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DAEGIS INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The discussion in this Quarterly Report on Form 10-Q contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on current expectations, estimates and projections about the software and eDiscovery industries and certain assumptions made by the Company's management. Words such as "anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates", variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, statements that refer to the anticipated impacts of acquisitions, statements made on goodwill, intangible assets, and impairment, statements about the ability to utilize deferred tax assets, and statements about other characterizations of future events or circumstances are forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include, but are not limited to, those set forth in the Company's Annual Report on Form 10-K under "Business - Risk Factors" and in the Company's other filings with the Securities and Exchange Commission ("SEC"). Unless required by law, the Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. However, readers should carefully review the risk factors set forth in other reports or documents the Company files from time to time with the SEC, particularly the Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. The following discussion should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and Notes thereto in Part I, Item 1 of this Quarterly Report on Form 10-Q and with the audited Consolidated Financial Statements and Notes thereto, together with Management's Discussion and Analysis of Financial Condition and Results of Operations, which are included in the Company's Annual Report on Form 10-K for the fiscal year ended April 30, 2014, as filed with the SEC. Overview Daegis Inc. (the "Company", "we", "us" or "our") is a global provider of archive, eDiscovery, application development, data management and migration software solutions. In fiscal 2014, we completed the restructuring and realignment of our company to meet customer and market needs and to operate with a more effective cost structure. We combined our Archive and eDiscovery businesses to offer a complete, cohesive information governance and eDiscovery solution that provides end-to-end data preservation and litigation readiness for our customers and clients. Accordingly, today we sell our solutions through two segments: the Archive and eDiscovery segment and the Development, Database, and Migration Tools segment. Our archive and eDiscovery solutions simplify and reduce the cost of information governance and eDiscovery while mitigating risk by improving data management. Our software includes Daegis AXS-One archiving for managing the preservation, collection, review and disposal of structured and unstructured data; Daegis Edge, our hosted, end-to-end eDiscovery software for processing, search, review and production of data; and Daegis Acumen technology-assisted review. Our services include managed document review, project management, search analytics consulting, collection and hosting of data. Our development, database, and migration tools business, Gupta Technologies ("Gupta"), includes mobile, Web and .NET application development, data management and application modernization software. Gupta Technologies delivers highly productive application development software for developers of all skill levels. Gupta's data management solutions are highly scalable and high performance. Gupta's Composer Technologies product line offers automated software and services for migrating Lotus Notes and Oracle Forms applications. Our products include TD Mobile, Team Developer, SQLBase, Report Builder, NXJ, DataServer, VISION, ACCELL, Composer Notes and Composer CipherSoft. Our customers and clients include corporate legal departments, law firms, information technology ("IT") departments, software value-added resellers ("VARs"), solutions integrators ("SIs") and independent software vendors ("ISVs") from a variety of industries. We are headquartered in Irving, Texas, with offices in Roseville, California and Rutherford, New Jersey and international offices in Australia, Canada, France, Germany, and the United Kingdom ("UK"). We market and sell our software directly in the United States, Europe, Canada, Japan, Singapore and Australia and indirectly through global distributors and resellers on a worldwide basis. 14 --------------------------------------------------------------------------------Certain prior period balances in our consolidated statements of operations have been reclassified between direct costs of eDiscovery revenue and selling, general and administrative expenses to conform with current presentation. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles ("GAAP") as set forth in the Financial Accounting Standards Board's Accounting Standards Codification (Codification) and consider the various staff accounting bulletins and other applicable guidance issued by the SEC. GAAP, as set forth within the Codification, requires us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following: º Revenue Recognition º Goodwill and Intangible Assets º Deferred Tax Asset Valuation Allowance º Accounts Receivable and Allowances for Doubtful Accounts º Accounting for Stock-based Compensation º Fair Value of Common Stock Warrant Liability In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management's judgment in its application. There are also areas in which management's judgment in selecting among available alternatives would not produce a materially different result. Our senior management has reviewed these critical accounting policies and related disclosures with the Audit Committee of the Board of Directors. During the first quarter of fiscal 2015, there were no significant changes to our critical accounting policies and estimates. Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended April 30, 2014 provides a more complete discussion of our critical accounting policies and estimates. In the first quarter of fiscal 2015, we recorded an additional restructuring charge related to the lease abandonment of $150 thousand. As of July 31, 2014, our accrued liability for unpaid restructuring charges was $0.4 million and is expected to be paid at various dates through May 2016. 15 --------------------------------------------------------------------------------Results of Operations The following table sets forth our consolidated statement of operations expressed as a percentage of total revenues for the periods indicated: Three Months Ended July 31, 2014 2013Revenues: Archive and eDiscovery 61.6 % 68.0 % Development, Database and Migration tools 38.4 32.0 Total revenues 100.0 100.0Operating expenses: Direct costs of Archive and eDiscovery revenue 23.4 27.6 Direct costs of Development, Database and Migration tools revenue 7.6 5.2 Product development 17.6 21.0 Selling, general and administrative 50.6 46.5 Total operating expenses 99.1 100.3 Income (loss) from operations 0.9 (0.3 )Other income (expenses) Gain (loss) from change in fair value of common stock warrant liability 1.4 (1.2 ) Interest expense (4.6 ) (5.2 ) Other, net (1.5 ) (0.4 ) Total other income (expenses) (4.7 ) (6.8 ) Loss before income taxes (3.8 ) (7.1 ) Provision for income taxes (0.1 ) 0.8 Net Loss (3.7 ) (7.9 ) Total Revenues We generate revenue from Archive and eDiscovery software and service sales as well as maintenance, support and consulting services. Our Archive and eDiscovery solutions are sold by our direct sales force in the United States and Europe. We also generate Development, Database, and Migration Tools revenue from software license sales and related services, including maintenance, support and consulting services. We sell our Development, Database, and Migration Tools solutions through our direct sales force in the United States and Europe, and through indirect channels comprised of distributors, ISVs, VARs, and other partners worldwide. Total revenues in the first quarter of fiscal 2015 were $6.7 million, a decrease of $1.3 million from the first quarter of fiscal 2014, or 16%. Total Archive and eDiscovery revenues in the first quarter of fiscal 2015 were $4.1 million, a decrease of $1.3 million from the first quarter of fiscal 2014, or 24%. The revenue from Archive and eDiscovery fluctuates depending on the activity of our clients' legal matters as well as the timing of Archive license sales and performance of professional service engagements. The decrease in Archive and eDiscovery revenue as compared to the prior year period is primarily related to a reduction in our professional services and hosting revenues. We have a continued reduction in services to our largest client as the consulting services for this particular matter was substantially complete at the end of fiscal year 2014. This client, which represented 20% of our consolidated revenue during the first quarter of fiscal year 2014, has declined to 15% of consolidated revenue during the first quarter of fiscal year 2015. In addition, we have begun transitioning our business model to bring to market a single managed solution for information governance, compliance and litigation readiness. This transition is negatively impacting our revenues during the first quarter of fiscal year 2015 due to longer sales cycles with this type of business model. Development, Database and Migration revenues in the first quarter of fiscal year 2014 were $2.6 million compared to $2.5 million in the prior year period, an increase of $0.1 million. This increase is the result of a growing interest in our migration tools license sales. 16 --------------------------------------------------------------------------------Operating Expenses Direct Costs of archive and eDiscovery Revenue. Direct costs of archive and eDiscovery revenue consist primarily of expenses related to employees, facilities, third party assistance and the amortization of purchased technology from third parties that were directly related to the generation of Archive and eDiscovery revenue. Direct costs of Archive and eDiscovery revenue were $1.6 million for the first quarter of fiscal 2015 compared to $2.2 million in the same period of fiscal 2014, a decline of $0.6 million. This decrease for the first quarter is a result of actions related to the organizational alignment during the third quarter of fiscal 2014. Direct Costs of Development, Database, and Migration Tools Revenue. Direct costs of development, database and migration tools revenue consist primarily of expenses related to employees, facilities, third party assistance, and royalty payments that were directly related to the generation of database and migration revenue. Direct costs of development, database and migration tools revenue were $0.5 million and $0.4 million for the first quarter of fiscal 2015 and fiscal 2014, respectively. The increase in direct costs of development, database and migration tools revenue is primarily due to a slight increase in salaries and related costs. Product Development. Product development efforts are focused on on-going enhancements and increased functionality for all of our core products: Daegis Edge, Daegis Acumen, Daegis AXS-One Archive, Team Developer, SQLBase, Report Builder, NXJ, VISION, Composer CipherSoft and Composer Notes. Within Gupta Technologies, we developed a new mobile enterprise application development product, TD Mobile. Product development expenses consist primarily of employee and facilities costs incurred in the development and testing of new products and in the porting of new and existing products to additional hardware platforms and operating systems. Product development costs decreased $0.5 million to $1.2 million for the first quarter of fiscal 2015 from $1.7 million in the first quarter of fiscal 2014. The decrease in product development expenses is primarily a result of open positions. Selling, General and Administrative. Selling, general and administrative ("SG&A") expenses consist primarily of salaries and benefits, marketing programs, travel expenses, professional services, facilities expenses, amortization of intangible assets, and bad debt expense. SG&A expenses were $3.4 million in the first quarter of fiscal 2015 and $3.7 million for the first quarter of fiscal 2014. The decrease in SG&A expense is primarily due to a reduction in outside consulting costs and employee benefits costs. Gain/(loss) from Change in Fair Value of Common Stock Warrant Liability. The change in fair value of common stock warrant liability for the third quarter of fiscal year 2015 resulted in a gain of $0.1 million, compared to a loss of $0.1 million in same period last year. This gain and loss are due primarily to changes in our common stock share price during the periods. Interest Expense. Interest expense for the first quarter of fiscal year 2015 was $0.3 million compared to $0.4 million for the same period last year. The decrease in interest expense in fiscal 2014 is due primarily to the amendment of our Revolving Credit and Term Loan Agreement with Wells Fargo in July 2013 which allowed us to move more of our debt from the higher interest bearing Term Note B to Term Note A as well as a decrease in the total outstanding debt as a result of the additional annual payment based on the Company's free cash flow. Other, Net. Other, net consists primarily of foreign exchange rate gains and losses and other income. Other, net was a loss of $0.1 million for the first quarter of fiscal 2015 and $31 thousand for the same period last year. Provision for Income Taxes. The provision for income taxes was a benefit of $3,000 for the first quarter of fiscal year 2015 and was primarily related to a federal tax benefit. The provision for income tax was $64,000 for the first quarter of fiscal year 2014. For the first quarter of fiscal year 2014, we recorded $20 thousand in foreign tax expense and $44 thousand in state and federal tax expense. Liquidity and Capital Resources At July 31, 2014, the Company had cash of $5.1 million compared to $7.2 million at April 30, 2014. Cash declined primarily as a result of our excess cash flow debt payments of $1.9 million and our quarterly principal payment of $0.3 million. The Company had net accounts receivable of $5.1 million as of July 31, 2014 compared to $6.7 million as of April 30, 2014. The decline in accounts receivable is primarily the result of collection activities as well as lower revenue during the period. 17 -------------------------------------------------------------------------------- Effective July 31, 2014, the Company entered into an amendment to its Revolving Credit and Term Loan Agreement with Wells Fargo Capital Finance (the "Credit Agreement"). In order to secure its obligations under the Wells Fargo Credit Agreement, the Company has granted the lender a first priority security interest in substantially all of our assets. Under the terms of the amendment, the Company is entitled to borrow up to $15.1 million. The total amount that can be borrowed under the Credit Agreement is based on a multiplier factor of the trailing twelve months of maintenance and Software-as-a-Service revenue. The Credit Agreement consisted of two term notes and a revolving credit note agreement. The Amendment extended the term of the Credit Agreement through June 30, 2017, reduced the interest rate and modified certain financial covenants. This Amendment, in conjunction with a prepayment made on July 31, 2014, under the Credit Agreement, reduced the outstanding principal balance on the Term A Loan to $10.1 million, and the Term B Loan, which incurred a minimum interest rate of 12.0%, has now been fully repaid. The Term Note A requires quarterly principal payments of $252,000 plus an additional annual payment based on the Company's free cash flow for the year with any remaining amount due at maturity. To the extent the company makes annual principal payments based on free cash flow, the quarterly principal payments will be reduced. The Company incurs interest at the prevailing LIBOR rate plus 3.5-4.0% per annum with a minimum rate of 5.0%. During the first quarter of fiscal year 2015, we incurred interest at the pre-amendment minimum rate of 6.5%. As of July 31, 2014 there is $10.1 million outstanding on the term note of which $1.0 million is current. Under the terms of the revolving line of credit, the Company can borrow up to $5.0 million. The Company incurs interest expense on funds borrowed at the prevailing LIBOR rate plus 3.5-4.0% per annum with a minimum rate of 5.0%. The revolver has a maturity date of June 30, 2017. As of July 31, 2014 there is $2.5 million borrowed on the revolving line of credit, none of which is current. As of July 31, 2014, the Company was eligible to borrow an additional $1.6 million. The Company is obligated to maintain certain minimum consolidated adjusted EBITDA levels, certain minimum liquidity levels, certain total leverage ratios, and certain fixed charge coverage ratios, all as calculated in accordance with the terms and definitions determining such amounts as contained in the Credit Agreement. The Credit Agreement also contains various information and financial reporting requirements. The Company is in compliance with all such covenants and requirements at July 31, 2014. We believe our existing cash, along with forecasted operating cash flows and the revolving line of credit under the Wells Fargo Credit Agreement, will provide us with sufficient working capital for us to meet our operating plan for fiscal year 2015. Operating Cash Flows. For the three months ended July 31, 2014 cash provided by operations was $0.2 million compared to $0.9 million for the same period last year. The reduction in operating cash flows was primarily the result of a smaller reduction in accounts receivable in the first quarter of fiscal 2015 as compared to the prior year. Investing Cash Flows. Net cash used in investing activities was $33,000 for the three months ended July 31, 2014 and consisted of capital expenditures. Net cash provided by investing activities was $0.4 million for the three months ended July 31, 2013 and was the result of proceeds from the sale of our Composer Mainframe product line, offset by capital expenditures. Financing Cash Flows. Net cash used in financing activities for the three months ended July 31, 2014 was $2.3 million compared to $1.7 million for the same period last year and consisted primarily of principal payments on the Credit Agreement. 18 --------------------------------------------------------------------------------A summary of certain contractual obligations is as follows (in thousands): as of July 31, 2014 (in thousands) Payments Due by Period 1 year After Contractual Obligations Total or less 2-3 years 4-5 years 5 years Debt financing $ 12,572 $ 1,007 $ 11,565 $ - $ - Estimated interest expense 1,624 601 1,023 - - Other liabilities 158 - - - 158 Capital lease obligations 116 116 - - - Operating leases 3,436 1,482 1,954 - - Total contractual cash obligations $ 17,906 $ 3,206 $ 14,542 $ - $ 158 Other liabilities primarily include mandatory severance costs associated with a French statutory government regulated plan covering all France employees. 19-------------------------------------------------------------------------------- |