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MODEL N, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements This report contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act). All statements other than statements of historical facts are statements that could be deemed forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as "anticipates," "goals," "plans," "believes," "seeks," "estimates," "continues," "may," "will," variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Forward-looking statements are based only on our current expectations and projections and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those identified below under "Part II, Item 1A. Risk Factors," and elsewhere in this report. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason. As used in this report, the terms "we," "us," "our," and "the Company" mean Model N, Inc. and its subsidiaries unless the context indicates otherwise. Overview We are a provider of revenue management solutions for the life science and technology industries. Our solutions enable our customers to maximize revenues and reduce revenue compliance risk by transforming their revenue lifecycle from a series of tactical, disjointed operations into a strategic end-to-end process. We believe our solutions serve as the system of record for our customers' revenue management processes and can provide a competitive advantage for them. Our solutions are comprised of two complementary suites of software applications: Revenue Management Enterprise and Revenue Management Intelligence. Sales of our solutions range from individual applications to complete suites, and deployments may vary from specific divisions or territories to enterprise-wide implementations. We derive revenues primarily from the sale of our on-premise and cloud-based solutions and related implementation services, as well as maintenance and support and application support. We price our solutions based on a number of factors, including revenues under management and number of users. Our license and implementation revenues are comprised of sales of perpetual license and related implementation services, which revenues are recognized over the implementation period, which commences when implementation work begins and typically ranges from a few months to three years. Maintenance and support revenues are recognized ratably over the support period, which is typically one year. SaaS revenues for cloud-based solutions are derived from subscription fees from customers accessing our cloud-based solutions, as well as from associated implementation services. The actual timing of revenue recognition may vary based on our customers' implementation requirements and availability of our services personnel. We market and sell our solutions to customers in the life science and technology industries. While we have historically generated the substantial majority of our revenues from companies in the life science industry, we have also grown our base of technology customers and intend to continue to focus on increasing the revenues from customers in the technology industry. Our most significant customers in any given period generally vary from period to period due to the timing of implementation and related revenue recognition over those periods of larger projects. For the three months ended December 31, 2012 and 2013, our revenues were $22.3 million and $21.6 million, respectively, representing a year-over-year decline of approximately 4%, primarily due to the sales execution challenges disclosed in our Annual Report filed on Form 10-K for the fiscal year ended September 30, 2013. 11 -------------------------------------------------------------------------------- Table of Contents Key Business Metrics In addition to the measures of financial performance presented in our Condensed Consolidated Financial Statements, we use certain key metrics to evaluate and manage our business, including four-quarter revenues from current customers and Adjusted EBITDA. We use these key metrics internally to manage the business, and we believe they are useful for investors to compare key financial data from various periods. Four-Quarter Revenues From Existing Customers We derive a large majority of revenues from existing customers, which we define as customers from which we have generated revenues in each of the preceding four quarters. We measure four-quarter revenues from our existing license and subscription customers by calculating the sum of revenues recognized during the last four quarters from any customer that has contributed revenue in each of the preceding four quarters. We believe four-quarter revenues from existing customers provide us and investors with a metric to measure the historical revenue visibility in our business. We also use this metric internally to understand the proportion of revenues being generated in any period from existing customers as compared to entirely new customers or customers with whom we have not been recently engaged. This measure helps us guide our sales activities and establish budgets and operational goals for our sales function. Our four-quarter revenues from existing customers for the periods presented were as follows: Four Quarters Ended September 30, December 31, March 31, June 30, September 30, December 31, 2012 2012 2013 2013 2013 2013 (unaudited) (in thousands) Four-quarter revenues $ 76,892 $ 77,633 $ 82,956 $ 85,856 $ 91,961 $ 91,974 Non-GAAP Financial Measure Adjusted EBITDA Adjusted EBITDA is a financial measure that is not calculated in accordance with generally accepted accounting principles in the United States (U.S. GAAP). We define Adjusted EBITDA as net loss before LeapFrogRx compensation charges, as discussed below, stock-based compensation, depreciation and amortization, restructuring charges, interest (income) expense, net, other expenses, net, and provision for income taxes. We believe Adjusted EBITDA provides investors with consistency and comparability with our past financial performance and facilitates period-to-period comparisons of our operating results and our competitors' operating results. We also use this measure internally to establish budgets and operational goals to manage our business and evaluate our performance. We understand that, although Adjusted EBITDA is frequently used by investors and securities analysts in their evaluations of companies, Adjusted EBITDA has limitations as an analytical tool, and it should not be considered in isolation or as a substitute for analysis of our results of operations as reported under the U.S. GAAP. These limitations include: • Adjusted EBITDA does not include the effect of the LeapFrogRx compensation charges, which are a cash expense; • Adjusted EBITDA does not reflect stock-based compensation expense; • Depreciation and amortization are non-cash charges, and the assets being depreciated or amortized will often have to be replaced in the future; Adjusted EBITDA does not reflect any cash requirements for these replacements; • Adjusted EBITDA does not reflect restructuring expense; • Adjusted EBITDA does not reflect cash requirements for income taxes and the cash impact of other income or expense; and • Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure. 12 -------------------------------------------------------------------------------- Table of Contents The following tables provide a reconciliation of Adjusted EBITDA to net loss: Three Months Ended December 31, 2013 2012 Reconciliation of Adjusted EBITDA: Net loss $ (3,123 ) $ (1,313 ) Adjustments: LeapFrogRx compensation charges 200 389 Stock-based compensation 1,972 557 Depreciation and amortization 958 523 Restructuring 69 - Interest (income) expense, net (4 ) 126 Other expenses, net 31 52 Provision for income taxes 83 61 Adjusted EBITDA $ 186 $ 395 Adjusted EBITDA was $0.2 million and $0.4 million for the three months ended December 31, 2013 and 2012, respectively. Our Adjusted EBITDA for the three months ended December 31, 2013 decreased primarily due to the decrease in total revenues. Key Components of Results of Operations Revenues Revenues are comprised of license and implementation revenues and SaaS and maintenance revenues. License and Implementation License and implementation revenues are generated from the sale of software licenses for our on-premise solutions and related implementation services. SaaS and Maintenance SaaS and maintenance revenues primarily include subscription and related implementation fees from customers accessing our cloud-based solutions and revenues associated with maintenance contracts from license customers. Also included in SaaS and maintenance revenues are other revenues, including revenues related to application support, training and customer-reimbursed expenses. Prior to 2012, revenues from subscriptions for our cloud-based solutions were not material; however, following our acquisition of certain assets and liabilities of LeapFrogRx in January 2012, they have increased but remain less than 15% of our total revenues. Cost of Revenues Our total cost of revenues is comprised of the following: License and Implementation Cost of license and implementation revenues includes costs related to the implementation of our on-premise solutions. Cost of license and implementation revenues primarily consists of personnel-related costs including salary, bonus, stock-based compensation and overhead allocation as well as third-party contractors, royalty fees paid to third parties for rights to their intellectual property and travel-related expenses. Cost of license and implementation revenues may vary from period to period depending on a number of factors, including the amount of implementation services required to deploy our solutions and the level of involvement of third-party contractors providing implementation services. 13 -------------------------------------------------------------------------------- Table of Contents SaaS and Maintenance Cost of SaaS and maintenance revenues includes those costs related to the implementation of our cloud-based solutions, maintenance and support and application support for our on-premise solutions and training. Cost of SaaS and maintenance revenues primarily consists of personnel-related costs including salary, bonus, stock-based compensation, LeapFrogRx compensation charges and overhead allocation as well as reimbursable expenses, third-party contractors and data center-related expenses. We believe that cost of SaaS and maintenance revenues will continue to increase in absolute dollars as we continue to focus on building infrastructure for our cloud-based solutions and partly due to the amortization of $5.1 million of capitalized software development costs over the estimated economic useful life of three years. Operating Expenses Our operating expenses consist of research and development, sales and marketing and general and administrative expenses. Research and Development Our research and development expenses consist primarily of personnel-related costs including salary, bonus, stock-based compensation and overhead allocation as well as third-party contractors and travel-related expenses. Our software development costs for new software solutions and enhancements to existing software solutions are generally expensed as incurred. Through September 30, 2013, we capitalized development costs of $5.1 million incurred in connection with the development of certain additional service offerings that are offered through the cloud. On September 30, 2013, this software became available for general release to our customers, and the future costs are expensed, as incurred. We expect our research and development expenses to increase in absolute dollars as we continue to develop new applications and enhance our existing software solutions. Sales and Marketing Our sales and marketing expenses consist primarily of personnel-related costs including salary, bonus, commissions, stock-based compensation, and overhead allocation as well as third-party contractors, travel-related expenses and marketing programs. We recognize sales commission expense upon booking the contract, while we recognize revenue over the period the services are provided. We expect our sales and marketing expenses to increase in absolute dollars as we increase the number of our sales and marketing employees to grow in our business. General and Administrative Our general and administrative expenses consist primarily of personnel-related costs including salary, bonus, stock-based compensation, and overhead allocation, audit and legal fees as well as third-party contractors and travel-related expenses. We expect to continue to incur significant accounting and legal costs related to being a public company, as well as insurance, investor relations and other costs. In addition, we expect to continue to incur additional costs related to the implementation of a new enterprise resource planning (ERP) system. LeapFrogRx Compensation Charges In January 2012, we acquired certain assets and liabilities of LeapFrogRx for initial cash consideration of $3.0 million as well as potential additional payments to former LeapFrogRx stockholders totaling up to $8.3 million, which are expected to be incurred through January 2015. These additional payments are, among other things, subject to future continued employment and are therefore considered compensatory in nature and are being recognized as compensation expense (LeapFrogRx compensation charges) over the term of each component. As of December 31, 2013, we had expensed an aggregate of $5.9 million of LeapFrogRx compensation charges. Results of Operations The following tables set forth our consolidated results of operations for the periods presented and as a percentage of our total revenues for those periods. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods. 14-------------------------------------------------------------------------------- Table of Contents Three Months Ended December 31, 2013 2012 (in thousands) Revenues: License and implementation $ 9,530 $ 12,462 SaaS and maintenance 12,029 9,879 Total revenues 21,559 22,341 Cost of Revenues: License and implementation(1) 4,599 5,560 SaaS and maintenance(1) 5,346 4,523 Total cost of revenues 9,945 10,083 Gross profit 11,614 12,258 Operating Expenses: Research and development(1) 4,867 4,119 Sales and marketing(1) 5,293 5,336 General and administrative(1) 4,398 3,877 Restructuring 69 - Total operating expenses 14,627 13,332 Loss from operations (3,013 ) (1,074 ) Interest (income) expense, net (4 ) 126 Other expenses, net 31 52 Loss before income taxes (3,040 ) (1,252 ) Provision for income taxes 83 61 Net loss $ (3,123 ) $ (1,313 ) (1) Includes stock-based compensation as follows: Three Months Ended December 31, 2013 2012 (in thousands) Cost of services: License and implementation $ 216 $ 40 SaaS and maintenance 225 74 Research and development 262 54 Sales and marketing 542 259 General and administrative 727 130 Total stock-based compensation $ 1,972 $ 557 Three Months Ended December 31, 2013 2012 (as a % of revenues) Revenues: License and implementation 44 % 56 % SaaS and maintenance 56 44 Total revenues 100 100 Cost of Revenues: License and implementation 21 25 SaaS and maintenance 25 20 Total cost of revenues 46 45 Gross profit 54 55 Operating Expenses: Research and development 23 18 Sales and marketing 25 24 General and administrative 20 18 Restructuring - - Total operating expenses 68 60 Loss from operations (14 ) (5 ) Interest (income) expense, net - 1 Other expenses, net - - Loss before income taxes (14 ) (6 ) Provision for income taxes - - Net loss (14 )% (6 )% 15 -------------------------------------------------------------------------------- Table of Contents Comparison of the Three Months Ended December 31, 2013 and 2012 Revenues Three Months Ended December 31, 2013 2012 Change % of % of Total Total Amount Revenues Amount Revenues ($) (%) (in thousands, except percentages) Revenues: License and implementation $ 9,530 44 % $ 12,462 56 % $ (2,932 ) (24 )% SaaS and maintenance 12,029 56 9,879 44 2,150 22 Total revenues $ 21,559 100 % $ 22,341 100 % $ (782 ) (4 )% License and Implementation License and implementation revenues decreased by $2.9 million, or 24%, to $9.5 million for the three months ended December 31, 2013 from $12.5 million for the three months ended December 31, 2012. Our revenues from existing customers were $8.3 million for the three months ended December 31, 2013 and $10.7 million for the three months ended December 31, 2012. This decrease was primarily due to a reduction in sales volume, primarily due to sales execution challenges discussed most recently in our Annual Report filed on Form 10-K for the fiscal year ended September 30, 2013. SaaS and Maintenance SaaS and maintenance revenues increased by $2.2 million, or 22%, to $12.0 million for the three months ended December 31, 2013 from $9.9 million for the three months ended December 31, 2012. The increase in SaaS and maintenance revenues was primarily driven by an increase of $1.6 million in maintenance and support and application support revenues primarily due to an increase in the number of service contracts, and a $0.5 million net increase in SaaS revenues. Cost of Revenues Three Months Ended December 31, 2013 2012 Change % of % of Amount Revenues Amount Revenues ($) (%) (in thousands, except percentages) Cost of revenues: License and implementation $ 4,599 48 % $ 5,560 45 % $ (961 ) (17 )% SaaS and maintenance 5,346 44 4,523 46 823 18 Total cost of revenues $ 9,945 46 % $ 10,083 45 % $ (138 ) (1 )% Gross profit: License and implementation $ 4,931 52 % $ 6,902 55 % $ (1,971 ) (29 )% SaaS and maintenance 6,683 56 5,356 54 1,327 25 Total gross profit $ 11,614 54 % $ 12,258 55 % $ (644 ) (5 )% License and Implementation Cost of license and implementation revenues decreased by approximately $1.0 million, or 17%, to $4.6 million during the three months ended December 31, 2013 from $5.6 million for the three months ended December 31, 2012. This decrease was mainly due to the corresponding decrease in license and implementation revenue. As a percentage of revenue, cost of license and implementation revenues increased from 45% to 48% during the three months ended December 31, 2013. The decrease in the cost of license and implementation revenue was primarily the result of a reduction of $0.5 million in personnel costs due in large part to decreased headcount due to the Company's restructuring and $0.5 million decrease in consulting costs incurred on third-party contractors. SaaS and Maintenance Cost of SaaS and maintenance revenues increased $0.8 million, or 18%, to $5.3 million during the three months ended December 31, 2013 from $4.5 million for the three months ended December 31, 2012. This increase was associated with the increase in SaaS and maintenance revenue during the three months ended December 31, 2013. As a percentage of revenue, cost of SaaS and maintenance revenues decreased slightly from 46% in the quarter ended December 31, 2013 to 44% in the first quarter of fiscal year 2014 primarily due to the increase in overall revenues and the relatively fixed nature of certain associated costs. The increase in the cost of SaaS and maintenance revenue in absolute dollars was primarily due to $0.4 million of amortization recorded on internally developed software that became generally available to our customers as of the beginning of the current quarter and a net increase of $0.3 million in personnel costs. 16 -------------------------------------------------------------------------------- Table of Contents Operating Expenses Three Months Ended December 31, 2013 2012 Change Amount Amount ($) (%) (in thousands, except percentages) Operating expenses: Research and development $ 4,867 $ 4,119 $ 748 18 % Sales and marketing 5,293 5,336 (43 ) (1 ) General and administrative 4,398 3,877 521 13 Restructuring 69 - 69 Total operating expenses $ 14,627 $ 13,332 $ 1,295 10 % Research and Development Research and development expenses increased by $0.7 million, or 18%, to $4.9 million during the three months ended December 31, 2013 as compared to $4.1 million for the three months ended December 31, 2012. The increase of $0.5 million was the result of cessation of capitalization of software development costs upon the software being available for general release to our customers on September 30, 2013 and an increase in stock-based compensation of $0.2 million. We believe that continued investment in our technology is important to our future growth, and as a result, we expect research and development expenses to increase in absolute dollars in the future. Sales and Marketing Sales and marketing expenses during the three months ended December 31, 2013 were relatively consistent with sales and marketing expenses for the three months ended December 31, 2012. We expect sales and marketing expenses to increase in absolute dollars in the future as we continue to expand our direct sales teams and increase our marketing activities. General and Administrative General and administrative expenses increased by $0.5 million, or 13%, to $4.4 million during the three months ended December 31, 2013 as compared to $3.9 million for the three months ended December 31, 2012. This increase was primarily due to an increase in an increase in stock-based compensation. We expect to incur higher general and administrative expenses in absolute dollars as a result of both our growth and our being a public company, including higher legal, insurance and accounting expenses. Restructuring On September 30, 2013, we commenced a plan to align our workforce with our strategic initiatives. This plan was completed by December 31, 2013 and resulted in a reduction in the size of our workforce, primarily in professional services. We intend to hire employees primarily in research and development and sales and marketing to continue to support our strategic initiatives in the future. During the three months ended December 31, 2013, we recorded a workforce reduction restructuring charge of $0.1 million primarily related to employee separation packages, which included severance pay, benefits continuation and outplacement costs to be fully paid through March 31, 2014. There was no corresponding charge in the three months ended December 31, 2012. Interest and Other Expense, Net Three Months Ended December 31, 2013 2012 Change Amount Amount ($) (%) (in thousands, except percentages) Interest (income) expense, net $ (4 ) $ 126 $ (130 ) (103 )% Other expenses, net 31 52 (21 ) (40 ) Interest (income) expense, net primarily relates to financing costs related to our term loan and capital leases and interest earned on cash and cash equivalents and short term investments. The decrease in expense was primarily due to the repayment in full of our term loan in May 2013. Other expenses, net during the three months ended December 31, 2013 were relatively consistent with other expenses, net for the three months ended December 31, 2012. Provision for Income Taxes Three Months Ended December 31, 2013 2012 Change Amount Amount ($) (%) (in thousands, except percentages) Provision for income taxes $ 83 $ 61 $ 22 36 % Provision for income taxes is primarily related to the state minimum tax and foreign tax on our profitable foreign operations. The change in income tax provision is primarily due to the change in income related to our foreign operations. 17 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources As of December 31, 2013, we had an aggregate cash and cash equivalents and short-term investments of $102.8 million. Since inception, we have financed our operations primarily through proceeds from the issuance of capital stock and since 2006 through cash flows from operations. In addition, in March 2013, we closed our IPO with an aggregate net proceeds of $101.1 million, net of underwriting discounts and commissions. We expended $1.8 million and $1.1 million cash flows in operating activities in the three months ended December 31, 2013 and 2012, respectively. We believe our current cash and cash equivalents and short-term investments are sufficient to meet our operating cash flow needs for at least the next twelve months. We expect to see more cash flows used in operating activities mainly due to our sales execution challenges. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, and the timing and extent of spending to support research and development efforts and expansion of our business and capital expenditures for the purchase of computer hardware and software. To the extent that existing cash and cash equivalents and short-term investments and cash from operations are insufficient to fund our future activities, we may elect to raise additional capital through the sale of additional equity or debt securities, obtain a credit facility or sell certain assets. If additional funds are raised through the issuance of debt securities, these securities could have rights, preferences and privileges senior to holders of common stock, and terms of any debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders and additional financing may not be available in amounts or on terms acceptable to us. We may also seek to invest in or acquire complementary businesses or technologies, any of which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all. Three Months Ended December 31, 2013 2012 (in thousands) Cash flows used in operating activities $ (1,800 ) $ (1,116 ) Cash flows used in investing activities (10,079 ) (1,118 ) Cash flows provided by (used in) financing activities 1,323 (890 ) Cash Flows from Operating Activities Net cash used in operating activities was $1.8 million for the three months ended December 31, 2013, compared to $1.1 million for the three months ended December 31, 2012. Net cash used in operating activities for the three months ended December 31, 2013 was primarily the result of our net loss of $3.1 million and a net change of $1.6 million in operating assets and liabilities, partially offset by non-cash adjustments such as stock-based compensation and depreciation and amortization aggregating to $2.9 million. The net changes in operating assets and liabilities primarily relate to a reduction in accounts payable, accrued employee compensation and other accrued and long-term liabilities of $1.3 million primarily due to the payment of bonus, operating expenses and restructuring charges, a reduction in deferred revenue of $0.9 million mainly driven by higher revenues recognized upon completion of customer projects and an increase in accounts receivable of $0.6 million, partially offset by a reduction of $1.1 million in prepaid expenses and other assets upon expense recognition for prepayments made in prior quarters related to office rent, insurance premium etc. Net cash used in operating activities in the three months ended December 31, 2012 was primarily the result of a net loss after excluding non-cash items of $0.2 million and changes in assets and liabilities of $0.9 million. The significant components of the assets and liabilities changes included increased accounts receivable of $3.5 million and increased prepaid expenses and other assets of $1.3 million, partially offset by $1.2 million of increases in accounts payable and $2.0 million of increases in other accrued and long-term liabilities. Cash Flows from Investing Activities Net cash used in investing activities was $10.0 million for the three months ended December 31, 2013, compared to $1.1 million for the three months ended December 31, 2012. Net cash used in investing activities for the three months ended December 31, 2013 was primarily due to the purchase of short-term investments of $10.0 million. Net cash used in investing activities for the three months ended December 31, 2012 was primarily due to capitalization of software development costs of $0.9 million and the purchase of property and equipment of $0.2 million. Cash Flows from Financing Activities Net cash provided by financing activities was $1.3 million for the three months ended December 31, 2013, compared to net cash used of $0.9 million for the three months ended December 31, 2012. Net cash provided by financing activities for the three months ended December 31, 2013 primarily consisted of $1.5 million from exercises of stock options. Net cash used in financing activities for the three months ended December 31, 2012 was primarily due to loan and capital lease payments of $0.8 million and $0.2 million payment of IPO costs. 18-------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements As of December 31, 2013, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Critical Accounting Policies and Estimates We prepare our condensed consolidated financial statements in accordance with generally accepted accounting principles in the United States. The preparation of condensed consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from the estimates made by our management. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management's judgments and estimates. Other than the estimates used to calculate the grant date fair value of the performance-based restricted stock units granted during the current quarter, as discussed in Note 3 of the Condensed Consolidated Financial Statements, there have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our most recent Annual Report filed on Form 10-K for the fiscal year ended September 30, 2013. |