QUMU CORPORATION The following discussion and analysis of our financial condition and results of operations should be read together with the section titled "Selected Financial Data" and our audited financial statements and related notes which are included elsewhere in this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated in the forward-looking statements included in this discussion as a result of certain factors, including, but not limited to, those discussed in "Risk Factors" included in Item 1A in this Annual Report on Form 10-K. Overview The Company generates revenue through the sale of enterprise video content management software, hardware, maintenance and support, and professional and other services. Software sales may take the form of a perpetual software license, a cloud-hosted software as a service (SaaS) or a term software license. Software licenses and appliances revenue includes sales of perpetual software licenses and hardware. Service revenue includes SaaS, term software licenses, maintenance and support, and professional and other services. For the years endedDecember 31, 2019 , 2018 and 2017, the Company generated revenues of$25.4 million ,$25.0 million and$28.2 million , respectively. Critical Accounting Policies The discussion of the Company's financial condition and results of operations is based upon its financial statements, which are prepared in accordance with accounting principles generally accepted inthe United States of America , or GAAP. The preparation of these financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, management evaluates its estimates and assumptions. Management bases its estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that management believes to be reasonable. The Company's actual results may differ from these estimates under different assumptions or conditions. Management believes that of the Company's significant accounting policies, which are described in the notes to our financial statements, the following accounting policies involve a greater degree of judgment, complexity and effect on materiality. A critical accounting policy is one that is both material to the presentation of our financial statements and requires management to make difficult, subjective or complex judgments for uncertain matters that could have a material effect on the Company's financial condition and results of operations. Accordingly, these are the policies management believes are the most critical to aid in fully understanding and evaluating the Company's financial condition and results of operations. Revenue Recognition The Company adopted ASC 606, Revenue from Contracts with Customers, as ofJanuary 1, 2018 . The Company generates revenue through the sale of enterprise video content management software, hardware, maintenance and support, and professional and other services. Software sales may take the form of a perpetual software license, a cloud-hosted software as a service (SaaS) or a term software license. Software licenses and appliances revenue includes sales of perpetual software licenses and hardware. Service revenue includes SaaS, term software licenses, maintenance and support, and professional and other services. Sales can range from a single year agreement for thousands of dollars to a multi-year agreement for over a million dollars. The Company follows a five-step model to assess a sale to a customer: identify the legally binding contract, identify the performance obligations, determine the transaction price, allocate the transaction price, and determine whether revenue will be recognized at a point in time or over time. Revenue is recognized upon transfer of control of promised products or services (i.e., performance obligations) to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for promised goods or services. The Company's performance obligations are satisfied either over time (for cloud-hosted software as a service, maintenance and support, and other services) or at a point in time (for software licenses and hardware). The Company enters into contracts that can include various combinations of software licenses, appliances, maintenance and services, some of which are distinct and are accounted for as separate performance obligations. For contracts with multiple performance obligations, the Company allocates the transaction price of the contract to each distinct performance obligation, on a relative basis using its standalone selling price. 20
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The Company determines the standalone selling price (SSP) for software-related
elements, including professional services and software maintenance and support
contracts, based on the price charged for the deliverable when sold separately.
The Company estimates SSP by maximizing use of observable prices such as the
prices charged to customers on a standalone basis, established prices lists,
contractually stated prices, profit margins and other entity-specific factors,
or by using information such as market conditions and other observable inputs.
However, the selling prices of its software licenses and cloud-hosted SaaS
arrangements are highly variable. Thus, the Company estimates SSP for software
licenses and cloud-hosted SaaS arrangements using the residual approach,
determined based on total transaction price less the SSP of other goods and
services promised in the contract.
Other items relating to charges collected from customers include reimbursable
expenses, shipping and handling charges and sales taxes charges. Charges
collected from customers as part of the Company's sales transactions are
included in revenues and the associated costs are included in cost of revenues.
Sales taxes charged to and collected from customers as part of the Company's
sales transactions are excluded from revenues and recorded as a liability to the
applicable governmental taxing authority.
Perpetual software licenses
The Company's perpetual software license arrangements grant customers the right
to use the software indefinitely as it exists at the time of purchase. The
Company recognizes revenue for distinct software licenses once the license
period has begun and the software has been made available to the customer.
Payments for perpetual software license contracts are generally received upon
fulfillment of the software product.
Term software licenses
The Company's term software licenses differ from perpetual software licenses in
that the customer's right to use the licensed product has a termination date.
Term software licenses are recognized upon transfer of control, which is
typically at fulfillment, resulting in up-front revenue recognition. The Company
categorizes revenue from term software licenses as subscription, maintenance and
support revenue in service revenues. Payments are generally received quarterly
or annually in equal or near equal installments over the term of the agreement.
Cloud-hosted software as a service
Cloud-hosted software as a service (SaaS) arrangements grant customers the right
to access and use the licensed products at the outset of an arrangement via
third-party cloud providers. Updates are generally made available throughout the
entire term of the arrangement, which is generally one to three years. The
Company provides an online library and technical support resources in these
cloud-hosted SaaS arrangements, which in conjunction with the SaaS license
constitute a single, combined performance obligation, and revenue is recognized
over the term of the license. Payments are generally received annually in
advance of the service period.
Hardware
The Company sells appliances that are typically drop shipped from third-party
suppliers selected by the Company. The transaction price allocated to the
appliance is generally recognized as revenue at fulfillment when the customer
obtains control of the product. Payments for appliances are generally received
upon delivery of the hardware product.
Maintenance and support
Maintenance and support arrangements grant customers the right to software
updates and technical support over the term of the maintenance and support
contract. Revenue from maintenance and support is generally recognized ratably
over the contract term beginning on the commencement date of each contract,
which is upon fulfillment of the software obligation. Payments are generally
received annually in advance of the service period.
Professional services and training
Professional services and training generally consist of software implementation,
on-boarding services and best practices consulting. Revenue from professional
services contracts is typically recognized as performed, generally using hours
expended to measure progress. Services are generally invoiced monthly for work
performed.
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Leases
The Company is a lessee in several non-cancellable (1) operating leases, primarily for office space, and (2) finance leases, for certain IT equipment. The Company determines if an arrangement is or contains a lease at contract inception and recognizes a right of use (ROU) asset and a lease liability at the lease commencement date. For operating leases, the lease liability is initially and subsequently measured at the present value of the unpaid lease payments at the lease commencement date. For finance leases, the lease liability is initially measured in the same manner and at the same date as for operating leases, and is subsequently measured at amortized cost using the effective interest method. The ROU asset is initially measured at cost, which comprises the initial amount of the lease liability adjusted for lease payments made at or before the lease commencement date, plus any initial direct costs incurred less any lease incentives received. Lease expense for lease payments is recognized on a straight-line basis over the earlier of the useful life or the lease term. Key estimates and judgments in accounting for leases under Topic 842 include how the Company determines (1) the discount rate it uses to discount the unpaid lease payments to present value, (2) lease term and (3) lease payments. The Company has elected not to recognize ROU assets and lease liabilities for short-term leases that have a lease term of 12 months or less. The Company recognizes the lease payments associated with its short-term leases as an expense on a straight-line basis over the lease term. Derivative Liability In conjunction with the debt financings completed inOctober 2016 andJanuary 2018 , the Company issued two warrants for the purchase of up to an aggregate of 1,239,286 shares of the Company's common stock and onAugust 31, 2018 , issued a separate warrant to a sales partner for the purchase of up to 100,000 shares of the Company's common stock. All warrants remained unexercised and outstanding atDecember 31, 2019 . The Company accounts for the warrants, which are derivative financial instruments, as a current liability based upon the characteristics and provisions of the instruments. The warrants were determined to be ineligible for equity classification because of provisions that allow the holder under certain circumstances, essentially the sale of the Company as defined in the warrant agreements, to receive cash payment or other consideration at the option of the holder in lieu of the Company's common shares. See Note 14-"Subsequent Event" of the accompanying consolidated financial statements for a discussion of the Company's merger agreement with Synacor, Inc., which impacts the cash settlement feature of the Hale warrant and ESW warrant. A warrant liability is recorded in the Company's consolidated balance sheets at its fair value on the date of issuance and is revalued on each subsequent balance sheet date until such instrument is exercised or expires, with any changes in the fair value between reporting periods recorded as other income or expense. The Company estimates the fair value of this liability using option pricing models that are based on the individual characteristics of the warrants on the valuation date, which include the Company's stock price and assumptions for expected volatility, expected life and risk-free interest rate, as well as the present value of the minimum cash payment component of the instrument for the warrants, when applicable. Changes in the assumptions used could have a material impact on the resulting fair value of each warrant. The primary inputs affecting the value of the warrant liability are the Company's stock price and volatility in the Company's stock price, as well as assumptions about the probability and timing of certain events, such as a change in control or future equity offerings. Increases in the fair value of the underlying stock or increases in the volatility of the stock price generally result in a corresponding increase in the fair value of the warrant liability; conversely, decreases in the fair value of the underlying stock or decreases in the volatility of the stock price generally result in a corresponding decrease in the fair value of the warrant liability. 22
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Results of Operations The percentage relationships to revenues of certain income and expense items for the years endedDecember 31, 2019 , 2018 and 2017, and the percentage changes in these income and expense items between years, are contained in the following table: Percentage of Revenues
Percent Increase (Decrease)
2019 2018 2017 2018 to 2019 2017 to 2018
Revenues 100.0 % 100.0 % 100.0 % 1 % (11 )%
Cost of revenues (27.8 ) (34.0 ) (36.4 ) (17 ) (17 )
Gross profit 72.2 66.0 63.6 11 (8 )
Operating expenses:
Research and development 29.0 27.9 25.9 5 (4 )
Sales and marketing 34.3 33.6 35.6 4 (16 )
General and administrative 26.8 28.5 30.4 (5 ) (17 )Amortization of purchased intangibles 3.0 3.6 3.2
(16 ) -
Total operating expenses 93.1 93.6 95.1 1 (12 )
Operating loss (20.9 ) (27.6 ) (31.5 ) (23 ) (22 )
Other income (expense), net (5.3 ) 14.3 (11.4 ) (137 ) (212 )
Loss before income taxes (26.2 ) (13.3 ) (42.9 ) 100 (73 )
Income tax expense (benefit) (0.8 ) 1.2 (1.3 ) (165 ) (183 )
Net loss (25.4 )% (14.5 )% (41.6 )% 78 % (69 )%
Revenues
The Company generates revenue through the sale of enterprise video content
management software, hardware, maintenance and support, and professional and
other services. Software sales may take the form of a perpetual software
license, a cloud-hosted software as a service (SaaS) or a term software license.
Software licenses and appliances revenue includes sales of perpetual software
licenses and hardware. Service revenue includes SaaS, term software licenses,
maintenance and support, and professional and other services.
The table below describes Qumu's revenues by product category (dollars in
thousands):
Year Ended December 31, Increase (Decrease) Percent Increase (Decrease)
2019 2018 2017 2018 to 2019 2017 to 2018 2018 to 2019 2017 to 2018
Software licenses
and appliances $ 4,903 $ 5,814 $ 5,982 $ (911 ) $ (168 ) (16 )% (3 )%
Service
Subscription,
maintenance and
support 18,249 17,132 19,374 1,117 (2,242 ) 7 (12 )
Professional
services and other 2,210 2,067 2,811 143 (744 ) 7 (26 )
Total service 20,459 19,199 22,185 1,260 (2,986 ) 7 (13 )
Total revenues $ 25,362 $ 25,013 $ 28,167 $ 349 $ (3,154 ) 1 % (11 )%
Revenues can vary year to year based on the type of contract the Company enters
into with each customer. The $349,000 increase in total revenues from 2018 to
2019 reflects a $1.3 million increase in service revenues and a $911,000
decrease in software licenses and appliances revenues. The $1.3 million increase
in service revenues from 2018 to 2019 resulted from a $1.1 million increase in
subscription, maintenance and support revenues and a $143,000 increase in
professional services revenues. The decrease in software licenses and appliances
revenues in 2019 compared to 2018 was driven by a decrease in perpetual software
license and appliance sales to both new and existing customers. The increase in
subscription, maintenance and support revenues in 2019 compared to 2018 primary
resulted from significant first quarter 2019 term software license sales for
which revenue is recognized up front, as well as the revenue attributable to new
subscription, maintenance and support agreements from new and existing
customers.
The $3.2 million decrease in total revenues from 2017 to 2018 reflects a $3.0
million decrease in service revenues and a $168,000 decrease in software
licenses and appliances revenues. The $3.0 million decrease in service revenues
from 2017 to 2018 resulted from a $2.2 million decrease in subscription,
maintenance and support revenues and a $744,000 decrease in professional
services revenues. The decrease in subscription, maintenance and support
revenues was driven primarily by approximately $2.4 million of decreased
recurring revenue resulting from the loss of a large customer in the fourth
quarter of 2017 and a $212,000 decrease in revenue related to the Company's
adoption of Topic 606 effective January 1, 2018 , partially offset by
subscription, maintenance and support growth from new and existing customers.
The $0.7
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million decrease in professional services revenues, which generally move
directionally with changes in perpetual license sales and are impacted by custom
work and the timing of customer acceptance, was primarily due to the inclusion
of a large former customer in 2017 revenues and to lower utilization and reduced
size of the Company's global professional services team in 2018.
Future consolidated revenues will be dependent upon many factors, including the
rate of adoption of the Company's software solutions in its targeted markets and
whether arrangements with customers are structured as a perpetual, term or SaaS
licenses, which impacts the timing of revenue recognition. Other factors that
will influence future consolidated revenues include the timing of customer
orders and renewals, the product and service mix of customer orders, the impact
of changes in economic conditions and the impact of foreign currency exchange
rate fluctuations.
Gross Profit and Gross Margin
A comparison of gross profit and gross margin by revenue category is as follows
(dollars in thousands):
Year Ended December 31, Increase (Decrease) Percent Increase (Decrease)
2019 2018 2017 2018 to 2019 2017 to 2018 2018 to 2019 2017 to 2018
Gross profit:
Software licenses
and appliances $ 2,992 $ 3,537 $ 3,575 $ (545 ) $ (38 ) (15 )% (1 )%
Service 15,311 12,983 14,330 2,328 (1,347 ) 18 (9 )
Total gross profit
$ (1,385 ) 11 % (8 )% Gross margin: Software licenses and appliances 61.0 % 60.8 % 59.8 % 0.2 % 1.0 % Service 74.8 % 67.6 % 64.6 % 7.2 % 3.0 % Total gross margin 72.2 % 66.0 % 63.6 % 6.2 % 2.4 % For the years endedDecember 31, 2019 , 2018 and 2017, gross margins are inclusive of the impact of approximately$455,000 ,$1.0 million and$1.2 million , respectively, in amortization expense associated with intangible assets acquired as a result of the acquisition ofQumu, Inc. in the fourth quarter of 2011 andKulu Valley in the fourth quarter of 2014. The Company had 19, 18 and 26 service personnel atDecember 31, 2019 , 2018 and 2017, respectively. Gross margin percentages by category and in total increased for both 2019 and 2018, compared to the respective prior years. The 6.2% improvement in gross margin in 2019, compared to 2018, was primarily driven by a 7.2% improvement in service gross margin due to an increase in term software license revenue, decreased amortization expense as certain purchased intangible assets became fully amortized during 2018, and lower royalty expense associated with third-party software licenses. The 2.4% improvement in gross margin in 2018, compared to 2017, was primarily driven by a 3.0% improvement in service gross margin due to lower royalty expense associated with third-party software licenses, fewer service personnel in 2018 as compared to 2017 and decreased amortization expense as certain purchased intangible assets became fully amortized during 2018. Future gross profit margins will fluctuate quarter to quarter and will be impacted by the rate of growth and mix of the Company's product and service offerings and foreign currency exchange rate fluctuations. Cost of software licenses and appliances revenues in 2020 is expected to include approximately$0.3 million of amortization expense for purchased intangibles. Operating Expenses The following is a summary of operating expenses (dollars in thousands): Year Ended December 31, Increase (Decrease) Percent Increase (Decrease) 2019 2018 2017 2018 to 2019 2017 to 2018 2018 to 2019 2017 to 2018 Operating expenses: Research and development$ 7,360 $ 7,013 $ 7,279 $ 347 $ (266 ) 5 % (4 )% Sales and marketing 8,709 8,394 10,026 315 (1,632 ) 4 (16 ) General and administrative 6,787 7,122 8,567 (335 ) (1,445 ) (5 ) (17 ) Amortization of purchased intangibles 757 904 904 (147 ) - (16 ) - Total operating expenses$ 23,613 $ 23,433 $ 26,776 $ 180 $ (3,343 ) 1 % (12 )% 24
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While operating expenses for 2019 increased 1% compared to 2018, operating expenses as a percent of revenue decreased slightly to 93.1% for 2019 compared to 93.6% for 2018 and 95.1% for 2017, reflecting continued year-over-year improvement in the Company's operational efficiency. Operating expenses for 2019, 2018 and 2017 included severance expense of$152,000 ,$237,000 and$256,000 , respectively, relating the cost reduction initiatives and personnel transitions. Research and development Research and development expenses were as follows (dollars in thousands): Year Ended December 31, Increase (Decrease) Percent Increase (Decrease) 2019 2018 2017 2018 to 2019 2017 to 2018 2018 to 2019 2017 to 2018 Compensation and employee-related$ 5,123 $ 5,215 $ 5,475 $ (92 ) $ (260 ) (2 )% (5 )% Overhead and other expenses 1,516 1,211 1,064 305 147 25 14 Outside services and consulting 589 409 473 180 (64 ) 44 (14 ) Depreciation and amortization 2 28 133 (26 ) (105 ) (93 ) (79 ) Equity-based compensation 130 150 134 (20 ) 16 (13 ) 12 Total research and development expenses$ 7,360 $ 7,013 $ 7,279 $ 347 $ (266 ) 5 % (4 )% Total research and development expenses for the years endedDecember 31, 2019 , 2018 and 2017 represented 29%, 28% and 26% of revenues, respectively. The Company had 36, 34 and 41 research and development personnel atDecember 31, 2019 , 2018 and 2017, respectively. The$347,000 increase in total expenses in 2019, compared to 2018, was primarily due to transition costs related to the Company's in-process migration and consolidation of cloud hosting providers during 2019, impacting outside services and consulting expenses, as well as overhead and other expenses. The$266,000 decrease in total expense in 2018, compared to 2017, was driven primarily by less utilization of contractors and lower employee costs due to fewer research and development personnel in 2018 as compared to 2017, partially offset by increased hosting service expense included in overhead and other expenses. Depreciation and amortization expense decreased during 2019 and 2018 as certain fixed assets became fully depreciated. Sales and marketing Sales and marketing expenses were as follows (dollars in thousands): Year Ended December 31, Increase (Decrease) Percent Increase (Decrease) 2019 2018 2017 2018 to 2019 2017 to 2018 2018 to 2019 2017 to 2018 Compensation and employee-related$ 6,822 $ 6,199 $ 7,806 $ 623 $ (1,607 ) 10 % (21 )% Overhead and other expenses 1,022 1,230 1,046 (208 ) 184 (17 ) 18 Outside services and consulting 781 802 935 (21 ) (133 ) (3 ) (14 ) Depreciation and amortization 11 12 58 (1 ) (46 ) (8 ) (79 ) Equity-based compensation 73 151 181 (78 ) (30 ) (52 ) (17 ) Total sales and marketing expenses$ 8,709 $ 8,394 $ 10,026 $ 315 $ (1,632 ) 4 % (16 )% Total sales and marketing expenses for the years endedDecember 31, 2019 , 2018 and 2017 represented 34%, 34% and 36% of revenues, respectively. The Company had 32, 27 and 33 sales and marketing personnel atDecember 31, 2019 , 2018 and 2017, respectively. The$315,000 increase in total sales and marketing expense in 2019 as compared to 2018 was driven primarily driven by increased compensation and employee-related costs due to higher commissions expense and the mix and number of sales and marketing personnel, partially offset by a decrease in overhead and other expenses impacted by continued cost reduction initiatives. The$1.6 million decrease in total sales and marketing expense in 2018 as compared to 2017 was driven primarily by lower employee costs due to fewer sales and marketing personnel in 2018. Sales and marketing expenses for 2019, 2018 and 2017 included severance expense of$152,000 ,$111,000 and$234,000 , respectively, relating to cost reduction initiatives and personnel transitions. 25
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General and administrative
General and administrative expenses were as follows (dollars in thousands):
Year Ended December 31, Increase (Decrease) Percent Increase (Decrease)
2019 2018 2017 2018 to 2019 2017 to 2018 2018 to 2019 2017 to 2018
Compensation and
employee-related $ 3,147 $ 2,797 $ 3,525 $ 350 $ (728 ) 13 % (21 )%
Overhead and other
expenses 1,127 1,028 1,078 99 (50 ) 10 (5 )
Outside services
and consulting 1,584 2,159 2,404 (575 ) (245 ) (27 ) (10 )
Depreciation and
amortization 301 391 724 (90 ) (333 ) (23 ) (46 )
Equity-based
compensation 628 747 836 (119 ) (89 ) (16 ) (11 )
Total general and
administrative
expenses $ 6,787 $ 7,122 $ 8,567 $ (335 ) $ (1,445 ) (5 )% (17 )%
Total general and administrative expenses for the years ended December 31, 2019 ,
2018 and 2017 represented 27%, 29% and 30% of revenues, respectively. The
Company had 18, 18 and 21 general and administrative personnel at December 31,
2019 , 2018 and 2017, respectively.
The $335,000 decrease in total expenses in 2019 as compared to 2018 was driven
primarily by lower outside services costs resulting from lower expenses
associated with legal professional services, a reduction in audit fees and lower
contractor costs. The $1.4 million decrease in total expenses in 2018 compared
to 2017 was driven primarily by lower employee costs due to fewer general and
administrative personnel in 2018 .
Amortization of Purchased Intangibles
Operating expenses include $757,000 , $904,000 and $904,000 in 2019, 2018 and
2017, respectively, for the amortization of intangible assets acquired as part
of the Company's acquisition of Qumu, Inc. in October 2011 and Kulu Valley in
October 2014 . Operating expenses in 2020 are expected to include approximately
$0.7 million of amortization expense associated with purchased intangibles,
exclusive of the portion classified in cost of revenue.
Other Income (Expense), Net
Other income (expense), net was as follows (dollars in thousands):
Year Ended December 31, Increase (Decrease) Percent Increase (Decrease)
2019 2018 2017 2018 to 2019 2017 to 2018 2018 to 2019 2017 to 2018
Interest expense,
net $ (754 ) $ (1,809 ) $ (2,852 ) $ 1,055 $ 1,043 (58 )% (37 )%
Decrease (increase)
in fair value of
warrant liability (141 ) 368 74 (509 ) 294 (138 ) 397
Gain on sale of
BriefCam, Ltd. 41 6,602 - (6,561 ) 6,602 (99 ) n/a
Loss on
extinguishment of
debt (348 ) (1,189 ) - 841 (1,189 ) (71 ) n/a
Other expense, net (125 ) (378 ) (433 ) 253 55 (67 ) (13 )
Total other income
(expense), net
(212 )%
Interest expense, net
The Company recognized interest expense of $754,000 , $1.8 million and $2.9
million in 2019, 2018 and 2017, respectively, primarily related to its term
loans and capital leases, including the amortization of deferred financing
costs. The decrease in interest expense in 2019, compared to 2018, was primarily
due to a decrease in term loan debt resulting from the Company's $6.0 million
principal balance repayment in July 2018 on the $10.0 million credit agreement
with ESW Holdings, Inc. , and resulting from the Company's $4.0 million remaining
principal balance payment which the Company paid on November 12, 2019 .
The decrease in interest expense in 2018, compared to 2017, was primary due to
the inclusion in 2017 of expense related to the accelerated amortization of
deferred financing costs in connection with a modification to the Company's term
loan agreement on November 6, 2017 with Hale Capital Partners, LP . At that time
the Company commenced a plan to refinance the term loan, which it completed upon
the closing of its $10.0 million credit agreement with ESW Holdings, Inc. on
January 12, 2018 . As a result of the loan modification, the Company recognized
$1.6 million of interest expense for the amortization of deferred financing
costs through December 31, 2017 , resulting in unamortized debt discount and debt
issuance costs of $395,000 as of December 31, 2017 . The balance of unamortized
deferred financing costs was amortized in 2018 during the year-to-date period
ending January 12, 2018 , to coincide with the extinguishment of the term note
under the Hale credit agreement.
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Change in fair value of warrant liability In conjunction with the debt financings completed inOctober 2016 andJanuary 2018 , the Company issued two warrants for the purchase of up to an aggregate of 1,239,286 shares of the Company's common stock, which remained unexercised and outstanding atDecember 31, 2019 . The warrant issued in conjunction with theOctober 21, 2016 debt financing (Hale warrant) for the purchase of up to 314,286 shares of the Company's common stock expires onOctober 21, 2026 , has an exercise price of$2.80 per share and is transferable. The warrant issued in conjunction with theJanuary 12, 2018 debt financing (ESW warrant) for the purchase of up to 925,000 shares of the Company's common stock expires onJanuary 12, 2028 , has an exercise price of$1.96 per share and is transferable. Additionally, onAugust 31, 2018 , the Company issued a warrant to a sales partner, iStudy Co., Ltd., (iStudy warrant) for the purchase of up to 100,000 shares of the Company's common stock; the warrant expires onAugust 31, 2028 , has an exercise price of$2.43 per share and is transferable. The Hale warrant and ESW warrant contain a cash settlement feature upon the occurrence of a certain events, essentially the sale of the Company as defined in the warrant agreements. Upon a sale of the Company, the holder of the iStudy warrant may exercise the warrant or may elect to receive the same consideration as it would have been entitled to receive upon the occurrence of such transaction if it had been the holder of the shares then issuable upon such exercise of the warrant. As a result of these features, the warrants are subject to derivative accounting as prescribed under ASC 815. Accordingly, the fair value of the warrants on the dates of issuance was recorded in the Company's consolidated balance sheets as a liability. The warrant liability was recorded in the Company's consolidated balance sheets at its fair value on the respective dates of issuance and is revalued on each subsequent balance sheet date until such instrument is exercised or expires, with any changes in the fair value between reporting periods recorded as other income or expense. During 2019, 2018 and 2017, the Company recorded a non-cash gain (loss) from the change in fair value of the warrant liability of$(141,000) ,$368,000 and$74,000 , respectively. The gain (loss) for each year resulted from changes in inputs for the Company's stock price, expected volatility, expected life and risk-free interest rates, as well as the present value of the minimum cash payment component of the instrument for the warrants, when applicable, along with management's assumptions including the probability and timing of certain events, such as a change in control or future equity offerings. Gain on sale ofBriefCam, Ltd. As ofDecember 31, 2017 , the Company held an investment reported in other assets, non-current, totaling$3.1 million in convertible preferred stock ofBriefCam, Ltd. (BriefCam), a privately-held Israeli company that develops video synopsis technology to augment security and surveillance systems to facilitate review of surveillance video. OnMay 7, 2018 , BriefCam, Canon Inc. (Canon ), and the shareholders of BriefCam, including the Company, entered into a stock purchase agreement by whichCanon would acquire all of the outstanding shares of BriefCam. OnJuly 3, 2018 , BriefCam announced thatCanon had completed its acquisition of BriefCam and, onJuly 6, 2018 , the Company received$9.7 million from the closing proceeds for its shares of BriefCam, as well as received$100,000 onOctober 31, 2018 following the satisfaction of a contingency, resulting in a gain on sale of$6.6 million during 2018. Additionally, during 2019, the Company recognized a gain of$41,000 related to the release of cash from escrow in connection with the sale. Loss on extinguishment of debt OnJuly 19, 2018 , the Company paid$6.5 million on its outstanding term loan fromESW Holdings, Inc. under its term loan credit agreement datedJanuary 12, 2018 . The payment was comprised of principal of$6.0 million and accrued interest of$463,000 for the periodJanuary 12, 2018 to the payment date ofJuly 19, 2018 . The Company used a portion of the net proceeds from the sale of its investment in BriefCam to fund the prepayment. The Company determined that the prepayment of principal constituted a partial extinguishment of debt and, as such, recognized a$1.2 million loss related to the write down of unamortized debt discount and issuance costs in 2018. OnNovember 12, 2019 , the Company paid the remaining$4.8 million due on its outstanding term loan fromESW Holdings, Inc. The payment was comprised of principal of$4.0 million and accrued interest of$528,000 for the periodJuly 19, 2018 to the payment date ofNovember 12, 2019 . The Company used a portion of the$8.2 million in net proceeds from the issuance of common stock onNovember 7, 2019 to fund the payment. The Company determined that the payment of principal constituted an extinguishment of debt and, as such, recognized a$348,000 loss related to the write down of$98,000 of unamortized debt discount and issuance costs and recognition of a$250,000 prepayment fee upon payment of the remaining term loan balance. 27
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Other expense, net The Company determined that it had excess capacity at itsMinneapolis, Minnesota headquarters and effectiveMay 1, 2018 ceased using a portion of its leased space, subsequently making it available for occupancy by a sublessee. The Company entered into a sublease agreement having a term beginningMay 1, 2018 and extending throughJanuary 2023 . Accordingly, the Company recorded a liability at fair value of$224,000 for the future contractual lease payments, net of expected sublease receipts. Included in other expense, net, for 2018 is the loss related to the leasing-related exit activity of$177,000 , which is net of adjustments for the derecognition of leasehold improvement and deferred rent balances related to the exit activity. OnJanuary 17, 2019 , the Company terminated the sublease agreement, effectiveFebruary 15, 2019 , and contemporaneously modified the Company's head lease agreement to relinquish to the lessor, and be relieved of future lease payments for, the previously sublet space, effectiveMarch 1, 2019 . During 2017, the Company determined that a portion of its leased space inLondon, England was no longer needed and, inDecember 2017 , ceased using the unneeded space, subsequently making it available for occupancy by a sublessee. Also inDecember 2017 , the Company entered into a sublease agreement, having a term beginningJanuary 1, 2018 and extending throughSeptember 2019 , and received the first year's sublease payment of$122,000 . The Company recorded a loss related to the exit activity of$72,000 , which is included in other income (expense), net, for the year endedDecember 31, 2017 . Other expense, net, also includes net losses on foreign currency transactions of$260,000 ,$55,000 and$356,000 in 2019, 2018 and 2017, respectively. See "Liquidity and Capital Resources" below for a discussion of changes in cash levels. Income Taxes The provision for income taxes represents federal, state, and foreign income taxes or income tax benefit on income or loss. Net income tax benefit was$194,000 and$358,000 for the years endedDecember 31, 2019 and 2017, respectively, and net income tax expense was$298,000 for the year endedDecember 31, 2018 . OnDecember 22, 2017 , the Tax Cuts and Jobs Act (the Tax Act) was enacted, significantly alteringU.S. corporate income tax law. The Tax Act establishes new tax laws affecting 2018 and after, including a reduction in theU.S. federal corporate income tax rate from 34% to 21%, repeal of the corporate AMT system, limitations on the deductibility of interest expense and executive compensation, and changes to net operating loss carryforward rules. The Tax Act also includes various international provisions, including a one-time deemed mandatory repatriation of accumulated foreign earnings and a new tax referred to as Global Intangible Low-Tax Income (GILTI). For further discussion of the Tax Act and its impact on the Company's consolidated financial statements, see Note 11-"Income Taxes" of the accompanying consolidated financial statements. All future impacts of future issued guidance will be appropriately accounted for in the period in which the law is enacted. The net income tax benefit for 2019 was impacted by the tax benefit for refundable research credits fromUnited Kingdom operations. The net income tax expense for 2018 was impacted by an increase in reserves for unrecognized tax benefits, partially offset by a tax benefit for refundable research credits fromUnited Kingdom operations. Income tax benefit for 2017 is primarily attributable to provisional estimates recorded as a result of the Tax Act and to research credits fromUnited Kingdom operations. Liquidity and Capital Resources The following table sets forth certain relevant measures of the Company's liquidity and capital resources (in thousands): December 31, 2019 2018 Cash and cash equivalents$ 10,639 $ 8,636 Working capital$ 829 $ 865 Financing obligations$ 240 $ 209 Term loan - 3,431
Financing obligations and term loan
The Company expects it will be able to maintain current operations and
anticipated capital expenditure requirements for at least the next 12 months
through its cash reserves, as well as any cash flows that may be generated from
current operations.
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AtDecember 31, 2019 , the Company had aggregate positive working capital of$829,000 , down$36,000 from working capital of$865,000 atDecember 31, 2018 . Working capital includes current deferred revenue of$10.1 million and$9.7 million atDecember 31, 2019 and 2018, respectively. The primary contributor to the change in working capital was a$2.0 million increase in cash and cash equivalents resulting from$8.2 million of net proceeds from the issuance of common stock inNovember 2019 , offset by a payment of$4.8 million for principal, accrued interest and prepayment fee on the Company's term loan withESW Holdings, Inc. , as well as a$5.3 million operating loss for the year endedDecember 31, 2019 . The term loan balance of$3.4 million as ofDecember 31, 2018 consisted of the carrying value of the Company's term loan credit agreement withESW Holdings, Inc. as lender and administrative agent, datedJanuary 12, 2018 . OnNovember 12, 2019 , the Company paid the outstanding balance due on the term loan. The payment was comprised of principal of$4.0 million , accrued interest of$528,000 for the periodJuly 19, 2018 to the payment date ofNovember 12, 2019 , and prepayment fee of$250,000 . The Company used a portion of the$8.2 million in net proceeds from the issuance of common stock, as described in Note 6-"Stockholders Equity" of the accompanying consolidated financial statements to fund the payment. Financing obligations of$240,000 as ofDecember 31, 2019 consist of capital leases related to the acquisition of computer and network equipment and furniture and other financing obligations. The Company's primary source of cash from operating activities has been cash collections from sales of products and services to customers. The Company expects cash inflows from operating activities to be affected by increases or decreases in sales and timing of collections. The Company's primary use of cash for operating activities has been for personnel costs and outside service providers, payment of royalties associated with third-party software licenses and purchases of equipment to fulfill customer orders. The Company expects cash flows from operating activities to be affected by fluctuations in revenues, personnel costs, outside service providers, and the amount and timing of royalty payments and equipment purchases as the Company continues to support the growth of the business. In addition, the Company expects cash flows to be negatively impacted in the first quarter 2020 by approximately$0.6 million in professional fees, costs and other expenses associated with the Merger Agreement that was signed onFebruary 11, 2020 and the Company anticipates additional transaction related expenses in future quarters. See Part I - Item 1A - Risk Factors - Risks Relating to the Merger. The amount of cash and cash equivalents held by the Company's international subsidiaries that is not available to fund domestic operations unless repatriated was$2.8 million as ofDecember 31, 2019 . The repatriation of cash and cash equivalents held by the Company's international subsidiaries would not result in an adverse tax impact on cash given that the future tax consequences of repatriation are expected to be insignificant as a result of the Tax Act. Summary of Cash Flows. A summary of cash flows is as follows (in thousands): Year Ended December 31, 2019 2018 2017 Cash flows from (used in): Operating activities$ (1,538 ) $ (2,843 ) $ (2,012 ) Investing activities (127 ) 9,651 (24 ) Financing activities 3,602 (5,743 ) (747 )
Effect of exchange rate changes on cash 66 (119 ) 109
Net change in cash and cash equivalents
Operating activities Net cash used in operating activities was$1.5 million for 2019 compared to$2.8 million in 2018. The change in operating cash flows for 2019 as compared to 2018 was impacted by changes in operating assets and liabilities, including the favorable impacts of changes in receivables and accounts payable and other accrued liabilities, offset by unfavorable changes in contract assets and accrued compensation. Investing activities Net cash provided by investing activities from the sale of the Company's investment in BriefCam totaled$41,000 in 2019 compared to$9.8 million in 2018. Net cash used in investing activities for the purchases of property and equipment totaled$168,000 in 2019 compared to$127,000 in 2018. Financing activities Financing activities provided net cash of$3.6 million in 2019, primarily consisting$8.2 million in net proceeds from the issuance of common stock, partially offset by cash used for payments on the Company's term note, capital leases and other financing obligations. During 2019, financing cash outflows included a principal payment of$4.0 million , accrued interest of 29
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$528,000 for the periodJuly 19, 2018 to the payment date ofNovember 12, 2019 , and prepayment fee of$250,000 on the outstanding term loan withESW Holdings, Inc. Additionally, during 2019, the Company made principal payments of$320,000 on capital leases and other financing obligations. Financing activities used net cash of$5.7 million in 2018, primarily consisting of a principal payment of$6.0 million on the outstanding term loan withESW Holdings, Inc. , principal payments of$402,000 on capital leases and other financing obligations, a principal payment on the term loan credit agreement (Hale credit agreement) withHCP-FVD, LLC as lender andHale Capital Partners, LP as administrative agent, of$8.0 million and a prepayment fee of$800,000 , offset by$10.0 million in proceeds from the term loan withESW Holdings inJanuary 2018 , a portion of which was used to repay the term loan under the Hale credit agreement. Financing activities used net cash of$747,000 during 2017, primarily consisting of cash used for payments on financing obligations of$505,000 and payments for fees to amend the Hale credit agreement of$225,000 . SinceOctober 2010 , the Company's Board of Directors has approved common stock repurchases of up to 3,500,000 shares. Shares may be purchased at prevailing market prices in the open market or in private transactions, subject to market conditions, share price, trading volume and other factors. The repurchase program has been funded to date using cash on hand and may be discontinued at any time. The Company did not repurchase any shares of its common stock under the repurchase program during the years endedDecember 31, 2019 , 2018 and 2017. As ofDecember 31, 2019 , the Company had 778,365 shares available for repurchase under the authorizations. While the current authorization remains in effect, the Company expects its primary use of cash will be to fund operations in support of the Company's goals for revenue growth and operating margin improvement. Under the Company's Merger Agreement with Synacor, Inc., the Company is prohibited from repurchasing or redeeming its stock, subject to certain exceptions relating to the exercise or vesting of equity awards. The Company did not declare or pay any dividends during the years endedDecember 31, 2019 , 2018 and 2017. Under the Company's Merger Agreement with Synacor, Inc., the Company is prohibited from making dividends, distributions or payments on its capital stock. Contractual Obligations. The following table summarizes the Company's contractual cash obligations atDecember 31, 2019 , and the net effect such obligations are expected to have on liquidity and cash flow in future periods. Some of the amounts included in this table are based on management's estimates and assumptions about these obligations, including their duration, the possibility of renewal, anticipated actions by third parties and other factors. Because these estimates and assumptions are necessarily subjective, the amounts the Company will actually pay in future periods may vary from those reflected in the table. (In thousands) Payments Due by
Period
Contractual Obligations 2020 2021 2022 2023
2024 Thereafter Total Operating leases$ 764 $ 712 $ 672 $ 294 $ 114 $ -$ 2,556 Capital leases and other 91 80 5 - - - 176 financing obligations (1) Purchase obligations (2) 524 124 70 - - - 718
Income tax liabilities under - - - -
- - -
ASC 740 (3)
Total contractual cash $ 1,379 $ 916 $ 747 $ 294 $ 114 $ - $ 3,450
obligations
_________________________________________________
(1) Amounts include principal and interest.
(2) Purchase obligations include all commitments to purchase goods or services
that meet one or both of the following criteria: (1) they are
non-cancellable or (2) the Company must make specified minimum payments even
if it does not take delivery of the contracted products or services. If the
obligation is non-cancellable, the entire value of the contract is included
in the table.
(3) The Company does not currently expect any income tax liabilities accrued
under ASC 740 as of
authorities in 2020. The full balance of unrecognized tax benefits under ASC
740 of
table as the period of payment or reversal cannot be reasonably estimated.
This amount is before reduction for deferred federal benefits of uncertain
tax positions and also excludes potential interest and penalties.
Recently Adopted Accounting Standards and Recently Issued Accounting Standards Not Yet Adopted For information about our recently adopted accounting standards and recently issued accounting standards not yet adopted, see Note 1 of the accompanying Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.
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