TMCnet News

DIALOGIC INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
[March 31, 2014]

DIALOGIC INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of our operation should be read in conjunction with the consolidated financial statements and the notes to those statements included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed in "Statement Regarding Forward-Looking Statements" and Part I, Item 1A "Risk Factors" and elsewhere in this report.



Overview Dialogic Inc. helps the world's leading service providers and application developers to improve the performance of media-rich communications across the most advanced networks. We increase the reliability of any-to-any network connections, enhance the impact of applications and amplify the capacity of congested networks, supported by a world class global services team.

23 -------------------------------------------------------------------------------- Table of Contents Wireless and wireline service providers use our products to transport, transcode, manage and optimize video, voice and data traffic while enabling Voice over Internet Protocol and other media rich services. These service providers also utilize our technology to energize their revenue-generating value-added services platforms such as messaging, Short Message Service, voice mail and conferencing, all of which are becoming increasingly video-enabled.


Enterprises rely on our innovative products to simplify the integration of Internet Protocol and wireless technologies and endpoints into existing communication networks, and to empower applications that serve businesses, including unified communication applications, contact centers and Interactive Voice Response/ Interactive Voice and Video Response.

We sell our products to both service provider and enterprise customers and sell directly and indirectly through distribution partners such as Technology Equipment Manufacturers, Value Added Resellers and other channel partners. Our customers have the potential to enhance their networks, enterprise communications solutions, or their value-added services with our products.

We were incorporated in Delaware on October 18, 2001 as Softswitch Enterprises, Inc., and subsequently changed our name to NexVerse Networks, Inc.

in 2001, Veraz Networks, Inc. in 2002 and Dialogic Inc. in 2010. We and businesses that we have acquired have been providing products and services for nearly 25 years.

Critical Accounting Policies and Estimates Management's discussion and analysis of our financial position and results of operations is based upon the consolidated financial statements, which have been prepared in accordance with U.S. GAAP pursuant to the rules and regulations of the Securities and Exchange Commission. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We base our estimates on historical experience, knowledge of current conditions and beliefs of what could occur in the future given available information. If actual results differ significantly from management's estimates and projections, there could be a material effect on our financial statements. The accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results, and which required the most subjective judgment by us, are the following: •Revenue Recognition; •Accounts Receivable and Allowance for Doubtful Accounts; •Inventory; •Impairment of Long-Lived Assets and Goodwill; •Stock-Based Compensation; and •Accounting for Income Taxes Revenue Recognition We derive substantially all of our revenue from the sale of hardware/ software, the licensing of software and the performance of professional services. Our products are sold directly through our own sales force and independently through distribution partners.

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred and, if applicable, acceptance is received, the fee is fixed or determinable, and collectability is probable. In making these judgments, we evaluate these criteria as follows: •Persuasive evidence of an arrangement exists. A written contract signed by the customer and us, or a purchase order, and/ or other written or electronic order documentation for those customers who have previously negotiated a standard arrangement with us, is deemed to represent persuasive evidence of an agreement.

•Delivery has occurred. We consider delivery of hardware and software products to have occurred at the point of shipment when title and risk of loss is passed to the customer and no post-delivery obligations exist. In instances where customer acceptance is required, delivery is deemed to have occurred when customer acceptance has been achieved or we have completed our contractual requirements. Services revenue is recognized when the services are completed. In certain arrangements involving subsequent sales of hardware and software products to expand customers' networks, the revenue recognition on these arrangements after the initial arrangement has been accepted typically occurs at the point of shipment, since we have historically experienced successful implementations of these expansions and customer acceptance, although contractually required, does not represent a significant risk.

•The fee is fixed or determinable. We consider the fee to be fixed and determinable unless the fee is subject to refund or adjustment or is not payable within normal payment terms. If the fee is subject to refund or adjustment, revenue is recognized when the refund or adjustment right lapses. If payment terms exceed our normal terms, revenue is recognized upon the receipt of cash.

•Collectability is probable. Each customer is evaluated for creditworthiness through a credit review process at the inception of an arrangement. Collection is deemed probable if, based upon our evaluation; we expect that the customer will be able to pay 24 -------------------------------------------------------------------------------- Table of Contents amounts under the arrangement as payments become due. If it is determined that collection is not probable, revenue is deferred and recognized upon cash collection.

During the first quarter of 2011, we prospectively adopted the guidance of Accounting Standards Update, or ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements, or ASU No. 2009-13 and ASU No. 2009-14, Software (Topic 985): Certain Revenue Arrangement That Include Software Elements, or ASU No. 2009-14.

The amendments in ASU No. 2009-14 provided that tangible products containing software components and non-software components that function together to deliver the tangible product's essential functionality are no longer within the scope of the software revenue recognition guidance in Accounting Standards Codification, or ASC Topic 985-605, Software Revenue Recognition, or ASC 985-605 and should follow the guidance in ASU No. 2009-13 for multiple-element arrangements. All non-essential and standalone software components will continue to be accounted for under the guidance of ASC 985-605.

ASU No. 2009-13 established a selling price hierarchy for determining the selling price of a deliverable in a revenue arrangement. The selling price for each deliverable is based on vendor-specific objective evidence, or VSOE, if available, third-party evidence, or TPE, if VSOE is not available, or our estimated selling price, or ESP, if neither VSOE nor TPE are available. The amendments in ASU No. 2009-13 eliminated the residual method of allocating arrangement consideration and required that it be allocated at inception of the arrangement to all deliverables using the relative selling price method. The relative selling price method allocates any discount in the arrangement proportionately to each deliverable on the basis of the deliverable's estimated selling price.

Our products typically have both hardware and software and components that function together to deliver the product's essential functionality. Although our products are primarily marketed based on the software elements contained therein, the hardware sold, generally cannot be used apart from the software.

Many of our sales involve multiple-element arrangements that include product, maintenance and professional services. We may enter into sales transactions that do not contain tangible hardware components, which continue to be accounted for under guidance of ASC 985-605.

Multiple-deliverable revenue guidance requires the evaluation of each deliverable in an arrangement to determine whether such deliverable represents a separate unit of accounting. The delivered item constitutes a separate unit of accounting when it has stand-alone value to the customer. If the arrangement includes a general refund or return right relative to the delivered item and the delivery and performance of the undelivered items are considered probable and substantially in our control, the delivered element constitutes a separate unit of accounting. In instances when the aforementioned criteria are not met, the deliverable is combined with the undelivered elements and revenue recognition is determined for the combination as a single unit of accounting. Most of our products qualify as single deliverables because they are sold as a single tangible product containing both hardware and software to deliver the product's essential functionality and have standalone value to the customers, accordingly, revenue is recognized when the applicable revenue recognition criteria are met.

Hardware and software expansion and spare or replacement parts are treated as separate units of accounting because they have standalone value to the customer and general right of return does not exist; therefore, revenue is recognized upon delivery for these components assuming all other revenue recognition criteria are also met.

The total arrangement fees are allocated to all the deliverables based on their respective relative selling prices. The relative selling price is determined using VSOE, when available. We generally use VSOE to derive the selling price for its maintenance and professional services deliverables. VSOE for maintenance is based on contractual stated renewal rates, whereas professional services are based on historical pricing for standalone professional service transactions. When VSOE cannot be established, we attempt to determine the TPE for the deliverables. TPE is determined based on prices for similar deliverables, sold by competitors. Generally, our offerings differ from those of our competitors and comparable pricing of our competitors is often not available.

When we are unable to establish selling price using VSOE or TPE, we use ESP in our allocation of arrangement fees. The ESP for a deliverable is determined as the price at which we would transact, if the products or services were sold on a standalone basis. The ESP for each deliverable is determined using an average historical discounted selling price based on several factors, including but not limited to, marketing strategy, customer considerations and pricing practices in a region. For arrangements with contingent revenue provisions (a portion of the relative selling price of a delivered item is contingent upon the delivery of additional items or meeting other specified performance conditions), revenue recognized on delivered items is limited to the non-contingent amount.

•Revenue Reserves and Adjustments Sales incentives, which are offered on some of our products, are recorded as a reduction of revenue as there are no identifiable benefits received. We record a provision for estimated sales returns and allowances as a reduction from sales in the same period during which the related revenue is recorded. These estimates are based on historical sales returns and allowances, analysis of credit memo data and other known factors.

We have agreements with certain distributors which allow for stock rotation rights. The stock rotation rights permit the distributors to return a defined percentage of their purchases. Most distributors must exchange this stock for orders of an equal or greater amount. We recognize an allowance for stock rotation rights based on historical experience. The provision is recorded as a reduction in revenue in the period during which the related revenue is recognized.

25 -------------------------------------------------------------------------------- Table of Contents We also have agreements with certain distributors that allow for price adjustments. We recognize an allowance for these price adjustments based on historical experience. The price adjustments are recorded as a reduction in revenue in the period during which the related revenue is recognized.

Revenue is primarily recognized net of sales taxes. Revenue includes amounts billed to customers for shipping and handling. Shipping and handling costs are included in cost of revenue in the accompanying consolidated statements of operations and comprehensive loss.

Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable consist of amounts due from normal business activities. We maintain an allowance for estimated losses resulting from the inability of our customers to make required payments. We estimate uncollectible amounts based upon historical bad debts, evaluation of current customer receivable balances, age of customer receivable balances, the customer's financial condition and current economic trends. We review our allowance for doubtful accounts on a regular basis. Account balances are charged off against the allowance after all means of collection has been made and the potential for recovery is considered remote. Historically, the allowance for doubtful accounts has been adequate to cover the actual losses from uncollectible accounts.

Inventory Inventory is stated at the lower of cost, determined on a first in, first out basis, or market, and consists primarily of raw material and components; work in process and finished products. We provide for inventory losses based on obsolescence and levels in excess of forecasted demand. In assessing the net realizable value of inventory, we are required to make judgments as to future demand requirements and compare these with the current or committed inventory levels.

Impairment of Long-lived Assets and Goodwill Long-lived assets, such as property and equipment, and intangible assets, are assessed for recoverability when events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable. The assessment of possible impairment is based upon the ability to recover the cost of the asset from the expected future undiscounted cash flows of related operations. In the event undiscounted cash flow projections indicate impairment, we would record an impairment charge based on the fair value of the assets at the date of the impairment.

Goodwill represents costs in excess of the fair value of net tangible and identifiable net intangible assets acquired in business combinations. We are required to perform a test for impairment of goodwill and indefinite-lived intangible assets on an annual basis or more frequently if impairment indicators arise during the year.

As of December 31, 2013, we performed our annual impairment test. We performed first step and second step impairment tests on our reporting unit. Based on the results of the annual impairment test, it was determined that the fair value of the reporting unit was less than the carrying value. As a result, we made the determination to write down the value of goodwill and indefinite-lived assets related to the reporting unit. The total amount of the non-cash impairment charge during the year ended December 31, 2013 was $31.8 million, of which $22.9 million related to goodwill and $8.9 million related to indefinite-lived assets.

During the 2013 annual impairment test, we used a weighted approach of both discounted cash flows and market approach. The discounted cash flow method derives a value by determining the present value of a projected level of income stream, including a terminal value. This method involves the present value of a series of estimated future benefits at the valuation date by the application of a discount rate, one which a prudent investor would require before making an equity investment.

Key assumptions within our discounted cash flow model include projected financial operating results, a long term growth rate of 3% and discount rate of approximately 17%. As stated above, as the discounted cash flow method derives value from the present value of a projected level of income stream, a modification to our projected operating results including changes to the long term growth rate could impact the fair value. The present value of the cash flows is determined using a discount rate that was based on the capital structure and capital costs of comparable public companies as identified by us.

A change to the discount rate could impact the fair value determination.

The market approach is a general way of determining a value indication of a business by using one or more methods that compare the subject to similar businesses that have been sold. The market approach is a valuation technique in which the fair value is estimated based on market prices realized in actual arm's length transactions. The technique consists of undertaking a detailed market analysis of publicly traded companies that provides a reasonable basis for comparison to our relative investment characteristics of us. The most critical assumption underlying the market approach utilized by us is the comparable companies utilized. As such, a change to the comparable companies could have an impact on the fair value determination.

In deriving our fair value estimates, we have utilized certain key assumptions. These assumptions, specifically those included within the discounted cash flow estimate, are comprised of the revenue growth rate, gross margin, operating expenses, working capital requirements, and depreciation and amortization expense.

We have estimated a revenue decline of approximately 11.0% for fiscal year 2014 and minimal growth over the following three years, based on our assessment of market demand for our existing and future products. We have utilized gross margin estimates of approximately 64 - 65% that are materially consistent with historical gross margins achieved. Estimates of operating expenses and 26 -------------------------------------------------------------------------------- Table of Contents depreciation and amortization expense utilized are consistent with actual historical amounts and expected cost savings from recent restructuring actions.

Working capital requirements used in the impairment test reflect current financial trends.

The current economic conditions and the continued volatility in the U.S. and in many other countries where we operate could contribute to decreased consumer confidence which may adversely impact our operating performance, including the revenue growth rates utilized in the discounted cash flow model. Reductions in the expected revenue growth rate or gross margins or a reduction in the discount rate used could have a material adverse impact on the underlying estimates used in deriving the fair value or could result in additional triggering events requiring future interim impairment tests. These conditions may result in additional impairment charges in future periods.

Stock-Based Compensation Stock-based compensation cost is estimated at the grant date based on the award's fair-value. For stock options, fair value is calculated by the Black-Scholes option-pricing model. For restricted stock units, or RSUs, fair value is determined based on the stock price on grant date. We recognize the compensation cost of stock-based awards on a straight-line basis over requisite service period, which is generally the vesting period of the award. The Black-Scholes model requires various judgment-based assumptions including interest rates, expected volatility and expected term.

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant for the period commensurate with the expected term. The computation of expected volatility is based on the historical volatility of our stock, as well as historical and implied volatility of comparable companies from a representative peer group based on industry and market capitalization data. The expected term represents the period that stock-based awards are expected to be outstanding, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee exercise behavior. The expected term for stock-based awards has been determined using the "simplified" method. We will continue to use the simplified method until we have enough historical experience to provide a reasonable estimate of expected term. We have not paid, and do not anticipate paying, cash dividends on our common stock; therefore the expected dividend yield is assumed to be zero. Management makes an estimate of expected forfeitures and recognizes compensation expense only for the equity awards expected to vest.

Generally, stock options and RSUs vest over four years in equal installments on each of the first through fourth anniversaries of the vesting commencement date. Upon vesting, all RSUs will convert into an equivalent number of shares of common stock.

Accounting for Income Taxes We account for income taxes using the asset and liability approach, which requires the recognition of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or tax returns. The measurement of current and deferred tax liabilities and assets are based on provisions of the enacted tax law. A valuation allowance is provided if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. A change in taxable income in future periods that is significantly different from that projected may cause adjustments to the valuation allowance that could materially increase or decrease future income tax expense.

We classify interest and penalties related to uncertain tax contingencies as a component of income tax expense in the consolidated statements of operations and comprehensive loss. Income tax reserves for uncertain tax positions are recorded whenever there is a difference between amounts reported in our tax returns and the amounts we believe we would likely pay in the event of an examination by the taxing authorities. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in the recognition or measurement are reflected in the period in which the change occurs.

27 -------------------------------------------------------------------------------- Table of Contents Results of Operations Comparison of Years Ended December 31, 2013 and 2012 Revenue 2013 2012 Period-to-Period Change % of % of Total Total Amount Revenue Amount Revenue Amount Percentage Revenue: Products $ 93,705 71% $ 121,339 76% $ (27,634) (23%) Services 38,376 29% 38,740 24% (364) (1%) Total revenue $ 132,081 100% $ 160,079 100% $ (27,998) (17%) Legacy vs. Next Generation: Legacy $ 38,392 29% $ 55,309 35% $ (16,917) (31%) Next Generation 93,689 71% 104,770 65% (11,081) (11%) Total revenue $ 132,081 100% $ 160,079 100% $ (27,998) (17%) Revenue by geography: Americas $ 61,305 46% $ 72,432 45% $ (11,127) (15%) Europe, Middle East and Africa 45,823 35% 51,842 32% (6,019) (12%) Asia Pacific 24,953 19% 35,805 22% (10,852) (30%) Total revenue $ 132,081 100% $ 160,079 100% $ (27,998) (17%) Revenue Total revenue of $132.1 million for the year ended December 31, 2013, decreased by $28.0 million, or 17%, from $160.1 million for the year ended December 31, 2012.

Our product revenue was 71% of total revenue at $93.7 million for the year ended December 31, 2013, compared to 76% of total revenue, or $121.3 million for the year ended December 31, 2012, a decrease of $27.6 million, or 23%. The decrease in product revenue is primarily attributable to a decline in demand for our Legacy products, as well as project timing and associated revenue recognition of Next Generation products.

Our services revenue was 29% of total revenue at $38.4 million for the year ended December 31, 2013, compared to 24% of total revenue, or $38.7 million for the year ended December 31, 2012, a decrease of $0.3 million, or 1%. The decrease in services revenue was the result of decommissioning of our Legacy products in certain customer networks, partially offset by customer expansions and upgrades of our Next Generation products.

28 -------------------------------------------------------------------------------- Table of Contents Cost of Revenue and Gross Profit 2013 2012 Period-to-Period Change % of % of Total Total Amount Revenue Amount Revenue Amount Percentage Cost of Revenue: Products $ 33,433 36% $ 48,479 40% $ (15,046) (31%) Services 17,402 45% 19,712 51% (2,310) (12%) Total cost of revenue $ 50,835 38% $ 68,191 43% $ (17,356) (25%) Gross Profit: Products $ 60,272 64% $ 72,860 60% $ (12,588) (17%) Services 20,974 55% 19,028 49% 1,946 10% Total gross profit $ 81,246 62% $ 91,888 57% $ (10,642) (12%) Cost of Revenue Total cost of revenue of $50.8 million for the year ended December 31, 2013 decreased by 25%, or $17.4 million, from $68.2 million for the year ended December 31, 2012.

Cost of product revenue of $33.4 million for the year ended December 31, 2013 decreased by 31%, or $15.1 million, from $48.5 million for the year ended December 31, 2012. The change is primarily attributable to decline in product volume and a reduction in salaries and benefits due to the decrease in operations personnel headcount.

Cost of services revenue of $17.4 million for the year ended December 31, 2013 decreased by 12%, or $2.3 million, from $19.7 million for the year ended December 31, 2012. The change is primarily attributable to the decrease in headcount compared to the corresponding prior year period. Cost of services includes the direct costs of customer support and consists primarily of payroll, related benefits and travel for our support personnel.

Gross Profit Gross profit of $81.2 million for the year ended December 31, 2013 decreased by $10.6 million, or 12%, from $91.9 million for the year ended December 31, 2012.

Gross profit margin increased from 57% of total revenue for the year ended December 31, 2012 to 62% of total revenue for the year ended December 31, 2013.

For the year ended December 31, 2013, product gross profit decreased by 17%, or $12.6 million, from $72.9 million for the year ended December 31, 2012 to $60.3 million for the year ended December 31, 2013. The decrease in gross profit on product revenue is primarily a result of an overall decline in product revenue.

Gross profit margin increased from 60% of total product revenue for the year ended December 31, 2012 to 64% of total product revenue for the year ended December 31, 2013 due to product mix.

For the year ended December 31, 2013, services gross profit increased by 10%, or $2.0 million from $19.0 million for the year ended December 31, 2012 to $21.0 million for the year ended December 31, 2013. Gross profit margin increased from 49% of total services revenue for the year ended December 31, 2012 to 55% of total services revenue for the year ended December 31, 2013 due to a higher level of maintenance renewals.

29 -------------------------------------------------------------------------------- Table of Contents Operating Expenses 2013 2012 Period-to-Period Change % of % of Total Total Amount Revenue Amount Revenue Amount Percentage Research and development, net $ 27,279 21% $ 42,785 27% $ (15,506) (36%) Sales and marketing 33,374 25% 41,456 26% (8,082) (19%) General and administrative 29,388 22% 31,180 19% (1,792) (6%) Restructuring charges, net 2,644 2% 7,030 4% (4,386) (62%) Impairment of goodwill and indefinite-lived assets 31,841 24% - 0% 31,841 100% Total operating expenses $ 124,526 94% $ 122,451 76% $ 2,075 2% Research and Development Expenses Research and development expenses of $27.3 million, or 21% of total revenue, for the year ended December 31, 2013 decreased by $15.5 million, or 36%, from $42.8 million, or 27% of total revenue for the year ended December 31, 2012. The decrease was primarily the result of an $11.7 million decrease in salaries and employee benefits and stock-based compensation associated with a decrease in departmental headcount, as a result of our restructuring actions. In addition, the allocation of occupancy costs for the year ended December 31, 2013 was favorable by $1.1 million due primarily to the Settlement Agreement with Intel as described below.

We expect that research and development expenses on an absolute basis and as a percentage of total revenue will continue to decrease in 2014.

Sales and Marketing Sales and marketing expenses of $33.4 million, or 25% of total revenue, for the year ended December 31, 2013 decreased by $8.1 million, or 19%, from $41.5 million, or 26% of total revenue for the year ended December 31, 2012. The change in sales and marketing expenses is primarily attributable to decreases in salaries and employee benefits and stock-based compensation of $2.6 million, third party commissions of $0.9 million, sales commissions of $1.3 million, marketing related costs of $0.6 million, allocation of occupancy costs of $0.5 million primarily related to Settlement Agreement with Intel as described below, and travel and expenses of $0.3 million.

We expect that sales and marketing expenses, as a percentage of total revenue, to remain consistent in 2014.

General and Administrative General and administrative expenses of $29.4 million, or 22% of total revenue, for the year ended December 31, 2013 decreased by $1.8 million, or 6%, from $31.2 million, or 19% of total revenue for the year ended December 31, 2012. The change is primarily attributable to decreases in legal fees of $1.0 million, other third party professional services of $1.2 million, and salaries and employee benefits of $1.0 million, partially offset by an increase in bad debt expense of $1.8 million.

We expect that general and administrative expenses, on an absolute dollar basis and as a percentage of total revenue, will decrease in 2014 as we further integrate and enhance our general and administrative operations and gain efficiencies in lower overhead and cost basis.

Restructuring Charges For the years ended December 31, 2013 and 2012, we recorded charges in the amount of $4.6 million and $5.8 million for employee separation costs and other costs related to employee termination benefits. As of December 31, 2013 and 2012, $4.2 million and $2.5 million, respectively, remained accrued and unpaid for these termination benefits, which are reflected as a component of accrued liabilities in the accompanying consolidated balance sheets.

In an effort to reduce overall operating expenses, we decided it was beneficial to close or consolidate office space at certain locations. In addition, we amended our sublease for office space and settled unpaid rent during the third quarter 2013 under a Settlement Agreement with Intel. For the year ended December 31, 2013, we recorded a benefit in the amount of $2.3 million related to the reversal of its restructuring accrual for the Parsippany, New Jersey location based on the new sublease which allows for the Company to exit the space within 60 days, with no future liability or penalty, based on new sublease terms. In addition, during the year ended December 31, 2013, we recorded a net charge in the amount of $0.3 million for adjustments to our facility related 30 -------------------------------------------------------------------------------- Table of Contents restructuring accruals for Eatontown, New Jersey and Renningen, Germany, which was partially offset by idle space in Milpitas, California, and Needham, Massachusetts. For the year ended December 31, 2012, the Company incurred expense of $1.2 million in lease and facility exit costs related to the Company's research and development facilities in Getzville, New York and Renningen, Germany. As of December 31, 2013 and 2012, $0.2 million and $1.2 million, respectively, of lease and facility exit costs were reflected as a component of accrued liabilities and $0.5 million and $1.9 million, respectively, were reflected as a component of other non-current liabilities in the accompanying consolidated balance sheets.

Impairment of Goodwill and Indefinite-Lived Assets We maintain certain indefinite-lived assets, trade names, which are subject to annual impairment tests. We estimated fair value of our indefinite-lived asset using the relief from royalty method. As part of the annual impairment test, it was determined that the fair value of the Dialogic Inc. trade name was $8.9 million less than its carrying value, and as a result, we wrote down our indefinite-lived assets to $1.1 million.

As of December 31, 2013, we performed our annual impairment test for goodwill.

We performed step one and step two impairment tests on our reporting unit. Based on the results of the step one impairment test, it was determined that the fair value of the reporting unit was less than the carrying value. As a result, we performed the step two test and wrote down the value of goodwill. The total amount of the non-cash impairment charge for goodwill during the year ended December 31, 2013 was $22.9 million.

Interest Expense Interest expense decreased by $0.5 million or 5%, from $10.7 million for the year ended December 31, 2012 to $10.2 million for the year ended December 31, 2013. The decrease is primarily attributable to lower interest rates for the year ended December 31, 2013 on our Term Loan Agreement, which decreased from a stated interest rate of 15% to 10% during the second quarter of 2012. In addition, the average interest rate on the Revolving Credit Agreement decreased from 4.97% for the year ended December 31, 2012 to 4.75% for the year ended December 31, 2013.

Change in Fair Value of Warrants The change in fair value of warrants represented a gain of $1.8 million for the year ended December 31, 2013, as a result of a decline in our stock price for the period. For the year ended December 31, 2012, we recorded a gain of $5.1 million related to the change in fair value of warrants, which were granted on March 22, 2012, as a result of a decrease in our stock price.

Foreign Exchange Loss, net Foreign exchange loss, net was $0.8 million for the year ended December 31, 2013, compared to a foreign exchange loss, net of $1.4 million for the year ended December 31, 2012.

Income Tax Provision For the years ended December 31, 2013 and 2012, we recorded a provision for income taxes of $1.8 million and $0.2 million, respectively. The tax expense for the years ended December 31, 2013 and 2012 was primarily due to the current tax expense in our profitable foreign entities and in 2013 an additional valuation allowance against foreign net operating losses.

Financial Position Liquidity and Capital Resources Our primary anticipated sources of liquidity are funds generated from operations, and as required, funds borrowed under the Revolving Credit Agreement and Term Loan Agreement. Both debt instruments expire on March 31, 2015. We monitor and manage liquidity by preparing and updating annual budgets, as well as monitor compliance with terms of our financing agreements.

We have experienced significant losses in the past and have not sustained quarter over quarter profits. As of December 31, 2013, we had cash and cash equivalents of $4.5 million, compared to $6.5 million of cash and cash equivalents as of December 31, 2012. During the year ended December 31, 2013, we used net cash in operating activities of $4.5 million. As of December 31, 2013, we had borrowed $12.1 million, based on the prior month's borrowing base calculation, under our Revolving Credit Agreement and the unused line of credit totaled $12.9 million, of which $3.1 million was available to us in the first week of January 2014. As of December 31, 2013, our long-term debt with related parties was $75.5 million, net of discount, and during the year ended December 31, 2013, we borrowed $4.0 million under the Term Loan Agreement. During the year ended December 31, 2013, we paid $0.5 million to service the interest payments on the Revolving Credit Agreement. No cash interest was paid during the year ended December 31, 2013 related to the Term Loan Agreement as all interest incurred during the year ended December 31, 2013 was paid in kind, as permitted by the Term Loan Agreement. For 2014, the Term Lenders have agreed to allow us to treat all interest as paid in kind.

31 -------------------------------------------------------------------------------- Table of Contents During 2012, we entered into and subsequently amended the Term Loan Agreement to, among other things, reduce the stated interest rate to 10% from 15%, revise the financial covenants and provide for additional borrowings.

On February 7, 2013, we entered into a Twentieth Amendment to the Revolving Credit Agreement, or Twentieth Amendment, with the Revolving Credit Lender.

Pursuant to the Twentieth Amendment, the Revolving Credit Agreement was amended to change the minimum Adjusted EBITDA financial covenant and postpone its application until the first quarter ending March 31, 2014. Previously, the minimum Adjusted EBITDA financial covenant would have commenced in the quarter ending June 30, 2013. The "Availability Block" was increased to $0.5 million, increasing by an additional $0.1 million on July 1, 2013 and on the first day of each fiscal quarter thereafter. The Revolving Credit Agreement was also amended to reduce the Borrowing Base by the Availability Block at all times. The 2012 and 2013 Term Loan Agreement amendments were determined to be troubled debt restructurings and were taken to improve our liquidity, leverage and future operating cash flow.

On March 28, 2014, we entered into a Fourth Amendment to the Term Loan Agreement or Fourth Amendment. Pursuant to the Fourth Amendment, the minimum Adjusted EBITDA financial covenant in the Term Loan Agreement is no longer applicable.

On March 28, 2014, we entered into a Twenty-Second Amendment to the Revolving Credit Agreement, or Twenty-Second Amendment. Pursuant to the Twenty-Second Amendment, the Revolving Credit Agreement was amended to change the minimum Adjusted EBITDA financial covenant and postpone its application until the twelve-month period ending on March 31, 2015. The Twenty-Second Amendment also provides that the minimum Adjusted EBITDA will not be tested for the periods ending on March 31, 2014, June 30, 2014, September 30, 2014 and December 31, 2014. Under the Twenty-Second Amendment, the minimum Adjusted EBITDA remains set at $6.0 million and will be increased by 80% of pro forma adjustment to Adjusted EBITDA (as set forth in the definition thereof for any applicable Reference Period) concurrently with the closing of each Permitted Acquisition (as defined in the Revolving Credit Agreement). The Revolving Credit Agreement was also amended to increase the "Availability Block" to $1.4 million, increasing by an additional $100,000 on April 1, 2014 and on the first day of each fiscal quarter thereafter. We may not be able to maintain as high of a borrowing base under the Revolving Credit Agreement due to the increase in Availability Block. Also, if our revenue continues to decline and the corresponding accounts receivable balance declines, this would also reduce the available borrowing base under the Revolving Credit Agreement.

As described above, the maturity date for both of our debt agreements is March 31, 2015. On March 31, 2014, we may be required to reclassify our long-term debt under the Term Loan Agreement to current on our consolidated balance sheet if the Term Loan Agreement has not been extended as of that date. We have not yet executed any extensions on either of the debt agreements and do not anticipate having sufficient cash and cash equivalents to repay the debt at the maturity of these agreements on March 31, 2015, or if the maturity dates were accelerated.

We would be forced to restructure these agreements and/or seek alternative sources of financing. There can be no assurances that restructuring of the debt or alternative financing will be available on acceptable terms or at all. In the event of an acceleration of our obligations under the Revolving Credit Agreement or Term Loan Agreement prior to their maturity or if the agreements are not extended or otherwise restructured as of March 31, 2015 and we fail to pay the amounts that would then become due, the Revolving Credit Lender and Term Lenders could seek to foreclose on our assets, as a result of which we would likely need to seek protection under the provisions of the U.S. Bankruptcy Code or other applicable bankruptcy codes. In that event, we could seek to reorganize our business or a trustee appointed by the court could be required to liquidate our assets. In either of these events, whether the stockholders receive any value for their shares is highly uncertain. If we needed to liquidate our assets, we might realize significantly less from them than the value that could be obtained in a transaction outside of a bankruptcy proceeding. The funds resulting from the liquidation of our assets would be used first to pay off the debt owed to secured creditors, including the Term Lenders and the Revolving Credit Lender, followed by any unsecured creditors, before any funds would be available to pay our stockholders. If we are required to liquidate under the federal bankruptcy laws, it is unlikely that stockholders would receive any value for their shares.

We will need to either raise additional funding to fund our debt obligations in 2015 or to implement a business plan where cash flow will fully fund operations and debt repayments. However, there is no assurance that additional funding will be available to us on acceptable terms on a timely basis, if at all, or that we will achieve profitable operations to fund both operations and our debt obligations. If we are unable to raise additional capital or achieve sufficient operating cash flows to fund our operations and debt obligations, we will need to curtail planned activities and to reduce costs. Doing so may affect our ability to operate effectively.

Based on our current plans and business conditions, including the restructuring actions that were taken at the end of 2013 which will result in a workforce reduction of approximately 90 full-time employees and expected cost savings in 2014, as well as additional cost-cutting measures that we expect to employ during 2014, we believe that our existing cash and cash equivalents, expected cash generated from operations and available credit facilities will be sufficient to satisfy our anticipated cash requirements through the end of 2014.

Accordingly, our consolidated financial statements have been prepared on a going concern basis.

Operating Activities Net cash used in operating activities of $4.5 million for the year ended December 31, 2013 was primarily attributable to our net loss of $53.9 million, partially offset by adjustments for non-cash items aggregating to $50.3 million.

Operating assets decreased by $9.9 million and operating liabilities decreased by $10.8 million. The decrease in operating assets relates to accounts receivable of 32 -------------------------------------------------------------------------------- Table of Contents $5.2 million, inventory of $3.0 million, and other current assets of $1.7 million. The decrease in operating liabilities is primarily attributable to decreases of $10.0 million in accounts payable and accrued liabilities, $1.0 million in other long-term liabilities and $0.1 million of income taxes payable, partially offset by an increase in deferred revenue of $0.4 million.

Net cash used in operating activities of $5.5 million for the year ended December 31, 2012 was primarily attributable to our net loss of $37.6 million, partially offset by adjustments for non-cash items aggregating to $18.3 million.

Operating assets decreased by $22.9 million and operating liabilities decreased by $9.2 million. The decrease in operating assets relates to accounts receivable of $11.4 million, inventory of $11.1 million, and other current assets of $0.5 million. The decrease in operating liabilities is primarily attributable to decreases of $7.9 million in accounts payable and accrued liabilities, deferred revenue of $2.4 million, income taxes payable of $0.6 million, partially offset by an increase in other long-term liabilities of $1.7 million.

Investing Activities Net cash used in investing activities of $1.1 million for the year ended December 31, 2013 consisted primarily of a decrease of $1.0 million related to the purchase of property and equipment and $0.3 million related to restricted cash, partially offset by the sale of intangible assets of $0.2 million.

Net cash used in investing activities of $0.6 million for the year ended December 31, 2012 consisted primarily of a decrease of $1.1 million related to the purchase of property and equipment and $0.1 million of intangible asset purchases, partially offset by an increase of $0.6 million related to restricted cash.

Financing Activities Net cash provided by financing activities of $3.6 million for the year ended December 31, 2013 included $3.2 million in net borrowings under the Term Loan Agreement and $0.4 million of net borrowings under the Revolving Credit Agreement.

Net cash provided by financing activities of $2.2 million for the year ended December 31, 2012 included $4.5 million in proceeds from our long-term debt and $0.1 million from the sale of ESPP shares, partially offset by net payments to our Revolving Credit Agreement of $0.8 million and debt issuance costs of $1.5 million.

Off-Balance Sheet Arrangements At December 31, 2013, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, special purpose or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We do not have any off-balance sheet arrangements that are currently material or reasonably likely to be material to our consolidated financial position or results of operations.

Recent Accounting Pronouncements See Note 2 of the Consolidated Financial Statements for a full description of the recent accounting pronouncements including the expected date of adoption and effect on results of operations and financial condition.

[ Back To TMCnet.com's Homepage ]