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MARLBOROUGH SOFTWARE DEVELOPMENT HOLDINGS INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge)
All statements, trend analysis and other information contained in the following
discussion relative to markets for our products and trends in revenue, gross
margin and anticipated expense levels, as well as other statements, including
words such as "may," "anticipate," "believe," "plan," "estimate," "expect," and
"intend" and other similar expressions constitute forward-looking statements.
These forward-looking statements are subject to business and economic risks and
uncertainties and our actual results of operations may differ materially from
those contained in the forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, those discussed
under Item 1A Risk Factors as well as other risks and uncertainties referenced
in this report.
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EXECUTIVE OVERVIEW
Marlborough Software Development Holdings Inc. ("MSDH" or "We" or the "Company")
was formed on July 18, 2011 in conjunction with our former parent company's,
Bitstream Inc. ("Bitstream"), planned merger (the "Bitstream Merger") with and
acquisition by Monotype Imaging Holdings Inc., a Delaware corporation
("Monotype") pursuant to an agreement and plan of merger (the "Bitstream Merger
Agreement") entered into by and between Bitstream and Monotype on November 10,
2011 (the "Separation Date"). On the Separation Date, Bitstream transferred and
assigned to MSDH all of the assets and liabilities relating to, arising from or
in connection with Bitstream's Pageflex and BOLT product lines (the
"Separation") pursuant to the terms and conditions of a Contribution Agreement
dated November 10, 2011 by and between Bitstream and MSDH (the "Contribution
Agreement"). On March 14, 2012, Bitstream distributed all of the shares of MSDH
common stock to the stockholders of Bitstream on a pro rata basis (the
"Distribution") pursuant to the terms and conditions of the Distribution
Agreement dated November 10, 2011 between Bitstream and MSDH (the "Distribution
Agreement"). On March 19, 2012, Bitstream completed the Bitstream Merger with
Monotype.
MSDH is a software development company focused on bringing innovative and
proprietary software products to a wide variety of markets. Our core software
products include mobile browsing technologies and variable data publishing,
Web-to-print, and multi-channel communications technologies.
Automated Marketing Communication and Print Production Variable Technologies.
The Pageflex product line enables companies across the globe to communicate
their marketing messages more easily and effectively. It is the advanced
technology for brand management, web-to-print applications, and sophisticated
personalized communications based on customer information. We pioneered flexible
variable data software in 1997 and have been a technology innovator in the
document customization arena ever since. The platform produces rich, creative,
award-winning document designs that look like they were given the individual
attention of a graphic designer but were, in reality, created on-the-fly with
Pageflex variable publishing technology. Print service providers, marketing
service providers, corporate marketers, and publishers use Pageflex Products to
ensure design integrity and brand control while empowering local users to
customize and personalize print collateral, email campaigns, and 1-to-1
marketing Web sites. Pageflex Persona is desktop software that produces
personalized print and email documents using data from a database. Pageflex
Studio ID is a plug-in to Adobe InDesign for producing personalized print
pieces. Pageflex Storefront is a turnkey solution for producing web portals for
document customization and online purchasing of print documents. Pageflex Server
provides an enterprise solution for high-volume document customization driven by
a database or requests from a web site. Pageflex iWay provides business flow
automation for printing companies. Pageflex Campaign Manager lets companies
develop personal conversations with their customers in print, email, and online.
And finally, Pageflex Chart works with these Pageflex Products to add dynamic
charts and graphs to print documents. Pageflex Products enable companies
worldwide to manage, streamline, and automate their document production
processes, communicate more personally with their customers, and control their
brand and market messaging while enabling their remote employees, franchises,
and consumers to use a self-serve model to order customized communications.
Pageflex Products are purchased by both corporations and the printing companies
that support them, who also use the software to control and track production
processes in order to improve their business ROI.
We market our products and acquire our customers through a variety of sources
including participation in industry trade shows, trade association sponsorships,
online marketing, including search engines and advertising on online networks
and other websites, and other marketing efforts, relationships with our
partners, referrals from our growing customer base, general brand awareness and
the inclusion of a link to our website in the footer of the emails sent by our
customers.
Mobile Browsing Technologies. BOLT provides a consistent, full desktop-style
browsing experience on almost any handset. The BOLT mobile browser offers
faithful rendering of Web pages and it is the only browser for mobile phones of
all types to support streaming video from popular media sharing sites such as
YouTube and MySpace. Compatible with most handsets that support the J2ME or
BREW/BMP operating systems, BOLT's
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advanced features include W3C based widget support, direct Twitter integration,
six levels of magnification, international localization, copy/paste, FOTA
updates, and additional usability features such as auto-complete url, save page,
secure browsing, patented split-screen minimap, password manager, rss
subscriptions, automatic socket support, history and keypad shortcuts. BOLT is a
WebKit based cloud-computing mobile browser. This cloud -computing architecture
is the key to BOLT's capabilities. Web pages are first loaded by the BOLT
servers, then transcoded and sent to the BOLT mobile browser client on handsets.
This client/server approach maintains the integrity of Web page layouts, reduces
packet consumption on data networks, dramatically improves page load speeds, and
enables advanced features such as video streaming.
Our business strategy focuses on expanding both our direct sales effort as well
as expanding our relationships with our OEM and reseller channels. We are also
focused on improving our product offerings and expanding our market share.
Certain Financial and Operating Metrics
In connection with the ongoing operation of our business, our management
regularly reviews key financial and operating metrics, such as revenue, gross
margin, expenses, and capital expenditures, among others. Management considers
these financial and operating metrics critical to understanding and improving
our business, reviewing our historical performance, comparing our performance
versus other companies and identifying current and future trends, and for
planning purposes.
Certain Trends and Uncertainties
The following represents a summary of known trends and uncertainties which could
have a significant impact on our financial condition and results of operations.
This summary should be considered along with the factors discussed under the
headings "Risk Factors" and "Forward-Looking Statements" elsewhere in this
Form 10-k.
• On November 10, 2011 we completed the Separation from Bitstream and on March 14, 2012 Bitstream completed the Distribution, thereby resulting in
MSDH becoming a separate, stand-alone public company. On March 19, 2012,
Bitstream completed the Bitstream Merger with Monotype. We may experience
disruption in our business related to the Separation and the Bitstream
Merger, including, but not limited to, attention and time spent on the
Separation, Distribution and Bitstream Merger, our common utilization of
integrated information system and financial reporting infrastructure with
Bitstream and the assignment of material contracts to us for which some of
the parties may not consent to the assignment. If we experience
significant disruption as a result of these or any other factors related to the Separation, Distribution and Bitstream Merger, our financial
results could be adversely impacted.
• The Pageflex and Bolt product activities were conducted by Bitstream as a
whole and integrated with the Fonts Products activities. Our historic
financial information may not be representative of our results as a
separate company.
• We continue to closely monitor current economic conditions, particularly
as they impact our customers. We believe that our customers continue to
experience some amount of economic hardship. If this economic hardship
continues or worsens, our financial results could be adversely impacted.
• We continue to develop new products and new versions of our existing product offerings. Failure to develop and launch new products and versions
could negatively impact our financial results.
CRITICAL ACCOUNTING POLICIES
MSDH has identified the policies below as critical to its business operations
and the understanding of its results of operations. The impact and any
associated risks related to these policies on our business operations is
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discussed throughout this Management's Discussion and Analysis of Financial
Condition and Results of Operations where such policies affect MSDH's reported
and expected financial results. Note that our preparation of this prospectus
requires us to make estimates and assumptions that affect the reported amount of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of our financial statements, and the reported amounts of revenue and
expenses during the reporting period. There can be no assurance that actual
results will not differ from those estimates.
Allocation Methodologies
The financial statements of MSDH have been derived from the financial statements
of Bitstream Inc. utilizing the following methodologies: the MSDH balance sheet
generally reflects the financial position of MSDH as if it had been a separate
entity as of December 31, 2011. Only those assets and liabilities which were
specifically identifiable to the MSDH business or those assets and liabilities
that were used primarily by the MSDH business, such as our leased facilities in
the US, have been attributed and included in the balance sheet of MSDH. The MSDH
statements of operations reflect revenue directly attributable to the MSDH
business. Cost of revenue, research and development, and sales and marketing
departments have historically been product specific and thus have been primarily
assigned to MSDH based on product line information. Certain general and
administrative ("G&A") items that could be specifically identified and
allocated, including amortization of intangibles, were allocated. Other general
expenses that could not be specifically identified to a product line were
allocated based on the most relevant measure, such as head count and product
revenue. Certain assets that were used by both Bitstream and MSDH were assigned
to MSDH as the primary user of the assets. MSDH charges Bitstream a fee,
approximating fair value, for the use of these assets. The fee is netted with
the expenses of MSDH in the Statement of Operations and was not material for the
years ended December 31, 2011 and 2010. MSDH's operating results historically
have been included in Bitstream's consolidated U.S. and state tax returns. The
provision for income taxes in MSDH's financial statements has been determined on
a separate-return basis.
There is significant judgment in determining the allocation of income, expense,
and attribution of assets and liabilities. Management believes that the
methodologies used in the allocation are reasonable.
Revenue Recognition
We derive revenue from the license of our software products, and from consulting
and support and maintenance services. Primarily, we recognize revenue when
persuasive evidence of an arrangement exists, the product has been delivered or
services have been provided, the fee is fixed or determinable, and collection of
the fee is probable.
Multiple-element arrangements
We recognize revenue under multiple-element arrangements using the residual
method when vendor-specific objective evidence ("VSOE") of fair value exists for
all of the undelivered elements under the arrangement. Under the residual
method, the arrangement consideration is first allocated to undelivered elements
based on vendor-specific objective evidence of the fair value for each element
and the residual amount is allocated to the delivered elements. Arrangement
consideration allocated to undelivered elements is deferred and recognized as
revenue when the elements are delivered, if all other revenue recognition
criteria are met. We have established sufficient vendor-specific objective
evidence for the value of our training and maintenance services, based on the
price charged when these elements are sold separately. VSOE of the fair value of
maintenance services is supported by substantive renewal rates within customer
contracts.
License Revenue
We receive and recognize licensing fees and royalty revenue from: (1) Original
Equipment Manufacturer ("OEM") customers for page composition technologies;
(2) direct and indirect licenses of software publishing
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applications for the creation, enhancement, management, transport, viewing and
printing of electronic information; (3) direct sales of custom design and
consulting services to end users such as graphic artists, desktop publishers,
corporations and resellers; and (4) sales of publishing applications to foreign
customers primarily through distributors and resellers.
We recognize license revenue from the resale of our products through various
resellers. Resellers may sell our products in either an electronic format or CD
format. Revenue is recognized if collection is probable, upon notification from
the reseller that it has sold the product, or for a CD product, upon delivery of
the software.
Revenue from end user product sales is recognized upon delivery of the software,
net of estimated returns and allowances, and when collection is probable.
Service Revenue
Professional services include custom design and development, and training. We
recognize professional services revenue under software development contracts as
services are provided for per diem contracts or by using the
percentage-of-completion method of accounting for long-term fixed price
contracts. Provisions for any estimated losses on contracts are made in the
period in which such losses become probable. There are no losses accrued at the
balance sheet dates presented.
We recognize revenue from support and maintenance agreements ratably over the
term of the agreement.
Deferred revenue includes unearned software support and maintenance revenue, and
advanced billings for unrecognized revenue from contracts.
Cost of revenue from software licenses consists primarily of hosting costs,
amortization of intangibles related to the iWay product, and costs to distribute
the product, including the cost of the media on which it is delivered. Cost of
revenue from services consists primarily of costs associated with customer
support, consulting and custom product development services.
We generally warrant that our products will function substantially in accordance
with documentation provided to customers for approximately 90 days following
initial delivery. We have not incurred any material expenses related to warranty
claims.
Stock-based Compensation
We account for stock-based compensation in accordance with authoritative
guidance. Under the fair value recognition provisions of this guidance,
stock-based compensation cost is measured at the grant date based on the fair
value of the award, net of an estimated forfeiture rate, and is recognized as
expense on a straight-line basis over the requisite service period, which is the
vesting period. All assumptions used in valuing our stock option grants and
estimating our forfeiture rates are based on the historical information and
assumptions used by Bitstream.
We currently use the Black-Scholes option pricing model to determine the fair
value of stock options and awards. Inputs into the pricing model represent the
inputs used by Bitstream based on their historical experience. The determination
of the fair value of stock-based payment awards on the date of grant using an
option-pricing model is affected by Bitstream's stock price as well as
assumptions regarding a number of complex and subjective variables. These
variables include Bitstream's expected stock price volatility over the term of
the awards, actual and projected employee stock option exercise behaviors,
risk-free interest rate and expected dividends.
We estimate the expected term of options granted by calculating the average term
from Bitstream's historical stock option exercise experience. We estimate the
volatility of our common stock by Bitstream's
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historical volatility. We base the risk-free interest rate that we use in the
option pricing model on zero-coupon yields implied from U.S. Treasury issues
with remaining terms similar to the expected term on the options. Bitstream did
not anticipate paying any cash dividends in the foreseeable future and therefore
the expected dividend yield was zero in the option pricing model. We are
required to estimate forfeitures at the time of grant and revise those estimates
in subsequent periods if actual forfeitures differ from those estimates. We use
Bitstream's historical data to estimate pre-vesting option forfeitures and
record stock-based compensation expense only for those awards that are expected
to vest.
If factors change and we employ different assumptions for estimating stock-based
compensation expense inclusive of assumption based on MSDH factors in future
periods or if we decide to use a different valuation model, stock-based
compensation expense in future periods may differ significantly from what we
have recorded in the current period and could materially affect our operating
income, net income and net income per share.
The Black-Scholes option-pricing model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable, characteristics not present in our option grants and awards.
Existing valuation models, including the Black-Scholes and lattice binomial
models, may not provide reliable measures of the fair values of our stock-based
compensation. Consequently, there is a risk that our estimates of the fair
values of our stock-based compensation awards on the grant dates may bear little
resemblance to the actual values realized upon the exercise, expiration, early
termination or forfeiture of those stock-based payments in the future. Certain
stock-based payments, such as employee stock options, may expire worthless or
otherwise result in zero intrinsic value as compared to the fair values
originally estimated on the grant date and reported in our financial statements.
Alternatively, value may be realized from these instruments that are
significantly higher than the fair values originally estimated on the grant date
and reported in our financial statements. There currently is no market-based
mechanism or other practical application to verify the reliability and accuracy
of the estimates stemming from these valuation models, nor is there a means to
compare and adjust the estimates to actual values.
The application of these principles using authoritative guidance may be subject
to further interpretation and refinement over time. There are significant
differences among valuation models, and there is a possibility that we will
adopt different valuation models in the future. This may result in a lack of
consistency in future periods and materially affect the fair value estimate of
stock-based payments. It may also result in a lack of comparability with other
companies that use different models, methods and assumptions.
Impairment of Goodwill and Other Long-Lived Assets
Under authoritative guidance, goodwill is not amortized, but is required to be
reviewed annually for impairment or more frequently if impairment indicators
arise. For purposes of testing impairment, MSDH has determined it has one
reporting unit. Therefore, goodwill is tested for impairment based upon an
enterprise wide valuation. We conducted impairment testing as of each balance
sheet date presented in the consolidated financial statements and determined
that there was no impairment. Although none of the goodwill was impaired, there
can be no assurance that, in the future, a material impairment charge will not
be required.
Whenever events or changes in circumstances indicate that the carrying amounts
of a long-lived asset may not be recoverable, we review these assets for
impairment. If the future undiscounted cash flows are less than the carrying
amount of that asset, impairment exists. We recognize an impairment loss based
on the excess of the carrying amount over the fair value of the assets. Fair
value is normally assessed using a discounted cash flow model. We believe that,
as of each balance sheet date presented, none of our long-lived assets were
impaired.
Accounts Receivable
We perform ongoing credit evaluations of our customers and adjust credit limits
based upon payment history and the customer's current credit worthiness, as
determined by our review of their current credit
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information. We continuously monitor collections and payments from customers and
maintain a provision for estimated credit losses based on our historical
experience and any specific customer collection issues that we identify. In
2010, we wrote-off several accounts against a substantial portion of our 2009
reserves that were established as a result of the downturn in the global economy
that affected our customers. We did not record significant additional reserves
during 2011 or 2010. We cannot guarantee that our credit loss rates will not
worsen or that we will experience credit loss rates approximating those that we
have experienced in the past.
Software Development Costs
We incur costs to develop computer software to be licensed or otherwise marketed
to customers. Research and development costs are expensed as incurred, except
for costs of internally developed or externally purchased software that qualify
for capitalization. Development costs for software to be sold externally
incurred subsequent to the establishment of technological feasibility, but prior
to the general release of the product, are capitalized and, upon general
release, are amortized over the expected life of the related products.
Income Taxes
For purposes of MSDH's consolidated financial statements, income tax expense and
deferred tax balances have been recorded as if the Company had filed tax returns
on a separate return basis from Bitstream. The deferred tax balances in
these consolidated financial statements will differ from the Company's deferred
tax balances post-separation, as a portion of the separate return tax loss and
credit carry forwards have either been utilized by Bitstream or will not be
available to the Company post-separation. The calculation of income taxes for
the Company on a separate return basis requires a considerable amount of
judgment and use of both estimates and allocations. In most cases, the tax
losses and tax credits generated by the Company, while a subsidiary within
Bitstream's legal entities and included in these financial statements, have
either been utilized by Bitstream's other businesses or will remain with
Bitstream post-separation.
Our effective tax rate is based on pre-tax income and the tax rates applicable
to that income in the various state jurisdictions in which we operate. An
estimated effective tax rate for a year is applied to our quarterly operating
results, adjusted for losses in tax jurisdictions where the losses cannot be tax
benefited due to valuation allowances. In the event that there is a significant
unusual or discrete item recognized, or expected to be recognized, in our
quarterly operating results, including the resolution of prior-year tax matters,
the tax attributable to that item would be separately calculated and recorded at
the same time as the unusual or discrete item. Significant judgment is required
in determining our effective tax rate and in evaluating its tax positions. We
establish reserves when it is deemed more likely than not we will not realize
the full tax benefit of the position. We periodically adjusts these reserves in
light of changing facts and circumstances.
Tax regulations may require items of income and expense to be included in a tax
return in different periods than the items are reflected in the consolidated
financial statements. As a result, the effective tax rate reflected in the
consolidated financial statements may be different than the tax rate reported in
the income tax return. Some of these differences are permanent, such as expenses
that are not deductible on the tax return, and some are temporary differences,
such as depreciation expense. Temporary differences create deferred tax assets
and liabilities. Deferred tax assets generally represent items that can be used
as a tax deduction or credit in the tax return in future years for which we have
already recorded the tax benefit in the financial statements. Deferred tax
liabilities generally represent tax expense recognized in the financial
statements for which payment has been deferred or expense for which we have
already taken a deduction on an income tax return, but has not yet been
recognized in the consolidated financial statements.
We account for income taxes in accordance with FASB guidance, which requires
that deferred tax assets and liabilities be recognized using enacted tax rates
for the effect of the temporary differences between the book and tax basis of
recorded assets and liabilities. We make estimates and judgments with regard to
the calculation of certain income tax assets and liabilities. This FASB guidance
requires that deferred tax assets be reduced by valuation allowances if, based
on the consideration of all available evidence, it is more likely than not that
some portion of the deferred tax asset will not be realized. Significant weight
is given to evidence that can be objectively verified.
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Recent Accounting Pronouncements Not Yet Adopted
In June 2011, the Financial Accounting Standards Board issued guidance on
presentation of comprehensive income. The new guidance eliminates the current
option to report other comprehensive income and its components in the statement
of changes in equity. Instead, an entity will be required to present either a
continuous statement of net income and other comprehensive income or in two
separate but consecutive statements. In December 2011, the FASB indefinitely
deferred the amendment's requirement to present reclassification adjustments of
other comprehensive income by line item on the face of the income statement.
This guidance is effective for us on January 1, 2012. As the new guidance
relates only to how comprehensive income is disclosed and does not change the
items that must be reported as comprehensive income, adoption will not have an
effect on our consolidated financial statements.
In September 2011, the Financial Accounting Standards Board issued guidance
which simplifies how companies test goodwill for impairment. The amendment
permits an entity to first assess qualitative factors to determine whether 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 described in the goodwill accounting
standard. The amendments are effective for annual and interim goodwill
impairment tests performed for fiscal years beginning after December 15, 2011.
MSDH does not expect the new guidance to have a material effect on our
consolidated financial statements.
OVERVIEW
RESULTS OF OPERATIONS (in thousands, except percentages and per share amounts)
Revenue and Gross Profit:
Year Ended December 31,
% of % of Change
2011 Revenue 2010 Revenue Dollars Percent
Revenue
Software licenses $ 2,793 32 % $ 1,964 31 % $ 829 42 %
Services 5,849 68 4,370 69 1,479 34
Total revenue 8,642 100 6,334 100 2,308 36
Cost of Revenue
Software licenses 1,103 13 571 9 532 93
Services 2,025 23 1,750 28 275 16
Total cost of revenue 3,128 36 2,321 37 807 35
Gross Profit $ 5,514 64 % $ 4,013 63 % $ 1,501 37 %
License Revenue
We recognize license revenue from direct sales and licensing agreements of our
products and products from third parties, licensing agreements with OEMs and
ISVs, and from the resale of our products through various resellers. We
recognize reseller revenue on a sell-in basis and bear no obligation after the
license has been delivered to the reseller.
The increase in revenue from software licenses for the year ended December 31,
2011 from the year ended December 31, 2010 primarily resulted from increased
sales of the iWay product acquired from Press-Sense in June 2010 of $1,125,
partially offset by a decrease in sales of our other publishing products of
$334. iWay products were available for sale for full year in 2011 versus only
seven months in 2010 and we have seen an increase in OEM royalties for units
shipped since the acquisition of the iWay product line. We continue to be
affected by the global economic downturn, as are our customers. However, with
the stabilization of the iWay product, the localization of the Pageflex
Storefront product and our increase in sales and marketing resources, we expect
our revenue to increase during the next year as compared to 2011.
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Service Revenue
Service Revenue for the year ended December 31, 2011 increased from service
revenues in the year ended December 31, 2010 primarily due to an increase in
support contracts for the iWay product of $1,101 and an increase in consulting
services engagements related to the Pageflex Storefront and iWay products of
$254 for the year ended December 31, 2011 as compared to the same period in
2010. Other product services revenue for customer support, consulting, custom
design and training services were generally flat year over year. The increase in
iWay support revenue is due to an increase in support contracts related to
increased customer sales. We expect the revenue from support contracts to
continue to increase into 2012. Consulting, graphic design and training services
vary with specific requirements of customers and may be affected more by
economic concerns as customers may delay design changes, custom development and
training.
Cost of Revenue
Cost of revenue includes hosting costs, royalties and fees paid to third parties
for the license of rights to technology, costs incurred in the fulfillment of
custom orders, costs incurred in providing customer support, maintenance and
training, and costs associated with the duplication, packaging and shipping of
products. Cost of revenue also includes amortization of acquired-technology from
the acquisition of assets from Press-Sense Ltd. starting in 2010.
Cost of License Revenue
The increase in cost of license revenue for the year ended December 31, 2011 as
compared to year ended December 31, 2010 was primarily related to the inclusion
of hosting costs for the browsing product in 2011, resulting in an increase of
$460. Browser hosting costs were included in Research and Development in 2010 as
we had yet to monetize our free user base and provide hosting services to
carrier and device manufacturers. In addition, cost of licenses increased due to
an additional $78 of amortization of the iWay technology acquired in June 2010
as part of the Press-Sense Ltd. acquisition. We also incurred increased support
infrastructure costs for our browsing product line during year ended
December 31, 2011.
Cost of Service Revenue
The increase in cost of services revenue for the year ended December 31, 2011,
as compared to the same period in 2010 was primarily due to an increase of $224
related to salary and related expense associated with the Israel office
established in June 2010, and to an $89 reduction in the internal allocation of
resources charged to research and development projects, resulting in higher cost
of services expense. Our cost of services infrastructure remained relatively
constant during 2011 and we expect our variable costs to increase as the demand
for these services increases and also with the addition of support and
consulting services for the iWay product which was acquired as part of the
acquisition of the Press-Sense Ltd. assets.
Operating Expenses:
Year Ended December 31,
% of % of Change
2011 Revenue 2010 Revenue Dollars Percent
Marketing and selling $ 3,863 45 % $ 3,089 49 % $ 774 25 %
Research and development 7,119 82 5,514 87 1,605 29
General and administrative 3,208 37 2,503 40 705 28
Total operating expenses $ 14,190 164 % $ 11,106 175 % $ 3,084 28 %
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Marketing and Selling ("M&S") Expense
Marketing and selling ("M&S") expense consists primarily of salaries and
benefits, commissions, travel expense and facilities costs related to sales and
marketing personnel, as well as marketing program-related costs. The increase in
M&S for the year ended December 31, 2011 as compared to the year ended
December 31, 2010 related primarily to an increase in salary related costs, an
increase in professional marketing services and consulting, and an increase in
amortization partially offset by a decrease in advertising costs. Salary related
costs increased by $359 primarily due to the addition of sales and marketing
personnel associated with the iWay product acquired in June 2010. Professional
services increased by $214 primarily due to iWay sales consulting. Travel
expenses increased by $84 primarily due to sales travel for salesman summit and
user conference. Amortization increased by $80 primarily due to the amortization
of iWay acquired customer lists. We expect that our M&S expense will increase in
both absolute dollars and as a percentage of revenue during 2012, as
commissionable sales increase and as we invest in new sales and marketing
resources.
Research and Development ("R&D") Expense
Research and development ("R&D") expense consists primarily of salary and
benefit costs, contracted third-party development costs, and facility costs
related to software developers and management. R&D expense increased for the
year ended December 31, 2011, as compared to the year ended December 31, 2010
primarily due to an increase in salaries and benefits. Salary related expense
increased by $1,386 primarily related to the addition of R&D personnel for the
iWay product as well as for additional headcount added in India during 2010.
These increases are partially offset by the inclusion of browser hosting costs
in cost of revenue in 2011. These costs were included as R&D expense in 2010, as
MSDH had yet to monetize its free user base and provide hosting services to
carrier and device manufacturers. We expect our development efforts and R&D
expense to increase as compared to 2011 both in absolute dollars and as a
percentage of sales during 2012.
General and Administrative ("G&A") Expense
G&A expense consists primarily of salaries, benefits, and other related costs
including travel and facility expenses for finance, human resource, legal and
executive personnel, legal and accounting professional services, provision for
bad debts, directors fees and director and officer insurance. G&A expense
increased for the year ended December 31, 2011 as compared to the year ended
December 31, 2010 primarily due to an increase in salary related costs of $733
and an increase in facility-related costs of $183, partially offset by a
decrease in professional service fees of $224. A significant contributor to the
salary increase was due to the resignation and related severance for our former
CEO as well as an increase in salaries, benefits and facility-related costs in
the Israel office established in June 2010. We expect that G&A expenses, other
than those associated with the resignation agreement, will remain at similar
levels in 2012.
Other Income, Net:
Year Ended December 31,
% of % of Change
2011 Revenue 2010 Revenue Dollars Percent
Interest and other income, net $ 10 0 % $ - - % $ 10 100 %
Other income consists primarily of interest income allocated from Bitstream and
foreign currency transactions gains or losses.
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Provision for Income Taxes:
Year Ended December 31,
% of % of Change
2011 Revenue 2010 Revenue Dollars Percent
Provision for income taxes $ 162 2 % $ - - % $ 162 100 %
The provision for income taxes consists of foreign taxes in Israel.
For purposes of MSDH's consolidated financial statements, income tax expense and
deferred tax balances have been recorded as if the Company had filed tax returns
on a separate return basis from Bitstream. The deferred tax balances in
these consolidated financial statements will differ from the Company's deferred
tax balances post-separation, as a portion of the separate return tax loss and
credit carry forwards have either been utilized by Bitstream or will not be
available to the Company post-separation. The calculation of income taxes for
the Company on a separate return basis requires a considerable amount of
judgment and use of both estimates and allocations. In most cases, the tax
losses and tax credits generated by the Company, while a subsidiary within
Bitstream's legal entities and included in these financial statements, have
either been utilized by Bitstream's other businesses or will remain with
Bitstream post-separation.
The Company's consolidated financial statements reflect deferred tax assets, net
of deferred tax liabilities, but before consideration of valuation allowances,
of $19,100 and valuation allowances of $19,200 on a separate return basis as of
December 31, 2011. The Company estimates that post-separation its beginning
deferred tax assets, net of deferred tax liabilities, but before consideration
of valuation allowances, will be approximately $115 and valuation allowances
will be approximately $0. The decrease in deferred tax assets and valuation
allowances is primarily attributable to separate return tax loss and credit
carry forwards that will not be available to the Company post-separation.
Bitstream's tax strategies are not necessarily reflective of the tax strategies
we would have followed or will follow as a stand-alone company, nor were they
necessarily strategies that optimized our stand-alone tax position. As a result,
our deferred tax balances and effective tax rate as a stand-alone entity may
differ from those prevailing in historical periods.
Our effective tax rate is based on pre-tax income and the tax rates applicable
to that income in the various state jurisdictions in which we operate. An
estimated effective tax rate for a year is applied to our quarterly operating
results, adjusted for losses in tax jurisdictions where the losses cannot be tax
benefited due to valuation allowances. In the event that there is a significant
unusual or discrete item recognized, or expected to be recognized, in our
quarterly operating results, including the resolution of prior-year tax matters,
the tax attributable to that item would be separately calculated and recorded at
the same time as the unusual or discrete item. Significant judgment is required
in determining our effective tax rate and in evaluating its tax positions. We
establish reserves when it is deemed more likely than not we will not realize
the full tax benefit of the position. We periodically adjust these reserves in
light of changing facts and circumstances.
Tax regulations may require items of income and expense to be included in a tax
return in different periods than the items are reflected in the consolidated
financial statements. As a result, the effective tax rate reflected in the
consolidated financial statements may be different than the tax rate reported in
the income tax return. Some of these differences are permanent, such as expenses
that are not deductible on the tax return, and some are temporary differences,
such as depreciation expense. Temporary differences create deferred tax assets
and liabilities. Deferred tax assets generally represent items that can be used
as a tax deduction or credit in the tax return in future years for which we have
already recorded the tax benefit in the financial statements. Deferred tax
liabilities generally represent tax expense recognized in the financial
statements for which payment has been deferred or expense for which we have
already taken a deduction on an income tax return, but has not yet been
recognized in the consolidated financial statements.
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We account for income taxes in accordance with FASB guidance, which requires
that deferred tax assets and liabilities be recognized using enacted tax rates
for the effect of the temporary differences between the book and tax basis of
recorded assets and liabilities. We make estimates and judgments with regard to
the calculation of certain income tax assets and liabilities. This FASB guidance
requires that deferred tax assets be reduced by valuation allowances if, based
on the consideration of all available evidence, it is more likely than not that
some portion of the deferred tax asset will not be realized. Significant weight
is given to evidence that can be objectively verified.
We evaluate deferred income taxes on a quarterly basis to determine whether
valuation allowances are required by considering available evidence, including
historical and projected taxable income and tax planning strategies that are
both prudent and feasible. As of December 31, 2011, our U.S. operations had
generated three consecutive years of pre-tax losses. Because of our recent
history of losses, we believe that the weight of negative historic evidence
precludes us from considering any forecasted income from our analysis of the
recoverability of its U.S. deferred tax assets. We also considered in our
analysis tax planning strategies that are prudent and can be reasonably
implemented. Based on all available positive and negative evidence, we concluded
that a full valuation allowance should be recorded against the net deferred tax
assets of our U.S. operations.
The tax loss and credit carry forwards reflected in our consolidated financial
statements, representing $18,900 million of deferred tax assets, have been
calculated as if we had filed our tax returns on a separate return basis
separate from Bitstream. The tax carry forwards include U.S. tax carry forwards
for federal and state net operating losses, general business credits and state
tax credits. The tax carry forwards are not representative of the tax carry
forwards we will have available for use after separation from Bitstream. Our
post-separation tax carry forwards will be significantly lower than those
reflected in the consolidated financial statements and the related valuation
allowances will also be correspondingly lower.
We estimate that post-separation we will have deferred tax assets for tax loss
and credit carry forwards of approximately $0. The tax carry forwards are in the
U.S. and total approximately $0 in net operating losses ($0 tax effected)
and approximately $0 in tax credits.
As noted above, we estimate that post-separation our net deferred tax assets,
before considering valuation allowances, will be approximately $115. The
post-separation net deferred tax assets (tax effected) will include
approximately $0 of tax loss and credit carry forwards.
LIQUIDITY AND CAPITAL RESOURCES (dollar amounts in thousands)
At December 31, 2011, our primary source of liquidity comes from our cash and
cash equivalents of $551.
The Pageflex and BOLT products historically have been funded directly through
the conduct of our operations as a component of Bitstream. For the years ended
December 31, 2011 and 2010, we incurred net losses of $8,828 and $7,093,
respectively. Bitstream contributed capital of $7,887 and $12,493 for the years
ended December 31, 2011 and 2010, respectively. As of December 31, 2011, we had
a working capital deficit of $1,959.
Our operating activities used cash during the years ended December 31, 2011 and
2010 of $6,973 and $5,177, respectively. The increased usage of cash during the
year ended December 31, 2011 as compared to the prior year resulted primarily
from an increased net loss and a decrease in contributions from working capital
accounts of $191 partially offset by an increase in the add-backs of non-cash
expense items of $130. Cash used in operating activities has historically been
affected by the amount of net loss, changes in working capital accounts and
add-backs of non-cash expense items such as depreciation and amortization and
the expense associated with stock-based awards.
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Cash used by investing activities during the years ended December 31, 2011 and
2010 was $964 and $6,715, respectively. Cash used in investing activities during
the year ended December 31, 2011 consisted of the capitalization of internally
developed software of $688, the purchase of property and equipment of $261 and
additions to intangible assets of $15. Cash used in investing activities in 2010
consisted of cash paid for the acquisition of assets of Press-Sense of $6,528,
the purchase of property and equipment of $165 and the additions of intangible
assets of $36 partially offset by proceeds from the sale of property and
equipment of $14.
Our financing activities for the years ended December 31, 2011 and 2010 provided
cash of $7,887 and $12,493, respectively. Cash provided by financing activities
consists entirely of contributions from Bitstream.
We conduct our operations in leased facilities. In June 2009, we entered into a
ten-year lease agreement for 27,000 square feet of office space with the right
of first refusal on an additional 4,000 square feet in a building located in
Marlborough, Massachusetts. This lease agreement commenced September 1, 2009 and
obligates us to make minimum lease payments plus our pro-rata share of future
real estate tax increases and certain operating expense increases above the base
year. The lease payments began after three (3) free months of rent and increase
approximately 2% per annum. The total commitment under the lease is
approximately $5,390, net of a tenant allowance of $411. We record rent expense
on a straight-line basis, taking into consideration the free rent period, the
tenant allowance received at the outset of the lease, and annual incremental
increases to the lease payments. This lease agreement also required us to obtain
a Letter of Credit in the amount of $136 to be in place through October 31,
2019, which we collateralized with a certificate of deposit classified as a
long-term restricted asset on our Consolidated Balance Sheets.
In January 2011, Bitstream Israel Ltd., a wholly-owned subsidiary of MSDH,
entered into a thirty-six (36) month lease agreement in Caesarea, Israel. This
lease agreement commenced April 15, 2011 and obligates us to make semi-annual
payments including service taxes. Our total financial commitment during the
thirty-six (36) month lease period is approximately $384 U.S. dollars. This
lease agreement also required us to obtain a bank guarantee backed by our cash
deposits in the amount of approximately $56 U.S. dollars to be in place through
May 14, 2014. The bank guarantee is classified as a long-term restricted asset
on our Balance Sheet.
We will be utilizing approximately 50% of the square footage of the Marlborough,
Massachusetts headquarters after the decrease in personnel associated with the
Bitstream Merger. Management anticipates a reduction in operating costs through
the elimination of certain fixed costs, including, without limitation, the
possible sub-letting or returning to the landlord of the unutilized space that
currently exists. However, there can be no assurance that management will be
successful in implementing these cost cutting plans or that such plans will be
successful or, if successful, how long they will take.
The future minimum annual lease payments under our leased facilities and
equipment as of December 31, 2011, excluding any anticipated rent income of
MSDH, are as follows:
Operating leases:
2012 $ 657
2013 671
2014 556
2015 570
2016 578
Thereafter 1,604
Total $ 4,636
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In June 2011, the Company entered into an agreement with Net-Translators LLC
with an estimated fee structure of $835, payable in installments upon completion
of milestones specified in the agreement. In December 2011, Net-Translators
revised the overall fee structure to $695. Net-Translators provides software
development services related to the localization of our Storefront product into
ten languages. At December 31, 2011, the Company paid $488, with an estimated
$207 remaining commitment which is expected to be paid during the first half of
2012. The contract has no specific term and is enforceable until completion,
which is anticipated to be before April 2012. Either party may cancel the
contract for an unremedied material breach by the other party or if the other
party becomes bankrupt. If we subsequently cancel, reduce in scope or frustrate
(by act of omission) the agreement, except for in the case of a material breach,
the full price of the agreement shall remain payable unless otherwise agreed to
in advance.
The consolidated financial statements have been prepared on a basis that
contemplates the realization of assets and the satisfaction of liabilities and
commitments in the normal course of business. MSDH's long-term viability is
dependent on its ability to generate sufficient product revenue, net income and
cash flows from operations to support its business as well as its ability to
obtain additional financing, if needed. Management's plans also include reducing
operating costs and delaying certain expenditures if necessary to maintain the
Company's liquidity. The Separation from Bitstream Inc. may disrupt our business
and management, negatively affecting our business, operating results or
financial condition and may cause other risks to the Company. MSDH has suffered
recurring losses from operations and has a working capital deficit as of
December 31, 2011 and, for its liquidity, has relied on contributions from
Bitstream. As of December 31, 2011, MSDH had accumulated contributions of
approximately $48,500 from its parent company.
MSDH had a cash balance of $551 as of December 31, 2011. Under the terms of the
Distribution Agreement, subsequent to December 31, 2011, Bitstream contributed
approximately $6,000 to MSDH. Management believes that this contributed cash,
together with cash generated from future operations and existing funds are, and
will be, sufficient to meet its working capital and capital expenditure
requirements through at least the next twelve months. There can be no assurance,
however, that MSDH will not require additional financing in the future if funds
from future operations or estimated expenses differ materially from those
amounts estimated by management. If we were required to obtain additional
financing in the future, there can be no assurance that sources of capital would
be available on terms favorable to us, if at all. In addition, MSDH and
Bitstream have entered into certain ancillary agreements in connection with the
Separation and Distribution that provide for indemnification of Bitstream with
respect to certain liabilities of the Pageflex and BOLT Products contributed to
MSDH.
Potential Indemnification Obligations
We enter into standard indemnification agreements in the ordinary course of
business. Pursuant to these agreements, we indemnify, hold harmless, and agree
to reimburse the indemnified party for losses suffered or incurred by the
indemnified party, generally business partners or customers, in connection with
any U.S. patent, or any copyright or other intellectual property infringement
claim by any third party with respect to our products. The term of these
indemnification agreements is generally perpetual any time after execution of
the agreement. The maximum potential amount of future payments we could be
required to make under these indemnification agreements is unlimited. We have
never incurred costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, we believe the estimated fair value of
these agreements is minimal, but we can provide no assurance that payments will
not be required under these agreements in the future.
In connection with the contribution of Pageflex and BOLT related assets and
liabilities from Bitstream to MSDH, MSDH agreed to indemnify, defend and hold
harmless Bitstream, its affiliates and their respective successors and assigns
from, against and in respect of any damages, losses, claims or liabilities
(including but not limited to reasonable attorneys' fees) relating to or arising
out of MSDH's failure to satisfy any of the Assumed Liabilities under the
Contribution Agreement.
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MSDH also has agreed to indemnify, defend and hold harmless Bitstream, its
affiliates and their successors and assigns from, against and in respect of any
liabilities and obligations of Bitstream relating to certain fees and expenses
of the Bitstream Merger and Distribution, severance costs, lease termination
fees and similar items not otherwise accounted for in the calculation of the
final merger consideration, which amounts are not expected to be material to
MSDH.
The Company and Bitstream have entered into a tax indemnity agreement (the "Tax
Indemnity Agreement") pursuant to which MSDH will indemnify Bitstream against
taxes incurred by Bitstream as a result of the Distribution.
Management believes that MSDH will not incur any liability to Bitstream under
the Tax Indemnity Agreement because management believes that the income and
franchise taxes incurred by Bitstream as a result of the Distribution will be
fully offset by net operating loss and business tax credit carry forwards of
Bitstream and that no taxes other than income and franchise taxes will be
incurred by reason of the Distribution. Such belief is based in part upon our
valuation for tax purposes of MSDH of approximately $19,800 as well as our
determinations with respect to the expected value of the stock of MSDH, the tax
basis of Bitstream in the stock of MSDH, and the availability of net operating
loss and business credit carry forwards.
There can be no assurance that the Internal Revenue Service or another taxing
authority will concur that no taxes will be incurred by Bitstream as a result of
Distribution, either because the value of the MSDH as of the date of the
Distribution differs from the expected value of the MSDH stock at that time as
currently projected or for other reasons. Any liabilities that MSDH may incur
under the Tax Indemnity Agreement will adversely affect MSDH's financial
condition and results of operations.
OFF-BALANCE SHEET ARRANGEMENTSWe do not have any off-balance sheet arrangements or unconsolidated
special-purpose entities within the meaning of Item 303(a)(4) of Regulation S-K.
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