Contact Center Solutions Industry News

TMCNet:  MITEL NETWORKS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

[November 29, 2012]

MITEL NETWORKS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the unaudited interim consolidated financial statements and accompanying notes included elsewhere in this Quarterly Report on Form 10-Q ("Report") and our audited annual consolidated financial statements included in our Form 10-K for the fiscal year ended April 30, 2012 ("Annual Report"). All amounts are expressed in U.S.

dollars unless otherwise noted.

Certain information contained in this Report, including information regarding future financial results, performance and plans, expectations, and objectives of management, constitute forward-looking information within the meaning of Canadian securities laws and forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We refer to all of these as forward-looking statements. Statements that include the words "may," "will," "should," "could," "estimate," "continue," "expect," "intend," "plan," "predict," "potential," "believe," "project," "anticipate" and similar statements of a forward-looking nature, or the negatives of those statements, identify forward-looking statements. In particular, this Report contains forward-looking statements pertaining to, among other matters: general global economic conditions; our business strategy; our plans and objectives for future operations; our industry; our future economic performance, profitability and financial condition; the costs of operating as a public company; our R&D expenditures; our ability to successfully implement our restructuring plans; and, our ability to implement and achieve our business strategies successfully.

Forward-looking statements are subject to a variety of known and unknown risks, uncertainties, assumptions and other factors that could cause actual events or results to differ from those expressed or implied by the forward-looking statements.

These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. We operate in a very competitive and rapidly changing environment. New risks emerge from time to time. In making these statements we have made assumptions regarding, among other things: stable foreign exchange rates; no unforeseen changes occurring in the competitive landscape that would affect our industry; a stable economic environment; no significant event occurring outside the ordinary course of our business; stable interest rates; our ability to successfully implement our restructuring plans; and certain other assumptions that are set out proximate to the applicable forward-looking statements contained in this Report. While we believe our plans, intentions, expectations, assumptions and strategies reflected in these forward-looking statements are reasonable, we cannot assure you that these plans, intentions, expectations, assumptions and strategies will be achieved. Our actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained in this Report as a result of various factors, including the risks and uncertainties discussed elsewhere in this Report and in our Annual Report.

All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth in this Report. Except as required by law, we are under no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. Please refer to the section entitled "Risk Factors" included in our Annual Report for a further discussion of risks and uncertainties affecting our business and financial results.

Overview Mitel is a global provider of business communications and collaboration software and services. Our communication solutions meet the needs of customers in over 100 countries. Mitel operates as three business units; Mitel Communications Solutions ("MCS"), Mitel NetSolutions ("NetSolutions") and Other.

MCS MCS provides a wide range of unified communication and collaboration ("UCC") solutions to organizations of all types and sizes worldwide. While generally focused on the small-to-medium sized enterprise ("SME") market, we also have a strong and growing presence in the large enterprise market with a portfolio of products which supports up to 65,000 users. Our IP-based communications solutions consist of a combination of IP telephony platforms, which we deliver as software, appliances and desktop devices, and a suite of UCC applications that integrate voice, video and data communications with business applications.

We refer to these IP telephony platforms and UCC applications as integrated communications solutions. We believe that our solutions, which may include associated managed and network services, enable our customers to realize significant cost benefits and to conduct their business more effectively.

We have invested heavily in the research and development ("R&D") of our IP-based communications solutions to take advantage of the telecommunications industry shift from traditional PBX systems to IP-based communications solutions. Our R&D has produced a global portfolio of over 1,600 patents and pending applications, and provides us with the expertise to anticipate market trends and meet the current and future needs of our customers. We believe our early and sustained R&D investment in IP-based communications solutions has positioned us well to capitalize on the industry shift to IP-based communications solutions.

19-------------------------------------------------------------------------------- NetSolutions NetSolutions is a U.S.-based communications service provider. We focus on delivering leading telecommunications solutions to businesses with the following services: • Mitel NetSolutions for Voice and Data provides businesses with voice and data communication services and is a registered Competitive Local Exchange Carrier ("CLEC") in all 50 U.S. states; • Mitel Mobile Solutions provides business-class 3G and 4G wireless voice, text and internet services on a nationwide network; and • Mitel AnyWare provides a cloud-based service that delivers business communications without the need to own and maintain a traditional phone system.

Other Our Other division sells products and related services that complement the Company's core unified communications offering. Prior to the third quarter of fiscal 2012, the "Other" segment included our DataNet and CommSource business ("DataNet") and consisted primarily of the now-discontinued operations of the DataNet business, as described below.

Significant events and recent developments In the third quarter of fiscal 2012, we began to actively market for sale our DataNet business, which distributes a wide variety of third party telephony and data products and related services. As a result, at October 31, 2012, the assets of DataNet have been classified and accounted for as held for sale on the consolidated balance sheets and the operating results have been reported on the consolidated statements of operations as discontinued operations. Although we anticipate that a sale will be completed in fiscal 2013, there is no assurance of when and if a sale will be completed.

In August 2012, we completed amendments to our first lien and second lien credit agreements, effective July 23, 2012, in order to permit the potential disposition of the DataNet business for cash or vendor take-back promissory notes.

In response to macro-economic concerns, in the second quarter of fiscal 2013, we implemented a restructuring plan that included the termination of approximately 200 employees as well as the closure of excess facilities.

Operating results Total revenue for the three months ended October 31, 2012 was $145.5 million compared to $154.6 million for the three months ended October 31, 2011. The revenue decrease was primarily due to lower sales in our MCS segment as a result of a general deterioration in the macro-economic environment coupled with unfavorable changes in foreign exchange rates. Our operating income for the three months ended October 31, 2012 was $3.8 million compared to $2.8 million for the three months ended October 31, 2011. The increase in operating income was driven by a decrease in selling, general and administration costs. In addition, our gross margin percentage increased by an absolute 3.2% to 56.2% in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 as a result of lower product and service costs, as well as improved product mix in our MCS segment. The higher gross margin percentage was offset by the lower revenues.

20 -------------------------------------------------------------------------------- Selected financial data - results of operations The following table sets forth our comparative results of operations, both in dollars and as a percentage of total revenues, for the three months ended October 31, 2012 and October 31, 2011: Three months ended October 31, 2012 2011 Change % of % of Amount Revenue Amount Revenue Amount % (in millions, except percentages and per share amounts) Revenues $ 145.5 $ 154.6 $ (9.1 ) (5.9 ) Cost of revenues 63.7 43.8 % 72.6 47.0 % (8.9 ) (12.3 ) Gross margin 81.8 56.2 % 82.0 53.0 % (0.2 ) (0.2 ) Expenses: Selling, general and administrative 54.4 37.4 % 55.9 36.2 % (1.5 ) (2.7 ) Research and development 13.9 9.6 % 14.4 9.3 % (0.5 ) (3.5 ) Special charges and restructuring costs 9.3 6.4 % 8.4 5.4 % 0.9 10.7 Loss on litigation settlement 0.4 0.3 % 0.5 0.3 % (0.1 ) + 78.0 53.6 % 79.2 51.2 % (1.2 ) (1.5 ) Operating income from continuing operations 3.8 2.6 % 2.8 1.8 % 1.0 + Interest expense (4.6 ) (3.2 )% (4.6 ) (3.0 )% - - Other income (expense) 0.6 0.4 % (0.2 ) (0.1 )% 0.8 + Loss from continuing operations, before taxes (0.2 ) (0.1 )% (2.0 ) (1.3 )% 1.8 + Income tax recovery (expense) (1.4 ) (1.0 )% 0.3 0.2 % (1.7 ) + Net loss from continuing operations (1.6 ) (1.1 )% (1.7 ) (1.1 )% 0.1 + Net income (loss) from discontinued operations (0.3 ) (0.2 )% 0.5 0.3 % (0.8 ) + Net loss $ (1.9 ) (1.3 )% $ (1.2 ) (0.8 )% $ (0.7 ) + Adjusted EBITDA from continuing operations, a non-GAAP measure $ 24.1 16.6 % $ 21.4 13.8 % $ 2.7 12.6 Adjusted EBITDA from discontinued operations, a non-GAAP measure (0.5 ) (0.3 )% 0.8 0.5 % (1.3 ) + Adjusted EBITDA, a non-GAAP measure $ 23.6 16.2 % $ 22.2 14.4 % $ 1.4 6.3 + The comparison is not meaningful.

Net income (loss) per common share-Basic Net loss per share from continuing operations $ (0.03 ) $ (0.03 ) Net income (loss) per share from discontinued operations $ (0.01 ) $ 0.01 Net loss per share $ (0.04 ) $ (0.02 ) Net income (loss) per common share-Diluted Net loss per share from continuing operations $ (0.03 ) $ (0.03 ) Net income (loss) per share from discontinued operations $ (0.01 ) $ 0.01 Net loss per share $ (0.04 ) $ (0.02 ) Weighted-average number of common shares outstanding Basic 53.7 53.6 Diluted 53.7 53.6 21 -------------------------------------------------------------------------------- The following table sets forth our comparative results of operations, both in dollars and as a percentage of total revenues, for the six months ended October 31, 2012 and October 31, 2011: Six months ended October 31, 2012 2011 Change % of % of Amount Revenue Amount Revenue Amount % (in millions, except percentages and per share amounts) Revenues $ 284.0 $ 303.7 $ (19.7 ) (6.5 ) Cost of revenues 126.9 44.7 % 143.8 47.3 % (16.9 ) (11.8 ) Gross margin 157.1 55.3 % 159.9 52.7 % (2.8 ) (1.8 ) Expenses: Selling, general and administrative 112.3 39.5 % 111.4 36.7 % 0.9 0.8 Research and development 28.4 10.0 % 29.5 9.7 % (1.1 ) (3.7 ) Special charges and restructuring costs 11.3 4.0 % 13.2 4.3 % (1.9 ) (14.4 ) Loss on litigation settlement 1.1 0.4 % 1.0 0.3 % 0.1 + 153.1 53.9 % 155.1 51.1 % (2.0 ) (1.3 ) Operating income from continuing operations 4.0 1.4 % 4.8 1.6 % (0.8 ) + Interest expense (9.3 ) (3.3 )% (9.4 ) (3.1 )% 0.1 (1.1 ) Other income (expense) 0.6 0.2 % (0.6 ) (0.2 )% 1.2 + Loss from continuing operations, before taxes (4.7 ) (1.7 )% (5.2 ) (1.7 )% 0.5 + Income tax recovery 1.2 0.4 % 0.2 0.1 % 1.0 + Net loss from continuing operations (3.5 ) (1.2 )% (5.0 ) (1.6 )% 1.5 + Net income (loss) from discontinued operations (0.5 ) (0.2 )% 1.0 0.3 % (1.5 ) + Net loss $ (4.0 ) (1.4 )% $ (4.0 ) (1.3 )% $ - - Adjusted EBITDA from continuing operations, a non-GAAP measure $ 36.9 13.0 % $ 38.6 12.7 % $ (1.7 ) (4.4 ) Adjusted EBITDA from discontinued operations, a non-GAAP measure (0.9 ) (0.3 )% 1.6 0.5 % (2.5 ) + Adjusted EBITDA, a non-GAAP measure $ 36.0 12.7 % $ 40.2 13.2 % $ (4.2 ) (10.4 ) + The comparison is not meaningful.

Net income (loss) per common share-Basic Net loss per share from continuing operations $ (0.06 ) $ (0.09 ) Net income (loss) per share from discontinued operations $ (0.01 ) $ 0.02 Net loss per share $ (0.07 ) $ (0.07 ) Net income (loss) per common share-Diluted Net loss per share from continuing operations $ (0.06 ) $ (0.09 ) Net income (loss) per share from discontinued operations $ (0.01 ) $ 0.02 Net loss per share $ (0.07 ) $ (0.07 ) Weighted-average number of common shares outstanding Basic 53.6 53.4 Diluted 53.6 53.4 22 -------------------------------------------------------------------------------- Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA") The following table presents a reconciliation of Adjusted EBITDA to net income, the most directly comparable U.S. GAAP measure, for the three and six months ended October 31, 2012 and October 31, 2011: Three months ended Six months ended October 31 October 31 2012 2011 2012 2011 (in millions) (in millions) Net loss $ (1.9 ) $ (1.2 ) $ (4.0 ) $ (4.0 ) Net loss (income) from discontinued operations 0.3 (0.5 ) 0.5 (1.0 ) Net loss from continuing operations (1.6 ) (1.7 ) (3.5 ) (5.0 ) Adjustments: Interest expense 4.6 4.6 9.3 9.4 Income tax expense (recovery) 1.4 (0.3 ) (1.2 ) (0.2 ) Amortization and depreciation 9.0 8.1 17.6 16.5 Foreign exchange loss (gain) (0.1 ) 0.4 0.1 1.0 Special charges and restructuring costs 9.3 8.4 11.3 13.2 Stock-based compensation 1.1 1.4 2.2 2.7 Loss on litigation settlement 0.4 0.5 1.1 1.0 Adjusted EBITDA from continuing operations 24.1 21.4 36.9 38.6 Adjusted EBITDA from discontinued operations(1) (0.5 ) 0.8 (0.9 ) 1.6 Adjusted EBITDA $ 23.6 $ 22.2 $ 36.0 $ 40.2 (1) The reconciliation of net income from discontinued operations to Adjusted EBITDA from discontinued operations consists of income tax expense (recovery) of ($0.2), $0.3, ($0.4) and $0.6 million for the periods presented, respectively.

We believe that the use of Adjusted EBITDA provides consistency and comparability of period to period comparisons, and also facilitates comparisons with other companies in our industry, many of which use similar non-GAAP financial measures to supplement their U.S. GAAP results.

We believe Adjusted EBITDA may also be useful to investors in evaluating our operating performance because securities analysts use Adjusted EBITDA as a supplemental measure to evaluate the overall operating performance of companies, and our investor and analyst presentations include Adjusted EBITDA. However, we also caution you that other companies in our industry may calculate Adjusted EBITDA or similarly titled measures differently than we do, which limits the usefulness of Adjusted EBITDA as a comparative measure.

Moreover, although Adjusted EBITDA is frequently used by investors and securities analysts in their evaluations of companies, Adjusted EBITDA and similar non-GAAP measures have limitations as analytical tools, and you should not consider them in isolation or as a substitute for an analysis of our results of operations as reported under U.S. GAAP.

Adjusted EBITDA is not a measure calculated in accordance with U.S. GAAP.

Adjusted EBITDA should not be considered as an alternative to net income, income from operations or any other measure of financial performance calculated and presented in accordance with U.S. GAAP. We prepare Adjusted EBITDA to eliminate the impact of items that we do not consider indicative of our core operating performance. We encourage you to evaluate these adjustments and the reasons we consider them appropriate, as well as the material limitations of non-GAAP measures and the manner in which we compensate for those limitations. Our use of Adjusted EBITDA and its limitations are further discussed under Item 6 of our Annual Report.

23 -------------------------------------------------------------------------------- Results of operations Revenues The following table sets forth revenues by business segment in dollars and as a percentage of total revenues: Three months ended October 31, 2012 2011 Change % of % of Revenues Revenues Revenues Revenues Amount % (in millions, except percentages) Mitel Communications Solutions ("MCS") $ 122.0 83.8 % $ 129.4 83.7 % $ (7.4 ) (5.7 ) NetSolutions 20.9 14.4 % 20.4 13.2 % 0.5 2.5 Other 2.6 1.8 % 4.8 3.1 % (2.2 ) (45.8 ) $ 145.5 100.0 % $ 154.6 100.0 % $ (9.1 ) (5.9 ) Six months ended October 31, 2012 2011 Change % of % of Revenues Revenues Revenues Revenues Amount % (in millions, except percentages) Mitel Communications Solutions ("MCS") $ 236.5 83.3 % $ 253.8 83.6 % $ (17.3 ) (6.8 ) NetSolutions 41.6 14.6 % 40.4 13.3 % 1.2 3.0 Other 5.9 2.1 % 9.5 3.1 % (3.6 ) (37.9 ) $ 284.0 100.0 % $ 303.7 100.0 % $ (19.7 ) (6.5 ) MCS revenues decreased by $7.4 million, or 5.7%, in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 and decreased by $17.3 million, or 6.8%, in the first six months of fiscal 2013 compared to the first six months of fiscal 2012. The decreases were due primarily to lower volumes across most geographies as a result of a general deterioration in the macro-economic environment coupled with unfavorable changes in foreign exchange rates. The U.S. dollar was stronger against most currencies in the first six months of fiscal 2013 compared to the first six months of fiscal 2012. In particular, the U.S. dollar was stronger against the British pound sterling and Euro by an average of 1.3% and 10.9%, respectively, in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012. The U.S. dollar was also stronger against the British pound sterling and Euro by an average of 2.4% and 11.3%, respectively, in the comparative six month periods. The weaker foreign currencies resulted in foreign sales being translated at a lower rate, which caused a $1.3 million decrease in revenues in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 and a $4.1 million decrease in revenues in the comparative six month periods.

These decreases in revenues in the second quarter and first six months of fiscal 2013 were partially offset by initial sales to a new distributor in the U.S. In the second quarter of fiscal 2013, we entered into a new U.S. distribution agreement with one of the world's largest distributors of technology products.

This evolution in our channel structure aims to ensure our diverse product offerings are brought to market through the broadest and most effective channel delivery and distribution vehicles.

NetSolutions revenues increased by $0.5 million, or 2.5%, in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 and increased by $1.2 million, or 3.0%, in the first six months of fiscal 2013 compared to the first six months of fiscal 2012. The increased revenues were driven by an increase in spending per customer.

Other revenues decreased by $2.2 million, or 45.8%, in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 and decreased by $3.6 million, or 37.9%, in the first six months of fiscal 2013 compared to the first six months of fiscal 2012. The decreases in revenues were due primarily to the completion of a significant non-core managed service contract at the end of the second quarter of fiscal 2012.

Gross Margin The following table sets forth gross margin, both in dollars and as a percentage of revenues: Three months ended October 31, Six months ended October 31, 2012 2011 2012 2011 Gross Gross Gross Gross Gross Gross Gross Gross Margin Margin % Margin Margin % Margin Margin % Margin Margin % (in millions, except percentages) Gross margin 81.8 56.2 % 82.0 53.0 % 157.1 55.3 % 159.9 52.7 % 24 -------------------------------------------------------------------------------- Overall gross margin percentage in the second quarter of fiscal 2013 increased by an absolute 3.2% to 56.2% compared to 53.0% for the second quarter of fiscal 2012. For the first six months of fiscal 2013 the gross margin increased an absolute 2.6% to 55.3% compared to 52.7% for the first six months of fiscal 2012. Both increases were primarily due to a stronger gross margin percentage in the MCS segment. MCS gross margin percentage increased due to lower product and service costs as well as product mix as our sales mix continues to trend to higher margin software products.

NetSolutions gross margin percentage remained consistent in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 as well as the first six months of fiscal 2013 when compared to the first six months of fiscal 2012.

Operating Expenses Selling, General and Administrative ("SG&A") SG&A expenses increased to 37.4% of revenues in the second quarter of fiscal 2013 from 36.2% in the second quarter of fiscal 2012, a decrease of $1.5 million in absolute dollars. Our SG&A expenses for the second quarter of fiscal 2013 included certain non-cash charges, most significantly $5.6 million (second quarter of fiscal 2012-$5.6 million) for the amortization of intangible assets related to the fiscal 2008 acquisition of Inter-Tel. In addition, SG&A expenses included $1.1 million (second quarter of fiscal 2012-$1.4 million) of non-cash compensation expenses associated with employee stock options. The decrease in absolute dollars in SG&A expenses was largely driven by lower variable compensation due to lower revenue levels.

For the first six months of fiscal 2013, SG&A expenses increased to 39.5% of revenues from 36.7% in the first six months of fiscal 2012, an increase of $0.9 million in absolute dollars. Our SG&A expenses for the first six months of fiscal 2013 included certain non-cash charges, most significantly $11.2 million (first six months of fiscal 2012-$11.2 million) for the amortization of intangible assets related to the fiscal 2008 acquisition of Inter-Tel. In addition, SG&A expenses included $2.2 million (first six months of fiscal 2012-$2.7 million) of non-cash compensation expenses associated with employee stock options. The increase in SG&A expenses was largely driven by increased expenses for marketing events and legal costs relating to patent settlements incurred during the first quarter of fiscal 2013, which were partially offset by lower variable compensation to employees due to lower revenue levels.

Research and Development ("R&D") R&D expenses in the second quarter of fiscal 2013 increased to 9.6% of revenues compared to 9.3% of revenues for the second quarter of fiscal 2012, a decrease of $0.5 million in absolute dollars. R&D expenses in the first six months of fiscal 2013 increased to 10.0% of revenues compared to 9.7% of revenues for the first six months of fiscal 2012, a decrease of $1.1 million in absolute dollars.

The decrease in absolute dollars for both the three-month and six-month periods was primarily driven by a reduction in costs as a result of the closure of a research and development facility in Ireland at the end of the second quarter of fiscal 2012.

We have historically invested heavily in R&D, consistent with an aggressive R&D investment strategy which we believe has positioned us well with a broad range of feature-rich, scalable, standards-based and interoperable IP-based communication solutions. Our R&D expenses in absolute dollars can fluctuate depending on the timing and number of development initiatives in any given quarter. R&D expenses as a percentage of revenues is highly dependent on revenue levels and could vary significantly depending on actual revenues achieved.

Special Charges and Restructuring Costs We recorded special charges and restructuring costs of $9.3 million in the second quarter of fiscal 2013. In response to macro-economic concerns, in August 2012, we implemented a restructuring plan that included the termination of approximately 200 employees as well as the closure of excess facilities. The second quarter charges consisted of $6.0 million in employee termination costs and $3.3 million in facility-related charges, primarily related to our August 2012 restructuring actions.

We recorded special charges and restructuring costs of $2.0 million in the first quarter of fiscal 2013. The charges primarily related to headcount reductions and additional lease termination obligations in North America as we reduced our cost structure.

We recorded restructuring costs of $8.4 million in the second quarter of fiscal 2012. The special charges consisted of $4.2 million for facility and employee termination costs for approximately 50 people related to the planned closure of a research and development facility in Ireland. The remaining charge for the second quarter of fiscal 2012 primarily related to lease termination costs and severance costs for approximately 100 people in North America as we realigned our business in the United States.

We recorded restructuring costs of $4.8 million in the first quarter of fiscal 2012. The special charges consisted of $3.3 million of employee termination costs related to the reorganization of our business announced in May 2011 as well as facility charges of $1.5 million recorded largely as a result of changes in estimates relating to our lease termination obligations.

We may take additional restructuring actions in the future to reduce our operating expenses and gain operating efficiencies. The timing and potential amount of such actions will depend on several factors, including future revenue levels and opportunities for operating efficiencies identified by management.

25 -------------------------------------------------------------------------------- Operating Income from Continuing Operations We reported operating income from continuing operations of $3.8 million in the second quarter of fiscal 2013 compared to $2.8 million in the second quarter of fiscal 2012. The increase was primarily due to lower SG&A expenses. Gross margin, in dollars, remained consistent as a higher gross margin percentage was offset by lower revenues. We reported operating income from continuing operations of $4.0 million for the first six months of fiscal 2013 compared to $4.8 million for the first six months of fiscal 2012. The decrease was primarily due to lower gross margin in the first quarter of fiscal 2013 compared to the first quarter of fiscal 2012 due to lower revenues, which was partially offset by lower special charges and restructuring costs, as described above.

Non-Operating Expenses Interest Expense Interest expense was $4.6 million in the second quarter of fiscal 2013 compared to $4.6 million in the second quarter of fiscal 2012. Interest expense was $9.3 million for the first six months of fiscal 2013 compared to $9.4 million for the first six months of fiscal 2012. The slight decrease in interest expense was primarily due to lower debt balances, primarily as a result of the $2.2 million excess cash flow repayment made at the beginning of the second quarter of fiscal 2013 and the $12.3 million excess cash flow repayment made at the end of the first quarter of fiscal 2012.

Provision for Income Taxes We recorded a net income tax expense of $1.4 million in the second quarter of fiscal 2013, compared to a recovery of $0.3 million for the second quarter of fiscal 2012. The net income tax expense in the second quarter of fiscal 2013 is the result of taxable income in certain jurisdictions. We recorded a net income tax recovery of $1.2 million for the first six months of fiscal 2013, compared to a recovery of $0.2 million for the first six months of fiscal 2012. The net income tax recovery for the first six months of fiscal 2013 was primarily driven by an increase in the tax rate in Ontario, Canada in the first quarter of fiscal 2013, which resulted in an increase in the value of our deferred tax assets.

Net Loss from Continuing Operations Our net loss from continuing operations for the second quarter of fiscal 2013 was $1.6 million compared to a net loss from continuing operations of $1.7 million in the second quarter of fiscal 2012. The net loss from continuing operations remained consistent as higher operating income from continuing operations was largely offset by higher tax expense, as described above.

Our net loss from continuing operations for the first six months of fiscal 2013 was $3.5 million compared to a net loss from continuing operations of $5.0 million for the first six months of fiscal 2012. The lower net loss from continuing operations was primarily due to the tax recovery in the first quarter of fiscal 2013, which was partially offset by lower operating income from continuing operations, as described above.

Net Income (Loss) from Discontinued Operations The operations of DataNet have been reported on the consolidated statements of operations as discontinued operations, as discussed in the "Significant events and recent developments" under the "Overview" section above. The following table provides information on the operations of DataNet for the periods presented: Three months ended Six months ended October 31, October 31, October 31, October 31, 2012 2011 2012 2011 Revenues $ 11.3 $ 14.2 $ 23.9 $ 29.2 Income (loss) from discontinued operations, before taxes $ (0.5 ) $ 0.8 $ (0.9 ) $ 1.6 Income tax recovery (expense) 0.2 (0.3 ) 0.4 (0.6 ) Net income (loss) from discontinued operations, net of tax $ (0.3 ) $ 0.5 $ (0.5 ) $ 1.0 Our net loss from discontinued operations for the second quarter of fiscal 2013 was $0.3 million compared to net income from discontinued operations of $0.5 million in the second quarter of fiscal 2012. Our net loss from discontinued operations for the first six months of fiscal 2013 was $0.5 million compared to net income from discontinued operations of $1.0 million for the first six months of fiscal 2012. The decrease in net income from discontinued operations was driven by lower revenues, including through our direct business as a result of our new go-to-market model.

26 -------------------------------------------------------------------------------- Net Loss Our net loss for the second quarter of fiscal 2013 was $1.9 million compared to a net loss of $1.2 million in the second quarter of fiscal 2012. Our net loss for the first six months of fiscal 2013 was $4.0 million compared to a net loss of $4.0 million for the first six months of fiscal 2012. Improved net loss from continuing operations for the three- and six-month periods was largely offset by higher losses from our discontinued operations.

Other Comprehensive Income (Loss) Other comprehensive income for the first six months of fiscal 2013 includes a gain of $5.6 million recorded in the second quarter of fiscal 2013 related to a pension liability adjustment on the Company's U.K. subsidiary's defined benefit pension plan. The pension valuation was updated at October 31, 2012 to reflect a change in assumptions and actual investment performance for the first six months of fiscal 2013.

Other comprehensive loss for the first six months of fiscal 2012 includes a loss of $6.9 million recorded in the first quarter of fiscal 2012 related to a pension liability adjustment on the Company's U.K. subsidiary's defined benefit pension plan. The pension valuation was updated at July 31, 2011 to reflect a change in assumptions and actual investment performance for the first quarter of fiscal 2012.

Adjusted EBITDA Adjusted EBITDA, a non-GAAP measure, was $23.6 million in the second quarter of fiscal 2013 compared to $22.2 million in the second quarter of fiscal 2012, an increase of $1.4 million. This increase was driven primarily by lower SG&A and R&D expenses, which were partially offset by lower Adjusted EBITDA from discontinued operations.

Adjusted EBITDA, a non-GAAP measure, was $36.0 million in the first six months of fiscal 2013 compared to $40.2 million in the first six months of fiscal 2012, a decrease of $4.2 million. This decrease was driven by our lower Adjusted EBITDA in the first quarter of fiscal 2013 compared to the first quarter of fiscal 2012. The first quarter decrease was driven by lower gross margin due to lower revenues, higher SG&A expenses and lower Adjusted EBITDA from discontinued operations.

For a definition and explanation of Adjusted EBITDA and why we believe it is useful in evaluating our financial condition, as well as a reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP measure, see "Selected consolidated financial data - Results of operations", elsewhere in this Report.

Cash Flows Below is a summary of comparative results of cash flows and a discussion of the results for the three and six months ended October 31, 2012 and October 31, 2011.

Three months ended Six months ended October 31, October 31, 2012 2011 Change 2012 2011 Change (in millions) Net cash provided by (used in) Operating activities $ 16.7 $ 3.8 $ 12.9 $ 20.1 $ 16.2 $ 3.9 Investing activities (4.4 ) (3.9 ) (0.5 ) (7.9 ) (6.5 ) (1.4 ) Financing activities (3.0 ) (1.8 ) (1.2 ) (3.3 ) (13.9 ) 10.6 Effect of exchange rate changes on cash and cash equivalents 0.6 (0.5 ) 1.1 (0.2 ) (0.8 ) 0.6 Increase (decrease) in cash and cash equivalents $ 9.9 $ (2.4 ) $ 12.3 $ 8.7 $ (5.0 ) $ 13.7 Cash Provided by Operating Activities Cash generated from operating activities in the second quarter of fiscal 2013 was $16.7 million compared to $3.8 million in the second quarter of fiscal 2012.

The second quarter increase was largely due to favorable change in non-cash operating assets and liabilities, in particular the change in accounts payable and accrued liabilities. The cash generated from operating activities for the first six months of fiscal 2013 was $20.1 million compared to $16.2 million for the first six months of fiscal 2012 due primarily to the same factor as for the second quarter.

Cash Used in Investing Activities Net cash used for investing activities was $4.4 million in the second quarter of fiscal 2013 compared to $3.9 million in the second quarter of fiscal 2012. Net cash used for investing activities was $7.9 million in the first six months of fiscal 2013 compared to $6.5 million in the first six months of fiscal 2012. The higher use of cash in the fiscal 2013 periods was due primarily to higher additions to property, plant and equipment including our investment in facilities and information technology infrastructure made during the periods.

27 -------------------------------------------------------------------------------- Cash Used in Financing Activities Net cash used in financing activities in the second quarter of fiscal 2013 was $3.0 million compared to cash used in financing activities of $1.8 million during the second quarter of fiscal 2012. Net cash used in financing activities in the first six months of fiscal 2013 was $3.3 million compared to cash used in financing activities of $13.9 million during the first six months of fiscal 2012. The use of cash in the second quarter of fiscal 2013 includes the $2.2 million repayment of our first lien term loan made in August 2012 relating to the annual repayment of excess cash flow as defined in the first lien credit agreement, due 100 days after our fiscal year-end. In fiscal 2012, the excess cash flow repayment of $12.3 million was made in July 2011 (first quarter of fiscal 2012).

Effect of Exchange Rate Changes on Cash Our overall cash position was also impacted by exchange rate changes during the period, which increased cash by $0.6 million during the second quarter of fiscal 2013 (second quarter of fiscal 2012- decreased by $0.5 million) and decreased by $0.2 million during the first six months of fiscal 2013 (first six months of 2012 - decreased by $0.8 million).

Liquidity and Capital Resources As of October 31, 2012, our liquidity consisted primarily of cash and cash equivalents of $87.4 million. Our undrawn $30.0 million revolving facility matured in August 2012. At October 31, 2012, we had a liability of $303.8 million (April 30, 2012-$306.1 million) relating to amounts outstanding under our secured credit facilities, consisting of a first lien term loan due August 2014 and second lien term loan due August 2015.

In August 2012, we repaid $2.2 million of our first lien term loan primarily relating to the annual repayment of excess cash flow as defined in the first lien credit agreement. The annual excess cash flow payment is due 100 days after our fiscal year-end.

The Company is subject to annual repayments of excess cash flow under the terms of the first lien credit agreement. In addition, the proceeds from the issuance of equity or debt (including proceeds received from the exercise of options), and proceeds from the sale of Company assets, including those from the potential sale of DataNet, may also be required to be used, in whole or in part, to make mandatory prepayments under the first lien credit agreement and, once the first lien term loan is repaid, under the second lien credit agreement.

Our first and second lien credit agreements, as amended, include various covenants, including a maximum ratio of Consolidated Total Debt to the trailing twelve months Earnings before Interest, Taxes, Depreciation and Amortization ("Leverage Ratio"). The following table presents our maximum Leverage Ratio and our actual Leverage ratio for the last seven fiscal periods.

Maximum Actual Period Ending Leverage Ratio Leverage Ratio April 30, 2011 4.1 3.6 July 31, 2011 4.1 3.6 October 31, 2011 4.1 3.3 January 31, 2012 3.9 3.1 April 30, 2012 3.6 2.9 July 31, 2012 3.4 3.1 October 31, 2012 3.2 3.0 At October 31, 2012 and April 30, 2012, our cash equivalents consist of short-term, investment-grade commercial paper and government debt. We classify our cash equivalents as current based on their nature and their availability for use in current operations. We believe the overall credit quality of our portfolio is strong, with a majority of our cash equivalents invested in federal government treasury bills of Canada, the U.S. and the U.K.

We follow an investment policy where our excess cash is invested in investment-grade commercial paper and government debt, generally with a maturity of less than three months. There is no limit on the investments in the federal governments of Canada, the U.S. or the U.K. We diversify our portfolio by limiting the amount invested in any other single institution.

We have a defined benefit pension plan in place for a number of our past and present employees in the U.K. The plan has been closed to new members since 2001. At October 31, 2012, the plan had an unfunded pension liability of $69.3 million (April 30, 2012-$75.2 million). Contributions to fund the benefit obligations under this plan are based on actuarial valuations, which themselves are based on certain assumptions about the long-term operations of the plan, including employee turnover and retirement rates, the performance of the financial markets and interest rates. The amount of annual employer contributions required to fund the 28 -------------------------------------------------------------------------------- pension deficit annually is determined every three years, in accordance with U.K. regulations and is based on a calendar year. In October 2010, the Company's annual funding requirement to fund the pension deficit for the 2011 calendar year was determined to be $4.0 million (£2.5 million), and increases at an annual rate of 3% for the calendar years 2012 and 2013. In the three and six months ended October 31, 2012, we contributed $1.1 million and $2.1 million, respectively, to fund the pension deficit (three and six months ended October 31, 2011-$1.0 million and $2.0 million, respectively).

We believe that we will have sufficient liquidity to support our business operations for the next 12 months. However, we may elect to seek additional funding prior to that time. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support product development efforts and expansion of sales and marketing, the timing of introductions of new products and enhancements to existing products, and market acceptance of our products. Additional equity or debt financing may not be available on acceptable terms or at all. In addition, any proceeds from the issuance of equity or debt may be required to be used, in whole or in part, to make mandatory payments under our credit agreements. We believe that our sources of liquidity beyond the next 12 months will be from our then-current cash balances and funds from operations.

Contractual Obligations The following table sets forth our contractual obligations as of October 31, 2012: Payments Due by Fiscal Year Last six 2018 months and Contractual Obligations of 2013 2014 2015 2016 2017 beyond Total (in millions) Long-term debt obligations (1) $ 8.4 $ 23.5 $ 177.5 $ 132.7 $ - $ - $ 342.1 Capital lease obligations (2) 3.2 3.7 2.7 1.8 0.4 - 11.8 Operating lease obligations (3) 8.9 14.1 12.9 11.0 6.1 17.8 70.8 Defined benefit pension plan contributions (4) 2.5 3.5 - - - - 6.0 Other (5) 2.3 4.3 4.1 2.0 - - 12.7 Total $ 25.3 $ 49.1 $ 197.2 $ 147.5 $ 6.5 $ 17.8 $ 443.4 (1) Represents the principal balance and interest payments for the first and second lien term loans. Interest on the first and second lien term loans is based on LIBOR plus 3.25%, and LIBOR plus 7.0%, respectively, as described in our audited annual consolidated financial statements. For the purposes of estimating the variable interest, the average 3-month LIBOR from the last three years, 0.4%, has been used. Included in fiscal 2014 is $7.8 million of first lien term loan repayment relating to the annual repayment of excess cash flows from fiscal 2013, as described in the "Liquidity and Capital Resources" section, above.

(2) Represents the principal and interest payments for capital lease obligations.

Interest rates on these obligations range from 5.5% to 11.0%.

(3) Operating lease obligations exclude payments to be received by us under sublease arrangements.

(4) Represents the estimated contribution to our defined benefit pension plan in the United Kingdom over the next 12 months. The amount of annual employer contributions required to fund the deficit is determined every three years in accordance with U.K. regulations, and is based on a calendar year. In October 2010, the Company's annual funding requirement to fund the pension deficit for the calendar year 2011 was determined to be $4.0 million (£2.5 million), with increases at an annual rate of 3% for calendar years 2012 and 2013.

Future funding requirements after calendar year 2013 are highly dependent on the unfunded pension liability and the time period in which the deficit is amortized. As a result, liabilities arising from the remaining unfunded deficit in our defined benefit pension plan are not included in the above table.

(5) Represents payments under an information technology outsourcing agreement.

Total contractual obligations listed do not include contractual obligations recorded on the balance sheet as current liabilities, except for those associated with a long-term liability. Contractual obligations also exclude $11.2 million of liabilities relating to uncertain tax positions due to the uncertainty of the timing of any potential payments.

Purchase orders or contracts for the purchase of raw materials and other goods and services are not included in the table above. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements.

29 -------------------------------------------------------------------------------- Off-Balance Sheet Arrangements Off-balance sheet arrangements that have material changes from those disclosed in our Annual Report are as follows: Sales-type leases We offer our customers lease financing and other services under our managed services offering. We fund this offering, which we have branded as the TotalSolution ® program, in part through the sale to financial institutions of rental payment streams under the leases. Such financial institutions have the option to require us to repurchase such income streams, subject to limitations, in the event of defaults by lease customers and, accordingly, we maintain reserves based on loss experience and past due accounts. In addition, such financial institutions have the option to require us to repurchase such income streams upon any uncured breach by us under the terms of the underlying sale agreements. At October 31, 2012, sold payments remaining unbilled net of lease recourse reserves, which represents the total balance of leases that are not included in our balance sheet, were $121.8 million (April 30, 2012-$135.8 million).

Critical Accounting Policies The preparation of our consolidated financial statements and related disclosures in conformity with GAAP requires us to make estimates and assumptions about future events that can have a material impact on the amounts reported in our consolidated financial statements and accompanying notes. The determination of estimates requires the use of assumptions and the exercise of judgment and, as such, actual results could differ from those estimated. Our significant accounting policies are described in Note 2 to our audited annual consolidated financial statements included in our Annual Report. The following critical accounting policies are those that we believe require a high level of subjectivity and judgment and have a material impact on our financial condition and operating performance: revenue recognition, allowance for doubtful accounts and the lease recourse liability, provisions for inventory, provisions for product warranties, long-lived asset depreciation, goodwill valuation, special charges, contingencies, deferred taxes, pension and post-retirement benefits, and the valuation of stock options, warrants and other derivative instruments.

The following critical accounting policies have been updated from the disclosure provided in our Annual Report.

Sales-Type Leases, reserves Our total reserve for losses related to the entire lease portfolio, including amounts classified as accounts receivable on our balance sheet, was 4.5% of the ending aggregate lease portfolio as of October 31, 2012 compared to 4.9% at April 30, 2012. The reserve is based on a review of our past write-off experience and a review of the accounts receivable aging as of October 31, 2012.

We believe our reserves are adequate to cover future potential write-offs.

Should, however, the financial condition of our customers deteriorate in the future, additional reserves in amounts that could be material to the financial statements could be required.

Allowance for Doubtful Accounts Our allowance for doubtful accounts is based on our assessment of the collectability of customer accounts. A considerable amount of judgment is required in order to make this assessment, including a detailed analysis of the aging of our accounts receivable, the current creditworthiness of our customers and an analysis of historical bad debts and other adjustments. If there is a deterioration of a major customer's creditworthiness or actual defaults are higher than our historical experience, our estimate of the recoverability of amounts due could be adversely affected. We review in detail our allowance for doubtful accounts on a quarterly basis and adjust the allowance amount estimate to reflect actual portfolio performance and change in future portfolio performance expectations. As of October 31, 2012 and April 30, 2012, the provision represented 4.2% and 4.0% of gross receivables, respectively.

Stock-Based Compensation The fair value of the stock options granted is estimated on the grant date using the Black-Scholes option-pricing model for each award, net of estimated forfeitures, and is recognized over the employee's requisite service period, which is generally the vesting period. The assumptions used in the Black-Scholes option-pricing model for the options granted in the first six months of fiscal 2013 are included in note 13 to the unaudited interim consolidated financial statements.

For the three and six months ended October 31, 2012, stock-based compensation expense was $1.1 million and $2.2 million, respectively (three and six months ended October 31, 2011-$1.4 million and $2.7 million, respectively). As of October 31, 2012, there was $7.7 million of unrecognized stock-based compensation expense related to stock option awards (April 30, 2012-$8.5 million). We expect this cost to be recognized over a weighted average period of 2.3 years (April 30, 2012-2.5 years).

Recent Accounting Pronouncements Comprehensive income In June 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2011-05 to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of comprehensive income. The ASU provides amendments to the Comprehensive Income subtopic of the FASB Accounting Standards Codification ("ASC"), such that comprehensive income must be presented in a single continuous statement with net income, or in a separate, but consecutive, statement. We adopted this ASU in the first quarter of fiscal 2013 by reporting a separate statement of comprehensive income.

30--------------------------------------------------------------------------------

[ Back To Contact Center Solutions's Homepage ]

Subscribe here for your FREE Contact
Center Solutions
enewslettter.

Events

Weekly Live Demo
Contact Center Solutions

Register Today!


Weekly Live Demo
CaaS Small Center

Register Today!