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ENVIVIO INC - 10-Q - 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 operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and elsewhere in this Quarterly Report on Form 10-Q, including those discussed in "Risk Factors." Overview We are a leading provider of software-based IP video processing and distribution solutions that enable the delivery of high-quality video to consumers. Based on our unique video compression and advanced IP video networking technologies, our solution is designed to enable service providers and content providers to offer high-quality video anytime, anywhere across a broad array of video formats, networks, consumer devices and operating systems. Our software-based solution runs on industry-standard hardware and includes encoders, transcoders, network media processors, all controlled through our network management system. We were founded in January 2000 by a small group of talented software and electrical engineers from France Telecom. Since our inception, we have been focused on developing a software-based architecture for processing and distributing IP video to video-enabled devices at the highest video quality possible. At that time, our software-based approach was a novel strategy for addressing video processing and distribution as most existing technologies processed and distributed video by designing hardware products for the transfer of video over a fixed format to standard TVs. These hardware products generally focused on improving quality of video, but did not attempt to address multiple formats or the challenges created by multiple devices and different networks. Because of our founding team's software expertise and the challenge of delivering video to mobile devices, which utilizes multiple formats and has multiple delivery requirements, our solution was designed from the beginning to provide a flexible solution that could adapt quickly and cost-effectively to the rapidly changing landscape of technologies, formats and capabilities of mobile devices. While attempting to address the challenges of processing and distributing video across a rapidly changing landscape of formats, networks, devices and operating systems, we have maintained our focus on improving the quality of the video delivered by our solution. We originally focused on developing technologies supported by the MPEG-4 standard, which is an industry standard for a group of audio and video coding formats and related technology that is capable of providing the highest quality video in the marketplace today. When we initially developed this technology, the standard in the marketplace was MPEG-2, a previous similar standard available since 1992. Throughout our history, we believe we have made valuable contributions to the ISO/IEC Moving Picture Experts Group, or MPEG, including having several of our employees sit on the governing standards body and by contributing several technologies to the video community that fostered the development of MPEG-4 as an industry standard. We believe these contributions demonstrate our innovation and thought leadership in the video processing and distribution industry. Our software-based approach to developing a flexible solution while delivering high-quality video has led to the development of several key products throughout our history. From 2001 to 2004, we introduced several new products targeting the MPEG-4 standard, which allowed us to address various markets utilizing this standard. We focused on our expansion into Asia in 2005 by providing the IPTV system for a service provider in China and a mobile digital TV service provider in Japan. In 2007, we developed our first all IP-based headend, an innovative and cost-reducing design for consumer video distribution, and our first AVS encoder, which allowed us to address the expanding video services market in China. In 2008, we introduced the world's first three-screen convergence encoder, which enabled operators to deliver video to three screens (mobile, PC and TV) from a single product. In 2010, we introduced 3D TV support with multi-video encoding standard on our C4 encoder, as well as support for the expanding set of mobile and web streaming formats. In November 2010, we launched a new class of product, a network media processor, which we call Halo, which enables the optimization of networks for distribution of multi-screen, multi-format video. In December 2011, we released Muse, our new multi-screen software designed for live or file-based video transcoding and distribution to any device. In September 2012, we introduced the 4Caster G4 encoding appliance for the Muse software-based encoder family which offers more density compared to the previous platform, with the potential for further density improvements. In March 2013, we introduced our early access program for HEVC encoding, based on the latest compression standard, HEVC (H.265), which can deliver up to 50% bandwidth improvement compared to MPEG-4 AVC. Our Halo™ Experience Server, which we announced in April 2013, is an innovative new multi-screen technology that allows operators to further personalize the user experience based on individual viewer requests. In September 2013, we also publicly demonstrated 4K Ultra HD compression using Muse encoders for the first time. Ultra HD provides high video quality with up to four times as many pixels as 1080p HDTV, twice the frame rate, and a broader color range with the new BT 2020 standard. 15-------------------------------------------------------------------------------- Table of Contents As a result of our close relationship with France Telecom, we initially focused on the telecommunications market both for broadband IPTV delivery and delivery of video to mobile devices. However, as consumer demands have evolved over time, our solution has become attractive to a larger set of customers. In reaction to telecommunications companies providing video content and services to multiple devices with IPTV as well as mobile video services, traditional cable TV service providers have launched innovative services that deliver video content to PCs and mobile devices. Most recently over-the-top, or OTT, providers have also gained market share by offering innovative and cost-effective video services to mobile devices, PCs and even TVs for consumers through the open Internet. This set of competing service offerings, when combined with increased consumer demand for video on multiple screens, led us to design a single solution that addresses the needs of a broader customer base of service providers and content providers. For example, one of our first major end-customers purchased our IPTV solution in 2008 to enable delivery of video to TVs over broadband networks. This same customer began providing OTT services in 2009, and purchased our OTT solution to enable its OTT services. Finally, in 2010, this customer began to offer mobile video content and purchased our solution to address this video delivery mode as well. We target several different types of video service providers and content providers, including telecommunications companies and cable, satellite and OTT providers. These target customers have unique characteristics, including their infrastructure, target consumer demands, scale, delivery models and business models. We focus on providing video delivery solutions to these customers that allow them to better target their growth markets, such as mobile TV, Pay-TV, IPTV and OTT. To date, our solution has been deployed by over 300 end-customers worldwide in over 50 different countries. We outsource the manufacturing of our products to a single manufacturer in California. In some cases, we rely on our manufacturer to procure the components for our equipment. For certain components, we contract directly with the supplier. We ship our solutions directly from our manufacturer. Our products and support services are sold worldwide, either through systems integrators, which serve as our channel partners or directly through our internal sales force. Our channel partners assist us with the sales process, systems integration, deployment and support. We employ a sales force that is responsible for managing our relationships with our channel partners within each geographic territory in which we market and sell our products. We also sell our products and support services directly to end-customers. In many cases, even when we sell our products through channel partners, we market and work directly with the end-customer to promote our products. Since inception, we have expended significant resources on our research and development operations. Our research and development activities are exclusively conducted in the metropolitan area of Rennes, France, which we believe provides us access to highly qualified engineers on a cost-effective basis located in what has traditionally been viewed as a top broadcast center of Europe. Factors Affecting Our Results of Operations The following are key factors that impact our results of operations: Consumer Demand and Infrastructure Capacity Most of our products are installed into networks operated by telecommunications, cable, satellite and OTT providers to deliver high-quality video to a consumer. The demand for our products is significantly impacted by the end consumer of video services and the demands these end consumers place on service providers and content providers to deliver high-quality video across disparate networks and to multiple devices. As this consumer demand increases, service providers respond by expanding or enhancing their infrastructure and equipment to address these needs. As the infrastructure capacity increases, high-quality video can be made available to more consumers over broadband and wireless IP networks, which we believe will also increase the number of global broadband users. Our solution is designed to address the infrastructure challenge of delivering massive amounts of content over different types of networks to consumers who are increasingly viewing video on a growing variety of devices, such as tablets, smartphones, laptops, and Internet-enabled TVs and media players. As consumer expectations of video delivery increase, the demand from telecommunications, cable, satellite and OTT providers for the type of video delivery solutions that we provide increases. Accordingly, we measure consumer demand for video services by monitoring a collection of key market metrics, including the introduction of new mobile devices, such as tablets, new access mediums that are emerging in the digital home, such as Internet-enabled TVs and new video applications, and enhanced product offerings, such as bundling on-demand video services with other traditional service offerings. We believe the combination of the increased availability of video-enabled connected devices combined with the evolution of the network infrastructure will, in turn, drive service providers and content providers to seek flexible solutions to deliver video to consumers that can continue to adapt to changing formats, networks and devices, while maintaining the highest possible video quality. 16 -------------------------------------------------------------------------------- Table of Contents Competitive Environment and Geographic Mix The market for our products is competitive and our gross margin is impacted by the level of competition we face and the geographic mix of product sales worldwide. We face significant competition in selling our solution. In any given sales opportunity, the level of competition we face could impact our gross margin. In addition, our gross margin may be impacted by the location of our target customer as different geographic regions have different pricing environments based on customer expectation, business models and our customers' revenue opportunity from the services we enable. For example, we typically experience lower sales prices in the Asia-Pacific region. We anticipate that our geographic mix will continue to fluctuate in the future from quarter to quarter, which could impact our future gross margin. Evolution of Hardware Platform We utilize industry-standard hardware, and therefore, are able to leverage the evolutionary increase in computing power in each new generation of hardware. In the past, this has allowed us to increase the number of video streams at a given resolution with each new hardware platform, and we expect this to continue. This increase in performance may offset any potential decline in the sales prices of the prior generation of our solution. Seasonality Our business may be subject to seasonality, particularly in the first quarter of each fiscal year. A significant portion of our revenue comes from major service providers whose capital and operational spending are dependent on annual budget levels and timing of budgeting cycles. Therefore, we expect that a typical calendar year service provider will utilize the remainder of its budget towards the end of the year, postpone or slowdown spending during the first quarter of the following year as new projects are planned and the new fiscal budget is created, and resume spending thereafter as a function of the projects that are planned for the year. As a result, we would typically expect our revenue in the first quarter of our fiscal year to be even with or lower than our revenue in the preceding fourth quarter of our fiscal year. This seasonality in our business has been discernible in the past, but could become more pronounced as our business and the spending patterns of our service provider customers evolve. Components of Revenue, Cost of Revenue and Operating Expenses Revenue Our revenue is derived primarily from the sale of our IP video processing and distribution solutions, which consists of both hardware and software. Our proprietary software is an essential component in the products we sell and provides a key differentiator between us and our competitors. Our hardware generally consists of industry-standard components, which are readily available from third-party providers. To a lesser extent, we derive revenue from professional services as well as support and maintenance of our products. Our maintenance contracts may include future software upgrades depending on the level of maintenance purchased. Our support contracts typically include telephone and email access to technical support personnel. When we sell an enhanced support offering we provide our customers with rights to software upgrades as well as maintenance releases and patches released during the term of the support period. Cost of Revenue Our cost of revenue consists primarily of third-party manufacturing costs and component costs. Our cost of revenue also includes shipping costs, third-party logistics costs, personnel costs associated with our technical support and professional services teams and write-offs for excess and obsolete inventory. To a lesser extent, our cost of revenue includes personnel costs associated with our operations and logistics. Operating Expenses Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The largest component of our operating expenses is personnel costs. Personnel costs consist of salaries and benefits for our employees. We expect to manage our operating expenses in both the near and long term to ensure that our expenses are in-line with our operating plan. However, our operating expenses may fluctuate as a percentage of revenue. Research and Development Expenses Research and development expenses primarily consist of personnel, engineering, testing and compliance, facilities and professional services costs. We expense research and development costs as incurred. Research and development expenses are presented net of French government research tax credits. We continue to closely manage our existing research and development resources as well as strategically invest in additional resources to add more functionality to our existing products and develop new products that support our overall company strategy. 17 -------------------------------------------------------------------------------- Table of Contents Sales and Marketing Expenses Sales and marketing expenses primarily consist of personnel costs, sales commissions, travel costs, costs for marketing programs and facilities costs. We continue to closely monitor sales and marketing expenses and augment our sales force in key areas to further expand our strategic relationships with current and future channel partners and direct customers. We expect these expenses to grow modestly over time. General and Administrative Expenses General and administrative expenses primarily consist of personnel, professional services and facilities costs related to our executive, finance, human resource and information technology functions. Professional services costs consist of outside legal, accounting and information technology consulting costs. As a public company, we expect to continually incur costs related to compliance with rules and regulations enacted by the SEC. Such costs include additional professional services costs, additional insurance, investor relations and similar costs associated with being a public company. Interest Income (Expense), net Interest income (expense), net, consists primarily of interest income from our cash and cash equivalent balances held during the fiscal year and interest expense when we have balances related to our line of credit. Other Income (Expense), net Other income (expense), net, consists primarily of charges due to fluctuations in foreign exchange rates on receivables and payables denominated in currencies other than the U.S. dollar. The foreign currency transaction gains and losses relate to transactions that are exercised in a different currency than the respective functional currency of the Company's subsidiaries. Critical Accounting Policies, Judgments and Estimates There have been no material changes to our critical accounting policies, judgments and estimates during the three months ended April 30, 2014 from those disclosed in our annual report on Form 10-K for the year ended January 31, 2014 filed with the Securities and Exchange Commission on April 25, 2014. 18-------------------------------------------------------------------------------- Table of Contents Three Months Ended April 30, 2014 Compared to the Three Months Ended April 30, 2013 The following table presents our historical operating results and the changes in these results in dollars (in thousands) and as a percentage for the periods presented: Three Months Ended April 30, $ Change % Change 2014 2013 Revenue: Product $ 6,111 $ 5,669 442 8 % Professional services and support 2,303 1,793 510 28 % Total revenue 8,414 7,462 952 13 % Cost of revenue: Product 2,051 2,276 (225 ) -10 % Professional services and support 643 465 178 38 % Total cost of revenue 2,694 2,741 (47 ) -2 % Gross profit 5,720 4,721 999 21 % Gross profit% 68 % 63 % 5 % Operating expenses: Research and development 2,500 1,967 533 27 % Sales and marketing 5,068 5,063 5 0 % General and administrative 2,680 2,553 127 5 % Total operating expenses 10,248 9,583 665 7 % Loss from operations (4,528 ) (4,862 ) 334 -7 % Interest income, net 2 19 (17 ) -89 % Other expense, net (32 ) (7 ) (25 ) 357 % Loss before benefit for income taxes (4,558 ) (4,850 ) 292 -6 % Income tax benefit (28 ) (111 ) 83 -75 % Net loss (4,530 ) (4,739 ) 209 -4 % Revenue Our total revenue increased by $1.0 million, or 13%, to $8.4 million during the three months ended April 30, 2014 from $7.5 million during the three months ended April 30, 2013. Product revenue slightly increased by $442,000 primarily due to increased sales across all of our regions, particulary in North America, and driven by large orders from our existing tier 1 service providers. We also attribute this increase to improvements in overall sales execution, growing market acceptance of software-based solutions for multiscreen video processing, and stronger market demand compared to the same prior year period. Our professional services and support revenue increased primarily due to stronger sales of professional services and support related to a larger install base compared to the same prior year period. Cost of Revenue and Gross Profit Our gross margin percentage increased from 63% during the three months ended April 30, 2013 to 68% during the three months ended April 30, 2014. Our product gross margin percentage increased from 60% to 66%, which was primarily due to more sales of our higher margin software-only products during the three months ended April 30, 2014. This was offset by a decrease in gross margin on professional services and support from 74% to 72%, which is due to increased costs relating to strategic expansion of our professional services and support team to better support and serve our service provider customers, which includes costs related to the opening of our Denver, Colorado office. Operating Expenses Our operating expenses increased by $665,000, or 7%, to $10.2 million during the three months ended April 30, 2014 from $9.6 million during the three months ended April 30, 2013. Research and Development Expenses Research and development expenses increased $533,000, or 27%, to $2.5 million during the three months ended April 30, 2014 from $2.0 million during the three months ended April 30, 2013, primarily due to an increase of $700,000 in salaries, employee related costs and consultants relating to various projects which include extension of our Muse software to a new platform and focus on our 4K Ultra HD technology, offset by an expected increase of $300,000 in the French governmental research tax credit during the period. Although we are devoting substantial resources to the development of additional functionality for our existing products and the development of new products, we are focusing on only deploying resources to activities that align with our overall corporate strategy. We expect research and development expenses to increase for the year ended January 31, 2015 compared to the year ended January 31, 2014. 19-------------------------------------------------------------------------------- Table of Contents Sales and Marketing Expenses Sales and marketing expenses remained the same at $5.1 million during the three months ended April 30, 2014 and 2013. Headcount and consulting related expenses increased by $160,000 due to the expansion of our professional services and support team, and was largely offset by a decrease of $129,000 in overall marketing activities. We expect sales and marketing expenses for the year ended January 31, 2015 to remain substantially the same compared to the year ended January 31, 2014 as we continue to monitor our sales and marketing expenses to ensure they align with our overall corporate strategy. General and Administrative Expenses General and administrative expenses increased by $127,000, or 5%, to $2.7 million during the three months ended April 30, 2014 from $2.6 million during the three months ended April 30, 2013, primarily due to a $280,000 increase in legal costs mainly relating to our ongoing litigation and $89,000 in stock compensation expense, largely offset by a decrease of $198,000 due to decreased headcount which resulted in lower salary, bonus and other employee related costs. We expect our general and administrative expenses for the year ended January 31, 2015 to remain substantially the same compared to the year ended January 31, 2014 as we continue to monitor our general and administrative expenses to ensure they align with our overall corporate strategy. Interest Income, net Interest income net, decreased by $17,000, or 89%, from $19,000 during the three months ended April 30, 2013 to $2,000 during the three months ended April 30, 2014. The decrease was primarily due to a decrease in interest income earned from short-term investments as our short-term investments matured during our 2014 fiscal year. Upon maturity, proceeds have not been reinvested. Other Expense, net Other expense, net, increased by $25,000, or 357%, from $7,000 during the three months ended April 30, 2013 to $32,000 during the three months ended April 30, 2014. This change was primarily due to foreign currency losses during the three months ended April 30, 2014 compared to the three months ended April 30, 2013. Liquidity and Capital Resources On April 24, 2012, we sold 6,500,000 shares of common stock at a price to the public of $9.00 per share in an initial public offering, or IPO. The shares began trading on the NASDAQ Global Market on April 25, 2012. The $54.4 million in proceeds from the IPO, net of underwriters' discounts and commissions, but before deducting offering-related expenses payable by us of $5.8 million, were received on April 30, 2012, which was the closing date of the IPO. Immediately prior to the closing of the offering, all outstanding shares of convertible preferred stock converted into common stock on a one-for-one basis. We believe that our existing cash and cash equivalents as of April 30, 2014 will be sufficient to fund our operations and capital expenditures for at least the next 12 months. However, management may in the future elect to finance operations by utilizing our credit facilities or selling equity securities. If additional funding is required, there can be no assurance that additional funds will be available to us on acceptable terms on a timely basis, if at all, or that we will generate sufficient cash from operations to adequately fund our operating needs or sustain profitability. If we are unable to raise additional capital or generate sufficient cash from operations to adequately fund our operations, we will need to curtail planned activities to reduce costs. Doing so will likely have an unfavorable effect on our ability to execute on our business plan. Cash Requirements As of April 30, 2014, our cash and cash equivalents totaled $44.4 million. In November 2013, we issued an irrevocable standby letter of credit of $500,000 against our revolving loan facility for a tender bond to be issued in connection with a customer proposal. The irrevocable standby letter of credit expired on May 15, 2014. As a result, our borrowing availability as of April 30, 2014 was $10.0 million, which expires in July 2014. Financial Condition (Sources and Uses of Cash) Our cash and cash equivalents consisted of cash deposits and money market funds with a total amount of $44.4 million as of April 30, 2014. 20-------------------------------------------------------------------------------- Table of Contents Our cash flows during the three months ended April 30, 2014 and 2013 are summarized as follows: Three Months Ended April 30, 2014 2013 (in thousands) Net cash used in operating activities $ (2,541 ) $ (4,642 ) Net cash provided by (used in) investing activities (830 ) 2,103 Net cash provided by (used in) financing activities (4 ) 45 Cash Flows from Operating Activities Our primary uses of cash from operating activities have been for personnel costs, purchases of inventory and costs related to our facilities. We have experienced negative cash flows from operating activities as we expanded our business and generated operating losses. Our cash flows from operating activities will continue to be affected principally by our working capital requirements and the extent to which we spend on personnel and sales and marketing activities as our business requires. Cash used in operating activities of $2.5 million during the three months ended April 30, 2014 reflected a net loss of $4.5 million, partially offset by a decrease in net operating assets of $716,000 and non-cash charges of $656,000 for depreciation and amortization and $613,000 for stock-based compensation. The decrease in net operating assets was primarily due to a decrease of $1.6 million in accounts receivable and an increase of $665,000 in accounts payable, accrued liabilities and accrued compensation, offset by an increase of $873,000 in prepaid expense and other current assets and a decrease of $787,000 in deferred revenue. The decrease in accounts receivable was primarily due to lower revenue, and the increase in accounts payable, accrued liabilities and accrued compensation primarily resulted from higher operating expenses relative to prior quarter. Deferred revenue decreased during the three months ended April 30, 2014 primarily due to recognition of a large system integrator project during the current period. Cash used in operating activities of $4.6 million during the three months ended April 30, 2013 reflected a net loss of $4.7 million, partially offset by an increase in net operating assets of $1.2 million and non-cash charges of $734,000 for depreciation and amortization and $519,000 for stock-based compensation. The increase in net operating assets was primarily due to an increase of $591,000 in accounts receivable, an increase of $443,000 in prepaid expenses and other current assets, a decrease of $483,000 in accounts payable, accrued liabilities and accrued compensation, offset by an increase of $279,000 in deferred revenue. The increase in accounts receivable was primarily due to a higher concentration of sales in regions where customary payment terms are often longer such as East Asia, India and the Middle East. The decrease in accounts payable and accrued liabilities primarily resulted from lower revenue and thus, less amounts due to our third-party contract manufacturer. Cash Flows from Investing Activities During the three months ended April 30, 2014, cash used investing activities consisted of $830,000 capital expenditures, primarily for the purchase of equipment. During the three months ended April 30, 2013, cash provided by our investing activities consisted of net $2.5 million from sales and maturities of corporate bond investments in accordance with guidelines set forth in our investment policy, offset by capital expenditures amounting to $407,000 primarily for the purchase of equipment. Cash Flows from Financing Activities During the three months ended April 30, 2014, cash used in financing activities was $4,000, due to repayments of French governmental research grants of $66,000 offset by $62,000 in cash proceeds from the exercise of stock options. During the three months ended April 30, 2013, cash provided by financing activities was $45,000, as a result of cash proceeds from the exercise of stock options. Off-Balance Sheet Arrangements As of April 30, 2014, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. 21-------------------------------------------------------------------------------- Table of Contents Contractual Obligations and Commitments The following summarizes our contractual obligations as of April 30, 2014: Payments Due by Period Less Than More Than Contractual Obligations: 1 Year 1-3 Years 3-5 Years 5 Years Total (in thousands) Operating Lease obligations $ 690 $ 1,594 $ 1,269 $ 1,620 $ 5,173 French Governmental research grant repayments 263 113 - - 376 Uncertain tax positions 63 1,159 - - 1,222 Total $ 1,016 $ 2,866 $ 1,269 $ 1,620 $ 6,771 We outsource the manufacturing, assembly and testing of our encoding products to FutureQuest Incorporated ("FQ"). We generally do not use custom materials in our products and therefore, our obligation to FQ is limited to purchase orders. To the extent that we cancel a purchase order, we are only liable to the extent that FQ cannot otherwise utilize those components. To date, we have never been required to purchase any such components. Our outstanding purchase orders are not material as of April 30, 2014. |