UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2013
OR
o |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM TO
Commission file number 000-24643
DIGITAL RIVER, INC.
(Exact name of registrant as specified in its charter)
DELAWARE |
|
41-1901640 |
(State or other jurisdiction of |
|
(I.R.S. Employer |
incorporation or organization) |
|
Identification Number) |
10380 BREN ROAD WEST
MINNETONKA, MINNESOTA 55343
(Address of principal executive offices)
(952) 253-1234
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Exchange Act Rule 12b-2). See definition of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x |
|
Accelerated filer o |
|
Non-accelerated filer o |
|
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
The number of shares of common stock outstanding at October 1, 2013, was 33,432,526 shares.
DIGITAL RIVER, INC.
Form 10-Q
DIGITAL RIVER, INC.
(in thousands, except share data)
|
|
(Unaudited) |
|
|
| ||
|
|
September 30, |
|
December 31, |
| ||
|
|
2013 |
|
2012 |
| ||
ASSETS |
|
|
|
|
| ||
CURRENT ASSETS |
|
|
|
|
| ||
Cash and cash equivalents |
|
$ |
458,062 |
|
$ |
542,851 |
|
Short-term investments |
|
122,698 |
|
162,794 |
| ||
Accounts receivable, net of allowance of $2,853 and $4,834 |
|
50,605 |
|
55,192 |
| ||
Deferred tax assets |
|
119 |
|
457 |
| ||
Prepaid expenses and other |
|
28,807 |
|
31,813 |
| ||
Assets of discontinued operations |
|
6,584 |
|
7,561 |
| ||
Total current assets |
|
666,875 |
|
800,668 |
| ||
|
|
|
|
|
| ||
Property and equipment, net |
|
52,703 |
|
53,098 |
| ||
Goodwill |
|
140,389 |
|
108,960 |
| ||
Intangible assets, net of accumulated amortization of $85,655 and $78,757 |
|
32,255 |
|
11,718 |
| ||
Long-term investments |
|
52,810 |
|
71,735 |
| ||
Deferred income taxes |
|
1,390 |
|
1,792 |
| ||
Other assets |
|
2,512 |
|
4,313 |
| ||
TOTAL ASSETS |
|
$ |
948,934 |
|
$ |
1,052,284 |
|
|
|
|
|
|
| ||
LIABILITIES AND STOCKHOLDERS EQUITY |
|
|
|
|
| ||
CURRENT LIABILITIES |
|
|
|
|
| ||
Accounts payable |
|
$ |
135,699 |
|
$ |
201,826 |
|
Accrued payroll |
|
15,316 |
|
11,294 |
| ||
Deferred revenue |
|
10,008 |
|
13,119 |
| ||
Other current liabilities |
|
70,994 |
|
50,149 |
| ||
Liabilities of discontinued operations |
|
7,291 |
|
5,753 |
| ||
Total current liabilities |
|
239,308 |
|
282,141 |
| ||
|
|
|
|
|
| ||
NON-CURRENT LIABILITIES |
|
|
|
|
| ||
Senior convertible notes |
|
295,750 |
|
309,909 |
| ||
Other liabilities |
|
22,217 |
|
18,236 |
| ||
Total non-current liabilities |
|
317,967 |
|
328,145 |
| ||
TOTAL LIABILITIES |
|
557,275 |
|
610,286 |
| ||
|
|
|
|
|
| ||
STOCKHOLDERS EQUITY |
|
|
|
|
| ||
Preferred stock, $.01 par value; 5,000,000 shares authorized; no shares issued or outstanding |
|
|
|
|
| ||
Common stock, $.01 par value; 120,000,000 shares authorized; 49,928,175 and 48,941,402 shares issued |
|
499 |
|
489 |
| ||
Treasury stock at cost; 16,495,649 and 13,581,889 shares |
|
(416,999 |
) |
(368,721 |
) | ||
Additional paid-in capital |
|
756,239 |
|
737,499 |
| ||
Retained earnings |
|
51,177 |
|
75,901 |
| ||
Accumulated other comprehensive income (loss) |
|
743 |
|
(3,170 |
) | ||
Total stockholders equity |
|
391,659 |
|
441,998 |
| ||
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
|
$ |
948,934 |
|
$ |
1,052,284 |
|
See accompanying notes to consolidated financial statements.
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
September 30, |
|
September 30, |
| ||||||||
|
|
2013 |
|
2012 |
|
2013 |
|
2012 |
| ||||
Revenue |
|
$ |
87,260 |
|
$ |
87,056 |
|
$ |
288,444 |
|
$ |
272,377 |
|
Costs and expenses (exclusive of depreciation and amortization expense shown separately below): |
|
|
|
|
|
|
|
|
| ||||
Direct cost of services |
|
16,205 |
|
15,476 |
|
55,272 |
|
47,810 |
| ||||
Network and infrastructure |
|
14,648 |
|
13,184 |
|
44,049 |
|
38,322 |
| ||||
Sales and marketing |
|
25,013 |
|
22,756 |
|
80,415 |
|
74,593 |
| ||||
Product research and development |
|
18,108 |
|
15,201 |
|
52,967 |
|
45,632 |
| ||||
General and administrative |
|
12,011 |
|
13,726 |
|
44,040 |
|
37,025 |
| ||||
Goodwill impairment |
|
|
|
|
|
21,249 |
|
|
| ||||
Depreciation and amortization |
|
5,682 |
|
4,940 |
|
15,748 |
|
15,171 |
| ||||
Amortization of acquisition-related intangibles |
|
2,149 |
|
1,118 |
|
6,360 |
|
3,526 |
| ||||
Total costs and expenses |
|
93,816 |
|
86,401 |
|
320,100 |
|
262,079 |
| ||||
Income (loss) from operations |
|
(6,556 |
) |
655 |
|
(31,656 |
) |
10,298 |
| ||||
Interest income |
|
553 |
|
773 |
|
1,929 |
|
2,908 |
| ||||
Interest expense |
|
(1,941 |
) |
(2,262 |
) |
(5,884 |
) |
(6,756 |
) | ||||
Other income (expense), net |
|
(297 |
) |
(601 |
) |
16,717 |
|
124 |
| ||||
Income (loss) from continuing operations before income taxes |
|
(8,241 |
) |
(1,435 |
) |
(18,894 |
) |
6,574 |
| ||||
Income tax expense (benefit) |
|
(645 |
) |
(700 |
) |
(408 |
) |
1,444 |
| ||||
Income (loss) from continuing operations |
|
(7,596 |
) |
(735 |
) |
(18,486 |
) |
5,130 |
| ||||
Income (loss) from discontinued operations, net of tax |
|
(4,891 |
) |
1 |
|
(6,238 |
) |
(927 |
) | ||||
Net income (loss) |
|
$ |
(12,487 |
) |
$ |
(734 |
) |
$ |
(24,724 |
) |
$ |
4,203 |
|
|
|
|
|
|
|
|
|
|
| ||||
Income (loss) per share - basic: |
|
|
|
|
|
|
|
|
| ||||
Income (loss) from continuing operations |
|
$ |
(0.24 |
) |
$ |
(0.02 |
) |
$ |
(0.57 |
) |
$ |
0.16 |
|
Income (loss) from discontinued operations |
|
(0.16 |
) |
0.00 |
|
(0.19 |
) |
(0.03 |
) | ||||
Net income (loss) per share - basic |
|
$ |
(0.40 |
) |
$ |
(0.02 |
) |
$ |
(0.76 |
) |
$ |
0.13 |
|
|
|
|
|
|
|
|
|
|
| ||||
Income (loss) per share - diluted: |
|
|
|
|
|
|
|
|
| ||||
Income (loss) from continuing operations |
|
$ |
(0.24 |
) |
$ |
(0.02 |
) |
$ |
(0.57 |
) |
$ |
0.16 |
|
Income (loss) from discontinued operations |
|
(0.16 |
) |
0.00 |
|
(0.19 |
) |
(0.03 |
) | ||||
Net income (loss) per share - diluted |
|
$ |
(0.40 |
) |
$ |
(0.02 |
) |
$ |
(0.76 |
) |
$ |
0.13 |
|
|
|
|
|
|
|
|
|
|
| ||||
Shares used in per-share calculation - basic |
|
31,487 |
|
32,685 |
|
32,435 |
|
33,347 |
| ||||
Shares used in per-share calculation - diluted |
|
31,487 |
|
32,685 |
|
32,435 |
|
33,579 |
|
See accompanying notes to consolidated financial statements.
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands; unaudited)
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
September 30, |
|
September 30, |
| ||||||||
|
|
2013 |
|
2012 |
|
2013 |
|
2012 |
| ||||
Net income (loss) |
|
$ |
(12,487 |
) |
$ |
(734 |
) |
$ |
(24,724 |
) |
$ |
4,203 |
|
Other comprehensive income (loss): |
|
|
|
|
|
|
|
|
| ||||
Unrealized foreign currency translation gain (loss) |
|
8,749 |
|
9,297 |
|
524 |
|
1,601 |
| ||||
Unrealized gain (loss) on investments |
|
292 |
|
1,128 |
|
3,389 |
|
(5,159 |
) | ||||
Tax benefit (expense) |
|
1,053 |
|
(647 |
) |
|
|
1,981 |
| ||||
Other comprehensive income (loss) |
|
10,094 |
|
9,778 |
|
3,913 |
|
(1,577 |
) | ||||
Comprehensive income (loss) |
|
$ |
(2,393 |
) |
$ |
9,044 |
|
$ |
(20,811 |
) |
$ |
2,626 |
|
See accompanying notes to consolidated financial statements.
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
|
|
Nine Months Ended |
| ||||
|
|
September 30, |
| ||||
|
|
2013 |
|
2012 |
| ||
OPERATING ACTIVITIES |
|
|
|
|
| ||
Net income (loss) |
|
$ |
(24,724 |
) |
$ |
4,203 |
|
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |
|
|
|
|
| ||
Loss on disposal of discontinued businesses |
|
2,110 |
|
|
| ||
Amortization of acquisition-related intangibles |
|
6,360 |
|
5,301 |
| ||
Provision for doubtful accounts |
|
1,400 |
|
1,349 |
| ||
Depreciation and amortization |
|
15,831 |
|
15,258 |
| ||
Impairment of goodwill |
|
21,249 |
|
|
| ||
Debt issuance cost amortization |
|
1,278 |
|
1,481 |
| ||
Amortization of investment premiums |
|
2,246 |
|
|
| ||
Loss on sale of equipment |
|
121 |
|
39 |
| ||
Gain on sale of investment |
|
(17,526 |
) |
|
| ||
Stock-based compensation expense |
|
16,295 |
|
18,255 |
| ||
Excess tax benefits from stock-based compensation |
|
|
|
(129 |
) | ||
Deferred and other income taxes |
|
1,715 |
|
(4,325 |
) | ||
Change in operating assets and liabilities, net of acquisitions: |
|
|
|
|
| ||
Accounts receivable |
|
(2,856 |
) |
(11,539 |
) | ||
Prepaid and other assets |
|
5,940 |
|
(7,362 |
) | ||
Accounts payable |
|
(65,721 |
) |
(62,586 |
) | ||
Deferred revenue |
|
(4,321 |
) |
9,094 |
| ||
Income tax payable |
|
(2,151 |
) |
5,771 |
| ||
Other accrued liabilities |
|
(2,801 |
) |
846 |
| ||
Net cash provided by (used in) operating activities |
|
(45,555 |
) |
(24,344 |
) | ||
|
|
|
|
|
| ||
INVESTING ACTIVITIES |
|
|
|
|
| ||
Purchases of investments |
|
(53,243 |
) |
(95,776 |
) | ||
Sales of investments |
|
90,891 |
|
122,391 |
| ||
Cash received for cost method investments |
|
39,636 |
|
|
| ||
Cash paid for acquisitions, net of cash received |
|
(55,843 |
) |
|
| ||
Cash received from divestitures |
|
20 |
|
|
| ||
Purchases of equipment and capitalized software |
|
(15,662 |
) |
(14,394 |
) | ||
Net cash provided by (used in) investing activities |
|
5,799 |
|
12,221 |
| ||
|
|
|
|
|
| ||
FINANCING ACTIVITIES |
|
|
|
|
| ||
Repurchase of convertible senior notes |
|
(5,354 |
) |
|
| ||
Exercise of stock options |
|
1,273 |
|
1,522 |
| ||
Sales of common stock under employee stock purchase plan |
|
1,183 |
|
1,300 |
| ||
Repurchase of common stock |
|
(43,950 |
) |
(20,242 |
) | ||
Repurchase of restricted stock to satisfy tax withholding obligation |
|
(4,328 |
) |
(3,657 |
) | ||
Excess tax benefits from stock-based compensation |
|
|
|
129 |
| ||
Net cash provided by (used in) financing activities |
|
(51,176 |
) |
(20,948 |
) | ||
EFFECT OF EXCHANGE RATE CHANGES ON CASH |
|
6,143 |
|
1,333 |
| ||
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |
|
(84,789 |
) |
(31,738 |
) | ||
CASH AND CASH EQUIVALENTS, beginning of period |
|
542,851 |
|
497,193 |
| ||
CASH AND CASH EQUIVALENTS, end of period |
|
$ |
458,062 |
|
$ |
465,455 |
|
|
|
|
|
|
| ||
SUPPLEMENTAL DISCLOSURES |
|
|
|
|
| ||
Cash paid for interest on senior convertible notes |
|
$ |
3,123 |
|
$ |
3,560 |
|
Cash paid for income taxes |
|
$ |
3,373 |
|
$ |
2,314 |
|
See accompanying notes to consolidated financial statements.
1. BASIS OF PRESENTATION
The unaudited consolidated financial statements included herein reflect all adjustments, including normal recurring adjustments, which in our opinion are necessary to fairly state our consolidated financial position, results of operations and cash flows for the periods presented. These consolidated financial statements should be read in conjunction with our audited consolidated financial statements included in our Form 10-K for the year ended December 31, 2012, as filed with the Securities and Exchange Commission. The results of operations for the three and nine months ended September 30, 2013, are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire fiscal year ending December 31, 2013. The December 31, 2012, information was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles (GAAP) in the United States.
Summary of Significant Accounting Policies
A detailed description of our significant accounting policies can be found in our most recent Annual Report filed on Form 10-K for the fiscal year ended December 31, 2012. There were no material changes in significant accounting policies during the quarter ended September 30, 2013.
Revenue
Revenue Recognition. We recognize revenue from services rendered once all the following criteria for revenue recognition have been met: (1) persuasive evidence of an agreement exists; (2) the services have been rendered; (3) the fee is fixed and determinable; and, (4) collection of the amounts due is reasonably assured.
We also determine whether it is appropriate to record the gross amount of product sales and related costs or the net amount earned as net revenue. We typically are the seller and merchant of record on most of the transactions we process and have contractual relationships with our clients, which obligate us to pay to the client a specified percentage of each sale. We derive our revenue primarily from transaction fees based on a percentage of the products sale price and fees from services rendered associated with the e-commerce and other services provided to our clients and end customers. Our revenue is recorded net as generally our clients are subject to inventory risks and control customers product choices. We sell both physical and digital products. Revenue is recognized upon fulfillment and based upon when products are shipped and title and significant risk of ownership passes to the customer.
Our payment processing revenues are derived from one-time set-up fees, monthly gateway fees, and transaction fees paid to us by merchants. Transaction fees are recognized in the period in which the transaction occurs. Gateway fees are monthly subscription fees charged to our merchant customers for the use of our payment processor integrations and are recognized in the period in which the service is provided. Set-up fees represent one-time charges for initiating our processing services. Although these fees are generally paid at the commencement of the agreement, they are recognized ratably over the estimated average life of the merchant relationship.
The Company also provides customers with various proprietary software backup services. We recognize revenue for these backup services based upon historical usage within the contract period of the digital backup services when this information is available. Digital backup services are recognized straight-line over the life of the backup service when historical usage information is unavailable. Shipping revenues are recorded net of any associated costs.
We also, to a lesser extent, provide fee-based client services, which include website design, custom development and integration, analytical marketing, affiliate marketing and email marketing services. If we receive payments for fee-based services in advance of delivery, these amounts, if significant, are deferred and recognized over the service period.
Client service arrangements can have multiple deliverables such as delivery of website design or administrative site set up activities in connection with hosted reseller arrangements. These deliverables do not meet the criteria of separate units of accounting under GAAP. We account for these deliverables as one unit of accounting, as they generally only have value to the client during the time the hosted commerce site launches and commerce transactions occur. Therefore, associated revenue is recorded over the term of the hosting contract. Client services are executed through signed contractual agreements. Accordingly, our fees are fixed and determinable upon the execution of the agreement.
Provisions for doubtful accounts and transaction losses and authorized credits are made at the time of revenue recognition based upon our historical experience. The provision for doubtful accounts and transaction losses are recorded as charges to operating expense, while the provision for authorized credits is recognized as a reduction of net revenues.
Taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer may be presented on either a gross basis (included in revenues and costs) or on a net basis (excluded from revenues). The Company presents these taxes on a net basis in its financial statements.
Restricted Cash
Restricted cash consists of cash and cash equivalents that are held in escrow accounts or restricted by agreements with third parties for a particular purpose. Restricted cash and cash equivalents are included in current assets under Prepaid expenses and other on our Consolidated Balance Sheets, and are recorded at fair value. As of September 30, 2013 and December 31, 2012, we had $3.8 million and $0.4 million of restricted cash, respectively.
Prepaid Expenses and Other
Prepaid expenses and other are largely comprised of prepaid expenses, restricted cash, inventory, other current assets and value added tax assets. In the second quarter of 2012, $0.6 million was lent through a short-term promissory note to another company and recorded on the Prepaid expenses and other line of the Consolidated Balance Sheets. During the third quarter of 2012, collection of the note was deemed unlikely and a $0.6 million reserve was recorded against the note.
Software Development
Costs to develop software for internal use are required to be capitalized and amortized over the estimated useful life of the software. For the three months ended September 30, 2013 and 2012, we capitalized $0.5 million and $1.5 million related to software development, respectively. For the nine months ended September 30, 2013 and 2012, we capitalized $1.5 million and $4.3 million related to software development, respectively. This capitalization is primarily related to the development of our new commerce functionality and platform enhancements.
Goodwill
We complete our goodwill impairment analysis on an annual basis or more frequently if events or circumstances occur that would more likely than not reduce the fair value of the reporting unit below its carrying amount. As we only have one operating segment, goodwill is evaluated based on a single reporting unit. During the third quarter of 2013, as part of the sales of CustomCD, Inc. (CustomCD) and Digital River Education Services, Inc. (DRES), we allocated $0.3 million of goodwill from our single reporting unit to these entities, which was written-off and included in the computation of the loss on disposal of discontinued businesses as of September 30, 2013. Due to the sales of these entities, we were required to evaluate if the remaining goodwill in our single reporting unit is impaired. Based on our evaluation, we determined that no impairment exists on the remaining balance of goodwill in our single reporting unit as of September 30, 2013. See Note 11 Discontinued Operations, for further discussion of the sales of CustomCD and DRES.
In December 2012, due to the deterioration in our stock price in the second half of 2012, adjustments in our forecasted revenue growth and change in our chief operating decision maker, management completed an interim impairment test and determined that the book value of the Company was in excess of fair value and a goodwill impairment was required. In the fourth quarter 2012, we recorded a non-cash pretax goodwill impairment charge of $175.2 million, or $161.1 million after tax, relating to our single reporting unit. The impairment charge was an estimate pending final valuation of a privately held equity security in calculating the goodwill impairment charge of $175.2 million.
During the first quarter of 2013, we determined the fair market value of the privately held equity security, which we had estimated at year end, and completed our goodwill impairment analysis. As a result of our analysis we recorded an additional non-cash pretax goodwill impairment charge of $21.2 million relating to our single reporting unit. These goodwill charges are included as a separate operating expense line item, Goodwill impairment within Continuing Operations in our Consolidated Statements of Operations. The tax benefit was offset by our current period tax valuation allowance. A blended income and market approach was used to determine the fair value of our sole reporting unit and associated impairment charges. The application of goodwill impairment tests requires management judgment for many of the inputs. Key assumptions included in the impairment test included our revenue growth rate, discount rate assumptions, and estimates of our future cash flows. Changes in these estimates could result in additional impairment of goodwill in a future period. The impairment charge reflects our view of anticipated risks based on our expectations of market and general economic conditions. See Note 5 Goodwill for further details.
Comprehensive Income (Loss)
Comprehensive income (loss) includes revenues, expenses, and gains and losses that are excluded from net earnings under GAAP. Items of comprehensive income (loss) are unrealized gains and losses on investments and foreign currency translation adjustments which are added to net income (loss) to compute comprehensive income (loss). Comprehensive income (loss) is net of income tax benefit or expense, excluding cumulative translation adjustments as these funds are indefinitely invested.
The following table summarizes the changes in accumulated other comprehensive income (loss), net of tax, by component for the nine months ended September 30, 2013 (in thousands):
|
|
Foreign currency |
|
Unrealized gain |
|
Total |
| |||
Balance as of December 31, 2012 |
|
$ |
2,565 |
|
$ |
(5,735 |
) |
$ |
(3,170 |
) |
Other comprehensive income before reclassifications |
|
524 |
|
3,385 |
|
3,909 |
| |||
Amount reclassified from accumulated other comprehensive income (loss) |
|
|
|
4 |
|
4 |
| |||
Net current period other comprehensive income (loss) |
|
524 |
|
3,389 |
|
3,913 |
| |||
Balance as of September 30, 2013 |
|
$ |
3,089 |
|
$ |
(2,346 |
) |
$ |
743 |
|
Reclassifications out of accumulated other comprehensive income (loss), net of tax, were immaterial for the three months ended September 30, 2013. The following table summarizes the reclassifications out of accumulated other comprehensive income (loss), net of tax, for the nine months ended September 30, 2013 (in thousands):
Details about accumulated other comprehensive |
|
Amount reclassified |
|
Affected line item in the |
| |
Realized gains (losses) on investments |
|
|
|
|
| |
|
|
$ |
6 |
|
Other income (expense), net |
|
|
|
(2 |
) |
Income tax benefit (expense) |
| |
|
|
$ |
4 |
|
Net income (loss) |
|
Foreign Currency Translation
Substantially all of our foreign subsidiaries use the local currency of their respective countries as their functional currency. Assets and liabilities are translated at exchange rates prevailing at the balance sheet dates. Revenues, costs and expenses are translated at the average exchange rates for the reported period. Gains and losses resulting from translation are recorded as a component of Accumulated other comprehensive income (loss) within stockholders equity. Gains and losses resulting from foreign currency transactions are recognized as Other income (expense), net.
We are exposed to market risk from changes in foreign currency exchange rates. Our primary risk is the effect of foreign currency exchange rate fluctuations on the U.S. dollar value of foreign currency denominated operating sales and expenses. We are also exposed to financial risk related to exchange rate translation losses (or gains) associated with economic interests that are denominated in a foreign currency. The risk of translation losses due to foreign exchange volatility is partially mitigated by the use of foreign exchange forward contracts with maturities of less than three months. These derivative transactions are not designated as hedges and are adjusted to fair value each period through Other income (expense), net in our Consolidated Statements of Operations. The principal exposures mitigated were euro, Australian dollar, British pound, Canadian dollar, Danish krone and Japanese yen currencies. For the three and nine months ended September 30, 2013 and 2012, the gain/loss on derivative settlements was immaterial. The notional amounts held at period end and the underlying gain/loss were determined to be immaterial when compared to our overall cash and cash equivalents and the net income (loss) reported for the respective periods.
Our foreign currency contracts contain credit risk to the extent that our bank counterparties may be unable to meet the terms of the agreements. We minimize such risk by limiting our counterparties to major financial institutions of high credit quality.
Recent Accounting Pronouncements
ASU 2013-11 - Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists: In July 2013, the FASB issued ASU 2013-11, which requires an entity to present unrecognized tax benefits as a reduction of the deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, if net settlement is required or expected. To the extent that net settlement is not required or expected, the unrecognized tax benefit must be presented as a liability. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. ASU No. 2013-11 is effective for reporting periods beginning after December 15, 2013, and should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Because this standard only affects the presentation of unrecognized tax benefits and not the measurement of an unrecognized tax benefit, we do not expect this standard to have a material impact on our Consolidated Financial Statements.
ASU 2013-02 Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income: In February 2013, the FASB issued ASU 2013-02, which required entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, entities are required to present, either in the financial statements or footnotes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail on these amounts. ASU 2013-02 is effective prospectively for fiscal periods beginning after December 15, 2012. We have adopted the new guidance in ASU 2013-02 as of the period ended March 31, 2013, and its adoption did not have a material impact on our Consolidated Financial Statements.
We have determined that all other recently issued accounting standards will not have a material impact on our Consolidated Financial Statements, or do not apply to our operations.
Reclassifications
The results of the operations of CustomCD and DRES have been classified within Discontinued Operations within our Consolidated Statements of Operations for the three and nine month periods ending September 30, 2013. The operations of these entities in the corresponding periods of 2012 have been reclassified into Discontinued Operations for comparative purposes to conform to the current year presentation. In addition, all of the assets and liabilities of DRES, which was sold on October 1, 2013, meet the criteria for assets held for sale as of September 30, 2013, and are separately reported as current assets, at fair value, and current liabilities of discontinued operations within the Consolidated Balance Sheet at September 30, 2013. The assets and liabilities of CustomCD have been removed from our Consolidated Balance Sheet as of September 30, 2013, as the entity was sold on September 30, 2013. The assets and liabilities of both CustomCD and DRES in the December 31, 2012 Consolidated Balance Sheet have been reclassified and separately presented as current assets and current liabilities of discontinued operations for comparative purposes with the current year presentation.
Certain items in the prior years Consolidated Statements of Operations have been reclassified for comparative purposes to conform to the current year presentation. Historically, we have reported payment processing fees, chargebacks, and directly related personnel expenses within the Sales and marketing and General and administrative line items. We have reclassified these expenses to the Direct cost of services line as these costs are associated directly with services rendered. For the three and nine months ended September 30, 2012, excluding amounts related to CustomCD and DRES which have been reclassified to discontinued operations, we have reclassified $12.8 million and $39.3 million, respectively, previously reported as Sales and marketing and $0.4 million and $1.4 million, respectively, previously reported as General and administrative to Direct cost of services. The reclassifications did not have an effect on reported consolidated net income (loss).
2. NET INCOME (LOSS) PER SHARE
The following table summarizes the computation of basic and diluted income (loss) from continuing operations per share (in thousands, except per share amounts):
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
September 30, |
|
September 30, |
| ||||||||
|
|
2013 |
|
2012 |
|
2013 |
|
2012 |
| ||||
Income (loss) from continuing operations per share - basic |
|
|
|
|
|
|
|
|
| ||||
Income (loss) from continuing operations - basic |
|
$ |
(7,596 |
) |
$ |
(735 |
) |
$ |
(18,486 |
) |
$ |
5,130 |
|
Weighted average shares outstanding - basic |
|
31,487 |
|
32,685 |
|
32,435 |
|
33,347 |
| ||||
Income (loss) from continuing operations per share - basic |
|
$ |
(0.24 |
) |
$ |
(0.02 |
) |
$ |
(0.57 |
) |
$ |
0.16 |
|
|
|
|
|
|
|
|
|
|
| ||||
Income (loss) from continuing operations per share - diluted |
|
|
|
|
|
|
|
|
| ||||
Income (loss) from continuing operations - basic |
|
$ |
(7,596 |
) |
$ |
(735 |
) |
$ |
(18,486 |
) |
$ |
5,130 |
|
Exclude: Interest expense and amortized financing cost of convertible senior notes, net of tax benefit |
|
|
|
|
|
|
|
|
| ||||
Income (loss) from continuing operations - diluted |
|
$ |
(7,596 |
) |
$ |
(735 |
) |
$ |
(18,486 |
) |
$ |
5,130 |
|
|
|
|
|
|
|
|
|
|
| ||||
Weighted average shares outstanding - basic |
|
31,487 |
|
32,685 |
|
32,435 |
|
33,347 |
| ||||
Dilutive impact of non-vested stock and options outstanding |
|
|
|
|
|
|
|
232 |
| ||||
Dilutive impact of 2004 senior convertible notes |
|
|
|
|
|
|
|
|
| ||||
Weighted average shares outstanding - diluted |
|
31,487 |
|
32,685 |
|
32,435 |
|
33,579 |
| ||||
Income (loss) from continuing operations per share - diluted |
|
$ |
(0.24 |
) |
$ |
(0.02 |
) |
$ |
(0.57 |
) |
$ |
0.16 |
|
For the three and nine months ended September 30, 2013, incremental shares related to dilutive securities of 544,629 and 313,695, respectively, were not included in the diluted net income (loss) per share calculation because the Company reported a loss for both periods. For the three months ended September 30, 2012, 264,796 incremental shares, related to dilutive securities were not included in the diluted net income (loss) per share calculation because the Company reported a loss for this period. Incremental shares related to dilutive securities have an anti-dilutive impact on net income (loss) per share when a net loss is reported and therefore are not included in the calculation.
Options to purchase 589,943 and 1,463,689 shares for the three months ended September 30, 2013 and 2012, respectively, and 589,943 and 1,463,689 shares for the nine months ended September 30, 2013 and 2012, respectively, were not included in the computation of diluted net income (loss) per share because their effect on diluted net income (loss) per share would have been anti-dilutive.
The unissued shares underlying our 2004 senior convertible notes, 199,828 weighted average shares for the three and nine months ended September 30, 2013 and 2012, were excluded for the purposes of calculating diluted net income (loss) per share, because their effect on diluted net income (loss) per share would have been anti-dilutive. The unissued shares underlying our 2010 senior convertible notes, 6,019,607 and 7,022,027 weighted average shares for the three months ended September 30, 2013 and 2012, respectively, and 6,070,600 and 7,022,027 weighted average shares for the nine months ended September 30, 2013 and 2012, respectively, were excluded for the purposes of calculating diluted net income (loss) per share, because their effect on diluted net income (loss) per share would have been anti-dilutive.
3. FAIR VALUE MEASUREMENTS
Financial assets and liabilities that are remeasured and reported at fair value at each reporting period are classified and disclosed in one of the following three categories:
Level 1 Observable inputs such as quoted prices in active markets;
Level 2 Other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:
· Quoted prices for similar assets or liabilities in active markets;
· Quoted prices for identical or similar assets in less active markets than Level 1 investments;
· Inputs other than quoted prices that are observable for assets or liabilities; and
· Inputs that are derived principally from or corroborated by other observable market data.
Level 3 Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize managements estimate of market participant assumptions.
Assets and Liabilities that are Measured at Fair Value on a Recurring Basis
The fair value hierarchy requires the use of observable market data when available. In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability. The Companys policy is to recognize transfers between levels at the end of the quarter.
The following table sets forth by level within the fair value hierarchy, our financial assets that were accounted for at fair value on a recurring basis at September 30, 2013 and December 31, 2012, (in thousands), according to the valuation techniques we used to determine their fair values. There have been no transfers of assets between the fair value hierarchies presented below:
|
|
Fair Value Measurements |
| ||||||||||
|
|
Total |
|
Level 1 |
|
Level 2 |
|
Level 3 |
| ||||
Balance as of September 30, 2013 |
|
|
|
|
|
|
|
|
| ||||
Cash and cash equivalents |
|
$ |
458,062 |
|
$ |
458,062 |
|
$ |
|
|
$ |
|
|
Restricted cash |
|
3,832 |
|
3,832 |
|
|
|
|
| ||||
U.S. government sponsored entities |
|
7,994 |
|
|
|
7,994 |
|
|
| ||||
Corporate bonds |
|
114,704 |
|
114,704 |
|
|
|
|
| ||||
Market basis equity investments |
|
2,146 |
|
2,146 |
|
|
|
|
| ||||
Auction rate securities |
|
40,184 |
|
|
|
|
|
40,184 |
| ||||
Total assets measured at fair value |
|
$ |
626,922 |
|
$ |
578,744 |
|
$ |
7,994 |
|
$ |
40,184 |
|
|
|
|
|
|
|
|
|
|
| ||||
Balance as of December 31, 2012 |
|
|
|
|
|
|
|
|
| ||||
Cash and cash equivalents |
|
$ |
542,851 |
|
$ |
542,851 |
|
$ |
|
|
$ |
|
|
Restricted cash |
|
351 |
|
351 |
|
|
|
|
| ||||
U.S. government sponsored entities |
|
28,110 |
|
|
|
28,110 |
|
|
| ||||
Corporate bonds |
|
128,622 |
|
128,622 |
|
|
|
|
| ||||
Asset-backed securities |
|
6,062 |
|
|
|
6,062 |
|
|
| ||||
Market basis equity investments |
|
1,694 |
|
1,694 |
|
|
|
|
| ||||
Auction rate securities |
|
37,001 |
|
|
|
|
|
37,001 |
| ||||
Total assets measured at fair value |
|
$ |
744,691 |
|
$ |
673,518 |
|
$ |
34,172 |
|
$ |
37,001 |
|
The following table is a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3 inputs) (in thousands):
|
|
Fair Value Measurements Using |
| |
|
|
Significant Unobservable Inputs |
| |
|
|
(Level 3) |
| |
|
|
Auction rate securities |
| |
Balance as of December 31, 2011 |
|
$ |
65,338 |
|
Total unrealized gains (losses) included in other comprehensive income |
|
(2,637 |
) | |
Purchases |
|
|
| |
Issuances |
|
|
| |
Settlements |
|
(25,700 |
) | |
Transfers in and/or out of Level 3 |
|
|
| |
Balance as of December 31, 2012 |
|
$ |
37,001 |
|
Total unrealized gains (losses) included in other comprehensive income |
|
3,283 |
| |
Purchases |
|
|
| |
Issuances |
|
|
| |
Settlements |
|
(100 |
) | |
Transfers in and/or out of Level 3 |
|
|
| |
Balance as of September 30, 2013 |
|
$ |
40,184 |
|
The following methods and assumptions were used to estimate the fair value of each class of financial instrument. There have been no changes in the valuation techniques used by the Company to fair value our financial instruments:
Cash and Cash equivalents. Consist of cash on hand in bank deposits, highly liquid investments, primarily high grade commercial paper and money market accounts, all with original maturities of three months or less. The fair value was measured using quoted market prices and is classified as Level 1. The carrying amount approximates fair value.
Restricted Cash. Consists of cash and cash equivalents that are held in escrow accounts or restricted by agreements with third parties for a particular purpose. The carrying amount approximates fair value and is classified as Level 1.
U.S government sponsored entities. Consist of Fannie Mae, Freddie Mac and Federal Home Loan Bank investment grade bonds that are traded in less active markets than Level 1 investments. The fair value of these bonds is classified as Level 2. The contractual maturity of these investments is within three years.
Corporate Bonds. Consist of investment grade corporate bonds that trade with sufficient frequency and volume to enable us to obtain pricing information on an ongoing basis. The fair value of these bonds was measured using quoted market prices and is classified as Level 1. The contractual maturity of these investments is within three years.
Asset Backed Securities. Consist of securities backed by automobile loan receivables that are traded in less active markets than our Level 1 investments. The fair value is classified as Level 2.
Market Basis Equity Investments. Consist of available-for-sale equity securities that trade with sufficient frequency and volume to enable us to obtain pricing information on an ongoing basis. The fair value of these investments was measured using quoted market prices and is classified as Level 1.
Auction Rate Securities. As of September 30, 2013, we held $45.7 million of auction rate securities (ARS) at par value which we have recorded at fair value of $40.2 million. As of December 31, 2012, we held $45.8 million of ARS at par value which was recorded at fair value of $37.0 million. The ARS are 105 134% over-collateralized and the underlying student loans are guaranteed by the U.S. government. Almost all of these securities continue to fail at auction due to continued illiquid market conditions.
Due to the illiquid market conditions, we recorded a temporary fair value reduction of our ARS in the amount of $5.5 million (12.1% of par value) as of September 30, 2013, under Accumulated other comprehensive income (loss), compared to a $8.8 million temporary fair value reduction as of December 31, 2012 (19.3% of par value). In evaluating our ARS portfolio, we note sustained performance of our securities, strong parity levels, observed market redemption activity,
and continued receipt of interest and penalty payments. As we expect to receive all contractual cash flows, we do not believe the unrealized losses to be credit related. We continue to believe that we will be able to liquidate at par over time. We do not intend to sell the investments prior to recovery of their amortized cost basis nor do we believe it is more likely than not we may be required to sell the investments prior to recovery of their amortized cost basis. Accordingly, we treated the fair value decline as temporary. We anticipate we will have sufficient cash flow from operations to execute our business strategy and fund our operational needs. We believe that capital markets are also available if we need to finance other investment alternatives.
The discounted cash flow model we used to value these securities included the following assumptions:
|
|
September 30, |
|
December 31, |
|
|
|
2013 |
|
2012 |
|
Unobservable inputs |
|
|
|
|
|
Redemption period (in years) |
|
7 |
|
7 |
|
Credit ratings |
|
BB+ to AAA |
|
BB+ to AAA |
|
Penalty coupon rate |
|
1.0% to 1.5% |
|
1.0% to 1.5% |
|
Weighted average annualized yield |
|
1.2% |
|
1.5% |
|
Risk adjusted discount rate |
|
4.4% to 10.2% |
|
3.5% to 12.3% |
|
Management makes estimates and assumptions about the ARS, which can be sensitive to changes and effect the determination of fair value. An increase in the length of redemption period or an increase in the discount rate assumption would decrease our fair value. Also, a decrease in the securities credit ratings would decrease our fair value.
The portfolio had a weighted average maturity of 30.1 years and 30.8 years as of September 30, 2013 and December 31, 2012, respectively.
We classify our ARS as Level 3 long-term investments until we receive a call or partial call on the securities. Upon receipt of a call or partial call, we classify the securities subject to the call or partial call, as Level 1 short term investments. As of September 30, 2013 and December 31, 2012, our entire ARS portfolio was classified as Level 3 long-term investments. In the nine months ended September 30, 2013, we liquidated $0.1 million of ARS due to partial calls at par. During the year ended December 31, 2012, we liquidated $25.7 million of ARS due to full calls, partial calls or sales at par. The amount of Level 3 assets as a percentage of total assets measured at fair value on a recurring basis was 6.4% and 5.0% as of September 30, 2013 and December 31, 2012, respectively.
Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis
Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, they are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances including evidence of impairment. For the nine months ended September 30, 2013, other than the impairment disclosed in Note 5 Goodwill, we had no significant fair value adjustments of assets or liabilities on a nonrecurring basis subsequent to their initial recognition. The inputs used in the goodwill impairment fair value calculations fall within Level 3 inputs due to the significant unobservable inputs used to determine the fair value.
4. INVESTMENTS
As of September 30, 2013 and December 31, 2012, our available-for-sale securities consisted of the following (in thousands):
|
|
|
|
|
|
Gross Unrealized Losses |
|
|
|
Maturities/Reset Dates |
| |||||||||||
|
|
|
|
Gross Unrealized |
|
Less than 12 |
|
Greater than 12 |
|
|
|
Less than 12 |
|
Greater than 12 |
| |||||||
|
|
Cost |
|
Gains |
|
Months |
|
Months |
|
Fair Value |
|
Months |
|
Months |
| |||||||
Balance as of September 30, 2013 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
U.S. government sponsored entities |
|
$ |
8,000 |
|
$ |
|
|
$ |
(6 |
) |
$ |
|
|
$ |
7,994 |
|
$ |
4,000 |
|
$ |
3,994 |
|
Corporate bonds |
|
114,402 |
|
337 |
|
(35 |
) |
|
|
114,704 |
|
59,699 |
|
55,005 |
| |||||||
Market basis equity investments |
|
2,146 |
|
|
|
|
|
|
|
2,146 |
|
|
|
2,146 |
| |||||||
Auction rate securities |
|
45,725 |
|
|
|
|
|
(5,541 |
) |
40,184 |
|
|
|
40,184 |
| |||||||
Total available-for-sale securities |
|
$ |
170,273 |
|
$ |
337 |
|
$ |
(41 |
) |
$ |
(5,541 |
) |
$ |
165,028 |
|
$ |
63,699 |
|
$ |
101,329 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Balance as of December 31, 2012 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
U.S. government sponsored entities |
|
$ |
28,103 |
|
$ |
7 |
|
$ |
|
|
$ |
|
|
$ |
28,110 |
|
$ |
28,110 |
|
$ |
|
|
Corporate bonds |
|
128,035 |
|
587 |
|
|
|
|
|
128,622 |
|
51,094 |
|
77,528 |
| |||||||
Asset-backed securities |
|
6,058 |
|
4 |
|
|
|
|
|
6,062 |
|
6,062 |
|
|
| |||||||
Market basis equity investments |
|
1,694 |
|
|
|
|
|
|
|
1,694 |
|
|
|
1,694 |
| |||||||
Auction rate securities |
|
45,825 |
|
|
|
|
|
(8,824 |
) |
37,001 |
|
|
|
37,001 |
| |||||||
Total available-for-sale securities |
|
$ |
209,715 |
|
$ |
598 |
|
$ |
|
|
$ |
(8,824 |
) |
$ |
201,489 |
|
$ |
85,266 |
|
$ |
116,223 |
|
We consider the fair value decline of our investments in U.S. government sponsored entities, corporate bonds and auction rate securities to be temporary, as we do not intend to sell the investments and it is not likely that we will be required to sell the investments before recovery of their amortized cost basis. See Note 3 Fair Value Measurements, regarding the fair value decline in auction rate securities.
Realized gains or losses on investments are recorded in our Consolidated Statements of Operations within Other income (expense), net. As of September 30, 2013 and December 31, 2012, our proceeds on sales of investments equaled par value. Upon the sale of a security classified as available for sale, the amount reclassified out of Accumulated other comprehensive income (loss) into earnings is based on the specific identification method.
As of September 30, 2013 and December 31, 2012, our cost method equity investments were $10.5 million and $33.0 million, respectively, and are included under Long-term investments on the Consolidated Balance Sheets. During the first quarter of 2013, we sold a cost method equity investment to a third party and recorded a gain of $11.1 million. During the second quarter of 2013, we received additional funds based on our sales agreement and as a result we recorded a gain of $6.5 million on the line item Other income (expense), net in our Consolidated Statements of Operations. Based on future events, we may receive up to $3.1 million of additional sale proceeds. We have concluded that these additional funds represent contingent gains and have not accounted for them in our consolidated financial statements in accordance with U.S. GAAP. We have evaluated our cost method equity investments for impairment as of September 30, 2013 and we are not aware of any facts or circumstances that would indicate a decline in the fair value of these investments below their carrying value.
5. GOODWILL
Goodwill
We complete our goodwill impairment analysis on an annual basis or more frequently if events or circumstances occur that would more likely than not reduce the fair value of the reporting unit below its carrying amount. As we only have one operating segment, goodwill is evaluated based on a single reporting unit. During the third quarter of 2013, as part of the sales of CustomCD and DRES, we allocated $0.3 million of goodwill from our single reporting unit to these entities, which was written-off and included in the computation of the loss on disposal of discontinued businesses as of September 30, 2013. Due to the sales of these entities, we were required to evaluate if the remaining goodwill in our single reporting unit is impaired. Based on our evaluation, we determined that no impairment exists on the remaining balance of goodwill in our single reporting unit as of September 30, 2013. See Note 11 Discontinued Operations, for further discussion of the sales of CustomCD and DRES.
In December 2012, due to the deterioration in our stock price in the second half of 2012, adjustments in our forecasted revenue growth and change in our chief operating decision maker, management completed an interim impairment test and determined that the book value of the Company was in excess of fair value and a goodwill impairment was required. In the fourth quarter 2012, we recorded a non-cash pretax goodwill impairment charge of $175.2 million, or $161.1 million after tax, relating to our single reporting unit. The impairment charge was an estimate pending final valuation of a privately held equity security in calculating the goodwill impairment charge of $175.2 million.
During the first quarter of 2013, we determined the fair market value of the privately held equity security, which we had estimated at year end, and completed our goodwill impairment analysis. As a result of our analysis we recorded an
additional non-cash pretax goodwill impairment charge of $21.2 million relating to our single reporting unit. These goodwill charges are included as a separate operating expense line item, Goodwill impairment within Continuing Operations in our Consolidated Statements of Operations. The tax benefit was offset by our current period tax valuation allowance. A blended income and market approach was used to determine the fair value of our sole reporting unit and associated impairment charges. The application of goodwill impairment tests requires management judgment for many of the inputs. Key assumptions included in the impairment test included our revenue growth rate, discount rate assumptions, and estimates of our future cash flows. Changes in these estimates could result in additional impairment of goodwill in a future period. The impairment charge reflects our view of anticipated risks based on our expectations of market and general economic conditions.
The changes in the net carrying amount of goodwill for the periods ended September 30, 2013 and December 31, 2012 are as follows (in thousands):
|
|
|
|
Accumulated |
|
|
| |||
|
|
Goodwill |
|
Impairment |
|
Total |
| |||
Balance as of December 31, 2011 |
|
$ |
281,858 |
|
$ |
|
|
$ |
281,858 |
|
Disposal of goodwill |
|
(254 |
) |
|
|
(254 |
) | |||
Impairment losses |
|
|
|
(175,241 |
) |
(175,241 |
) | |||
Adjustments from foreign currency translation |
|
2,597 |
|
|
|
2,597 |
| |||
Balance as of December 31, 2012 |
|
$ |
284,201 |
|
$ |
(175,241 |
) |
$ |
108,960 |
|
Disposal of goodwill |
|
(260 |
) |
|
|
(260 |
) | |||
Goodwill from acquisitions |
|
54,287 |
|
|
|
54,287 |
| |||
Impairment losses |
|
|
|
(21,249 |
) |
(21,249 |
) | |||
Adjustments from foreign currency translation |
|
(1,349 |
) |
|
|
(1,349 |
) | |||
Balance as of September 30, 2013 |
|
$ |
336,879 |
|
$ |
(196,490 |
) |
$ |
140,389 |
|
Goodwill from acquisitions for the nine months ended September 30, 2013 is related to the acquisition of LML Payment Systems, Inc. (LML). Factors that contributed to the recognition of goodwill from the LML acquisition include synergies due to an assembled workforce and existence of complimentary business models which can be leveraged to build an enterprise of greater value than the sum of its parts. In accordance with ASC 350, this goodwill will be tested for
impairment annually or more frequently if certain indicators of impairment are present. See Note 10 Business Combinations for further details regarding the LML acquisition.
6. STOCK-BASED COMPENSATION
The following table summarizes stock-based compensation expense related to employee stock options, restricted stock awards and employee stock purchases recognized (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
September 30, |
|
September 30, |
| ||||||||
|
|
2013 |
|
2012 |
|
2013 |
|
2012 |
| ||||
Costs and expenses |
|
|
|
|
|
|
|
|
| ||||
Direct cost of services |
|
$ |
35 |
|
$ |
26 |
|
$ |
124 |
|
$ |
144 |
|
Network and infrastructure |
|
341 |
|
408 |
|
1,083 |
|
1,140 |
| ||||
Sales and marketing |
|
1,718 |
|
1,949 |
|
5,349 |
|
6,246 |
| ||||
Product research and development |
|
782 |
|
999 |
|
2,553 |
|
2,687 |
| ||||
General and administrative |
|
1,465 |
|
2,681 |
|
7,186 |
|
8,038 |
| ||||
Stock-based compensation included in costs and expenses |
|
$ |
4,341 |
|
$ |
6,063 |
|
$ |
16,295 |
|
$ |
18,255 |
|
7. INCOME TAXES
The provision (benefit) for income taxes for both continuing and discontinued operations is composed of the following (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
September 30, |
|
September 30, |
| ||||||||
|
|
2013 |
|
2012 |
|
2013 |
|
2012 |
| ||||
Current tax expense (benefit): |
|
|
|
|
|
|
|
|
| ||||
United States |
|
$ |
2,289 |
|
$ |
(520 |
) |
$ |
3,726 |
|
$ |
829 |
|
International |
|
(252 |
) |
(177 |
) |
(1,625 |
) |
76 |
| ||||
Total current provision for income taxes |
|
$ |
2,037 |
|
$ |
(697 |
) |
$ |
2,101 |
|
$ |
905 |
|
|
|
|
|
|
|
|
|
|
| ||||
Tax Rate |
|
(19.4 |
)% |
48.7 |
% |
(9.3 |
)% |
17.7 |
% |
The total current provision for income taxes for the three months ended September 30, 2013 is expense of $2.0 million, which is comprised of $0.6 million income tax benefit related to continuing operations and $2.6 million tax expense related to discontinued operations. The total current provision for income taxes for the three months ended September 30, 2012 is comprised of $0.7 million tax benefit related to continuing operations, with immaterial tax expense related to discontinued operations. For the nine months ended September 30, 2013, the total current provision for income taxes is $2.1 million, comprised of $0.4 million income tax benefit related to continuing operations and $2.5 million of income tax expense related to discontinued operations. For the nine months ended September 30, 2012, the total current provision for income taxes is $0.9 million, comprised of $1.4 million income tax expense related to continuing operations, offset by $0.5 million of income tax benefit related to discontinued operations. See Note 11 Discontinued Operations, for further illustration of the tax expense/benefit related to discontinued operations.
As of September 30, 2013, we had U.S. federal tax loss carryforwards of approximately $24.0 million and state tax loss carryforwards of approximately $44.0 million to offset future taxable income. The U.S. federal tax loss carryforwards expire in the years 2025 through 2032, while the state tax loss carryforwards expire in the years 2014 through 2032. As of September 30, 2013, we also had foreign tax loss carryforwards of approximately $9.0 million. The foreign tax loss carryforwards do not expire under current law.
On a quarterly basis, we assess whether a valuation allowance for net operating loss carryforwards and other deferred tax assets is needed. Based on our third quarter 2013 assessment, we concluded that accounting rules require us to maintain a valuation allowance against our net U.S. tax assets. At September 30, 2013, the Company had a valuation allowance on approximately $10.6 million of U.S. deferred tax assets related to operating losses and $46.4 million of deferred tax assets related to other U.S. tax attributes. We also have a valuation allowance on all of our foreign net operating losses of
approximately $2.3 million. Any future release of this valuation allowance will reduce expense.
As of September 30, 2013, we had $11.1 million of unrecognized tax benefits, including related interest. Approximately $10.5 million of these unrecognized tax benefits would affect our effective tax rate if recognized. As of September 30, 2013, we had approximately $1.4 million of accrued interest related to uncertain tax positions. During the quarter, $1.2 million of unrecognized tax benefits were released due to the expiration of a statute of limitations. Due to the potential resolution of examinations currently being performed by taxing authorities and the expiration of various statutes of limitation, it is reasonably possible that the balance of our unrecognized tax benefits may change within the next twelve months by a range of zero to $9.0 million.
8. COMMITMENTS AND CONTINGENCIES
Litigation
DDR Holdings, LLC (DDR) brought a claim against us and several other defendants regarding U.S. Patents Nos. 6,629,135 (the 135 patent), 6,993,572 (the 572 patent), and 7,818,399 (the 399 Patent), which are owned by DDR. These patents claim e-commerce outsourcing systems and methods relating to the provision of outsourced e-commerce support pages having a common look and feel with a hosts website. The case was filed in the U.S. District Court for the Eastern District of Texas on January 31, 2006 seeking injunctive relief, declaratory relief, damages and attorneys fees. We denied infringement of any valid claim of the patents-in-suit, and asserted counter-claims seeking a judicial declaration that the patents are invalid and not infringed. After a delay due to DDRs request for re-examination of the 135 and 572 patents, Digital River and DDR concluded discovery and pre-trial depositions in August 2012. In pre-trial motions, DDR dropped its claims against Digital River with respect to the 135 and 399 patent. On October 12, 2012, the jury found in favor of the plaintiff on the infringement claim in connection with the 572 patent and awarded damages of $0.8 million (versus plaintiffs demand of $10.2 million). On June 20, 2013, the court denied Digital Rivers post-trial motions and entered judgment in the amount of $1.1 million (which amount includes pre-judgment interest), plus costs and post-judgment interest. Digital River has appealed. During the third quarter of 2012, initial full settlement of the awarded damages (exclusive of interest which may be awarded by the court) was accrued for on the Other accrued liabilities line of the Consolidated Balance Sheets and the General and administrative line of the Consolidated Statements of Operations. The accrued amount was adjusted to $1.1 million during the second quarter of 2013 to reflect the award of pre-judgment interest. In addition, on August 20, 2013, DDR filed a second lawsuit against DR, alleging both additional infringement of the 572 patent as well as a newly issued continuation patent, Patent No. 8,515,825 issued on August 20, 2013 (the 825 patent). While we intend to vigorously defend this matter, we cannot predict the timing or ultimate outcome, nor estimate a range of loss, if any, for this matter.
In December 2010, a lawsuit was filed against a number of software companies, including us, by Uniloc USA, Inc. and Uniloc Singapore Private Limited in the United States District Court for the Eastern District of Texas. The complaint seeks monetary damages in unspecified amounts and permanent injunction based upon claims for alleged patent infringement. We are at an early stage of this matter. While we intend to vigorously defend this matter, we cannot predict the timing or ultimate outcome, nor estimate a range of loss, if any, for this matter.
We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. While the final outcome of these matters is currently not determinable, we believe there is no ordinary course litigation pending against us that is likely to have, individually or in the aggregate, a material effect on our consolidated financial position, results of operation, stockholders equity or cash flows. Because of the uncertainty inherent in litigation, it is possible that unfavorable resolutions of these lawsuits, proceedings and claims could exceed the amount we have currently reserved for these matters.
From time to time, we are involved in other disputes or regulatory inquiries that arise in the ordinary course of business. Any claims or regulatory actions against us, whether meritorious or not, could be time consuming, result in costly litigation, damage awards, injunctive relief or increased costs of doing business through adverse judgment or settlement, require us to change our business practices in expensive ways, require significant amounts of management time, result in the diversion of significant operational resources or otherwise harm our business. These matters are subject to inherent uncertainties and managements view of these matters may change in the future.
Third parties have from time-to-time claimed, and others may claim in the future, that we have infringed their intellectual property rights. We have been notified of several potential patent disputes, and expect that we will increasingly be subject to patent infringement claims as our services expand in scope and complexity. We have in the past been forced to litigate such claims. We may also become more vulnerable to third-party claims as laws, such as those related to privacy and online commerce the Digital Millennium Copyright Act, the Lanham Act and the Communications Decency Act are enacted by legislatures and interpreted by the courts, and as we expand geographically into jurisdictions where the underlying laws
with respect to the potential liability of online intermediaries like ourselves are either unclear or less favorable. These claims, whether meritorious or not, could be time consuming and costly to resolve, cause service upgrade delays, require expensive changes in our methods of doing business, or could require us to pay damages or enter into costly royalty or licensing agreements.
Indemnification Provisions
In the ordinary course of business we have included limited indemnification provisions in certain of our agreements with parties with whom we have commercial relations. Under these contracts, we generally indemnify, hold harmless and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with claims by any third party with respect to our domain names, trademarks, logos and other branding elements to the extent that such marks are applicable to our performance under the subject agreement. In certain agreements, including both agreements under which we have developed technology for certain commercial parties and agreements with our clients, we have provided an indemnity for other types of third-party claims. To date, no significant costs have been incurred, either individually or collectively, in connection with our indemnification provisions.
In addition, we are required by our credit card processors to comply with credit card association operating rules, and we have agreed to indemnify our processors for any fines they are assessed by credit card associations as a result of processing payments for us. The credit card associations and their member banks set and interpret the credit card rules. Visa, MasterCard, American Express or Discover could adopt new operating rules or re-interpret existing rules that we or our credit card processors might find difficult to follow. We also could be subject to fines or increased fees from MasterCard and Visa.
Commitments and Guarantees
At certain times, we enter into agreements where a letter of credit is required to ensure payment of future obligations by counterparties, such as our credit card processors and international taxing jurisdictions. Upon withdrawal, we are obligated to fund the executor bank on demand. We have not set aside specific funds to cover this potential obligation as we can generally recover these costs from our clients. If drawn upon, we expect to fund this commitment with cash and cash equivalents. There were $0.5 million and $3.6 million in undrawn letters of credit as of September 30, 2013 and December 31, 2012, respectively.
9. DEBT
2010 Senior Convertible Notes
On November 1, 2010, we sold and issued $345.0 million in aggregate principal amount of senior convertible notes (2010 Notes), in a private, unregistered offering. The 2010 Notes are unsecured obligations and rank equally with all of our existing and future senior unsecured debt. The 2010 Notes were sold at their total principal amount. The 2010 Notes bear interest at the rate of 2.00% per annum from the date of issuance, payable semi-annually on May 1 and November 1, commencing on May 1, 2011. The 2010 Notes will mature, unless earlier repurchased, redeemed or converted in accordance with their terms, on November 1, 2030.
We began repurchasing our 2010 senior convertible notes in the open market in the fourth quarter of 2012. No repurchases were made in the three months ended September 30, 2013. For the nine months ended September 30, 2013, we repurchased $5.4 million of the 2010 Notes in the open market at an average price of 98.8% of par. For the nine months ended September 30, 2013, the net gain on extinguishment of debt was immaterial, which is the net of the gain on sale offset by the write-off of debt issuance costs. As of December 31, 2012, we repurchased $43.9 million of the 2010 Notes in the open market at an average price of 98.5% of par. Notes repurchased are deemed to be extinguished for accounting purposes.
Holders have the right to convert some or all of the 2010 Notes at any time prior to the maturity date into shares of our common stock at the initial conversion rate of 20.3537 shares per $1,000 in principal amount of the 2010 Notes, which is equal to an initial conversion price of approximately $49.13 per share. At the initial conversion rate, assuming the conversion of all $295.8 million in aggregate principal amount, the 2010 Notes may be converted into approximately 6,019,607 shares of our common stock. We will adjust the conversion price if certain events occur, as specified in the related indenture, such as the issuance of our common stock as a dividend or distribution or the occurrence of a stock subdivision or combination. If we undergo certain types of fundamental changes, as defined in the indenture, on or before November 1, 2015, we will be required to pay a fundamental change make-whole premium on 2010 Notes converted in connection with such make-whole fundamental change by increasing the conversion rate. The amount of the fundamental change make-whole premium, if any, will be based on our common stock price and the effective date of the make-whole fundamental change.
At any time on or after November 1, 2015, and prior to the maturity date, we may redeem for cash some or all of the 2010 Notes at a redemption price equal to the principal amount of the 2010 Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.
Holders have the right to require us to repurchase some or all of their 2010 Notes for cash on each of November 1, 2015, November 1, 2020 and November 1, 2025, at a repurchase price equal to the principal amount of the 2010 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the relevant repurchase date. If we undergo certain types of fundamental changes prior to the maturity date, holders of the 2010 Notes will have the right, at their option, to require us to repurchase some or all of their 2010 Notes at a repurchase price equal to the principal amount of the 2010 Notes being repurchased, plus accrued and unpaid interest to, but excluding, the repurchase date.
As of September 30, 2013, the fair value of our $295.8 million 2010 senior convertible notes was valued at $294.3 million based on the quoted fair market value of the debt. As of December 31, 2012, the fair value of our $301.1 million 2010 senior convertible notes was valued at $285.3 million based on the quoted fair market value of the debt. Debt is classified as a level 3 fair value measurement. We determine fair value based on the market approach.
2004 Senior Convertible Notes
In 2004, we sold and issued $195.0 million in aggregate principal amount of 1.25% senior convertible notes due January 1, 2024 (2004 Notes), in a private, unregistered offering. The 2004 Notes were sold at their principal amount. On January 5, 2009, we announced that the majority of the holders of the 2004 Notes exercised the option to require us to repurchase those Notes on January 2, 2009. Notes with an aggregate principal amount of approximately $8.8 million remain outstanding. Holders of the remaining outstanding 2004 Notes have the right to require us to repurchase their 2004 Notes prior to maturity on January 1, 2014 and 2019. Due to the repurchase right on January 1, 2014, the aggregate principle balance of the 2004 Notes is classified within Other current liabilities in the September 30, 2013, balance sheet. The 2004 Notes are classified within Senior convertible notes in non-current liabilities at December 31, 2012.
We are required to pay interest on the 2004 Notes on January 1 and July 1 of each year so long as the 2004 Notes are outstanding. The 2004 Notes bear interest at a rate of 1.25% and, if specified conditions are met, are convertible into our common stock at a conversion price of $44.063 per share. At the initial conversion rate, assuming the conversion of our $8.8 million in remaining principal debt, the 2004 Notes may be converted into approximately 199,828 shares of our common stock. The 2004 Notes may be surrendered for conversion under certain circumstances, including the satisfaction of a market price condition, such that the price of our common stock reaches a specified threshold; the satisfaction of a trading price condition, such that the trading price of the 2004 Notes falls below a specified level; the redemption of the 2004 Notes by us, the occurrence of specified corporate transactions, as defined in the related indenture; and the occurrence of a fundamental change, as defined in the related indenture. The initial conversion price is equivalent to a conversion rate of approximately 22.6948 shares per $1,000 of principal amount of the 2004 Notes. We will adjust the conversion price if certain events occur, as specified in the related indenture, such as the issuance of our common stock as a dividend or distribution or the occurrence of a stock subdivision or combination.
As of September 30, 2013 and December 31, 2012, the fair value of our $8.8 million 1.25% 2004 senior convertible notes was valued at $8.7 million and $8.6 million, respectively, based on the quoted fair market value of the debt. Debt is classified as a level 3 fair value measurement. We determine fair value based on the market approach.
10. BUSINESS COMBINATIONS
On January 10, 2013 we acquired 100% of the capital stock of LML Payment Systems, Inc., a publically held payment service provider with operations in Victoria, British Columbia in an all cash transaction valued at $3.45 per share, or an aggregate purchase price of approximately $102.8 million. Acquisition and integration costs of $0.1 million and $4.9 million were expensed as incurred, and were recorded in the line item General and administrative on our Consolidated Statements of Operations for the three and nine months ended September 30, 2013, respectively. LML is a leading provider of payment processing services to the Canadian small and medium sized business market. This acquisition was made to broaden our online payments services to businesses of all sizes. The goodwill arising from the transaction consists primarily of synergies due the existence of an assembled workforce and synergies expected to be gained when combining the complimentary Digital River and LML business models. None of the goodwill recognized is expected to be deductible for income tax purposes.
For the three months ended September 30, 2013, LML revenue was $5.8 million and net loss was $1.3 million. LML revenue for the period starting as of the acquisition date of January 10, 2013, and ending on September 30, 2013, was
$18.0 million. LML net loss for the period starting as of the acquisition date of January 10, 2013, and ending on September 30, 2013, was $0.7 million.
The preliminary allocation of the purchase price for the LML acquisition has been assigned to assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The fair value of assets acquired and liabilities assumed was based upon a preliminary valuation and our estimates and assumptions are subject to change within the measurement period. During the three months ended September 30, 2013, the acquisition date fair value of other liabilities was decreased $0.5 million, due primarily to an adjustment to the opening balance of deferred revenue, which resulted in a corresponding increase in deferred tax liabilities of $0.1 million and a decrease in residual goodwill of $0.4 million. The resolution of various tax matters in the opening balance sheet resulted in an additional increase in deferred tax liabilities of $0.4 million with a corresponding increase in goodwill of $0.4 million. During the three months ended June 30, 2013, the acquisition date fair value of intangible assets was increased $2.6 million, which resulted in a corresponding increase in deferred tax liabilities of $0.6 million and a decrease in residual goodwill of $2.0 million. The remaining areas of the purchase price that are not yet finalized as of September 30, 2013 are related to accounts receivable, other assets, income taxes, deferred tax accounts, other liabilities and residual goodwill.
The preliminary allocation of the purchase price is summarized in the following table (in thousands):
|
|
LML Payment |
| |
Cash and cash equivalents |
|
$ |
46,957 |
|
Accounts receivable |
|
1,334 |
| |
Receivable of acquisition expenses incurred on behalf of Digital River |
|
1,068 |
| |
Customer and partner relationships |
|
23,230 |
| |
Trade names |
|
3,567 |
| |
Other intangibles |
|
1,185 |
| |
Goodwill |
|
54,287 |
| |
Other assets |
|
4,757 |
| |
Total assets acquired |
|
136,385 |
| |
Other liabilities |
|
33,585 |
| |
Total liabilities assumed |
|
33,585 |
| |
Total allocation of purchase price consideration |
|
102,800 |
| |
Less: cash acquired |
|
(46,957 |
) | |
Total purchase price, net of cash acquired |
|
$ |
55,843 |
|
For the LML acquisition, customer and partner relationships have a weighted average useful life of 5.0 years, trade names have a weighted average useful life of 5.0 years and other intangibles have a weighted average useful life of 4.8 years.
Information regarding our intangible assets acquired from the LML acquisition is as follows (in thousands):
|
|
As of September 30, 2013 |
| |||||||
|
|
Carrying Amount |
|
Accumulated |
|
Carrying Amount |
| |||
|
|
Gross |
|
Amortization |
|
Net |
| |||
Customer and partner relationships |
|
$ |
23,230 |
|
3,387 |
|
19,843 |
| ||
Trade names |
|
3,567 |
|
520 |
|
3,047 |
| |||
Other intangibles |
|
1,185 |
|
205 |
|
980 |
| |||
Total |
|
$ |
27,982 |
|
$ |
4,112 |
|
$ |
23,870 |
|
Amortization expense of LML acquisition-related intangible assets was $1.4 million and $4.1 million for the three and nine months ended September 30, 2013 respectively.
Estimated amortization expense for the remaining life of the LML intangible assets, based on intangible assets as of September 30, 2013, is as follows (in thousands):
Year |
|
|
| |
Remainder of 2013 |
|
$ |
1,418 |
|
2014 |
|
5,613 |
| |
2015 |
|
5,613 |
| |
2016 |
|
5,613 |
| |
2017 |
|
5,613 |
| |
Total |
|
$ |
23,870 |
|
Pro Forma Operating Results (Unaudited)
The unaudited pro forma financial information in the table below summarizes the combined results of operations for Digital River, Inc. and LML. The consolidated financial statements include the operating results of LML from the date of acquisition.
The historical financial information has been adjusted to give effect to pro forma events that are directly attributable to the transaction, are factually supportable and, in the case of the pro forma results of operations, have a nonrecurring impact. For the three and nine months ended September 30, 2012, the pro forma results include adjustments primarily related to amortization of acquired intangible assets of $1.4 million and $4.1 million, respectively, less elimination of LML historical intangible amortization expense of $0.2 million and $0.5 million, respectively, and income taxes benefit of $0.3 million and $0.9 million, respectively. The following unaudited pro forma condensed results of operations for three and nine months ended September 30, 2012 and 2013, have been prepared as if the LML acquisition had occurred on January 1, 2012, (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
September 30, |
|
September 30, |
| ||||||||
|
|
2013 |
|
2012 |
|
2013 |
|
2012 |
| ||||
Revenue |
|
$ |
87,260 |
|
$ |
92,815 |
|
$ |
289,366 |
|
$ |
294,321 |
|
Net income (loss) |
|
(12,487 |
) |
(1,314 |
) |
(24,432 |
) |
4,307 |
| ||||
This pro forma financial information does not purport to represent results that would actually have been obtained if the transactions had been in effect on January 1, 2012, as applicable, or any future results that may be realized.
All other business combination activities have been determined to be immaterial when compared to our consolidated financial statements.
11. DISCONTINUED OPERATIONS
On September 30, 2013, we sold substantially all of the net assets of CustomCD, Inc., which was based in Portland, Oregon in a stock sale to a former employee. We have recorded a pre-tax loss on the sale of $0.1 million within Income (loss) from discontinued operations, net of tax in our Consolidated Statements of Operations. The results of operations of CustomCD, including the loss on the sale, have been excluded from the results of continuing operations and are reported as discontinued operations.
On October 1, 2013, we sold substantially all of the net assets of Digital River Education Services, Inc., which was based in Plano, Texas in a stock sale to two former employees. We have determined that the criteria for reporting the assets and liabilities of DRES as held for sale, and the results of their operations, including the loss on the sale, as discontinued operations was met as of September 30, 2013. We have recorded a pre-tax loss on the sale of $2.0 million within Income (loss) from discontinued operations, net of tax in our Consolidated Statements of Operations.
We do not allocate interest income or interest expense to discontinued operations. The operating results of the discontinued operations included in the our Consolidated Statements of Operations for the three and nine month periods ended September 30, 2013 and 2012 were as follows (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
September 30, |
|
September 30, |
| ||||||||
|
|
2013 |
|
2012 |
|
2013 |
|
2012 |
| ||||
Revenue |
|
$ |
3,064 |
|
$ |
4,614 |
|
$ |
8,044 |
|
$ |
12,510 |
|
Income (loss) on discontinued operations before taxes and loss on disposal |
|
(99 |
) |
4 |
|
(1,619 |
) |
(1,466 |
) | ||||
Loss on disposal of discontinued businesses before taxes |
|
(2,110 |
) |
|
|
(2,110 |
) |
|
| ||||
Provision (benefit) for income taxes |
|
2,682 |
|
3 |
|
2,509 |
|
(539 |
) | ||||
Income (loss) on discontinued operations, net of tax |
|
$ |
(4,891 |
) |
$ |
1 |
|
$ |
(6,238 |
) |
$ |
(927 |
) |
The assets and liabilities of discontinued operations as of September 30, 2013 and December 31, 2012 were as follows (in thousands):
|
|
September 30, |
|
December 31, |
| ||
|
|
2013 |
|
2012 |
| ||
Current assets of discontinued operations |
|
$ |
6,584 |
|
$ |
7,365 |
|
Long-term assets of discontinued operations |
|
|
|
196 |
| ||
Total assets of discontinued operations |
|
$ |
6,584 |
|
$ |
7,561 |
|
|
|
|
|
|
| ||
Current liabilities of discontinued operations |
|
$ |
7,291 |
|
$ |
5,753 |
|
Non-current liabilities of discontinued operations |
|
|
|
0 |
| ||
Total liabilities of discontinued operations |
|
$ |
7,291 |
|
$ |
5,753 |
|
12. SUBSEQUENT EVENT
Subsequent to the quarter ended September 30, 3013, we reduced our workforce by 7% as part of our strategic transformation. Total severance and outplacement costs are expected to be $1.9 million, which will be recognized starting in the fourth quarter of 2013 when all of the criteria for one-time employee termination benefits under ASC 420 are met.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The discussion in this Quarterly Report contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Additional factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section entitled Risk Factors, included in Item 1A of Part II of this Quarterly Report. When used in this document, the words believes, expects, anticipates, intends, plans, and similar expressions, are intended to identify certain of these forward-looking statements. However, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. The cautionary statements made in this document should be read as being applicable to all related forward-looking statements wherever they appear in this document. We have no obligation to update the matters set forth herein, whether as a result of new information, future events or otherwise.
Business Overview
We provide end-to-end global cloud-commerce, payments and marketing solutions to a wide variety of companies in software, consumer electronics, computer games, video games and other markets. We offer our clients a broad range of services that enable them to quickly and cost effectively establish an online sales channel capability and to subsequently manage and grow online sales on a global basis while mitigating risks. Our services include design, development and hosting of online stores and shopping carts, store merchandising and optimization, order management, denied parties screening, export controls and management, tax compliance and management, fraud management, digital product delivery via download, physical product fulfillment, subscription management, online marketing including e-mail marketing, management of affiliate programs, paid search programs, payment processing services, web analytics and reporting, and website optimization.
Our commerce products and services allow our clients to focus on promoting and marketing their products and brands worldwide while leveraging our investments in technology and infrastructure to facilitate the purchase of products through their online websites. When shoppers visit one of our clients branded websites they are transferred to an online commerce store and/or shopping cart operated by us on our commerce platforms. Once on our system, shoppers can browse for products and make purchases online. We typically are the seller of record for transactions through our client branded stores. After a purchase is made, we either deliver the product digitally via download over the Internet or transmit instructions to a third party for physical fulfillment of the order. We also typically process the buyers payment as the merchant of record, including collection and remittance of applicable taxes and compliance with various regulatory matters. We have invested substantial resources to develop our cloud-commerce and marketing platforms, including direct-to-buyer software, and we provide access and use of our platforms to our clients as a service as opposed to selling the software to be operated on their own in-house computer hardware. Our cloud-commerce store solutions range from simple remote control
models to more comprehensive online store models.
Through Digital River World Payments (DRWP) and LML, we offer a full range of payment processing services to clients. These services include multiple payment methods, fraud management, tax management, cloud-based billing and other payment optimization services.
In addition to the services we provide that facilitate the completion of an online transaction, we also offer services designed to increase traffic to our clients websites and the associated online stores and to improve the sales productivity of those stores. Our services include paid search advertising, search engine optimization, affiliate marketing, store optimization, multi-variant testing, web analytic services and e-mail optimization. All of our services are designed to help our clients acquire customers more effectively, sell to those customers more often and more efficiently, and increase the lifetime value of each customer.
Current Period Results and Outlook
For the quarter ended September 30, 2013, we recorded a net loss of $12.5 million or ($0.40) per share, comprised of net loss from continuing operations of $7.6 million or ($0.24) per share and net loss from discontinued operations of $4.9 million or ($0.16) per share. For the comparative quarter ended September 30, 2012, we recorded a net loss of $0.7 million or ($0.02) per share, comprised of net loss from continuing operations of $0.7 million and breakeven discontinued operations. Revenues from continuing operations of $87.3 million in the quarter ended September 30, 2013, are consistent with revenues from continuing operations of $87.1 million in the same period in the prior year as payments revenue growth of $8.7 million offset a decrease in commerce revenue of $8.5 million compared to prior year. $5.8 million of the growth in payments revenue was related to LML, which was acquired in the first quarter of 2013. Client attrition was the primary driver of the decrease in commerce revenue compared to prior year. However, the level of client attrition and its impact on revenue continues to be consistent with our expectations and previous communications.
Total costs and expenses in continuing operations as of September 30, 2013, of $93.8 million increased 8.6% compared to the same period in the prior year. As of September 30, 2013 and December 31, 2012, we had $580.8 million and $705.6 million in cash, cash equivalents and short-term investments, respectively.
Our managements discussion and analysis includes the quarterly results of LMLs earnings starting as of the acquisition date of January 10, 2013.
We continue to move forward with the strategic transformation process. We are making substantial investments, up to $22 million in 2013, with continuing investments into 2014, to deliver a more flexible commerce ecosystem, pursue high-impact growth markets, as well as create financial capacity that will drive growth and improved operating margins over time.
Other
On May 8, 2012, we entered into with Microsoft Corporation (Microsoft), in the ordinary course of business, the Third Omnibus Amendment to the Microsoft Operations Digital Distribution Agreement (the Third Omnibus Amendment). The Third Omnibus Amendment extends the term of Microsoft Operations Digital Distribution Agreement to a date no earlier than March 1, 2014. Additionally, the Third Omnibus Amendment allowed for the expansion of the business relationship pursuant to which we have and continue to build, host and manage the Microsoft Store, an e-commerce store that supports the sale and fulfillment of Microsoft and third party software as well as consumer electronics products, to customers throughout the world. In addition, pursuant to the Third Omnibus Amendment, we continue to act as a reseller of Microsoft products.
We view our operations and manage our business as one reportable segment, providing outsourced commerce and payments solutions globally to a variety of companies.
We were incorporated in Delaware in February 1994. Our headquarters are located at 10380 Bren Road West, Minnetonka, Minnesota and our telephone number is 952-253-1234.
General information about us can be found at www.digitalriver.com under the Company/Investor Relations link or follow the Company on Twitter at twitter.com/digitalriverinc. Our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments or exhibits to those reports, are available free of charge through our website as soon as reasonably practicable after we file such reports with the Securities and Exchange Commission.
Results of Operations
LML Acquisition
On January 10, 2013, we acquired all of the capital stock of LML Payment Systems, Inc., a publically held payment service provider with operations in Victoria, British Columbia in an all cash transaction valued at $3.45 per share, or an aggregate purchase price of approximately $102.8 million. The inclusion of LMLs financial results since the acquisition date represent an increase to our operations in the nine months ended September 30, 2013 when compared to the same period in the prior year.
Reclassifications
The results of the operations of CustomCD and DRES have been classified within Discontinued Operations within our Consolidated Statements of Operations for the three and nine month periods ending September 30, 2013. The operations of these entities in the corresponding periods of 2012 have been reclassified into Discontinued Operations for comparative purposes to conform to the current year presentation. In addition, all of the assets and liabilities of DRES, which was sold on October 1, 2013, meet the criteria for assets held for sale as of September 30, 2013, and are separately reported as current assets, at fair value, and current liabilities of discontinued operations within the Consolidated Balance Sheet at September 30, 2013. The assets and liabilities of CustomCD have been removed from our Consolidated Balance Sheet as of September 30, 2013, as the entity was sold on September 30, 2013. The assets and liabilities of both CustomCD and DRES in the December 31, 2012 Consolidated Balance Sheet have been reclassified and separately presented as current assets and current liabilities of discontinued operations for comparative purposes with the current year presentation.
Certain items in the prior years Consolidated Statements of Operations have been reclassified for comparative purposes to conform to the current year presentation. Historically, we have reported payment processing fees, chargebacks, and directly related personnel expenses within the Sales and marketing and General and administrative line items. We have reclassified these expenses to the Direct cost of services line as these costs are associated directly with services rendered. For the three and nine months ended September 30, 2012, excluding amounts related to CustomCD and DRES which have been reclassified to discontinued operations, we have reclassified $12.8 million and $39.3 million, respectively, previously reported as Sales and marketing and $0.4 million and $1.4 million, respectively, previously reported as General and administrative to Direct cost of services. The reclassifications did not have an effect on reported consolidated net income (loss).
The following table sets forth certain items from our Consolidated Statements of Operations as a percentage of revenue from continuing operations for the periods indicated:
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||
|
|
September 30, |
|
September 30, |
| ||||
|
|
2013 |
|
2012 |
|
2013 |
|
2012 |
|
Revenue |
|
100.0 |
% |
100.0 |
% |
100.0 |
% |
100.0 |
% |
Costs and expenses (exclusive of depreciation and amortization expense shown separately below): |
|
|
|
|
|
|
|
|
|
Direct cost of services |
|
18.5 |
|
17.8 |
|
19.1 |
|
17.5 |
|
Network and infrastructure |
|
16.8 |
|
15.1 |
|
15.3 |
|
14.1 |
|
Sales and marketing |
|
28.7 |
|
26.1 |
|
27.9 |
|
27.4 |
|
Product research and development |
|
20.8 |
|
17.4 |
|
18.4 |
|
16.7 |
|
General and administrative |
|
13.8 |
|
15.8 |
|
15.3 |
|
13.6 |
|
Goodwill impairment |
|
|
|
|
|
7.4 |
|
|
|
Depreciation and amortization |
|
6.5 |
|
5.7 |
|
5.4 |
|
5.6 |
|
Amortization of acquisition-related intangibles |
|
2.4 |
|
1.3 |
|
2.2 |
|
1.3 |
|
Total costs and expenses |
|
107.5 |
|
99.2 |
|
111.0 |
|
96.2 |
|
Income (loss) from operations |
|
(7.5 |
) |
0.8 |
|
(11.0 |
) |
3.8 |
|
Interest income |
|
0.6 |
|
0.9 |
|
0.6 |
|
1.1 |
|
Interest expense |
|
(2.2 |
) |
(2.6 |
) |
(2.0 |
) |
(2.5 |
) |
Other income (expense), net |
|
(0.3 |
) |
(0.7 |
) |
5.8 |
|
|
|
Income (loss) from continuing operations before income taxes |
|
(9.4 |
) |
(1.6 |
) |
(6.6 |
) |
2.4 |
|
Income tax expense (benefit) |
|
(0.7 |
) |
(0.8 |
) |
(0.2 |
) |
0.5 |
|
Income (loss) from continuing operations |
|
(8.7 |
) |
(0.8 |
) |
(6.4 |
) |
1.9 |
|
Income (loss) from discontinued operations, net of tax |
|
(5.6 |
) |
|
|
(2.2 |
) |
(0.4 |
) |
Net income (loss) |
|
(14.3 |
)% |
(0.8 |
)% |
(8.6 |
)% |
1.5 |
% |
The following narrative discussion addresses the results of continuing operations for each financial statement caption. The results of discontinued operations are separately addressed at the conclusion of this discussion.
Revenue. Our revenue of $87.3 million for the three months ended September 30, 2013 was consistent with $87.1 million for the same period in the prior year. For the nine months ended September 30, 2013, revenue totaled $288.4 million, an increase of $16.0 million, or 6%, from revenue of $272.4 million for the same period in the prior year.
Our revenues are driven primarily by global commerce and payment services provided to a wide variety of companies in the software, consumer electronics, computer games and other markets. Continuing commerce revenues include revenues generated from Microsoft, as well as, our remaining supporting businesses. Revenues from our former supporting businesses, DRES and CustomCD, are included within discontinued operations. Payments revenues include revenues from DRWP and our first quarter 2013 acquisition, LML.
For the three months ended September 30, 2013, payments revenue increased $8.7 million, primarily due to $5.8 million of revenue from LML. DRWP revenue of $9.0 million was also up 47% compared to $6.1 million in the third quarter of 2012, driven by continued client expansion. This increase in payments revenue was offset by a decrease of $8.5 million in the continuing operations of our commerce business due mainly to the continued impact of client attrition from prior periods. For the nine months ended September 30, 2013, the $16.0 million increase in revenue was due to a $28.1 million increase in payments revenue, offset by $12.1 million decrease in commerce revenue. LML revenue for the period starting as of the acquisition date of January 10, 2013, and ending on September 30, 2013, was $18.0 million.
International sales were approximately 46.8% and 47.7% of total sales in the three and nine month periods ended September 30, 2013, compared to 45.8% and 46.4% for the same periods in the prior year.
Direct Cost of Services. Direct cost of services includes payment processing fees, chargeback expense, fraud detection and prevention, costs related to product fulfillment, delivery solutions and certain client-specific costs. Direct cost of service were $16.2 million for the three months ended September 30, 2013, compared to $15.5 million for the same period in the prior year. Direct cost of service expenses were $55.3 million for the nine months ended September 30, 2013, compared to $47.8 million for the same period in the prior year. The increase in direct cost of services is primarily related to higher revenue in the first nine months of 2013 compared to the same period in the prior year.
Network and Infrastructure. Our network and infrastructure expenses primarily include costs to operate and maintain our technology platforms, customer service, data communication and data center operations. Network and infrastructure expenses were $14.6 million and $13.2 million for the three months ended September 30, 2013 and 2012, respectively. Network and infrastructure expenses were $44.0 million and $38.3 million for the nine months ended September 30, 2013 and 2012, respectively. The increase was mainly due to higher data communication and IT related costs related to enhancing our flexibility and stability within our commerce environments.
Sales and Marketing. Our sales and marketing expenses include personnel and related costs, advertising, promotional and product marketing expenses, and bad debt expense. Sales and marketing expenses were $25.0 million and $22.8 million for the three months ended September 30, 2013 and 2012, respectively. Sales and marketing expenses were $80.4 million and $74.6 million for the nine months ended September 30, 2013 and 2012, respectively. The increase in costs in the third quarter was due mainly to increased workforce related expenses and LML sales and marketing initiatives. Year-to-date increases were driven by additional first quarter 2013 expenses primarily related to corporate website redesign and branding initiatives as well as the additional of LML expenses.
Product Research and Development. Our product research and development expenses include costs associated with design, development and enhancement of our technology platforms and related systems. Research and development costs are expensed as incurred, except certain internal-use software development costs that are eligible for capitalization and costs directly associated with preparing a client website launch that are eligible to be deferred and amortized over the life of the sites associated revenue streams. These costs drive enhanced technologies and strengthen our leadership position in the markets we serve. These investments advance our global system scalability, e-marketing capabilities, data management and client reporting. Product research and development expenses were $18.1 million and $15.2 million for the three months ended September 30, 2013 and 2012, respectively. Product research and development expenses were $53.0 million and $45.6 million for the nine months ended September 30, 2013 and 2012, respectively. The increase was primarily due to increased emphasis in our investment in platform stability, LML related research and development, and the recognition of expenses that were previously deferred until completion of a client site.
General and Administrative. Our general and administrative expenses primarily include executive, finance, human resources and other administrative workforce and other related expenses, fees for professional services, bank fees, litigation costs, insurance costs, integration costs and non-income related taxes. General and administrative expenses were $12.0 million and $13.7 million for the three months ended September 30, 2013 and 2012, respectively. General and administrative expenses were $44.0 million and $37.0 million for the nine months ended September 30, 2013 and 2012, respectively. The decrease in third quarter expenses was related mainly to lower stock compensation and consulting expense, as well as, LML acquisition fees that were incurred in the third quarter of 2012. The year-to-date increase is due to severance, legal fees, and acquisition and integration costs associated with LML in the first quarter of 2013 and strategic consulting expenses associated with business process transformation plans in the second quarter of 2013.
Goodwill Impairment. In December 2012, due to the deterioration in our stock price in the second half of 2012, adjustments in our forecasted revenue growth and change in our chief operating decision maker, management completed an interim impairment test and determined that the book value of the Company was in excess of fair value and a goodwill impairment was required. In the fourth quarter 2012, we recorded a non-cash pretax goodwill impairment charge of $175.2 million, or $161.1 million after tax, relating to our single reporting unit. The impairment charge was an estimate pending final valuation of a privately held equity security in calculating the goodwill impairment charge of $175.2 million. During the first quarter of 2013, we determined the fair market value of the privately held equity security which we had estimated at year end and completed our goodwill impairment analysis, recording an additional non-cash pretax goodwill impairment charge of $21.2 million, relating to our single reporting unit.
Depreciation and Amortization. Our depreciation and amortization expenses include the depreciation of computer equipment, office furniture and leasehold improvements and the amortization of purchased and internally developed software. Computer equipment, furniture and software are depreciated/amortized under the straight-line method using three to seven year lives and leasehold improvements are depreciated over the shorter of the life of the asset or the remaining length of the lease. Depreciation and amortization expense was $5.7 million and $4.9 million for the three months ended September 30, 2013 and 2012, respectively. Depreciation and amortization expense was $15.7 million and $15.2 million for the nine months ended September 30, 2013 and 2012, respectively.
Amortization of Acquisition-Related Intangibles. Amortization of acquisition-related intangibles consists of the amortization of intangible assets such as customer and partner relationships, technology and trade names acquired in business combinations. Amortization of acquisition-related intangible assets was $2.1 million and $1.1 million for the three months ended September 30, 2013 and 2012, respectively. Amortization of acquisition-related intangible assets was $6.4 million and
$3.5 million for the nine months ended September 30, 2013 and 2012, respectively. The increase was driven by the addition of intangibles associated with the purchase of LML.
Interest Income. Our interest income represents the total of interest income on our cash, cash equivalents, short-term investments and certain long-term investments. Interest income was $0.6 million and $0.8 million for the three months ended September 30, 2013 and 2012, respectively. Interest income was $1.9 million and $2.9 million for the nine months ended September 30, 2013 and 2012, respectively. The decrease in interest income was due to less cash and cash equivalents and short-term investments due to the acquisition of LML and stock and debt repurchases completed during 2013 and the fourth quarter of 2012.
Interest Expense. Our interest expense includes the total of cash and non-cash interest expense attributable to our outstanding convertible debt. For the three months ended September 30, 2013 and 2012, interest expense was $1.9 million and $2.3 million, respectively, which included $0.4 million and $0.5 million of debt financing cost amortization, respectively. For the nine months ended September 30, 2013 and 2012, interest expense was $5.9 million and $6.8 million, respectively, which included $1.3 million and $1.5 million of debt financing cost amortization, respectively. The decrease in interest expense, including debt financing cost amortization, was due to the repurchase of our 2010 senior convertible notes during the first half of 2013 and the fourth quarter of 2012, which bear an annual interest rate of 2.0%.
Other Income (Expense), Net. Our other income (expense), net includes foreign currency transaction gains and losses, gains and losses on investments or asset disposals (excluding disposal of businesses), other-than-temporary impairment of investments and dividend income. Other income (expense), net was ($0.3) million and ($0.6) million for the three months ended September 30, 2013 and 2012, respectively. For the three months ended September 30, 2013, the net decrease in expense was due to a $0.6 million note receivable reserve recorded in the third quarter of 2012, offset by $0.3 million of unfavorable foreign currency re-measurement losses during the quarter the third quarter of 2013. Other income (expense), net was $16.7 million and $0.1 million for the nine months ended September 30, 2013 and 2012, respectively. For the nine months ended September 30, 2013 the increase is primarily driven by the sale of a cost method equity investment to a third party which resulted in a gain of $17.6 million, offset by unfavorable foreign currency re-measurement losses.
Income Tax Expense (Benefit). For the three months ended September 30, 2013 and 2012, our tax benefit related to continuing operations was $0.6 million and $0.7 million, respectively. For the three month period ended September 30, 2013, our income tax expense related to discontinued operations was $2.6 million, with immaterial expense related to discontinued operations in the comparative prior quarter ended September 30, 2012. For the three months ended September 30, 2013, our total tax expense consisted of approximately $2.3 million of U.S. tax expense and $0.2 million of foreign tax benefit. For the three months ended September 30, 2012, our total tax benefit consisted of approximately $0.5 million of U.S. tax benefit and $0.2 million of foreign tax benefit. For the three months ended September 30, 2013 and 2012, the tax rate was (19.4%) and 48.7%, respectively. The difference in tax rates is due to different discrete items occurring in the quarters, as well as, the valuation allowance established in the fourth quarter of 2012.
For the nine months ended September 30, 2013, our tax benefit related to continuing operations was $0.4 million compared to $1.4 million of tax expense related to continuing operations for the nine months ended September 30, 2012. For the nine months ended September 30, 2013, our tax expense related to discontinued operations was $2.5 million compared to $0.5 million tax benefit related to discontinued operations for the nine months ended September 30, 2012. For the nine months ended September 30, 2013, our total tax expense consisted of approximately $3.7 million of U.S. tax expense and $1.6 million of foreign tax benefit. For the nine months ended September 30, 2012, our total tax expense consisted of approximately $0.8 million of U.S. tax expense and $0.1 million of foreign tax expense. For the nine months ended September 30, 2013 and 2012, the tax rate was (9.3%) and 17.7%, respectively. The difference in tax rates is due to different discrete items occurring between the periods, as well as, the valuation allowance established in the fourth quarter of 2012.
Discontinued Operations. For the three months ended September 30, 2013 revenues included within discontinued operations totaled $3.1 million, a decrease of $1.5 million, or 34%, from revenues of $4.6 million for the same period in the prior year. $1.0 million of the decrease relates to DRES and $0.5 million relates to CustomCD. Loss from discontinued operations before tax and loss on disposals for the three months ended September 30, 2013, totaled $0.1 million compared to break-even for the three months ended September 30, 2012. The pre-tax loss on disposal recorded in the three months ended September 30, 2013 was $2.1 million, $2.0 million related to DRES and $0.1 million related to CustomCD. Total net losses from discontinued operations were $4.9 million for the three months ended September 30, 2013, compared to break-even for the three months ended September 30, 2012.
For the nine months ended September 30, 2013, revenues included within discontinued operations totaled $8.0 million, a decrease of $4.5 million, or 36%, from revenues of $12.5 million for the same period in the prior year. $3.1 million of the decrease relates to DRES and $1.4 million relates to CustomCD. Loss from discontinued operations before tax and loss on disposals for the nine months ended September 30, 2013 totaled $1.6 million compared to $1.5 million for the nine months ended September 30, 2012. The pre-tax loss on disposal recorded in the nine months ended September 30, 2013 was $2.1 million, $2.0 million related to DRES and $0.1 million related to CustomCD. Total net losses from discontinued operations were $6.2 million for the nine months ended September 30, 2013 compared to net loss of $0.9 million for the nine months ended September 30, 2012.
Off Balance Sheet Arrangements
None.
Liquidity and Capital Resources
|
|
Nine Months Ended |
| ||||
|
|
September 30, |
| ||||
Cash Flows (in thousands) |
|
2013 |
|
2012 |
| ||
Cash provided by (used in): |
|
|
|
|
| ||
Operating activities |
|
$ |
(45,555 |
) |
$ |
(24,344 |
) |
Investing activities |
|
5,799 |
|
12,221 |
| ||
Financing activities |
|
(51,176 |
) |
(20,948 |
) | ||
Effect of exchange rate changes on cash and cash equivalents |
|
6,143 |
|
1,333 |
| ||
Net increase (decrease) in cash and cash equivalents |
|
$ |
(84,789 |
) |
$ |
(31,738 |
) |
Operating Activities
As of September 30, 2013, we had $458.1 million of cash and cash equivalents, approximately 49.7% of which are held by our international subsidiaries. If funds held by our international subsidiaries were repatriated to the U.S. we may incur a U.S. tax liability that is not currently accrued in our financial statements. However, cash and cash equivalents held in the U.S. are sufficient to fund our current and anticipated domestic operations. As a result, we do not anticipate any local liquidity restrictions that would preclude us from funding our expansion or operating needs and do not foresee a need to repatriate any earnings.
As of September 30, 2013 and December 31, 2012, we had $580.8 million and $705.6 million in cash, cash equivalents and short-term investments, respectively. Excluding client payables and client receivables, we had $470.4 million and $550.4 million in net short-term liquidity as of the end of September 30, 2013 and December 31, 2012, respectively. Our company cash, which includes cash and non-equity investments and excludes client payables and client receivables, was $510.5 million and $587.4 million as of September 30, 2013, and December 31, 2012, respectively.
Net cash used in operations for the nine months ended September 30, 2013 of $45.6 million was primarily the result of our net loss and changes in working capital, adjusted for non-cash expenses and income from gain on sale of an equity investment. Net cash used in operations for the nine months ended September 30, 2012 of $24.3 million was primarily the result of changes in working capital, offset by net income, adjusted for non-cash expenses.
Investing Activities
Net cash provided by investing activities for the nine months ended September 30, 2013 was $5.8 million and was the result of net sales of investments of $77.3 million, offset by net cash paid for acquisitions of $55.8 million and purchases of equipment and capitalized software of $15.7 million. Net cash provided by investing activities for the nine months ended September 30, 2012 was $12.2 million and was the result of net sales of investments of $26.6 million, offset by purchases of equipment and capitalized software of $14.4 million.
Financing Activities
Net cash used in financing activities for the nine months ended September 30, 2013 was $51.2 million. This was primarily driven by $44.0 million cash used in the repurchase of common stock, $4.3 million cash used in the repurchase of restricted stock to satisfy tax withholding obligations, and repurchase of convertible senior notes of $5.4 million, offset by proceeds of $1.3 million provided by the exercise of stock options. Net cash used in financing activities for the nine months ended September 30, 2012, was $20.9 million. This was primarily driven by $20.2 million cash used in the repurchase of common stock and $3.7 million cash used in the repurchase of restricted stock to satisfy tax withholding obligations, offset by proceeds of $1.5 million provided by the exercise of stock options.
Effect of Exchange Rate Changes
For the nine months ended September 30, 2013, changes in foreign currency rates resulted in a $6.1 million increase in our cash and cash equivalents. The change is due to foreign currency volatility on our international entity balance sheet exposures, primarily from the euro.
Auction Rate Securities
As of September 30, 2013, we held $45.7 million of auction rate securities (ARS) at par value which we have recorded at fair value of $40.2 million. As of December 31, 2012, we held $45.8 million of ARS at par value which was recorded at fair value of $37.0 million. The ARS are 105 134% over-collateralized and the underlying student loans are guaranteed by the U.S. government. Almost all of these securities continue to fail at auction due to continued illiquid market conditions.
Due to the illiquid market conditions, we recorded a temporary fair value reduction of our ARS in the amount of $5.5 million (12.1% of par value) as of September 30, 2013, under Accumulated other comprehensive income (loss), compared to a $8.8 million temporary fair value reduction as of December 31, 2012 (19.3% of par value). In evaluating our ARS portfolio, we note sustained performance of our securities, strong parity levels, observed market redemption activity, and continued receipt of interest and penalty payments. As we expect to receive all contractual cash flows, we do not believe the unrealized losses to be credit related. We continue to believe that we will be able to liquidate at par over time. We do not intend to sell the investments prior to recovery of their amortized cost basis nor do we believe it is more likely than not we may be required to sell the investments prior to recovery of their amortized cost basis. Accordingly, we treated the fair value decline as temporary. We anticipate we will have sufficient cash flow from operations to execute our business strategy and fund our operational needs. We believe that capital markets are also available if we need to finance other investment alternatives.
The discounted cash flow model we used to value these securities included the following assumptions:
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September 30, |
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December 31, |
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2013 |
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2012 |
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Unobservable inputs |
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Redemption period (in years) |
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7 |
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7 |
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Credit ratings |
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BB+ to AAA |
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BB+ to AAA |
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Penalty coupon rate |
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1.0% to 1.5% |
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1.0% to 1.5% |
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Weighted average annualized yield |
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1.2% |
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1.5% |
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Risk adjusted discount rate |
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4.4% to 10.2% |
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3.5% to 12.3% |
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Management makes estimates and assumptions about the ARS, which can be sensitive to changes and effect the determination of fair value. An increase in the length of redemption period or an increase in the discount rate assumption would decrease our fair value. Also, a decrease in the securities credit ratings would decrease our fair value.
The portfolio had a weighted average maturity of 30.1 years and 30.8 years as of September 30, 2013 and December 31, 2012, respectively.
We classify our ARS as Level 3 long-term investments until we receive a call or partial call on the securities. Upon receipt of a call or partial call, we classify the securities subject to the call or partial call, as Level 1 short term investments. As of September 30, 2013 and December 31, 2012, our entire ARS portfolio was classified as Level 3 long-term investments. In the nine months ended September 30, 2013, we liquidated $0.1 million of ARS due to partial calls at par. During the year ended December 31, 2012, we liquidated $25.7 million of ARS due to full calls, partial calls or sales at par. The amount of Level 3 assets as a percentage of total assets measured at fair value on a recurring basis was 6.4% and 5.0% as of September 30, 2013 and December 31, 2012, respectively.
Commitments and Guarantees
At certain times, we enter into agreements where a letter of credit is required to ensure payment of future obligations by counterparties, such as our credit card processors and international taxing jurisdictions. Upon withdrawal, we are obligated to fund the executor bank on demand. We have not set aside specific funds to cover this potential obligation as we can generally recover these costs from our clients. If drawn upon, we expect to fund this commitment with cash and cash equivalents. There were $0.5 million and $3.6 million in undrawn letters of credit at September 30, 2013 and December 31, 2012, respectively.
Application of Critical Accounting Policies
Critical Accounting Estimates and Policies
A detailed description of our significant accounting policies can be found in our most recent Annual Report filed on Form 10-K for the fiscal year ended December 31, 2012. There were no material changes in significant accounting policies during the quarter ended September 30, 2013.
Recent Accounting Pronouncements
Information regarding recently issued accounting standards is included in Note 1 to the Consolidated Financial Statements.
Item 3. Qualitative and Quantitative Disclosure about Market Risk
Interest Rate Risk
Our portfolio of cash equivalents, short-term and long-term investments is maintained in a variety of securities, including government agency obligations and money market funds. Investments are classified as available-for-sale securities and carried at their market value with cumulative unrealized gains or losses recorded as a component of Accumulated other comprehensive income (loss) within stockholders equity. A sharp rise in interest rates could have an adverse impact on the market value of certain securities in our portfolio. We do not currently hedge our interest rate exposure and do not purchase financial instruments for trading or speculative purposes.
At September 30, 2013, we had $304.6 million of Senior Convertible Notes ($295.8 million classified as Non-current Senior convertible notes and $8.8 million classified within Other current liabilities), which are fixed rate instruments. The market value of our convertible debt will fluctuate with movements of interest rates, increasing in periods of declining rates of interest and declining in periods of increasing rates of interest.
Foreign Currency Risk
Growth in our international operations will incrementally increase our exposure to foreign currency fluctuations as well as other risks typical of international operations, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures and other regulations and restrictions.
Foreign exchange rate fluctuations may adversely impact our consolidated results of operations as exchange rate fluctuations on transactions denominated in currencies other than our functional currencies result in gains and losses that are reflected in our Consolidated Statements of Operations. To the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency-denominated transactions will result in increased net revenues and operating expenses. Conversely, our net revenues and operating expenses will decrease when the U.S. dollar strengthens against foreign currencies.
Transaction Exposure
The Company enters into short-term foreign currency forward contracts to offset the foreign exchange gains and losses generated by the re-measurement of certain assets and liabilities recorded in non-functional currencies. Changes in the fair value of these derivatives, as well as re-measurement gains and losses, are recognized in current earnings in Other income (expense), net. Foreign currency transaction gains and losses were a loss of $0.3 million and were immaterial in the three months ended September 30, 2013 and 2012, respectively. Foreign currency transaction losses were $0.8 million and $0.2 million in the nine months ended September 30, 2013 and 2012, respectively.
Translation Exposure
Foreign exchange rate fluctuations may adversely impact our consolidated financial position as the assets and liabilities of our foreign operations are translated into U.S. dollars in preparing our Consolidated Balance Sheets. These gains or losses are recognized as an adjustment to stockholders equity which is reflected in our Consolidated Balance Sheets under Accumulated other comprehensive income (loss).
Other Market Risks
Investments in Auction Rate Securities
At September 30, 2013, we held approximately $45.7 million of ARS at par. In light of current conditions in the ARS market as described in Item 2, Managements Discussion and Analysis of Financial Condition and Results of Operations, in this Quarterly Report on Form 10-Q, we may incur temporary unrealized losses, or other-than-temporary realized losses, in the future if we are unable to recover the investment principal in our ARS.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We are committed to maintaining disclosure controls and procedures designed to ensure that information required to be disclosed in our periodic reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a 15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2013. The term disclosure controls and procedures means controls and other procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that such information is accumulated and communicated to the companys management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on their evaluation of our disclosure controls and procedures as of September 30, 2013, our Chief Executive Officer and our Chief Financial Officer concluded that as of that date, our disclosure controls were effective at the reasonable assurance level.
Changes in Internal Control over Financial Reporting
Except as set forth below, there were no changes in the Companys internal control over financial reporting (as defined in Rule 13a 15(f) and 15d 15(f) under the Exchange Act) during the quarter ended September 30, 2013, that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.
In connection with the acquisition of LML Payment Systems, Inc., management has elected to exclude LML from managements assessment of the effectiveness of our internal control over financial reporting for the year ended December 31, 2013, and the quarters therein, as permitted by the Securities and Exchange Commission. As of the quarter ended September 30, 2013, total assets attributable to LML, excluding $74.9 million of goodwill and intangible assets, represented approximately $29.7 million or 3.1% of our total assets. Total revenue attributable to LML represented approximately $5.8 million of net revenue, or 6.6% of net revenue for the quarter ended September 30, 2013. Total revenue attributable to LML represented approximately $18.0 million of net revenue, or 6.2% of net revenue for the period starting as of the acquisition date of January 10, 2013, and ending on September 30, 2013.
Limitations on the Effectiveness of Controls
Our management, including the Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining an adequate system of internal control over financial reporting. This system of internal accounting controls is designed to provide reasonable assurance that assets are safeguarded, transactions are properly recorded and executed in accordance with managements authorization and financial statements are prepared in accordance with generally accepted accounting principles. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
We have provided information about legal proceedings in which we are involved in Note 8 to the Consolidated Financial Statements in Part I, Item 1.
The risks described below are not the only ones facing our company. Additional risks not presently known to us or that we currently deem immaterial also may impair our business operations. Our business, financial condition or results of operations could be materially adversely affected by any of these risks and the value of our common stock could decline due to any of these risks, and you could lose all or part of the money you paid to buy our common stock. The following discussion of our risk factors should be read in conjunction with the consolidated financial statements and related notes thereto, and managements discussion and analysis, contained in this report, and the risk factors contained in our Annual Report on Form 10-K for the year ended December 31, 2012. Our business is also subject to general risks and uncertainties that affect many other companies. In addition, the current global economic climate amplifies many of these risks.
This report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced by us described below and elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2012.
Risks Related to Our Business
We may experience significant fluctuations in our revenues, operating results, growth rate and stock price.
Our quarterly and annual revenues, operating results, and growth rate have fluctuated significantly in the past and are likely to do so in the future due to a variety of factors, some of which are outside our control. As a result, we believe that quarter-to-quarter and year-to-year comparisons of our revenue and operating results are not necessarily meaningful, and that these comparisons may not be accurate indicators of future performance. If our annual or quarterly operating results fail to meet the guidance we provide to securities analysts and investors or otherwise fail to meet their expectations, the trading price of our common stock may be impacted.
Factors that may affect our revenues, operating results, continued growth, and our stock price include the risks described elsewhere in this section, as well as the following:
· Client Development and Retention. We generate revenue by providing services to a wide variety of companies, primarily in the software and high-tech products markets. Therefore, it is important to our ongoing success that we maintain our key client relationships and, at the same time, both develop new client relationships and increase the number and type of products offered through our services. If we cannot successfully market our products and services, develop and maintain satisfactory relationships with software and digital products publishers, manufacturers of consumer electronics and other goods, online retailers and online channel partners on acceptable commercial terms, or if clients elect to end their relationships with us and we are unable to generate sufficient additional revenue to compensate for the loss of those relationships, we will likely experience a decline in revenue and operating profit. New product verticals or market segments, and further penetration of existing product verticals and market segments, may require us to work with companies which have a limited operating history or greater risks than more established companies. This may result in the engagement with clients and offering of products which are subject to higher chargeback rates or legal exposure and may generally expose us to greater legal and/or business risk. We may not be able to fully anticipate, mitigate or control all such risks. In the event claims are brought against us in connection with products offered by clients, especially clients with a limited operating history, weak sales, or who are or may become insolvent or bankrupt, we may not be successful in seeking indemnification for such claims from such clients and may be ultimately responsible for such claims. In the event a client becomes insolvent or bankrupt, we may not be successful in obtaining and retaining all amounts owed to us by that client, and the client may cease offering products for sale through our commerce services resulting in a decline in revenue and operating profit.
· We also depend on our clients to create and support products that consumers will purchase. We generally purchase products for resale from consignment or from distributors at the time of the resale to the consumer, and do not maintain an inventory of products available for sale. If we are unable to obtain sufficient quantities of products for
any reason, or if the quality of service provided by these publishers and manufacturers falls below a satisfactory level, we could also experience a decline in revenue, operating profit and consumer satisfaction, and our reputation could be harmed.
· Our contracts with our clients are generally one to two years in duration, with an automatic renewal provision for additional one-year periods, unless we are provided with a written notice before the end of the contract. Some of our contracts are for longer periods, but may provide for early termination upon certain notice. For example, our contract with Microsoft expires March 1, 2014, subject to certain extension rights exercisable by Microsoft. We have no material long-term or exclusive contracts or arrangements with any clients that guarantee the availability of products. Clients that currently supply products to us may not continue to do so, and we may be unable to establish new relationships with clients to supplement or replace existing relationships. Clients may elect to cease offering certain products through online commerce, or cease allowing us to resell certain of their products. A client who believes we have failed to deliver the contractually-required services and benefits could terminate their agreements and bring claims against us for substantial damages, these claims could exceed the level of any insurance coverage that may be available to us, and if successful could adversely affect our operating results and financial condition. If an existing significant customer elects to end their relationship with us or if our sales of a significant customers products materially decreases, our revenue would decline and it may have a material adverse effect on our business, financial condition, results of operations, growth rate and stock price.
· In addition, a limited number of our other software, gaming and physical goods clients contribute a large portion of our annual revenue. If any one of these key contracts is not renewed or otherwise terminates, or if revenues from these clients decline for any other reason (such as competitive developments), our revenue would decline and our ability to sustain profitability would be impaired. For example, please see the risk factor below regarding the impact that may result from a termination of Microsofts e-commerce agreement with us.
· Dependence on Key Personnel and Employee Turnover. Our future success significantly depends on our ability to continue to identify, attract, hire, train, retain and motivate highly skilled personnel, including the continued services and performance of our senior management. Competition for these personnel is intense, particularly in the Internet industry. Our performance also depends on our ability to retain and motivate our key technical and other employees who are skilled in maintaining our proprietary technology platforms and business offerings. The loss of the services of any of our executive officers or other key employees could harm our business if we are unable to effectively replace that officer or employee, or if that person should decide to join a competitor or otherwise directly or indirectly compete with us. Employee turnover may also increase in light of the risks, uncertainties, expenses, delays and difficulties associated with operating a business in a relatively rapidly changing industry and environment. Effective February 28, 2013, Digital Rivers board of directors appointed David C. Dobson as chief executive officer and elected him to the Board of Directors of the Company. Mr. Dobson, age 50, has been a self-employed business consultant and private investor since July 2012. He served as Executive Vice President and Group Executive, Customer Solutions Group for CA, Inc. (CA), a leading enterprise information technology management software and solutions company, from July 2010 to July 2012, where he was responsible for managing CAs broad portfolio of products and solutions for mainframe, distributed and cloud computing environments. Prior to joining CA, Mr. Dobson served as Executive Vice President and Chief Strategy and Innovation Officer of Pitney Bowes Inc. (Pitney Bowes), a manufacturer of software and hardware and a provider of services related to documents, packaging, mailing and shipping, where he was responsible for leading the development of the companys long-term strategy from September 2008 to July 2009. In addition, he also served as President of Pitney Bowes Management Services, Inc., a wholly owned subsidiary of Pitney Bowes Inc., from August 2009 to July 2010. Prior to joining Pitney Bowes, he was Chief Executive Officer of Corel Corporation, a computer software company specializing in graphics processing, from 2005 to 2008. Before joining Corel Corporation, Mr. Dobson spent 19 years at IBM, where he held a number of senior management positions.
· Organizational Changes. In order to remain competitive and to control our costs, we have implemented in the past, and may be required to implement in the future, organizational changes within our company, such as the consolidation of e-commerce platforms or offices, utilization of subcontractors or outsourcing relationships, reorganization of our business, and reductions in force. We may incur significant costs in order to implement organizational changes to achieve efficiencies in our cost structure in the long term. Failure to effectively manage our subcontractors and outsourcing relationships may harm our business. These organizational changes may impact our ability to execute our business plans and could affect our operating results.
· Operating Expenses. Our operating expenses are based on our expectations of future revenue. These expenses are relatively fixed in the short-term. If our revenue for a quarter falls below our expectations and we are unable to quickly reduce spending in response, our operating results for that quarter would be harmed.
· Infrastructure. The introduction by us of new websites, web stores or services, new features and functionality, our utilization of new third-party Infrastructure-as-a-Service (IaaS), Platform-as-a-Service (PaaS), and Software-as-a-Service (SaaS) cloud computing services, and the continued upgrading, development and maintenance of our systems and infrastructure to meet emerging market needs, support 24x7 online commerce, leverage technical innovations, and remain competitive in our service and product offerings, may require a substantial investment of our resources and result in significant capital expenditures and operating costs and expose us to additional risk and legal liability despite efforts to control such risks and liabilities.
· Fluctuations in Demand. Our quarterly and annual operating results are subject to fluctuations in demand for the products or services offered by us or our clients, such as personal computer software and consumer electronics. In particular, sales of personal computer software represented a significant portion of our revenues in recent years, and continue to be very important to our business. The introduction of products and services competitive to those offered by our current clients may materially adversely affect our revenues. In addition, revenue generated by our software and digital commerce services is likely to fluctuate on a seasonal basis that is typical for the markets for our clients products, including the software publishing, consumer electronics, and computer and video games markets. Softening or weakening of traditionally high-volume periods, such as the holiday season, can materially adversely affect our revenues and operating results.
· Changes in the E-commerce and Payments Industries. The nature of our business and the e-commerce and payments industries in which we operate has undergone, and continues to undergo, rapid development and change. For example, new protocols or technologies and new rules and regulations applicable to our business and the e-commerce and payments industries can be introduced which could affect the ways in which e-commerce operates and products are sold online; online commerce and payments continues to experience a rapid shift towards mobile and multi-channel commerce and payments; the payments industry continues to experience growth in new technologies such as the introduction of mobile-based payment systems; and consumers may continue to shift from traditional computing platforms to mobile and tablet-based computing platforms. It may be difficult for us to predict or adjust our business in light of such developments. Thus, our chances of financial and operational success should be evaluated in light of the risks, uncertainties, expenses, delays and difficulties associated with operating a business in a relatively rapidly changing industry and environment. If we are unable to address these issues, we may not be financially or operationally successful.
· Other Factors. Additional industry risks that may affect our revenues, operating results, continued growth and our stock price include:
· Competitive developments, including the introduction of new products and services and the announcement of new client and strategic relationships by our competitors;
· Changes that affect our clients or the viability of their product lines, and client decisions to delay new product launches, invest in e-commerce initiatives, utilize the services of a competitor, or internalize their currently outsourced e-commerce operations;
· The cost of compliance with U.S. and foreign laws, rules and regulations relating to our business, including the potential effect of new laws, rules and regulations, or interpretations of existing laws, rules and regulations, that affect our business operations or otherwise restrict or affect online commerce and/or the Internet as a whole, as well as our compliance with the rules and policies of entities whose services are critical for our continued operations, such as banks and credit card associations;
· Our announcement of acquisitions, strategic partnerships, joint ventures or capital commitments or results of operations or other developments related to those acquisitions, and our ability to successfully integrate and manage acquired businesses, as well as similar announcements by our competitors;
· Required changes in generally accepted accounting principles and disclosures;
· Sales or other transactions involving our common stock or our convertible notes;
· General macroeconomic conditions, including severe downturns or recessions in the United States and elsewhere, global unrest, terrorist activities, adverse effects of the ongoing sovereign debt crisis in Europe, potential impact of automatic sequesters, spending reductions, tax increases, and other austerity measures
in the United States, and particularly those economic conditions affecting the e-commerce and retailer industries and affecting demand for products and services; and
· Conditions or trends in the Internet and online commerce industries in the United States and around the world, including slower-than-anticipated growth of the online market as a vehicle for the purchase of software products, changes in consumer confidence in the safety and security of online commerce, and changes in the usage of the Internet and e-commerce.
The following risks may also have a material adverse impact on our business, financial condition, results of operations and stock price:
Our stock price is volatile.
The stock market as a whole and the trading prices of companies in the electronic commerce industry in particular, has been notably volatile. The operating results of companies in the electronic commerce industry have experienced significant quarter-to-quarter fluctuations. This broad market and industry volatility could significantly reduce the price of our common stock at any time, without regard to our own operating performance.
The market price for our common stock has varied between a high of $20.29 and a low of $16.26 in the three months ended September 30, 2013. This volatility may affect the price at which you could sell your common stock. Our stock price is likely to continue to be volatile and subject to significant price and volume fluctuations in response to market and other factors; variations in our quarterly operating results from our expectations or those of securities analysts or investors; downward revisions in estimates by us or security analysts; and announcement by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments.
In addition, the price of our common stock may be impacted by the short sales and actions of other parties who may disseminate misleading information about us in an effort to profit from fluctuations in the price of our common stock. Further, the price of our common stock may be impacted by the announcement of the financial results or other decisions by our larger clients whose products represent a significant portion of our sales.
A material decline in the price of our common stock may result in the assertion of certain claims against us, and/or the commencement of inquiries and/or investigations against us. A prolonged decline in the price of our common stock could result in:
· A reduction in the liquidity of our common stock and a reduction in our ability to raise capital and the inability for you to obtain a favorable selling price for your shares;
· An event or circumstance that drives us to determine that it is more likely than not that the fair value of our one reporting segment is less than its carrying amount and record an impairment to our goodwill.
Any reduction in our ability to raise equity capital in the future may force us to reallocate funds from other planned uses and could have a significant negative effect on our business plans and operations.
The termination of our e-commerce agreement with Microsoft may materially adversely affect our business, financial condition or results of operations and stock price.
Sales of products for one client, Microsoft, accounted for a significant portion of our revenue in the quarter and year-to-date periods ended September 30, 2013. In addition, a limited number of other software, gaming and physical goods clients contribute a large portion of our annual revenue. If any one of these key contracts is not renewed or otherwise terminates, or if revenues from these clients decline for any other reason (such as competitive developments), our revenue would decline and our ability to sustain profitability would be impaired. Our contract with Microsoft expires March 1, 2014, subject to certain extension rights exercisable by Microsoft. If our contract with Microsoft is not renewed, renegotiated or otherwise extended, or if revenues from Microsoft decline for any other reason, our revenue and our ability to sustain profitability could be materially adversely impaired.
Loss of our credit card acceptance privileges, or changes to the fees, rules or practices of payment and card associations, networks and banks, would seriously hamper our ability to process the sale of merchandise and materially adversely affect our business.
The payment by consumers for the purchase of goods and services through our e-commerce systems is typically made by credit or debit card or similar payment method across many countries. As a result, we must rely on domestic and international banks and payment processors to process transactions, and must pay a fee for this service. From time to time,