2 million, an increase of $6.6 million from the December 31, 2012 balance of $20.6 million. The increase was primarily due to increases in accounts payable of $3.2 million and deferred revenue of $3.1 million. 28-------------------------------------------------------------------------------- Table of Contents Off Balance Sheet Arrangements The Company did not have any off balance sheet arrangements as of December 31, 2013. Financial Instruments Our financial instruments are comprised of cash and cash equivalents, accounts receivable, other receivables, deposits, accounts payable, accrued liabilities and amounts due to/from related parties. Fair value of financial instruments Fair value of a financial instrument is defined as the amount for which the instrument could be exchanged in a current transaction between willing parties. The estimated fair value of our financial instruments approximates their carrying value due to the short maturity term of these financial instruments. Risks associated with financial instruments Foreign exchange risk We are exposed to foreign exchange risk as a result of transactions in currencies other than our functional currency, the United States dollar. The majority of our revenues are transacted in U.S. dollars, and the majority of our expenses are transacted in U.S. dollars. We do not use derivative instruments to hedge against foreign exchange risk. Interest rate risk We are exposed to interest rate risk on our invested cash and cash equivalents and our short-term investments. The interest rates on these instruments are based on bank rates and therefore are subject to change with the market. We do not use derivative financial instruments to reduce our interest rate risk. Credit risk We sell our services to a variety of customers under various payment terms and therefore are exposed to credit risk. We have adopted policies and procedures designed to limit this risk. The maximum exposure to credit risk at the reporting date is the carrying value of receivables. We establish an allowance for doubtful accounts that represents our estimate of incurred losses in respect of accounts receivable. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our consolidated financial statements are prepared in conformity with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. On an ongoing basis, management reviews its estimates to ensure they appropriately reflect changes in our business and new information as it becomes available. If historical results and other factors used by management to make these estimates do not reasonably predict future actual results, our consolidated financial position and results of operations could be materially impacted. We believe the following critical accounting policies involve the more significant judgments and estimates used in the preparation of our consolidated financial statements. Allowance for doubtful accounts We maintain a provision for estimated losses resulting from the inability of our customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends and changes in customer payment terms. If the financial conditions of our customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. As of December 31, 2013 and 2012, the allowance for doubtful accounts was $105,292 and $85,882, respectively. 29-------------------------------------------------------------------------------- Table of Contents Inventory We evaluate our ending inventories for estimated excess quantities and obsolescence. This evaluation includes analyses of sales levels and projections of future demand within specific time horizons. Inventories in excess of future demand are reserved. In addition, we assess the impact of changing technology and market conditions on our inventory on hand and write off inventories that are considered obsolete. Property, plant and equipment We review the carrying value of property, plant and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. If these future undiscounted cash flows are less than the carrying value of the asset, then the carrying amount of the asset is written down to its fair value, based on the related estimated discounted future cash flows. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the property, plant and equipment is used and the effects of obsolescence, demand, competition and other economic factors. Based on this assessment, no impairment was recorded for the years ended December 31, 2013 and 2012. Intangible assets We review the carrying value of our definite lived intangible assets for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. If these future undiscounted cash flows are less than the carrying value of the asset, then the carrying amount of the asset is written down to its fair value, based on the related estimated discounted future cash flows. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the intangible assets are used and the effects of obsolescence, demand, competition and other economic factors. Based on this assessment, no impairment was recorded for the years ended December 31, 2013 and 2012. Goodwill Goodwill is not amortized but is subject to an annual impairment test at the reporting unit level and between annual tests if changes in circumstances indicate a potential impairment. The Company performs this annual goodwill impairment test as of October 1 of each calendar year. Goodwill impairment is assessed based on a comparison of the fair value of each reporting unit to the underlying carrying value of the reporting unit's net assets, including goodwill. If the carrying value of the reporting unit exceeds its fair value, the Company performs the second step of the goodwill impairment test to determine the amount of the impairment loss. The second step of the impairment test involves comparing the implied fair value of the reporting unit's goodwill with its carrying amount to measure the amount of impairment loss, if any. The Company's impairment test is based on its single operating segment and reporting unit structure. For the years ended December 31, 2013 and 2012, there was no impairment loss. Stock-based compensation and other stock-based payments We account for all stock options and warrants using a fair value-based method. The fair value of each stock option and warrant granted is estimated on the date of the grant using the Black-Scholes-Merton option pricing model and the related stock-based compensation expense is recognized over the expected life of the stock option or warrant. The fair value of the warrants granted to non-employees is measured and expensed as the warrants vest. Restricted stock awards give the holder the right to one share of common stock for each vested share of restricted stock. These awards vest on a yearly basis over a four-year vesting period. Stock-based compensation expense is recorded based on the market value of the common stock on the grant date and recognized over the vesting period of these awards. Amortization policies and useful lives We amortize the cost of property, plant and equipment and intangible assets over the estimated useful service lives of these items. The determinations of estimated useful lives of these long-lived assets involve considerable judgment. In determining these estimates, we take into account industry trends and Company-specific factors, including changing technologies and expectations for the in-service period of these assets. On an annual basis, we reassess our existing estimates of useful lives to ensure they match the anticipated life of the technology from a revenue producing perspective. If technological change happens more quickly than anticipated, we might have to shorten our estimate of the useful life of certain equipment, which could result in higher amortization expense in future periods or an impairment charge to write down the value of this equipment. 30-------------------------------------------------------------------------------- Table of Contents Taxes As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax expense, together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. The carrying value of our deferred tax assets is adjusted by a valuation allowance to recognize the extent to which the future tax benefits will be recognized on a more likely than not basis. Our net deferred tax liability consists primarily of indefinite lived intangibles. We record valuation allowances in order to reduce our deferred tax assets to the amount expected to be realized. In assessing the adequacy of recorded valuation allowances, we consider a variety of factors, including the scheduled reversal of deferred tax liabilities, future taxable income, and prudent and feasible tax planning strategies. Under the relevant accounting guidance, factors such as current and previous operating losses are given significantly greater weight than the outlook for future profitability in determining the deferred tax asset carrying value. Relevant accounting guidance addresses how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under such guidance, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such uncertain tax positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. 31-------------------------------------------------------------------------------- Table of Contents |