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TANGOE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and the related notes and other financial information included elsewhere in this quarterly report. Some of the information contained in this discussion and analysis or set forth elsewhere in this quarterly report, including information with respect to our plans and strategy for our business and related financing, include forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" and "Forward-Looking Statements" sections of this quarterly report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Overview Tangoe is a leading global provider of connection lifecycle management, or CLM, software and services to a wide range of global enterprises and service providers. CLM covers the entire spectrum of an enterprise's connection-based assets and services, such as voice and data services, mobile devices and usage, machine-to-machine connections, cloud software and services, enterprise social and information technology connections, and encompasses the entire lifecycle of these assets and services, including planning and sourcing, procurement and provisioning, inventory and usage management, mobile device management, real-time telecommunications expense management, invoice processing, expense allocation and accounting, and asset decommissioning and disposal. Our on-demand Matrix Solution Suite is a suite of software designed to manage and optimize the complex processes and expenses associated with this connection lifecycle. Our Matrix Solution Suite and related services have historically focused on enterprises' fixed and mobile connections, and related assets, usage, expenses and analytics. We continue to enhance and expand our software and service offerings by developing and implementing additional capabilities, including planned capabilities designed to turn on, track, manage, secure and support various additional connections in an enterprise's connection lifecycle, such as machine-to-machine, cloud software and services, enterprise social and information technology connections. We refer to our Matrix Solution Suite and related service offerings as Matrix. Our solution can provide a significant return on investment by enabling an enterprise to identify and resolve billing errors, to optimize service plans for its usage patterns and needs, to manage used and unused connection assets and services, to proactively monitor usage and to prevent bill overages. Our solution allows enterprises to improve the productivity of their employees by automating the provisioning of connection assets and services, and to reduce costs by controlling and allocating connection expenses. It also allows enterprises to enforce regulatory requirements and internal policies governing the use of connection assets and services. Further, our solution allows enterprises to manage their connection assets and services and helps them improve end user productivity. We designed our business model to sell recurring technology and services leveraging our Matrix Solution Suite. We review three key business metrics to help us monitor the performance of our business model and to identify trends affecting our business. The measures that we believe are the primary indicators of our quarterly and annual performance are as follows: Adjusted EBITDA. We define Adjusted EBITDA as net income (loss) plus interest expense, other expense, income tax provision, depreciation and amortization, amortization of marketing agreement intangible assets, stock-based compensation expense and restructuring charge less amortization of leasehold interest, interest income and other income. Our management uses Adjusted EBITDA to measure our operating performance because it does not include the impact of items not directly resulting from our core business and certain non-cash expenses such as depreciation and amortization and stock-based compensation. We believe that this measure provides us with additional useful information to measure and understand our performance on a consistent basis, particularly with respect to changes in performance from period to period. We use Adjusted EBITDA in the preparation of our annual operating budgets and to measure and evaluate the effectiveness of our business strategies. Adjusted EBITDA is not calculated in accordance with generally accepted accounting principles in the United States of America, or GAAP, and is not a substitute for or superior to financial measures determined in accordance with GAAP. Other companies in our industry may calculate Adjusted EBITDA in a manner differently from us, which reduces its usefulness as a comparative measure. Our Adjusted EBITDA has increased annually for each fiscal year since 2007 and we expect it to continue to increase in our fiscal year ending December 31, 2014. Recurring technology and services revenue growth. We provide recurring technology-enabled services leveraging both our technology and communications industry experience. We regularly review our recurring revenue growth to measure our success. We intend to continue to focus our sales and marketing efforts on increasing our recurring technology and services-related customer base, and we expect that our recurring technology and services revenue will increase in absolute dollars and remain consistent as a percentage of total revenue over the next 12 months due to our expectation that we will be able to: † retain a high percentage of the revenue we currently derive from our existing customers; 26 -------------------------------------------------------------------------------- Table of Contents † sell additional product and service offerings to our existing customers; and † add a significant number of new customers. We believe that we will be able to retain a high percentage of our existing recurring technology and services revenue due to our revenue retention rates, and the current levels of customer usage of our products and services, which we review on a monthly basis to provide an indication of impending increases or decreases in billed revenue for future periods. We believe that we will be able to sell additional product and service offerings to our existing customers in the next year based on our analysis of revenue on a per-customer basis for the last 12 months, which indicates that our customers on an aggregate basis have generally increased their usage of our solution on a quarterly basis. We believe that we will be able to add a significant number of new customers over the next 12 months as we continue to expand internationally and increase our share of the domestic market. Revenue retention rates. In addition, we consider our revenue retention rates. Since we began to fully realize the benefits of our recurring revenue model in 2009, our revenue retention rates have been higher than 90%. We measure revenue retention rates by assessing on a dollar basis the recurring technology and services revenue we retain for the same customer and product set in a given period versus the prior year period. We cannot predict our revenue retention rates in future periods. Our use of a revenue retention rate has limitations as an analytical tool, and you should not consider it in isolation. Other companies in our industry may calculate revenue retention rates differently, which reduces its usefulness as a comparative measure. We also review a number of other quantitative and qualitative trends in monitoring our performance, including our share of the CLM market, our customer satisfaction rates, our ability to attract, hire and retain a sufficient number of talented employees to staff our growing business and the development and performance of our solutions. Our review of these factors can affect aspects of our business and operations on an on-going basis, including potential acquisition strategies and investment in specific areas of product development or service support. Certain Trends and Uncertainties The following represents a summary of certain trends and uncertainties, which could have a significant impact on our financial condition and results of operations. This summary is not intended to be a complete list of potential trends and uncertainties that could impact our business in the long or short term. This summary, however, should be considered along with the factors identified in the "Risk Factors" section of this Quarterly Report on Form 10-Q. † The CLM market is characterized by rapid technological change and frequent new product and service introductions, including frequent introductions of new technologies and devices. To achieve and maintain market acceptance for our solution, we must effectively anticipate these changes and offer software products and services that respond to them in a timely manner. If we fail to develop software products and services that satisfy customer preferences in a timely and cost-effective manner, our ability to renew our agreements with existing customers and our ability to create or increase demand for our solution will be harmed. † We believe that competition will continue to increase. Increased competition could result from existing competitors or new competitors that enter the market because of the potential opportunity. We will continue to closely monitor competitive activity and respond accordingly. Increased competition could have an adverse effect on our financial condition and results of operations. † We continue to closely monitor current economic conditions, as any decline in the general economic environment that negatively affects the financial condition of our customers could have an adverse effect on our financial condition and results of operations. For example, during the most recent economic downturn, our customer cancellation rate during the first quarter of 2009 increased to a quarterly rate of over three times the average of the prior four quarters, partly as a result of customer bankruptcies. If economic conditions in the United States and other countries decline, we may face greater risks in operating our business. 27 -------------------------------------------------------------------------------- Table of Contents Acquisitions On April 18, 2013, we acquired all of the issued share capital of oneTEM GmbH, or oneTEM, a provider of strategic consulting services based in Germany. The purchase price was approximately €1.5 million, which consisted of €0.9 million in cash paid at the closing and €0.4 million in cash payable on the first anniversary of the closing. In addition, the acquisition consideration includes an earn-out payable pursuant to an earn-out formula based upon the business, whose historic revenue had been one-time consulting revenue, beginning to generate annual recurring revenue from specified customers and then year-over-year increases in annual recurring revenue from those specified customers during the earn-out periods. The earn-out period begins with the first full month after the closing and continues for four consecutive 12-month periods. The fair value of the earn-out consideration was valued at €0.2 million, which was estimated by applying the income approach. We paid the full €0.4 million of deferred consideration that was payable on the first anniversary of the closing in April 2014. This payment did not include any amounts related to the earn-out and no amounts became payable under the earn-out terms for the 12 month period from May 2013 to April 2014. The transaction costs were immaterial and were expensed as incurred. We continue to migrate to our platforms the customers of several of the businesses that we acquired during 2011 and 2012. While, to date, we have successfully migrated a number of these customers, there can be no assurance that we will complete these migrations in a timely manner or at all and the cost of these migrations may be more significant than we have estimated. We may pursue additional acquisitions of, or investments in, businesses, services and technologies that will expand the functionality of our solution, provide access to new markets or customers, or otherwise complement our existing operations. Sources of Revenue Recurring technology and services revenue. We derive our recurring technology and services revenue primarily from subscriptions and services related to our Matrix Solution Suite. We recognize revenue for software and related services when all of the following conditions are met: (a) there is persuasive evidence of an arrangement; (b) the service has been provided to the customer; (c) the collection of the contracted fee is probable; and (d) the amount of the fees to be paid by the customer or partner is fixed and determinable. These services include help desk, asset procurement and provisioning, and carrier dispute resolution. The recurring technology and services revenue is recognized ratably over the contract term. We license our on-demand software and sell related services primarily on a subscription basis under agreements that typically have terms ranging from 24 to 60 months. Our recurring technology and services revenue is driven by the amount of communications spend that we manage and the scope of the products and services that we provide to our customers. Under our fixed line contracts, we typically charge our customers a percentage of managed communications spend that is determined based on the products and services that we provide. Under our mobile contracts, we typically charge our customers fees that are based on the mobile products and services that we provide and the number of devices for which we provide those products and services. As of June 30, 2014, we managed a total of approximately $28.6 billion in annual communications expense as compared to approximately $26.0 billion in annual communications expense as of June 30, 2013. Our customers are typically subject to a minimum charge for up to a specified threshold amount of communications spend, transactional volume or number of mobile devices under management and additional charges to the extent the specified thresholds are exceeded. Any implementation fees associated with recurring technology and services engagements are recognized over the estimated expected life of the customer relationship, which we estimate to be equal to twice the contract life, and we recognize implementation fees ratably over this period. Many of our subscription contracts are non-cancelable, although customers have the right to terminate for cause if we materially fail to perform. Strategic consulting, software licenses and other revenue. In addition to our subscription fees, revenue is generated to a lesser extent by strategic consulting, software licenses, mobile device activation fees and sales of telecommunication accessories. Strategic consulting consists primarily of fees charged for contract negotiations and bill audits. Contract negotiation fees include both fixed project fees and incentive fees driven by the amount of savings that we are able to generate over the customer's existing communications rates. These fees are recognized when fixed and determinable, usually when the customer and carrier execute the contract. Bill audit fees are driven by the amount of savings that we are able to generate by reviewing current and prior communications invoices against the customer's existing contracts. These fees are recognized when fixed and determinable, usually when the carrier agrees to issue a credit or refund to our customer. On occasion, we license our Matrix Solution Suite to our customers on a perpetual basis. If we are able to derive vendor-specific objective evidence on the undelivered elements, the software portion is recognized when the revenue recognition criteria is met; otherwise the contract is recognized ratably over the contract life. Other professional services are recognized as the services are performed. We have an agreement with a carrier whereby we receive an activation fee for procuring a mobile device. The activation revenue is recognized upon confirmation from the carrier that the device has been procured. The revenue related to the sale of mobile telecommunication accessories is recognized upon shipment of the accessories to the customer. We expect our strategic consulting, software licenses and other revenue to increase in absolute dollars and remain relatively constant as a percentage of total revenue, as we continue to focus our sales and marketing efforts on our recurring technology and services revenue model. 28 -------------------------------------------------------------------------------- Table of Contents We historically have derived primarily all of our revenue from United States-based customers. We have been building our international sales operations by increasing our direct sales force abroad and expect to continue this expansion. We expect our international revenue to increase in absolute dollars and as a percentage of total revenue. Cost of Revenue and Gross Profit Cost of recurring technology and services revenue. Cost of recurring technology and services revenue consists primarily of costs associated with our data center operations, customer product support centers and client services group. This includes personnel-related costs such as salary, stock-based compensation and other compensation-related costs, subcontractor fees, hosting fees, communications costs and royalties related to third-party software included in our solution when our solution is licensed on a non-perpetual basis. Cost of strategic consulting, software licenses and other revenue. Cost of strategic consulting, software licenses and other revenue consists primarily of personnel-related costs, including salary, stock-based compensation and other compensation-related costs and subcontractor fees directly related to delivering the service and to a lesser extent, the cost of the mobile telecommunications accessories sold. As our customer base continues to grow, we expect our cost of revenue to increase in absolute dollars as we expand our data center and customer support operations to support our continued growth. Our cost of revenue could fluctuate as a percentage of revenue on a quarterly basis but remain relatively stable on an annual basis based on the mix of software and services sold and average contractual selling price. Gross profit. Gross profit as a percentage of revenue is affected by two main factors-the mix of software and services sold and the average contractual selling price. We expect our gross profit in absolute dollars to increase, but that our gross profit as a percentage of revenue will be affected as we integrate the businesses of our recent acquisitions, which have historically operated with lower margins than our business. We believe that over time we will achieve improvements in those margins as we integrate the acquired operations and capture the operating efficiencies of the overall business. Operating Expense Operating expense consists of sales and marketing, general and administrative, research and development and depreciation and amortization. Other than for depreciation and amortization expense, personnel-related costs are the most significant component of all of these operating expenses. We expect to continue to hire a significant number of new employees in order to support our overall growth. In any particular period, the timing of additional hires could materially affect our operating results, both in absolute dollars and as a percentage of revenue. Sales and marketing. Sales and marketing expense consists primarily of personnel-related costs, including salary, stock-based compensation and other compensation-related costs for our sales, marketing and business development employees, the cost of outside marketing programs such as on-line lead generation, promotional events, such as trade shows, user conferences, seminars and webinars, the cost of business development programs, travel-related costs and sales commissions. Sales commission rates are calculated at the time a contract is signed. The sales commission rate is applied to the contract's first year of revenue to calculate sales commission expense. Sales commission expense is accrued and expensed at the time we invoice the customer and is paid to the salesperson either when the invoice is collected or ratably over the next five quarters. Generally, new sales personnel require time to become familiar with our software and services and do not begin to generate sales immediately, which can result in increased sales and marketing expense without any immediate increase in revenue. We expect sales and marketing expense to increase in absolute dollars and as a percentage of revenue in the near term, as we continue to hire sales and marketing personnel in the United States and internationally to expand our solution globally. General and administrative. General and administrative expense consists of personnel-related costs, including salary, stock-based compensation and other compensation-related costs for finance and accounting, executive, human resources, legal and information technology personnel, rent and facility costs, legal and other professional fees, and other corporate expenses. We are incurring and will continue to incur costs associated with being a public company, including corporate insurance costs as well as certain personnel costs and professional fees, including legal and accounting fees as they relate to financial reporting and maintaining compliance with Section 404 of the Sarbanes-Oxley Act. We expect general and administrative expense to increase in absolute dollars and to decrease as a percentage of revenue over the next several years. Research and development. Research and development expense primarily consists of personnel-related costs, including salary, stock-based compensation and other compensation-related costs for development personnel, and fees to our outside contract development vendors. We anticipate that our research and development team will continue to focus on expanding our software and services and increasing the functionality of our current offerings. We expect research and development expense to increase in absolute dollars, but remain relatively constant as a percentage of revenue in the near term. 29 -------------------------------------------------------------------------------- Table of Contents Depreciation and amortization. Depreciation and amortization expense primarily consists of the non-cash write-down of tangible and intangible assets over their expected economic lives. We expect this expense to remain relatively constant in absolute dollars and decrease as a percentage of revenue as we continue to grow and incur capital expenditures to improve our technological infrastructure and acquire assets through potential future acquisitions. Other Income (Expense), Net Other income (expense), net consists primarily of interest expense on our short and long-term debt, interest income on our cash and cash equivalents balance. We have historically invested our cash in money market investments. We expect our interest income to vary in each reporting period depending on our average cash balances and interest rates. Income Tax Provision Income tax provision consists of federal and state corporate income taxes resulting from our operations in the United States, as well as operations in various foreign jurisdictions. We expect income tax expense to vary each reporting period depending upon taxable income fluctuations and the availability of tax benefits from net loss carryforwards. As of December 31, 2013, we had U.S. federal net operating loss carryforwards of approximately $44.7 million, which, if unused, expire from 2021 to 2032. In addition to this amount, we have approximately $41.0 million of federal income tax loss carryforwards resulting from tax deductions related to stock options awarded to employees, which will be realized only when these deductions reduce income taxes payable. We also have U.S. federal research and development tax credit carryforwards of approximately $3.5 million, which expire through 2032. We have engaged in several transactions since our inception that have resulted in a change in control as defined by Sections 382 and 383 of the Internal Revenue Code, which limits our ability to utilize these net operating loss and tax credit carryforwards in the future. As of December 31, 2013, $29.0 million of our net operating loss and tax credit carryforwards were so limited. At December 31, 2013, we had a valuation allowance against the full amount of our deferred tax assets, as management believes it is uncertain that they will be fully realized. If we determine in the future that we will be able to realize all or a portion of our net operating loss or tax credit carryforwards, an adjustment to our recorded valuation allowance would increase net income in the period in which we make such a determination. Critical Accounting Policies Our financial statements are prepared in accordance with GAAP. The preparation of our financial statements and related disclosures requires us to make estimates, assumptions and judgments that affect the reported amount of assets, liabilities, revenue, costs and expenses, and related disclosures. We base our estimates and assumptions on historical experience and other factors that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions and conditions. Our most critical accounting policies are disclosed in the audited consolidated financial statements for the year ended December 31, 2013 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 filed with the Securities and Exchange Commission, or the SEC, on March 17, 2014, which we refer to as the 2013 Form 10-K. Since the date of those financial statements, there have been no material changes to our significant accounting policies. 30 -------------------------------------------------------------------------------- Table of Contents Results of Operations for the Three and Six Month Periods Ended June 30, 2013 and 2014 The following table presents selected consolidated statements of operations data for the periods indicated. These consolidated results of operations are not necessarily indicative of the consolidated results of operations that will be achieved in any future period. Three Months Ended June 30, Six Months Ended June 30, % of % of % of % of(in thousands, except percentages) 2013 revenue 2014 revenue 2013 revenue 2014 revenue Revenue: Recurring technology and services $ 41,385 89% $ 47,069 89% $ 81,433 89% $ 93,068 90% Strategic consulting, software licenses and other 5,022 11% 5,605 11% 9,834 11% 10,000 10% Total revenue 46,407 100% 52,674 100% 91,267 100% 103,068 100% Cost of revenue: Recurring technology and services 18,871 41% 22,200 42% 37,626 41% 43,598 42% Strategic consulting, software licenses and other 1,965 4% 2,007 4% 4,026 4% 4,341 4% Total cost of revenue (1) 20,836 45% 24,207 46% 41,652 46% 47,939 47% Gross profit 25,571 55% 28,467 54% 49,615 54% 55,129 53% Operating expense: Sales and marketing (1) 8,205 18% 10,182 19% 15,597 17% 20,127 20% General and administrative (1) 8,669 19% 9,844 19% 16,796 18% 18,632 18% Research and development (1) 4,804 10% 5,794 11% 9,749 11% 10,923 11% Depreciation and amortization 2,548 5% 2,472 5% 5,037 6% 5,079 5% Restructuring charge 499 1% - 0% 654 1% - 0% Income from operations 846 2% 175 0% 1,782 2% 368 0% Other income (expense), net Interest expense (100 ) 0% (11 ) 0% (263 ) 0% (48 ) 0% Interest income 16 0% 9 0% 35 0% 18 0% Other income (expense) 203 0% (28 ) 0% 766 1% (15 ) 0% Income before income tax provision 965 2% 145 0% 2,320 3% 323 0% Income tax provision 415 1% 548 1% 646 1% 993 1% Net income (loss) $ 550 1% $ (403 ) (1)% $ 1,674 2% $ (670 ) (1)% -------------------------------------------------------------------------------- (1) Amounts in table above include stock-based compensation expense, as follows: Cost of revenue $ 525 $ 1,209 $ 1,080 $ 2,697 Sales and marketing 956 1,482 1,769 2,738 General and administrative 1,641 2,100 3,113 3,135 Research and development 249 867 509 1,285 $ 3,371 $ 5,658 $ 6,471 $ 9,855 31 -------------------------------------------------------------------------------- Table of Contents Revenue The following table presents our components of revenue for the periods presented: Three Months Ended June Six Months Ended June 30, Increase 30, Increase (in thousands, except percentages) 2013 2014 $ % 2013 2014 $ % Recurring technology and services $ 41,385 $ 47,069 $ 5,684 14% $ 81,433 $ 93,068 $ 11,635 14% Strategic consulting, software licenses and other 5,022 5,605 583 12% 9,834 10,000 166 2% Total revenue $ 46,407 $ 52,674 $ 6,267 14% $ 91,267 $ 103,068 $ 11,801 13% Our recurring technology and services revenue increased $5.7 million, or 14%, for the three months ended June 30, 2014 as compared to the same period in 2013. This increase was primarily attributable to $7.0 million in increased revenue from increases in the volume of fixed and mobile communications assets and service offerings being managed or provided through our on-demand communication management platform for existing and new customers, excluding customers acquired in acquisitions since January 1, 2011 except to the extent such acquisition customers purchased new products or services following the applicable acquisition. The increase was driven in part by a 16% increase in our total number of recurring revenue customers to 714 as of June 30, 2014, which amount excludes 314 acquisition customers for total recurring revenue customers of 1,028 as of June 30, 2014, from 613 as of June 30, 2013, which amount excludes 361 acquisition customers for total recurring revenue customers of 974 as of June 30, 2013. This increase in revenue was partially offset by a $1.3 million decrease for the three months ended June 30, 2014, as compared to the same period in 2013, in revenue from customers acquired in connection with acquisitions since January 1, 2011, to $12.7 million for the three months ended June 30, 2014 from $14.0 million for the three months ended June 30, 2013, including for purposes of this calculation revenue from acquisition customers who renewed their contracts with us after the applicable acquisition but excluding revenues from post-acquisition sales of new products and services. This decrease was principally attributable to normal and customary attrition in acquisition customers. Our recurring technology and services revenue includes contra-revenue related to the amortization of the value of a warrant to purchase common stock issued to IBM as part of a strategic marketing agreement. We recorded $66,832 and $110,808 of amortization as a contra-revenue charge during the three months ended June 30, 2013 and 2014, respectively, related to the warrant. Our strategic consulting, software licenses and other revenue increased $0.6 million, or 12%, for the three months ended June 30, 2014 as compared to the same period of 2013, primarily due to increases in strategic sourcing and consulting revenues of $0.9 million partially offset by a decrease in other revenue of $0.3 million. Our recurring technology and services revenue increased $11.6 million, or 14%, for the six months ended June 30, 2014 as compared to the same period in 2013. This increase was primarily attributable to $14.6 million in increased revenue from increases in the volume of fixed and mobile communications assets and service offerings being managed or provided through our on-demand communication management platform for existing and new customers, excluding customers acquired in acquisitions since January 1, 2011 except to the extent such acquisition customers purchased new products or services following the applicable acquisition. The increase was driven in part by the increase in our total number of recurring revenue customers between June 30, 2013 and June 30, 2014 described above. This increase in revenue was partially offset by a $3.0 million decrease for the six months ended June 30, 2014, as compared to the same period in 2013, in revenue from customers acquired in connection with acquisitions since January 1, 2011, to $25.9 million for the six months ended June 30, 2014 from $28.8 million for the six months ended June 30, 2013, including for purposes of this calculation revenue from acquisition customers who renewed their contracts with us after the applicable acquisition but excluding revenues from post-acquisition sales of new products and services. This decrease was principally attributable to normal and customary attrition in acquisition customers. Our recurring technology and services revenue includes contra-revenue related to the amortization of the value of a warrant to purchase common stock issued to IBM as part of a strategic marketing agreement. We recorded $122,190 and $218,570 of amortization as a contra-revenue charge during the six months ended June 30, 2013 and 2014, respectively, related to the warrant. Our strategic consulting, software licenses and other revenue increased $0.2 million, or 2%, for the six months ended June 30, 2014 as compared to the same period of 2013, primarily due to increases in strategic sourcing and consulting revenues of $0.3 million and software license fees of $0.1 million. These increases were partially offset by a decrease in other revenue of $0.2 million. 32 -------------------------------------------------------------------------------- Table of Contents Costs and Expenses Cost of Revenue The following table presents our cost of revenue: Three Months Ended Six Months Ended June 30, Increase June 30, Increase (in thousands, except percentages) 2013 2014 $ % 2013 2014 $ % Recurring technology and services $ 18,871 $ 22,200 $ 3,329 18% $ 37,626 $ 43,598 $ 5,972 16% Strategic consulting, software licenses and other 1,965 2,007 42 2% 4,026 4,341 315 8% Total cost of revenue $ 20,836 $ 24,207 $ 3,371 16% $ 41,652 $ 47,939 $ 6,287 15% Gross profit $ 25,571 $ 28,467 $ 2,896 11% $ 49,615 $ 55,129 $ 5,514 11% Gross margin 55% 54% 54% 53% Our recurring technology and services cost of revenue increased $3.3 million for the three months ended June 30, 2014 as compared to the same period in 2013. This increase is primarily due to an increase in personnel-related costs, including an increase in salary and other compensation-related costs, of $3.2 million, including an increase in stock-based compensation of $0.6 million and an increase in travel-related expenses and other infrastructure costs of $0.3 million. The increases in personnel-related costs and travel-related expenses and other infrastructure costs were primarily attributable to providing support for customer growth in our recurring technology and services business. The increase in stock-based compensation was related to the stock-based equity awards granted in 2014 having shorter vesting periods than those granted in 2013 resulting in a greater portion of the associated expense being recognized during the period. Our strategic consulting, software licenses and other cost of revenue was $2.0 million for each of the three months ended June 30, 2014 and 2013. As a percentage of revenue, gross profit decreased to 54% for the three months ended June 30, 2014 as compared to 55% for the same period in 2013. This decrease in gross margin was primarily due to the increase in stock-based compensation expense mentioned above and the decrease in strategic consulting, software licenses and other revenue. The $2.9 million increase in gross profit in absolute dollars was primarily a result of increases in recurring technology and services revenue. Our recurring technology and services cost of revenue increased $6.0 million for the six months ended June 30, 2014 as compared to the same period in 2013. This increase is primarily due to an increase in personnel-related costs, including an increase in salary and other compensation-related costs, of $6.0 million, including an increase in stock-based compensation of $1.3 million and an increase in travel-related expenses and other infrastructure costs of $0.7 million. The increases in personnel-related costs and travel-related expenses and other infrastructure costs were primarily attributable to providing support for customer growth in our recurring technology and services business. The increase in stock-based compensation was related to the stock-based equity awards granted in 2014 having shorter vesting periods than those granted in 2013 resulting in a greater portion of the associated expense being recognized during the period. Our strategic consulting, software licenses and other cost of revenue increased $0.3 million for the six months ended June 30, 2014 as compared to the same period in 2013, primarily attributable to a $0.2 million increase in salary and other compensation-related costs as a result of an increase in stock-based compensation expense related to the stock-based equity awards given to employees during the six months ended June 30, 2014 carrying greater per-share expense than the awards granted during the same period in 2013 as a result of shorter vesting periods. As a percentage of revenue, gross profit decreased to 53% for the six months ended June 30, 2014 as compared to 54% for the same period in 2013. This decrease in gross margin was primarily due to the increase in stock-based compensation expense mentioned above. The $5.5 million increase in gross profit in absolute dollars was primarily a result of increases in recurring technology and services revenue. 33 -------------------------------------------------------------------------------- Table of Contents Operating Expense The following table presents our components of operating expense for the periods presented: Three Months Ended June 30, Six Months Ended June 30, 2013 2014 Increase 2013 2014 Increase % of % of (Decrease) % of % of (Decrease)(in thousands, except percentages) Amount Revenue Amount Revenue $ % Amount Revenue Amount Revenue $ % Sales and marketing $ 8,205 18% $ 10,182 19% $ 1,977 24% $ 15,597 17% $ 20,127 20% $ 4,530 29% General and administrative 8,669 19% 9,844 19% 1,175 14% 16,796 18% 18,632 18% 1,836 11% Research and development 4,804 10% 5,794 11% 990 21% 9,749 11% 10,923 11% 1,174 12% Depreciation and amortization 2,548 5% 2,472 5% (76 ) -3% 5,037 6% 5,079 5% 42 1% Restructuring charge 499 1% - 0% (499 ) * 654 1% - 0% (654 ) * Total operating expense $ 24,725 53% $ 28,292 54% $ 3,567 14% $ 47,833 52% $ 54,761 53% $ 6,928 14% -------------------------------------------------------------------------------- * = Not meaningful Sales and marketing expense. Our sales and marketing expense increased $2.0 million for the three months ended June 30, 2014 as compared to the same period of 2013, primarily as a result of increases in personnel-related costs, including salary and other compensation-related costs, of $1.8 million, including increased employee compensation and benefits of $1.3 million and stock-based compensation expense of $0.5 million, as we both increased the number of global direct and indirect sales force employees to accommodate growth in sales opportunities and granted stock-based equity awards with shorter vesting periods than in the same period in 2013 resulting in a greater portion of the associated expense being recognized during the period, and an increase in travel expense of $0.2 million as a result of the increased headcount. Outside marketing expense increased $0.1 million for the three months ended June 30, 2014 as compared to the same period of 2013, primarily as result of increases in lead generation activities for new and existing geographies and customers. Our sales and marketing expense increased $4.5 million for the six months ended June 30, 2014 as compared to the same period of 2013, primarily as a result of increases in personnel-related costs, including salary and other compensation-related costs, of $3.9 million, including increased employee compensation and benefits of $3.0 million and stock-based compensation expense of $0.9 million, as we both increased the number of global direct and indirect sales force employees to accommodate growth in sales opportunities and granted stock-based equity awards with shorter vesting periods than in the same period in 2013 resulting in a greater portion of the associated expense being recognized during the period, and an increase in travel expense of $0.3 million as a result of the increased headcount. Outside marketing expense increased $0.3 million for the six months ended June 30, 2014 as compared to the same period of 2013, primarily as result of increases in lead generation activities for new and existing geographies and customers. General and administrative expense. Our general and administrative expenses increased $1.2 million for the three months ended June 30, 2014 as compared to the same period of 2013, primarily as a result of increases in personnel-related costs, including salary and other compensation-related costs, of $0.8 million, including increased employee compensation and benefits of $0.4 million as a result of increased headcount and stock-based compensation expense of $0.4 million as a result of stock-based equity awards granted in 2014 having shorter vesting periods than those granted in 2013 resulting in a greater portion of the associated expense being recognized during the period, and an increase in facility and overhead costs of $0.3 million, primarily attributable to the rent and overhead costs associated with additional facilities. Our general and administrative expenses increased $1.8 million for the six months ended June 30, 2014 as compared to the same period of 2013, primarily as a result of increases in personnel-related costs, including salary and other compensation-related costs, of $0.8 million as a result of increased headcount, facility and overhead costs of $0.5 million, primarily attributable to the rent and overhead costs associated with additional facilities, $0.2 million related to technology data center co-location costs and other general and administrative costs of $0.3 million, primarily related to foreign currency translation costs. Research and development expense. Our research and development expenses increased $1.0 million for the three months ended June 30, 2014 as compared to the same period of 2013, primarily as a result of increases in personnel-related costs, including salary and other compensation-related costs, of $1.3 million, including increased employee compensation and benefits of $0.6 million as a result of increased headcount related to our Matrix initiative to enhance the functionality of our products and improve our ability to scale for increased demand and stock-based compensation expense of $0.6 million as a result of stock-based equity awards granted in 2014 having shorter vesting periods than those granted in 2013 resulting in a greater portion of the associated expense being recognized during the period. This increase was partly offset by a decrease in third-party contractor costs of $0.3 million. Our research and development expenses increased $1.2 million for the six months ended June 30, 2014 as compared to the same period of 2013, primarily as a result of increases in personnel-related costs, including salary and other compensation-related costs, of $2.0 million, including increased employee compensation and benefits of $1.2 million as a result of increased headcount related to our Matrix initiative to enhance the functionality of our products and improve our ability to scale for increased demand and stock-based compensation expense of $0.8 million as a result of stock-based equity awards granted in 2014 having shorter vesting periods than those granted in 34 -------------------------------------------------------------------------------- Table of Contents 2013 resulting in a greater portion of the associated expense being recognized during the period. This increase was partly offset by a decrease in third-party contractor costs of $1.0 million. Depreciation and amortization expense. Depreciation and amortization expenses decreased $0.1 million for the three months ended June 30, 2014 as compared to the same period of 2013, primarily due to a decrease in amortization expense of $0.2 million, partly offset by an increase in depreciation expense of $0.1 million. The decrease in amortization expense was primarily due to an acquired identifiable intangible asset becoming fully amortized during the three months ended June 30, 2014. Depreciation and amortization expenses increased by less than $0.1 million for the six months ended June 30, 2014 as compared to the same period of 2013. The increase was primarily due to an increase in depreciation expense of $0.3 million, partly offset by a decrease in amortization expense of $0.2 million. The increase in depreciation expense was primarily due to an increase in capital expenditures to support our overall growth. The decrease in amortization expense was primarily due to an acquired identifiable intangible asset becoming fully amortized during the six months ended June 30, 2014. Restructuring charge. The restructuring charge recorded during the three and six months ended June 30, 2013 was a result of our inability to sublease the New Jersey office space acquired as part of our acquisition of HCL-EMS in the time period originally expected. Later in 2013, we executed a lease termination agreement with the landlord terminating the remaining term of the lease effective June 30, 2013 for a settlement fee of $0.9 million. We recorded an adjustment of $0.1 million to the restructuring charge as a result of our inability to sublease the office space in the time period originally expected during the three months ended March 31, 2013 and $0.5 million as a result of the lease termination agreement during the three months ended June 30, 2013. Other Income (Expense), Net The following table presents our components of other income (expense), net for the periods presented: Three Months Ended Six Months Ended June 30, Change June 30, Change (in thousands) 2013 2014 $ 2013 2014 $ Interest expense $ (100 ) $ (11 ) $ 89 $ (263 ) $ (48 ) $ 215 Interest income 16 9 (7 ) 35 18 (17 ) Other income (expense) 203 (28 ) (231 ) 766 (15 ) (781 ) Interest expense. The decrease in interest expense for the three months ended June 30, 2014 as compared to the same period of 2013 was a result of higher average debt balances in 2013 related to the ProfitLine and Symphony deferred consideration balances and capital leases. The decrease in interest expense for the six months ended June 30, 2014 as compared to the same period of 2013 was a result of higher average debt balances in 2013 related to the HCL-EMS, ProfitLine, ttMobiles and Symphony deferred consideration balances and capital leases. Interest income. Interest income was comparable for the respective three and six-month periods ended June 30, 2014 and 2013. Other income. Other income for the three months ended June 30, 2013 primarily consisted of a $0.1 million reduction in the Symphony deferred cash consideration as a result of a net asset shortfall adjustment. Other income for the six months ended June 30, 2013 primarily consisted of a $0.4 million reduction in the Telwares deferred cash consideration as a result of not achieving certain recurring revenue targets, a $0.2 million adjustment of the HCL-EMS year two earn-out estimate to actual and the $0.1 million reduction in the Symphony deferred cash consideration as a result of a net asset shortfall adjustment. Income Tax Provision. Our income tax provision increased $0.1 million and $0.3 million for the three and six months ended June 30, 2014, respectively, as compared to the same periods in 2013, primarily as a result of income tax expense related to our foreign subsidiaries. 35 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Sources of Liquidity Since our inception, we have funded our operations primarily from cash from operations, private placements of preferred stock, subordinated notes, term loans, revolving credit facilities and public offerings of equity. As of June 30, 2014, we had cash and cash equivalents of $45.7 million and accounts receivable of $51.7 million. As of June 30, 2014 we had amounts due under various debts and credit facilities of $1.2 million, which consisted of deferred consideration for the HCL-EMS and oneTEM acquisitions and capital lease and other financing obligations. We believe that our existing cash and cash equivalents and our cash flow from operating activities will be sufficient to meet our anticipated cash needs for at least the next twelve months. To the extent our cash and cash equivalents and cash flow from operating activities are insufficient to fund our future activities, we may need to raise additional funds through bank credit arrangements or public or private equity or debt financings. We also may need to raise additional funds in the event we determine in the future to effect one or more acquisitions of, or investments in, businesses, services or technologies. If additional funding is required, we may not be able to obtain bank credit arrangements or to effect an equity or debt financing on terms acceptable to us or at all. The following table sets forth our cash and cash equivalents and the major sources and uses of cash for each of the periods set forth below: December 31, June 30, (in thousands) 2013 2014 Cash and cash equivalents $ 43,182 $ 45,694 Six Months Ended June 30, (in thousands) 2013 2014 Net cash provided by operating activities $ 10,650 $ 5,924 Net cash used in investing activities (10,602 ) (2,582 ) Net cash used in financing activities (5,976 ) (820 ) Effect of exchange rate on cash (227 ) (10 ) Net (decrease) increase in cash and cash equivalents $ (6,155 ) $ 2,512 Cash Flows from Operating Activities Operating activities provided $5.9 million of net cash during the six months ended June 30, 2014. We incurred a net loss of $0.7 million for the six months ended June 30, 2014 that was principally offset by non-cash charges of stock-based compensation of $9.9 million and depreciation and amortization of $5.1 million, cash provided by a favorable impact of an increase in deferred revenue of $0.6 million and an increase in deferred income taxes of $0.6 million. Cash provided by operating activities was adversely impacted by an $8.4 million increase in accounts receivable, a $0.6 million increase in prepaid expenses and a $0.6 million decrease in accounts payable and accrued expenses. Operating activities provided $10.7 million of net cash during the six months ended June 30, 2013, which resulted from our net income of $1.7 million for the six months ended June 30, 2013 principally supplemented by non-cash charges of stock-based compensation of $6.5 million, depreciation and amortization of $5.0 million and other non-cash charges of $1.0 million and cash provided by an increase in deferred revenue of $1.0 million. Cash provided by operating activities was adversely impacted by a $2.3 million decrease in accounts payable and accrued expenses, a $1.5 million increase in accounts receivable and a $0.7 million decrease in fair value of contingent consideration during the six months ended June 30, 2013. 36 -------------------------------------------------------------------------------- Table of Contents Cash Flows from Investing Activities Cash used in investing activities totaled $2.6 million during the six months ended June 30, 2014 and consisted of capital expenditures of $2.1 million primarily related to the purchase of computer equipment and software and a $0.5 million payment of deferred cash consideration in connection with the oneTEM acquisition. Cash used in investing activities totaled $10.6 million during the six months ended June 30, 2013 and consisted of $9.6 million paid in connection with the Telwares, Anomalous, ttMobiles, Symphony and oneTEM acquisitions, net of cash acquired, and capital expenditures of $1.0 million primarily related to the purchase of computer equipment and software. Cash Flows from Financing Activities Cash used in financing activities totaled $0.8 million during the six months ended June 30, 2014 primarily consisting of $2.0 million of cash used to repurchase our common stock and $0.3 million of cash used for net repayment of debt partially offset by $1.5 million of proceeds from the exercise of stock options and stock warrants. Cash used in financing activities totaled $6.0 million during the six months ended June 30, 2013 primarily consisting of $6.2 million of cash used to repurchase our common stock, which includes $1.7 million of cash paid for shares repurchased in trades entered in 2012 which settled in 2013, and debt repayments of $0.4 million partially offset by proceeds from the exercise of stock options and stock warrants of $0.7 million. Contractual Obligations The following table summarizes our material contractual obligations at June 30, 2014 and the effect such obligations are expected to have on our liquidity and cash flows in future periods. Payments due by period Less than (dollars in thousands) Total 1 year 1-3 years 3-5 years Operating lease obligations $ 17,560 $ 6,527 $ 9,832 $ 1,201 Capital lease and other obligations 136 113 23 - Interest on capital lease obligations 2 2 - - HCL-EMS contingent consideration 891 891 - - oneTEM contingent consideration 221 65 156 - $ 18,810 $ 7,598 $ 10,011 $ 1,201 † Operating lease obligations include minimum lease obligations with remaining terms in excess of one year primarily related to office space as well as certain equipment. † Capital lease and other obligations include minimum lease obligations with remaining terms in excess of one year related to computer hardware and software. † HCL-EMS contingent consideration consists of an amount withheld from the payment due on the second anniversary of the HCL-EMS closing date of January 25, 2011, pending resolution of certain indemnity matters. † oneTEM contingent consideration consists of contingent earn-out cash consideration payable on April 18 in each of 2015, 2016 and 2017. Off-Balance Sheet Arrangements We do not engage in any off-balance sheet financing activities, nor do we have any interest in entities referred to as variable interest entities. 37 -------------------------------------------------------------------------------- Table of Contents Recent Accounting Pronouncements In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, or ASU 2014-09, which supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgments and estimates may be required within the revenue recognition process than are required under existing GAAP. The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2017. For information regarding other recent accounting pronouncements, refer to Note 3 to our financial statements included in the 2013 Form 10-K. 38 -------------------------------------------------------------------------------- Table of Contents |