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BROADSOFT, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Company Overview We are the leading global provider of software and services that enable mobile, fixed-line and cable service providers to deliver hosted, or cloud-based, Unified Communications and other voice and multimedia services over their Internet protocol, or IP, based networks. Our core communications platform consists of three offerings: BroadWorks, BroadCloud and BroadTouch. We began selling BroadWorks in 2001. Over 520 service providers in more than 69 countries have purchased and/or are delivering services utilizing our software, including 19 of the top 25 telecommunications service providers globally, as measured by revenue for the year ended December 31, 2011. We sell our products to service providers both directly and indirectly through distribution partners, such as telecommunications equipment vendors, VARs and other distributors. Executive Summary Our management team monitors and analyzes a number of key industry trends and performance indicators to manage our business and evaluate our financial and operating performance. In 2013, we expect to continue addressing what we see as the trend towards cloud-based and hosted communications. We are increasing our strategic investments in research and development of existing and new products, including client software and cloud-based services, as well as in sales and marketing headcount to support our product offerings and increase our go-to-market efforts. We increased our hiring in 2012, and expect to continue to grow in 2013. We plan to continue investment in BroadCloud PBX, our cloud-based PBX offering, which permits our service providers to offer BroadWorks features and functions through a service offering hosted and managed by us, reducing cost and increasing speed and ease of use for end-users. We believe that delivering innovative solutions to our existing customer base to meet their growing cloud-based needs will help service providers get to market faster and drive our revenue growth. We believe that in 2013, converged and mobile operators will continue to seek UC solutions to deliver to their enterprise customer base. Our UC-One platform, which we introduced in October 2012, seeks to address this evolution and allows service providers and operators to rapidly and efficiently deliver a UC experience regardless of end user device and whether or not the end user has fixed line or wireless access. Recognizing the importance of mobile, we have architected mobility into our solutions and products and have made integrating with existing mobile networks simple and a core competency of our platform. We have optimized our client, cloud and software solutions to enable mobility in all of our services, across a wide range of devices. We expect that our enterprise-based applications will grow more quickly than our consumer applications during 2013. This is driven by both increasing market acceptance of hosted Unified Communications, as well as a transition by service providers in their investment in consumer IP networks from their fixed line offerings to LTE. We believe that we have the opportunity for renewed growth in our consumer business once service providers begin to deploy VoLTE, which we believe could begin in 2014. Management also analyzes trends of billings from existing customers relative to billings from new customers as we believe billings are a key indicator of growth and performance of our business and reflect the level of selling activity in any particular time frame. During 2012, we saw continued growth in revenue and billings from our existing customer base, driven by both the growth of existing BroadWorks-based applications, deployment of new BroadWorks applications and the adoption of BroadCloud PBX. Growth from the acquisition of new customers was lower in 2012 and we expect this trend to continue in 2013. We have increasingly focused our selling efforts on our existing customers by, for example, increasing our go-to-market assistance to such service providers to help them accelerate the growth of their UC offerings. 40-------------------------------------------------------------------------------- Table of Contents Key Financial Highlights Some of our key GAAP financial highlights for the year ended December 31, 2012 include: • Total revenue increased by 19%, or $26.8 million, to $164.8 million, compared to $138.1 million for 2011; • Gross profit increased to $132.4 million, or 80% of revenue, compared to $113.1 million, or 82% of revenue for 2011; • Income from operations decreased to $25.4 million, or 15% of total revenue, compared to $27.4 million, or 20% of total revenue, for 2011; • Net income decreased to $12.1 million, compared to $32.3 million for 2011; • Net income per diluted share decreased to $0.43 per share from $1.15 per share for 2011; • Revenue plus net change in deferred revenue increased by 24% to $168.9 million, compared to $135.9 million for 2011; • Deferred revenue increased $4.0 million, compared to a decrease of $2.1 million for 2011; and • Cash provided by operating activities was $30.6 million, compared to $28.6 million for 2011. Some of our key non-GAAP financial highlights for the year ended December 31, 2012 include: • Non-GAAP gross profit increased to $136.8 million or 83% of revenue, compared to $115.3 million, or 84% of revenue in 2011; • Non-GAAP income from operations increased to $43.1 million, or 26% of total revenue, compared to $35.9 million, or 26% of total revenue, in 2011; • Non-GAAP net income increased to $40.9 million, compared to $34.5 million in 2011; and • Non-GAAP net income per diluted share increased to $1.44 per common share, compared to $1.23 per common share in 2011. For a discussion of these non-GAAP financial measures and a reconciliation of GAAP and non-GAAP financial results, please refer to "Non-GAAP Financial Measures" included elsewhere in this Management's Discussion and Analysis of Financial Condition and Results of Operations. Components of Operating Results Revenue We derive our revenue primarily from the sale of license software, subscription and maintenance support, and professional services. We recognize revenue when all revenue recognition criteria have been met in accordance with revenue recognition guidance. This guidance provides that revenue should be recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collection is probable. Our total revenue consists of the following: License software. We derive license software revenue from the sale of perpetual software licenses. We price our software based on the types of features and applications provided and on the number of subscriber licenses sold. These factors impact the average selling price of our licenses and the comparability of average selling prices. Our license software revenue may vary significantly from quarter to quarter or from year to year as a result of long sales and deployment cycles, variations in customer ordering practices and the 41-------------------------------------------------------------------------------- Table of Contents application of management's judgment in applying complex revenue recognition rules. Our deferred license software revenue balance consists of software orders that do not meet all the criteria for revenue recognition. We are unable to predict the proportion of orders that will meet all the criteria for revenue recognition relative to those orders that will not meet all such criteria and, as a result, we cannot forecast whether recognized license software revenue and deferred license software revenue will continue to increase or decrease in a given period. As of December 31, 2012, our deferred license software revenue balance was $18.4 million, the current portion of which was $10.8 million. Subscription and maintenance support. Subscription and maintenance support revenue includes recurring revenue from annual maintenance support contracts for our software licenses and, to a much lesser extent, from subscriptions related to our delivery of BroadCloud services. Our annual maintenance support contracts provide for software updates, upgrades and technical support. Our typical warranty on licensed software is 90 days and, during this period, our customers are entitled to receive maintenance and support without the purchase of a maintenance contract. After the expiration of the warranty period, our customers must purchase an annual maintenance contract to continue receiving ongoing software maintenance and customer support. Under our BroadCloud subscriptions, we are paid a recurring fee calculated based on the number of seats and type of services purchased or a usage fee based on the actual number of transactions. The recurring fee is typically billed monthly or annually based on the terms of the arrangement and the usage fee is billed one month in arrears. Our deferred subscription and maintenance support revenue balance consists of maintenance support and subscription orders that do not meet all the criteria for revenue recognition. As of December 31, 2012, our deferred subscription and maintenance support revenue balance was $35.9 million, the current portion of which was $31.7 million. Professional services and other. Professional services and other revenue primarily includes revenue from professional service engagements consisting of implementation, training and consulting services. Our professional services and other deferred revenue balance consists of orders that do not meet all the criteria for revenue recognition. As of December 31, 2012, our deferred professional services and other revenue balance was $6.9 million, the current portion of which was $6.8 million. Cost of Revenue Our total cost of revenue consists of the following: • Cost of license software revenue. A majority of the cost of license software revenue consists of amortization of acquired technology, personnel-related expenses, and royalties paid to third parties whose technology or products are sold as part of BroadWorks. A significant amount of these royalty payments are for the underlying embedded data base technology within BroadWorks for which we currently incur a fixed expense and/or pay a fixed fee per quarter, which increased beginning in June 2012 as a result of a third-party license agreement executed in 2011. Such costs are expensed ratably over the time period of the contract. • Cost of subscription and maintenance support revenue. Cost of subscription and maintenance support revenue consists primarily of personnel-related expenses and other direct costs associated with the support, maintenance and implementation of our software licenses, including maintenance and support expenses due to our use of third party software, amortization of acquired technology and operating and depreciation expenses associated with the delivery of BroadCloud services. Personnel-related expenses include salaries, benefits, bonuses, reimbursement of expenses and stock-based compensation. Such costs are expensed in the period in which they are incurred. • Cost of professional services and other revenue. Cost of professional services and other revenue consists primarily of personnel-related expenses and other direct costs associated with the delivery of 42 -------------------------------------------------------------------------------- Table of Contents our professional services. Personnel-related expenses include salaries, benefits, bonuses, reimbursement of expenses and stock-based compensation. Such costs are expensed in the period in which they are incurred. Gross Profit Gross profit is the calculation of total revenue minus cost of revenue. Our gross profit as a percentage of revenue, or gross margin, has been and will continue to be affected by a variety of factors, including: • Mix of license software, subscription and maintenance support and professional services and other revenue. We generate higher gross margins on license support revenue compared to subscription and maintenance support or professional services and other revenue. • Growth or decline of license software revenue. A significant portion of cost of license software revenue is fixed and is expensed in the period in which it is incurred. This cost consists primarily of the royalty payments to our embedded database provider and amortization of acquired technology. If license software revenue increases, these fixed payments will decline as a percentage of revenue. If license software revenue declines, these fixed payments will increase as a percentage of revenue. • Impact of deferred revenue. If any revenue recognition criteria have not been met, the applicable revenue derived from the arrangement is deferred, including license software, subscription and maintenance support, and professional services and other revenue, until all elements of revenue recognition criteria have been met. However, the cost of revenue, including the costs of license software, subscription and maintenance support and professional services and other, is typically expensed in the period in which it is incurred. Therefore, if relatively more revenue is deferred in a particular period, gross margin would decline in that period. Because the ability to recognize revenue on orders depends largely on the terms of the sale arrangement, and because we are not able to predict the proportion of orders that will not meet all the criteria for revenue recognition, we cannot forecast whether any historical trends in gross margin will continue. Revenue Plus Net Change in Deferred Revenue We believe revenue we recognize in a particular period plus the net change in our deferred revenue balance is a key measure of our sales activity for that period. The (decrease) increase in deferred revenue illustrates how the balance in deferred revenue has changed over a period of time. Revenue plus the net change in deferred revenue is as follows (in thousands): Year ended December 31, 2012 2011 2010 Beginning of period deferred revenue balance $ 57,136 $ 59,264 $ 40,047 End of period deferred revenue balance 61,149 57,136 59,264 Increase (decrease) in deferred revenue 4,013 (2,128 ) 19,217 Revenue 164,842 138,064 95,623 Revenue plus net change in deferred revenue 168,855 135,936 114,840 Operating Expenses Operating expenses consist of sales and marketing, research and development and general and administrative expenses. Salaries and other personnel costs are the most significant component of each of these expense categories. We grew to 611 employees at December 31, 2012 from 487 employees at December 31, 2011, and we expect to continue to hire new employees to support our anticipated growth. 43-------------------------------------------------------------------------------- Table of Contents Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries and personnel costs for our sales and marketing employees, including stock-based compensation, commissions and bonuses. Additional expenses include marketing programs, consulting, travel and other related overhead. We expect our sales and marketing expenses to increase in the foreseeable future as we further increase the number of our sales and marketing professionals and expand our marketing activities. Over the long term, we expect sales and marketing expenses to grow but to decrease as a percentage of total revenue as sales grow. Research and development expenses. Research and development expenses consist primarily of salaries and personnel costs for development employees, including stock-based compensation and bonuses. Additional expenses include costs related to development, quality assurance and testing of new software and enhancement of existing software, consulting, travel and other related overhead. We engage third-party international and domestic consulting firms for various research and development efforts, such as software development, documentation, quality assurance and software support. We intend to continue to invest in our research and development efforts, including by hiring additional development personnel and by using outside consulting firms for various research and development efforts. We believe continuing to invest in research and development efforts is essential to maintaining our competitive position. We expect research and development expenses to increase in the foreseeable future, but over the long-term to decrease as a percentage of total revenue as sales grow. In 2012, research and development grew as a percentage of revenue compared with 2011, and we expect that, in 2013, research and development expenses will again increase as a percentage of total revenue. General and administrative expenses. General and administrative expenses consist primarily of salary and personnel costs for administration, finance and accounting, legal, information systems and human resources employees, including stock-based compensation and bonuses. Additional expenses include consulting and professional fees, travel, insurance and other corporate expenses. We expect general and administrative expenses to increase in the foreseeable future, but over the long-term to decrease as a percentage of total revenue as sales grow. Stock-Based Compensation We include stock-based compensation as part of cost of revenue and operating expenses in connection with the grant of stock options and other equity awards to our directors, employees and consultants. Generally, stock-based compensation has been the fastest growing component of our employee-related expenses, and we expect this trend to continue. We apply the fair value method in accordance with authoritative guidance for determining the cost of stock-based compensation. The total cost of the grant is measured based on the estimated fair value of the award at the date of grant. The fair value is then recognized as stock-based compensation expense over the requisite service period, which is the vesting period, of the award. For 2012, 2011 and 2010, we recorded stock-based compensation expense of $15.0 million, $7.2 million and $3.0 million, respectively. Of the stock-based compensation expense recorded for 2010, $0.4 million related to the vesting of restricted stock units, or RSUs, covering an aggregate of 172,492 shares that were subject to a performance-based vesting condition and that vested in full upon the completion of the IPO. Based on stock options and other equity awards outstanding as of December 31, 2012, we expect to recognize future expense related to the non-vested portions of such options and other equity awards in the amount of $19.2 million over a weighted average period of approximately 1.37 years. Other Expense (Income), Net Other expense (income), net consists primarily of interest income, interest expense and, for periods prior to the IPO, the change in the fair value of the preferred stock warrants. Interest income represents interest received on our cash and cash equivalents and restricted cash. Interest expense consists primarily of the interest related to the 1.50% convertible senior notes due in 2018, or Notes, and our installment bank loan with Bank of America 44-------------------------------------------------------------------------------- Table of Contents Leasing and Capital, LLC, or Bank of America, and, for 2010, interest accrued on outstanding borrowings under the ORIX Loan. Income Tax Expense Income tax expense consists of U.S. federal, state and foreign income taxes. We are required to pay income taxes in certain states and foreign jurisdictions. Historically, we have not been required to pay U.S. federal income taxes due to our accumulated net operating losses. For the year ended December 31, 2012, we have net operating loss carryforwards to utilize in the U.S. For the year ended December 31, 2011, we paid alternative minimum tax in the U.S. due to the taxable income generated in the period. Critical Accounting Policies and Significant Judgments and Estimates Our management's discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reported period. In accordance with GAAP, we base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K, we believe the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our consolidated financial statements. Revenue Recognition We derive our revenue from: (a) the sale of (i) software licenses and related maintenance for those licenses (ii) professional services; and (b) subscription and usage fees related to our cloud offerings. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the arrangement fee is fixed or determinable and collectability of the related receivable is probable. In making judgments regarding revenue recognition, we analyze various factors, including the nature and terms of the specific transaction, the creditworthiness of our customers, our historical experience, accuracy of prior estimates and overall market and economic conditions. Moreover, in connection with the sale of a number of products and services under a single contractual arrangement (a multiple element arrangement), we make judgments as to whether there is sufficient vendor specific objective evidence ("VSOE") to enable the allocation of fair value among the various elements in software arrangements that contain multiple elements and as to relative selling prices for multiple element arrangements that do not contain software elements. In determining relative selling prices for products and services, we consider, among other things, our use of discounts from list prices, prices we charge for similar offerings and our historical pricing practices. Changes in judgments related to these items, or deterioration in market or economic conditions, could materially impact the timing and amount of revenue recognized. License Software Revenue We sell software licenses to service providers through our direct sales force and indirectly through distribution partners. For direct sales, we generally consider a purchase order or executed sales quote, when combined with a master license agreement, to constitute evidence of an arrangement. In the case of sales through distribution partners, we 45-------------------------------------------------------------------------------- Table of Contents generally consider a purchase order or executed sales quote, when combined with a reseller or similar agreement with the distribution partner, and evidence of the distribution partner's customer, to constitute evidence of an arrangement. For sales through distribution partners for which we are not able to ascertain proof of the distribution partner's customer, we defer revenue until we are able to do so. We consider delivery to have occurred when the customer is given electronic access to the licensed software and a license key for the software has been delivered or made available. Instances in which all ordered software features are not delivered are considered to be partial deliveries. Since we cannot determine VSOE of an undelivered software feature in the case of a partial delivery, we defer revenue recognition on all elements of such order until delivery for all ordered software features is complete. Acceptance of our licensed software generally occurs upon delivery. From time to time, we have agreed with certain customers to a specific set of acceptance criteria. In such cases, we defer revenue until these acceptance criteria have been met. Our sales generally consist of multiple elements: software licenses; maintenance support; and professional services. We calculate the amount of revenue allocated to the software license by determining the fair value of the undelivered elements, which often are maintenance support and professional services, and subtracting it from the total order amount. We establish VSOE of the fair value of the maintenance support based on the renewal price as stated in the agreement and as charged in the first optional renewal period under the arrangement. Our VSOE for professional services is determined based on an analysis of our historical daily rates when these professional services are sold separately from the software license. The warranty period for our licensed software is generally 90 days. During this period, the customer receives technical support and has the right to unspecified product upgrades on an if-and-when available basis. For these periods, we defer a portion of the license fee and recognize it ratably over the warranty period. Our license software revenue is subject to significant fluctuation as a result of the application of accounting regulations and related interpretations and policies regarding revenue recognition. We do not believe license revenue to be the only meaningful measure of our level of sales activity during the periods reported because of the impact of software license orders for these periods that were not yet recognized as revenue and therefore were recorded as deferred license software revenue. Our deferred license software revenue balance consists of software orders that do not meet all the criteria for revenue recognition. We are unable to predict the proportion of orders that will meet all the criteria for revenue recognition relative to those orders that will not meet all such criteria. As a result, we cannot forecast whether these historical trends in recognized license software revenue, and corresponding increases in deferred license revenue, will continue. Subscription and Maintenance Support Revenue We typically sell software in combination with maintenance subscriptions. Maintenance is generally renewable annually at the option of the customer. Rates for maintenance, including subsequent renewal rates, are typically established based upon a specific percentage of net license fees as set forth in the arrangement with the customer. Maintenance support revenue is recognized ratably over the maintenance period, assuming all other criteria of revenue recognition have been met. Under our BroadCloud subscriptions, we are paid a recurring fee calculated based on the number of seats and type of services purchased or a usage fee based on actual number of transactions. Typically, the recurring fee is billed monthly or annually based on the terms of the arrangement and the usage fee is billed one month in arrears. Revenue is recognized ratably over the contract term beginning with the date our service is made available to customers. We enter into arrangements with multiple-deliverables that generally include subscription and professional services. To treat deliverables in a multiple-deliverable arrangement as separate units of accounting, the 46-------------------------------------------------------------------------------- Table of Contents deliverables must have standalone value upon delivery. If the deliverables have standalone value upon delivery, we account for each deliverable separately. Subscription services have standalone value as such services are often sold separately. In determining whether professional services have standalone value, we consider the following factors for each professional services agreement: availability of the services from other vendors; the nature of the professional services; the timing of when the professional services contract was signed in comparison to the subscription service start date; and the contractual dependence of the subscription service on the customer's satisfaction with the professional services work. Per the accounting guidance, when multiple-deliverables included in an arrangement are separated into different units of accounting, the arrangement consideration is allocated to the identified separate units based on a relative selling price hierarchy. We determine the relative selling price for a deliverable based on its VSOE, if available, or our best estimate of selling price, or BESP, if VSOE is not available. We have determined that third-party evidence is not a practical alternative due to differences in our service offerings compared to other parties and the availability of relevant third-party pricing information. The amount of revenue allocated to delivered items is limited by contingent revenue, if any. We determined BESP by considering our overall pricing objectives and market conditions. Significant pricing practices taken into consideration include our discounting practices, our price lists, our go-to-market strategy, historical standalone sales and contract prices. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in relative selling prices, including both VSOE and BESP. Professional Services Revenue Revenue from professional services is typically recognized as services are performed. Services are not considered essential to the functionality of the licensed software. Software Development Costs Software development costs incurred prior to the establishment of technological feasibility are expensed as incurred as research and development expense. Software development costs incurred subsequent to the establishment of technological feasibility, if any, are capitalized until the software is available for general release to customers. For each software release, judgment is required to evaluate when technological feasibility has occurred. We have determined that technological feasibility has been established at approximately the same time as our general release of such software to customers. Therefore, to date, we have not capitalized any software development costs. Internal-Use Software Development Costs Costs associated with customized internal-use software systems that have reached the application development stage are capitalized. Such capitalized costs include costs directly associated with the development of the applications. Capitalization of such costs begins when the preliminary project stage is complete and ceases at the point in which the project is substantially complete and is ready for its intended purpose. Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable are stated at realizable value, net of an allowance for doubtful accounts that is maintained for estimated losses that would result from the inability of some customers to make payments. The allowance is based on an analysis of past due amounts and ongoing credit evaluations. Customers are generally evaluated for creditworthiness through a credit review process at the time of each order. Our collection experience has been consistent with our estimates. Business Combinations In a business combination, we allocate the purchase price to the acquired business' identifiable assets and liabilities at their acquisition date fair values. The excess of the purchase price over the amount allocated to the identifiable assets and liabilities, if any, is recorded as goodwill. The excess, if any, of the fair value of the identifiable assets acquired and liabilities assumed over the consideration transferred is recognized as a gain within other income in the consolidated statements of operations as of the acquisition date. 47 -------------------------------------------------------------------------------- Table of Contents To date, the assets acquired and liabilities assumed in our business combinations have primarily consisted of acquired working capital and definite-lived intangible assets. The carrying value of acquired working capital is assumed to be equal to its fair value, given the short-term nature of these assets and liabilities. We estimate the fair value of definite-lived intangible assets acquired using a discounted cash flow approach, which includes an analysis of the future cash flows expected to be generated by such assets and the risk associated with achieving such cash flows. The key assumptions used in the discounted cash flow model include the discount rate that is applied to the discretely forecasted future cash flows to calculate the present value of those cash flows and the estimate of future cash flows attributable to the acquired intangible assets, which include revenue, operating expenses and taxes. Goodwill Goodwill represents the excess of: (a) the aggregate of the fair value of consideration transferred in a business combination, over (b) the fair value of assets acquired, net of liabilities assumed. Goodwill is not amortized, but is subject to annual impairment tests as described below. We test goodwill for impairment annually on December 31, or more frequently if events or changes in business circumstances indicate the asset might be impaired. Examples of such events or circumstances include the following: • a significant adverse change in our business climate; • unanticipated competition; • a loss of key personnel; • a more likely than not expectation that a significant portion ofour business will be sold; or • the testing for recoverability of a significant asset group within the reporting unit. We first assess qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test included in GAAP. To the extent our assessment identifies adverse conditions, goodwill is tested for impairment at the reporting unit level using a two-step approach. The first step is to compare the fair value of the reporting unit to the carrying value of the net assets assigned to the reporting unit. If the fair value of the reporting unit is greater than the carrying value of the net assets assigned to the reporting unit, the assigned goodwill is not considered impaired. If the fair value is less than the reporting unit's carrying value, step two is required to measure the amount of the impairment, if any. In the second step, the fair value of goodwill is determined by deducting the fair value of the reporting unit's identifiable assets and liabilities from the fair value of the reporting unit as a whole, as if the reporting unit had just been acquired and the purchase price were being initially allocated. If the carrying value of goodwill exceeds the implied fair value, an impairment charge would be recorded to operating expenses in the consolidated statements of operations in the period the determination is made. We have determined that we have one reporting unit, BroadSoft, Inc., which is the consolidated entity. Based on the results of our annual goodwill impairment testing in 2012, 2011 and 2010, our fair value exceeded our book value by a substantial margin. Therefore, the second step of the impairment test was not required to be performed and no goodwill impairment was recognized. However, there can be no assurance that goodwill will not be impaired at any time in the future. Intangible Assets We acquired intangible assets in connection with certain of our business acquisitions. These assets were recorded at their estimated fair values at the acquisition date and are amortized over their respective estimated useful lives 48 -------------------------------------------------------------------------------- Table of Contents using a method of amortization that reflects the pattern in which the economic benefits of the intangible assets are used. Estimated useful lives are determined based on our historical use of similar assets and the expectation of future realization of cash flows attributable to the intangible assets. Changes in circumstances, such as technological advances or changes to our business model, could result in the actual useful lives differing from our current estimates. In those cases where we determine that the useful life of an intangible asset should be shortened, we amortize the net book value in excess of the estimated salvage value over its revised remaining useful life. We did not revise our previously assigned useful life estimates attributed to any of our intangible assets in 2012, 2011 or 2010. The estimated useful lives used in computing amortization of intangible assets are as follows: Customer relationships 3 - 7 years Developed technology 4 - 6 years Non-compete agreement 1 year Tradenames 2 - 4 years Impairment of Long-Lived Assets We review our long-lived assets, including property and equipment and intangible assets, for impairment whenever events or changes in circumstances indicate the carrying amount of an asset or an asset group may not be recoverable. Typical indicators that an asset may be impaired include, but are not limited to: • a significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition; • a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset; or • a current expectation that, more likely than not, a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected to be generated. Assets to be disposed of are recorded at the lower of the carrying amount or fair value less costs to sell. Recoverability measurement and estimating of undiscounted cash flows for assets to be held and used is done at the lowest possible levels for which there are identifiable assets. If such assets are considered impaired, generally the amount of impairment recognized would be equal to the amount by which the carrying amount of the assets exceeds the fair value of the assets, which we would compute using a discounted cash flow approach. Estimating future cash flows attributable to our long-lived assets requires significant judgment and projections may vary from cash flows eventually realized. There were no triggering events to cause us to record an impairment charge in 2012, 2011 or 2010. Income Taxes We use the liability method of accounting for income taxes as set forth in the authoritative guidance for accounting for income taxes. This method requires an asset and liability approach for the recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their respective tax bases, and for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured by applying enacted statutory tax rates applicable to the future years in which deferred amounts are expected to be settled or realized. Based upon our cumulative operating results through June 30, 2011 and an assessment of our expected future results of operations, we determined that there was significant positive evidence regarding the realization of our 49-------------------------------------------------------------------------------- Table of Contents U.S. deferred tax assets. After weighing both the positive and negative evidence, coupled with the continued success in commercializing our core products and services both inside and outside the U.S., we believe that it is more likely than not that our U.S. deferred tax assets will be realized. A portion of the U.S. valuation allowance was released in the period ended June 30, 2011 based on the amount of U.S. net deferred tax assets then expected to be remaining as of December 31, 2011. As of December 31, 2011, we reversed all of the remaining valuation allowance on the U.S. deferred tax assets because it was more likely than not that those deferred tax assets would be realized. The release of the U.S. valuation allowance was recorded as a tax benefit on our consolidated statements of operations for 2011. As of December 31, 2012, we had a remaining valuation allowance of approximately $5.6 million, which primarily relates to certain foreign NOLs and tax credits that more likely than not will not be realized. We operate in various tax jurisdictions and are subject to audit by various tax authorities. We recognize and measure benefits for uncertain tax positions using a two-step approach. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that the tax position will be sustained upon audit, including resolution of any related appeals or litigation processes. For tax positions that are more likely than not to be sustained upon audit, the second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon settlement. Significant judgment is required to evaluate uncertain tax positions. Changes in facts and circumstances could have a material impact on our effective tax rate and results of operations. Results of Operations Comparison of the Years Ended December 31, 2012 and 2011 Revenue Year ended December 31, Period-to-Period 2012 2011 Change Percent Percent of Total of Total Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Revenue by Type: License software $ 89,750 55 % $ 77,289 56 % $ 12,461 16 % Subscription and maintenance support 58,249 35 42,462 31 15,787 37 Professional services and other 16,843 10 18,313 13 (1,470 ) (8 ) Total revenue $ 164,842 100 % $ 138,064 100 % $ 26,778 19 % Revenue by Geography: Americas $ 107,514 65 % $ 87,866 64 % $ 19,648 22 % EMEA 39,334 24 24,866 18 14,468 58 APAC 17,994 11 25,332 18 (7,338 ) (29 ) Total revenue $ 164,842 100 % $ 138,064 100 % $ 26,778 19 % Total revenue for 2012 increased by 19%, or $26.8 million, to $164.8 million, compared to 2011. This growth was driven by a 16% increase in license software revenue and a 37% increase in subscription and maintenance support revenue, partially offset by an 8% decrease in professional services and other revenue. Deferred revenue increased by $4.0 million for 2012, compared to a decrease of $2.1 million in 2011. Total revenue from the Americas for 2012 increased by 22%, or $19.6 million, to $107.5 million compared to 2011. The increase in revenue from the Americas for 2012 was due to growth in software license sales for our hosted UC and consumer offerings and associated maintenance support revenue. In Europe, Middle East and 50 -------------------------------------------------------------------------------- Table of Contents Africa, or EMEA, total revenue for 2012 increased by 58%, or $14.5 million, to $39.3 million compared to 2011. The increase in EMEA revenue in 2012 was primarily due to growth in software license sales and related maintenance support, particularly our hosted UC applications, and the recognition of consumer applications revenue related to an arrangement that had been deferred in prior periods. In Asia Pacific, or APAC, total revenue for 2012 decreased by 29%, or $7.3 million, to $18.0 million compared to 2011. The decrease in APAC revenue was mostly due to the recognition of revenue in 2011 on a sizeable order for our call center application from a large incumbent provider that had been deferred in prior periods. License Software License software revenue for 2012 increased by 16%, or $12.5 million, to $89.8 million. The increase in revenue for 2012 was primarily related to growth in sales of software licenses. This growth was most significant in license sales for our hosted UC and consumer applications. Deferred license software revenue decreased by $2.2 million for 2012, compared to a decrease of $5.0 million in 2011. The decrease in deferred revenue for 2012 was primarily driven by a number of orders where revenue was deferred in prior periods and was recognized during 2012. Subscription and Maintenance Support Subscription and maintenance support revenue for 2012 increased by 37%, or $15.8 million, to $58.2 million, compared to 2011. The increase in subscription and maintenance support revenue and deferred revenue was the result of growth in our installed base of customers and licenses and subscription revenue contributions from certain of our recent acquisitions. Deferred subscription and maintenance support revenue grew by $6.4 million for 2012, compared to growth of $5.9 million in 2011. Professional Services and Other Professional services and other revenue for 2012 decreased by 8%, or $1.5 million, to $16.8 million, compared to 2011. The decrease in professional services and other revenue for 2012 was due to the recognition of revenue in 2011 for a new call center application that had been deferred in prior periods, partially offset by growth in demand for our professional services. Deferred professional services and other revenue had minimal change for 2012, compared to a decrease of $3.0 million in 2011. Cost of Revenue and Gross Profit Year ended December 31, Period-to-Period 2012 2011 Change Percent Percent of of Related Related Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Cost of Revenue: License software $ 8,643 10 % $ 6,077 8 % $ 2,566 42 % Subscription and maintenance support 14,831 25 10,419 25 4,412 42 Professional services and other 9,012 54 8,478 46 534 6 Total cost of revenue $ 32,486 20 % $ 24,974 18 % $ 7,512 30 % Gross Profit: License software $ 81,107 90 % $ 71,212 92 % $ 9,895 14 % Subscription and maintenance support 43,418 75 32,043 75 11,375 35 Professional services and other 7,831 46 9,835 54 (2,004 ) (20 ) Total gross profit $ 132,356 80 % $ 113,090 82 % $ 19,266 17 % 51 -------------------------------------------------------------------------------- Table of Contents For 2012, our gross margin decreased to 80% as compared to 82% in 2011 and our gross profit increased by 17%, or $19.3 million, to $132.4 million. We experienced an increase in both license software revenue gross profit and subscription and maintenance support gross profit and a decrease in professional services and other gross profit for 2012. The total gross profit growth is primarily due to growth in license software and subscription and maintenance support revenue relative to the respective cost of revenue. For 2012, license software gross margin decreased to 90% as compared to 92% in 2011 and license software gross profit increased by 14% to $81.1 million. License software cost of revenue increased by 42%, or $2.6 million, to $8.6 million for 2012. This increase was primarily due to a $1.0 million increase in equipment and resold third party software costs and a $0.8 million increase in personnel-related costs driven by an increase in headcount. The increase in license software gross profit was driven by revenue growth relative to lower growth in license software cost of revenue. For 2012, subscription and maintenance services gross margin remained at 75% as compared to 2011 and subscription and maintenance services gross profit increased by 35% to $43.4 million. Subscription and maintenance services cost of revenue increased by 42%, or $4.4 million, to $14.8 million in 2012 as compared to 2011. The increase in subscription and maintenance services cost of revenue was primarily due to an increase of $1.3 million in personnel-related costs driven by an increase in headcount, a $1.1 million increase in amortization of acquired intangibles, a $0.4 million increase in consulting fees and a $0.4 million increase in line costs. The increase in subscription and maintenance services gross profit was driven by revenue growth relative to lower growth in subscription and maintenance services cost of revenue. For 2012, professional services and other gross margin decreased to 46% as compared to 54% in 2011 and professional services and other gross profit decreased by 20% to $7.8 million. Professional services and other cost of revenue increased 6%, or $0.5 million, to $9.0 million for 2012. The increase in professional services cost of revenue was primarily due to an increase in personnel costs and consulting fees. The decrease in professional services and other gross margin was driven by the recognition of revenue in 2011 for a new call center application from a large APAC incumbent provider that had been deferred in prior periods. Operating Expenses Year ended December 31, Period-to-Period 2012 2011 Change Percent Percent of Total of Total Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Sales and marketing $ 47,911 29 % $ 38,376 28 % $ 9,535 25 % Research and development 36,178 22 27,744 20 8,434 30 General and administrative 22,863 14 19,534 14 3,329 17 Total operating expenses $ 106,952 65 % $ 85,654 62 % $ 21,298 25 % Sales and Marketing. Sales and marketing expense increased by 25%, or $9.5 million, to $47.9 million for 2012. The primary cause of this increase was a $7.2 million increase in personnel costs, primarily resulting from headcount growth and higher sales commissions, a $0.7 million increase in outside consulting fees and a $0.7 million increase in travel expenses. Research and Development. Research and development expense increased by 30%, or $8.4 million, to $36.2 million for 2012. This increase was primarily due to an $8.0 million increase in personnel costs, primarily from an increase in headcount as we continue to invest in our product offerings, as well as the impact of the acquisitions we made during 2011 and 2012. 52-------------------------------------------------------------------------------- Table of Contents General and Administrative. General and administrative expense increased by 17%, or $3.3 million, to $22.9 million for 2012. This increase was primarily attributable to a $2.0 million increase in personnel related costs, a $0.7 million increase in equipment and software costs, a $0.6 million increase in bad debt expense and an increase of $0.3 million in outside consulting fees. Income from Operations We had income from operations of $25.4 million for 2012, compared to $27.4 million in 2011. Other (Income) Expense Year ended December 31, Period-to-Period 2012 2011 Change Percent Percent of Total of Total Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Interest income $ (455 ) * $ (278 ) * $ (177 ) 64 % Interest expense 6,925 4 % 3,592 3 % 3,333 93 % Total other expense, net $ 6,470 4 % $ 3,314 3 % $ 3,156 95 % * Less than 1% Interest income increased by $0.2 million for 2012. Interest expense increased by $3.3 million compared to 2011. This increase in interest expense is primarily related to our Notes issued in June 2011 and a full year's recognition of interest expense in 2012. Provision (Benefit from) for Income Taxes Provision for income taxes was $6.9 million for the year ended December 31, 2012, compared to benefit from income taxes of $8.2 million for the year ended December 31, 2011. For the year ended December 31, 2012, the tax provision was positively impacted by $1.9 million due to the recognition of research and development tax credits relating to prior years. These credits were not recorded until an acceptance for the credits was established. The benefit from income taxes for 2011 related primarily to an $8.9 million benefit due to the discrete release of the U.S. tax valuation allowance, partially offset by foreign taxes. Comparison of the Years Ended December 31, 2011 and 2010 Revenue Year ended December 31, Period-to-Period 2011 2010 Change Percent Percent of Total of Total Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Revenue by Type: License software $ 77,289 56 % $ 53,302 56 % $ 23,987 45 % Subscription and maintenance support 42,462 31 33,743 35 8,719 26 Professional services and other 18,313 13 8,578 9 9,735 113 Total revenue $ 138,064 100 % $ 95,623 100 % $ 42,441 44 % Revenue by Geography: Americas $ 87,866 64 % $ 57,693 60 % $ 30,173 52 % EMEA 24,866 18 23,617 25 1,249 5 APAC 25,332 18 14,313 15 11,019 77 Total revenue $ 138,064 100 % $ 95,623 100 % $ 42,441 44 % 53 -------------------------------------------------------------------------------- Table of Contents Total revenue for 2011 increased by 44%, or $42.4 million, to $138.1 million, compared to 2010. This growth was driven by a 45% increase in license software revenue, a 26% increase in subscription and maintenance support and a 113% increase in professional services and other revenue. The revenue growth was driven by an increase in sales of our hosted Unified Communications and SIP Trunking products. Deferred revenue decreased by $2.1 million for 2011, compared to growth of $19.2 million in 2010. The decrease in deferred revenue was mainly attributed to a sizeable order where revenue was previously deferred and which was recognized during 2011. Total revenue from the Americas for 2011 increased by 52%, or $30.2 million, to $87.9 million compared to 2010. The increase in revenue from the Americas for 2011 was due to growth in software license sales and associated maintenance support revenue. In EMEA total revenue for 2011 increased by 5%, or $1.2 million, to $24.9 million compared to 2010. The increase in EMEA revenue in 2011 was due to growth in software license sales and associated maintenance support revenue. In APAC total revenue for 2011 increased by 77%, or $11.0 million, to $25.3 million compared to 2010. The increase in APAC revenue was driven by growth in our Unified Communications offerings, including a sizeable call center order. License Software License software revenue for 2011 increased by 45%, or $24.0 million, to $77.3 million. The increase in revenue for 2011 was primarily related to growth in sales of software licenses. This growth was most significant in license sales for our hosted UC and SIP Trunking applications. Deferred license software revenue decreased by $5.0 million for 2011, compared to growth of $6.1 million in 2010. The decrease in deferred revenue for 2011 was primarily driven by a sizeable order where revenue was previously deferred and which was recognized during 2011. Subscription and Maintenance Support Subscription and maintenance support revenue for 2011 increased by 26%, or $8.7 million, to $42.5 million, compared to 2010. Deferred subscription and maintenance support revenue increased by $5.9 million for 2011, compared to growth of $8.7 million in 2010. The increase in subscription and maintenance support revenue was the result of growth in our installed base of customers and licenses as well as from a sizeable order where revenue was previously deferred and which was recognized in 2011. Professional Services and Other Professional services and other revenue for 2011 increased by 113%, or $9.7 million, to $18.3 million, compared to 2010. Deferred professional services and other revenue decreased by $3.0 million for 2011, compared to an increase of $4.5 million in 2010. The increase in professional services and other revenue was the result of increased demand for our services offerings. The decrease in deferred revenue was mainly attributed to a sizeable order where revenue was previously deferred and which was recognized in 2011. 54-------------------------------------------------------------------------------- Table of Contents Cost of Revenue and Gross Profit Year ended December 31, Period-to-Period 2011 2010 Change Percent Percent of of Related Related Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Cost of Revenue: License software $ 6,077 8 % $ 5,341 10 % $ 736 14 % Subscription and maintenance support 10,419 25 7,691 23 2,728 35 Professional services and other 8,478 46 7,010 82 1,468 21 Total cost of revenue $ 24,974 18 % $ 20,042 21 % $ 4,932 25 % Gross Profit: License software $ 71,212 92 % $ 47,961 90 % $ 23,251 48 % Subscription and maintenance support 32,043 75 26,052 77 5,991 23 Professional services and other 9,835 54 1,568 18 8,267 527 Total gross profit $ 113,090 82 % $ 75,581 79 % $ 37,509 50 % For 2011, our gross margin increased to 82% as compared to 79% in 2010 and our gross profit increased by 50%, or $37.5 million, to $113.1 million. This increase in gross profit resulted from growth in each of license software revenue, subscription and maintenance support revenue and professional services and other revenue, in each case relative to the respective cost of revenue. For 2011, license software gross margin increased to 92% as compared to 90% in 2010 and license software gross profit increased by 48% to $71.2 million. License software cost of revenue increased by 14%, or $0.7 million, to $6.1 million for 2011. This increase was primarily due to a $0.6 million increase in personnel-related costs driven by an increase in headcount. The increase in license software gross profit and gross margin was driven by revenue growth relative to lower growth in license software cost of revenue. A substantial portion of license software cost of sales is fixed expense and therefore does not increase with revenue growth. For 2011, subscription and maintenance support gross margin decreased to 75% as compared to 77% in 2010 and subscription and maintenance support gross profit increased by 23% to $32.0 million. Subscription and maintenance support cost of revenue increased by 35%, or $2.7 million, to $10.4 million in 2011 as compared to 2010. The increase in subscription and maintenance support cost of revenue was primarily due to an increase in personnel and consulting fees allocated to cost of revenue due to an increase in the number of research and development employees and consultants working directly on specific features for certain customers and an increase in services personnel. For 2011, professional services and other gross margin increased to 54% as compared to 18% in 2010 and professional services and other gross profit increased by 527% to $9.8 million. Professional services and other cost of revenue increased by 21%, or $1.5 million, to $8.5 million in 2011 as compared to 2010. The increase in professional services and other costs of revenue was primarily due to an increase in personnel and consulting fees. The increase in professional service and other gross profit and gross margin was driven by revenue growth relative to lower growth in professional services and other cost of revenue. This was due to higher utilization of professional services resources and a sizeable order for which revenue was previously deferred and which was recognized in 2011. 55-------------------------------------------------------------------------------- Table of Contents Operating Expenses Year ended December 31, Period-to-Period 2011 2010 Change Percent Percent of Total of Total Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Sales and marketing $ 38,376 28 % $ 31,818 33 % $ 6,558 21 % Research and development 27,744 20 19,616 21 8,128 41 General and administrative 19,534 14 14,103 15 5,431 39 Total operating expenses $ 85,654 62 % $ 65,537 69 % $ 20,117 31 % Sales and Marketing. Sales and marketing expense increased by 21%, or $6.6 million, to $38.4 million for 2011. The primary driver of this increase was a $4.3 million increase in personnel costs that was driven by headcount growth and higher sales commissions and a $0.7 million increase in travel expenses. Research and Development. Research and development expense increased by 41%, or $8.1 million, to $27.7 million for 2011. This increase was primarily due to a $5.4 million increase in personnel costs, primarily from an increase in headcount, and a $1.0 million increase in outside consulting fees. General and Administrative. General and administrative expense increased by 39%, or $5.4 million, to $19.5 million for 2011. This increase was primarily attributable to a $3.1 million increase in personnel related costs and a $1.4 million increase in professional services fees. A significant portion of these increases were attributable to expenses related to being a public company, including fees associated with implementation, testing and auditing associated with our first internal controls audit under the Sarbanes-Oxley Act of 2002, and acquisition-related expenses. Income from Operations We had income from operations of $27.4 million for 2011, compared to $10.0 million in 2010. The increase in income from operations for 2011 was a result of the $37.5 million increase in gross profit, partially offset by a $20.1 million increase in total operating expenses described above. Other (Income) Expense Year ended December 31, Period-to-Period 2011 2010 Change Percent Percent of Total of Total Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Interest income $ (278 ) * $ (52 ) * $ (226 ) 435 % Interest expense 3,592 3 % 757 1 % 2,835 375 Other expense - * 174 * (174 ) NM Total other expense, net $ 3,314 3 % $ 879 1 % $ 2,435 277 % * Less than 1% NM - Not meaningful 56 -------------------------------------------------------------------------------- Table of Contents Interest income for 2011 was relatively unchanged as compared to 2010. Interest expense increased by $2.8 million compared to 2010. This increase in interest expense is primarily related to our Notes issued in June 2011, offset by a decrease attributable to the voluntary early repayment of the ORIX Loan in June 2010. Other expense for 2011 was similarly relatively unchanged as compared to 2010. We do not anticipate incurring significant other (income) expense in future years. (Benefit from) Provision for Income Taxes Benefit from income taxes was $8.2 million for the year ended December 31, 2011, compared to provision for income taxes of $1.2 million for the year ended December 31, 2010. The benefit from income taxes related primarily to an $8.9 million benefit due to the discrete release of the U.S. tax valuation allowance, partially offset by foreign taxes. Liquidity and Capital Resources Resources Since the beginning of 2009, we have funded our operations principally with cash provided by operating activities, which has resulted primarily from growth in net income and deferred revenue. Cash flow from operations was $30.6 million, $28.6 million and $19.4 million for the years ended December 31, 2012, 2011 and 2010, respectively. In June 2010, we completed our IPO through which we raised net proceeds of $40.0 million. In December 2010, we completed our follow-on offering through which we raised net proceeds of $9.9 million. In June 2011, we completed an offering of our Notes with net proceeds from the offering of approximately $115.7 million. Cash and Cash Equivalents, Accounts Receivable and Working Capital The following table presents a summary of our cash and cash equivalents, accounts receivable, working capital and cash flows as of the dates and for the periods indicated (in thousands). December 31, December 31, 2012 2011 Cash and cash equivalents $ 90,545 $ 94,072 Accounts receivable, net 48,980 47,048 Working capital 161,519 180,010 Year ended December 31, 2012 2011 2010 Cash (used in) provided by: Operating activities $ 30,598 $ 28,575 $ 19,386 Investing activities (34,153 ) (99,136 ) (24,274 ) Financing activities (121 ) 117,431 29,203 Our cash and cash equivalents at December 31, 2012 were held for working capital and other general corporate purposes and were invested primarily in demand deposit accounts or money market funds. We do not enter into investments for trading or speculative purposes. Restricted cash, which totaled $0.6 million at December 31, 2012 and is not included in cash and cash equivalents, consisted primarily of certificates of deposit that secure letters of credit related to operating leases for office space. Operating Activities For the year ended December 31, 2012, net cash provided by operating activities was $30.6 million, compared to $28.6 million for 2011. Cash provided by operating activities during 2012 was primarily a result of net income of $12.1 million, aggregate non-cash expenses of $34.6 million (including stock-based compensation expense of $15.0 million, depreciation and amortization of $5.2 million, non-cash interest on convertible debt of $5.1 57-------------------------------------------------------------------------------- Table of Contents million, provision for deferred income taxes of $5.1 million, and amortization of software licenses of $2.9 million) and a $4.0 million increase in deferred revenue. These amounts were partially offset by a $16.4 increase in other assets (which includes our up-front payment of a $6.5 million fee in connection with our recently executed third party licensing agreement), a $2.6 million increase in accounts receivable and a $1.1 million decrease in accounts payable, accrued expenses and other long-term liabilities. For the year ended December 31, 2011, operating activities provided $28.6 million in net cash compared to $19.4 million in 2010. This was primarily as a result of a net income of $32.3 million and non-cash items such as depreciation and amortization of $3.1 million, amortization of software licenses of $1.8 million and stock-based compensation expense of $7.2 million, partially offset by an increase in accounts receivable of $6.0 million. For the year ended December 31, 2010, operating activities provided $19.4 million in net cash compared to $10.4 million in 2009. This was primarily as a result of a net income of $8.0 million, a $19.2 million increase in deferred revenue, which was attributable primarily to increased sales of our software and non-cash items such as depreciation and amortization of $2.3 million, amortization of software licenses of $1.8 million and stock-based compensation expense of $3.0 million, partially offset by an increase in accounts receivable of $15.0 million. Investing Activities Our investing activities have consisted primarily of purchases of marketable securities and property and equipment and the acquisitions of businesses. For the year ended December 31, 2012, net cash used in investing activities was $34.2 million, compared to $99.1 million for 2011. This decrease was primarily attributable to a $73.6 million decrease in net purchases of marketable securities, offset by an $8.4 million increase in cash used for acquisitions. In 2011, net cash used in investing activities was $99.1 million, compared to $24.3 million for 2010. This increase was attributed to an increase of $118.6 million in marketable securities purchased with additional excess cash, and a $14.6 million increase in cash used for acquisitions, partially offset by proceeds from the sale and maturity of marketable securities of $58.2 million. For the year ended December 31, 2010, net cash used in investing activities was $24.3 million, compared to net cash provided of $0.7 million for 2009. This increase was attributed to $18.7 million in marketable securities purchased with excess cash and a $1.9 million increase in purchases of property and equipment, $0.5 million of which was for leasehold improvements and equipment for new office space. Financing Activities In 2012, net cash used in financing activities was $0.1 million, compared to net cash provided by financing activities of $117.4 million for 2011. The change is primarily the result of our receipt of $115.7 million of cash upon the issuance of the Notes during 2011, a $1.5 million decrease in proceeds from stock option exercises compared to 2011 and a $1.6 million increase in cash paid for taxes on the vesting of restricted stock units compared to 2011. In 2011, net cash provided by financing activities was $117.4 million, compared to $29.2 million in 2010. The principal source of cash generated from financing activities was related to the issuance of the Notes, which generated $115.7 million, net of issuance costs. Additionally in 2011, proceeds from common stock issued upon the exercise of stock options increased by $3.2 million compared to 2010. For the year ended December 31, 2010, net cash provided by financing activities was $29.2 million, compared to cash used of $2.7 million in 2009. This amount consisted primarily of the net proceeds of our IPO of $40.0 million and net proceeds of our follow-on offering of $9.9 million, partially offset by repayment of the ORIX 58 -------------------------------------------------------------------------------- Table of Contents Loan and other loan balances in the aggregate of $16.7 million and the $4.3 million payment for the redemption and subsequent cancellation of all outstanding shares of our Series A redeemable preferred stock. Borrowings and Credit Facilities Convertible Senior Notes In June 2011, we issued $120.0 million aggregate principal amount of our Notes. The Notes are our senior unsecured obligations, with interest payable semi-annually in cash at a rate of 1.50% per annum, and will mature on July 1, 2018, unless earlier repurchased, redeemed or converted. The initial conversion rate for the Notes is approximately $41.99 per share. The conversion price will be subject to adjustment in some events, but will not be adjusted for accrued interest. Upon conversion, we will pay cash up to the aggregate principal amount of the Notes to be converted and deliver shares of our common stock in respect of the remainder, if any, of the conversion obligation in excess of the aggregate principal amount of the Notes being converted. Conversion Prior to April 1, 2018: Note holders may convert their Notes at their option prior to April 1, 2018 only if any of the following occur: • if, for ten consecutive trading days, the trading price per Note is less than 98% of the product of the last reported sale price of the common stock and the applicable conversion rate of the Notes on such day, then the Notes may be converted at any time during the five business days following such ten day period; • if the closing price of our common stock exceeds 130% of the conversion price of the Notes for at least 20 of the final 30 trading days of a calendar quarter, then the Notes may be converted at any time during the following calendar quarter; • upon the occurrence of certain corporate events specified in the indenture governing the Notes, or the Indenture; or • if we call the Notes for redemption. Conversion on or After April 1, 2018: The Notes will be convertible, regardless of the foregoing circumstances, at any time on or after April 1, 2018 through the second scheduled trading day immediately preceding the maturity date. Redemption by Holders: Holders of the Notes may require us to repurchase some or all of the Notes for cash, subject to certain exceptions, upon a fundamental change, as defined in the Indenture, at a repurchase price equal to the principal amount of the Notes being repurchased, plus any accrued and unpaid interest up to but excluding the relevant repurchase date. In addition, if a make-whole fundamental change, as defined in the Indenture, occurs prior to the maturity date, we will in some cases increase the conversion rate for a holder that elects to convert its Notes in connection with such make-whole fundamental change. Redemption by BroadSoft: We may not redeem the Notes prior to July 1, 2015. Beginning July 1, 2015, we may redeem for cash all or part of the Notes (except for the Notes that we are required to repurchase as described above) if the last reported sale price of our common stock exceeds 140% of the applicable conversion price of the Notes for at least 20 of the final 30 trading days ending on the trading day immediately prior to the date of the redemption notice. The redemption price of any Notes we call for redemption prior to the maturity date will equal the sum of the 59 -------------------------------------------------------------------------------- Table of Contents principal amount of the Notes to be redeemed, plus accrued and unpaid interest, plus a "make-whole premium" payment. Tekes Loan In connection with our acquisition of Movial Applications Oy in October 2011, we assumed five installment loans with Tekes-the Finnish Funding Agency for Technology and Innovation in the aggregate principal amount of $1.0 million. The terms of the loans are governed by the Finnish Act on State Lending and State Guarantees, Government Decree on Research, Development and Innovation Funding. The loans are for funding approved research and development projects, repayment terms are determined on a per project basis, and the interest rate on each loan is variable, which is currently three percent. We expect to repay these loans in full during 2013, subject to completing a statutory audit in Finland. Operating and Capital Expenditure Requirements We believe the cash generated from operations, our current cash, cash equivalents and short-term and long-term investment balances and interest income we earn on these balances will be sufficient to meet our anticipated cash requirements through at least the next 12 months. In the future, we expect our operating and capital expenditures to grow as we increase headcount, expand our business activities, grow our customer base and implement and enhance our information technology and enterprise resource planning system. As sales grow, we expect our accounts receivable balance to increase. Any such increase in accounts receivable may not be completely offset by increases in accounts payable and accrued expenses, which would likely result in greater working capital requirements. If our available cash resources are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or convertible debt securities or enter into a credit facility. The sale of equity and convertible debt securities may result in dilution to our stockholders and those securities may have rights senior to those of our common shares. If we raise additional funds through the issuance of convertible debt securities, these securities could contain covenants that would restrict our operations. We may require additional capital beyond our currently anticipated amounts. Additional capital may not be available on reasonable terms, or at all. Contractual Obligations We have contractual obligations for non-cancelable office space, notes payable and other short-term and long-term liabilities. The following table discloses aggregate information about our contractual obligations as of December 31, 2012 and periods in which payments are due (in thousands): Payments Due by Year Total 2013 2014 - 2015 2016 - 2017 After 2017 Convertible Senior Notes, including interest * $ 130,800 $ 1,800 $ 3,600 $ 3,600 $ 121,800 Tekes Loan 969 $ 555 $ 263 $ 76 $ 75 Operating lease obligations 12,702 2,255 4,156 4,003 2,288 Equipment leases 104 74 30 - - Total $ 144,575 $ 4,684 $ 8,049 $ 7,679 $ 124,163 * Contractual interest obligations related to our Notes totaled $10.8 million at December 31, 2012, including $1.8 million, $3.6 million, $3.6 million and $1.8 million due in years 2013, 2014-2015, 2016-2017 and after 2017, respectively. As of December 31, 2012, we had unrecognized tax benefits of $0.8 million, which did not include any interest or penalties. We do not expect to recognize any of these benefits in 2013. Furthermore, we are not able to provide a reliable estimate of the timing of future payments relating to these unrecognized benefits. 60 -------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements As of December 31, 2012, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. Non-GAAP Financial Measures In addition to our GAAP operating results, we use certain non-GAAP financial measures when planning, monitoring, and evaluating our performance. We consider these non-GAAP financial measures to be useful metrics for management and investors because they exclude the effect of certain non-cash expenses, such as stock-based compensation expense, amortization of acquired intangibles expense, non-cash interest expense on our Notes and non-cash tax provision, so management and investors can compare our core business operating results over multiple periods. While we believe that these non-GAAP financial measures are useful in evaluating our business, this information should be considered as supplemental in nature and is not meant as a substitute for revenue recognized in accordance with GAAP. In addition, other companies, including companies in our industry, may calculate such measures differently, which reduces its usefulness as a comparative measure. We believe that these non-GAAP measures reflect our ongoing business in a manner that allows for meaningful period-to-period comparisons and analysis of trends in our business, as they exclude certain expenses. The presentation of non-GAAP net income, non-GAAP net income per share, non-GAAP gross profit, non-GAAP operating income and other non-GAAP financial measures in this Annual Report on Form 10-K is not meant to be a substitute for "net income," "net income per share," "gross profit," "income from operations" or other financial measures presented in accordance with GAAP, but rather should be evaluated in conjunction with such data. Our definition of "non-GAAP net income," "non-GAAP net income per share," "non-GAAP gross profit," "non-GAAP income from operations" and other non-GAAP financial measures may differ from similarly titled non-GAAP measures used by other companies and may differ from period to period. In reporting non-GAAP measures in the future, we may make other adjustments for expenses and gains we do not consider reflective of core operating performance in a particular period and may modify "non-GAAP net income," "non-GAAP net income per share," "non-GAAP gross profit," "non-GAAP income from operations" and such other non-GAAP measures by excluding these expenses and gains. Non-GAAP net income and net income per share. We define non-GAAP net income as net income plus stock-based compensation expense, amortization expense for acquired intangible assets, non-cash interest expense on our Notes, and non-cash tax expense included in the GAAP tax provision. We define non-GAAP income per share as non-GAAP net income divided by the weighted average shares outstanding. Non-GAAP gross profit, license gross profit, maintenance and services gross profit and professional services and other gross profit. We define non-GAAP gross profit as gross profit plus stock-based compensation expense and amortization expense for acquired intangible assets. We consider non-GAAP gross profit to be a useful metric for management and our investors because it excludes the effect of certain non-cash expenses so management and investors can compare our sales margins over multiple periods. Non-GAAP operating income. We define non-GAAP operating income as income from operations plus stock-based compensation expense and amortization expense for acquired intangible assets. We consider non-GAAP operating income to be a useful metric for management and investors because it excludes the effect of certain non-cash expenses so management and investors can compare our core business operating results over multiple periods. Non-GAAP operating expenses, sales and marketing expense, research and development expense and general and administrative expense. We define non-GAAP operating expenses as operating expense plus stock-based compensation expense allocated to sales and marketing, research and development and general and administrative expenses. Similarly, we define non-GAAP sales and marketing, research 61 -------------------------------------------------------------------------------- Table of Contents and development and general and administrative expenses as the relevant GAAP measure plus stock-based compensation expense allocated to the particular expense item. Years Ended December 31, 2012 2011 2010 (In thousands) Non-GAAP gross profit: GAAP gross profit $ 132,356 $ 113,090 $ 75,581 (percent of total revenue) 80 % 82 % 79 % Plus: Stock-based compensation expense 1,831 916 210 Amortization of acquired intangible assets 2,660 1,295 794 Non-GAAP gross profit $ 136,847 $ 115,301 $ 76,585 (percent of total revenue) 83 % 84 % 80 % Years Ended December 31, 2012 2011 2010 (In thousands) GAAP license gross profit $ 81,107 $ 71,212 $ 47,961 (percent of related revenue) 90 % 92 % 90 % Plus: Stock-based compensation expense 553 331 89 Amortization of acquired intangible assets 938 704 675 Non-GAAP license gross profit $ 82,598 $ 72,247 $ 48,725 (percent of related revenue) 92 % 93 % 91 % Years Ended December 31, 2012 2011 2010 (In thousands) GAAP subscription and maintenance support gross profit $ 43,418 $ 32,043 $ 26,052 (percent of related revenue) 75 % 75 % 77 % Plus: Stock-based compensation expense 839 334 81 Amortization of acquired intangible assets 1,722 591 119 Non-GAAP subscription and maintenance support gross profit $ 45,979 $ 32,968 $ 26,252 (percent of related revenue) 79 % 78 % 78 % Years Ended December 31, 2012 2011 2010 (In thousands) GAAP professional services and other gross profit $ 7,831 $ 9,835 $ 1,568 (percent of related revenue) 46 % 54 % 18 % Plus: Stock-based compensation expense 439 251 40 Non-GAAP professional services and other gross profit $ 8,270 $ 10,086 $ 1,608 (percent of related revenue) 49 % 55 % 19 % 62 -------------------------------------------------------------------------------- Table of Contents Years Ended December 31, 2012 2011 2010 (In thousands) Non-GAAP income from operations: GAAP income from operations $ 25,404 $ 27,436 $ 10,044 (percent of total revenue) 15 % 20 % 11 % Plus: Stock-based compensation expense 15,022 7,201 3,008 Amortization of acquired intangible assets 2,660 1,295 794 Non-GAAP income from operations $ 43,086 $ 35,932 $ 13,846 (percent of total revenue) 26 % 26 % 14 % Years Ended December 31, 2012 2011 2010 (In thousands) GAAP operating expense $ 106,952 $ 85,654 $65,537 Less: Stock-based compensation expense 13,191 6,285 2,798 Non-GAAP operating expense $ 93,761 $ 79,369 $ 62,739 (as percent of total revenue) 57 % 57 % 66 % Years Ended December 31, 2012 2011 2010 (In thousands) GAAP sales and marketing expense $ 47,911 $ 38,376 $ 31,818 Less: Stock-based compensation expense 5,609 1,984 882 Non-GAAP sales and marketing expense $ 42,302 $ 36,392 $ 30,936 (as percent of total revenue) 26 % 26 % 32 % Years Ended December 31, 2012 2011 2010 (In thousands) GAAP research and development expense $ 36,178 $ 27,744 $ 19,616 Less: Stock-based compensation expense 4,498 1,901 638 Non-GAAP research and development expense $ 31,680 $ 25,843 $ 18,978 (as percent of total revenue) 19 % 19 % 20 % Years Ended December 31, 2012 2011 2010 (In thousands) GAAP general and administrative expense $ 22,863 $ 19,534 $ 14,103 Less: Stock-based compensation expense 3,084 2,400 1,278 Non-GAAP general and administrative expense $ 19,779 $ 17,134 $ 12,825 (as percent of total revenue) 12 % 12 % 13 % 63 -------------------------------------------------------------------------------- Table of Contents Years Ended December 31, 2012 2011 2010 (In thousands) Non-GAAP net income and income per share: GAAP net income $ 12,076 $ 32,297 $ 7,992 Adjusted for: Stock-based compensation expense 15,022 7,201 3,008 Amortization of acquired intangible assets 2,660 1,295 794 Non-cash interest expense on our notes 5,120 2,561 - Non-cash tax provision (benefit) 6,023 (8,879 ) 1,093 Non-GAAP net income $ 40,901 $ 34,475 $ 12,887 Years Ended December 31, 2012 2011 2010 (In thousands) GAAP net income per basic common share $ 0.44 $ 1.21 $ 0.49 Adjusted for: Adjustment for preferred stock conversion (1) - - (0.13 ) Stock-based compensation expense 0.54 0.27 0.13 Amortization of acquired intangible assets 0.10 0.05 0.04 Non-cash interest expense on our notes 0.18 0.10 - Non-cash tax provision (benefit) 0.22 (0.33 ) 0.05 Non-GAAP net income per basic common share $ 1.48 $ 1.30 $ 0.58 Years Ended December 31, 2012 2011 2010 (In thousands) GAAP net income per diluted common share $ 0.43 $ 1.15 $ 0.32 Adjusted for: Stock-based compensation expense 0.53 0.26 0.12 Amortization of acquired intangible assets 0.09 0.05 0.04 Non-cash interest expense on our notes 0.18 0.09 - Non-cash tax provision (benefit) 0.21 (0.32 ) 0.04 Non-GAAP net income per diluted common share $ 1.44 $ 1.23 $ 0.52 (1) For purposes of the calculation of non-GAAP net income per basic common shares for the year ended December 31, 2010, GAAP weighted-average shares outstanding was adjusted as if the conversion of all shares of redeemable convertible preferred stock into common stock occurred at the beginning of the period. |