UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2014
OR
☐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
(Registrant’s 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 ☒ No ☐
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 ☒ No ☐
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 ☒ |
|
Accelerated filer ☐ |
|
Non-accelerated filer ☐ |
|
Smaller reporting company ☐ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
The number of shares of common stock outstanding at July 1, 2014, was 31,979,266 shares.
DIGITAL RIVER, INC.
Index
1
DIGITAL RIVER, INC.
(in thousands, except share data)
|
(Unaudited) |
|
|
|
|
|
June 30, |
|
December 31, |
||
|
2014 |
|
2013 |
||
ASSETS |
|
|
|
|
|
CURRENT ASSETS |
|
|
|
|
|
Cash and cash equivalents |
$ |
225,226 |
|
$ |
483,868 |
Short-term investments |
|
166,863 |
|
|
115,652 |
Accounts receivable, net of allowance of $2,987 and $3,206 |
|
58,994 |
|
|
70,865 |
Deferred tax assets |
|
1,552 |
|
|
1,479 |
Prepaid expenses and other |
|
23,406 |
|
|
27,878 |
Total current assets |
|
476,041 |
|
|
699,742 |
|
|
|
|
|
|
Property and equipment, net |
|
48,719 |
|
|
53,770 |
Goodwill |
|
138,757 |
|
|
139,318 |
Intangible assets, net |
|
24,631 |
|
|
29,217 |
Long-term investments |
|
53,074 |
|
|
56,023 |
Deferred income taxes |
|
1,174 |
|
|
1,037 |
Other assets |
|
993 |
|
|
2,067 |
TOTAL ASSETS |
$ |
743,389 |
|
$ |
981,174 |
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
|
CURRENT LIABILITIES |
|
|
|
|
|
Accounts payable |
$ |
167,554 |
|
$ |
187,635 |
Accrued payroll |
|
15,203 |
|
|
20,058 |
Deferred revenue |
|
5,052 |
|
|
6,904 |
Other current liabilities |
|
41,084 |
|
|
55,899 |
Total current liabilities |
|
228,893 |
|
|
270,496 |
|
|
|
|
|
|
NON-CURRENT LIABILITIES |
|
|
|
|
|
Senior convertible notes |
|
135,180 |
|
|
295,795 |
Other liabilities |
|
21,810 |
|
|
21,452 |
Total non-current liabilities |
|
156,990 |
|
|
317,247 |
TOTAL LIABILITIES |
|
385,883 |
|
|
587,743 |
|
|
|
|
|
|
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; 50,797,206 and 50,074,977 shares issued |
|
508 |
|
|
501 |
Treasury stock at cost; 18,817,940 and 16,910,883 shares |
|
(456,644) |
|
|
(424,416) |
Additional paid-in capital |
|
771,207 |
|
|
761,560 |
Retained earnings |
|
38,436 |
|
|
51,254 |
Accumulated other comprehensive income (loss) |
|
3,999 |
|
|
4,532 |
Total stockholders’ equity |
|
357,506 |
|
|
393,431 |
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY |
$ |
743,389 |
|
$ |
981,174 |
See accompanying notes to consolidated financial statements.
2
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
Three Months Ended |
Six Months Ended |
||||||||||
June 30, |
June 30, |
||||||||||
2014 |
2013 |
2014 |
2013 |
||||||||
Revenue |
$ |
87,386 |
$ |
90,163 |
$ |
185,193 |
$ |
201,184 | |||
Costs and expenses (exclusive of depreciation and amortization expense shown separately below): |
|||||||||||
Direct cost of services |
16,819 | 17,061 | 34,971 | 39,067 | |||||||
Network and infrastructure |
13,858 | 14,326 | 27,937 | 29,401 | |||||||
Sales and marketing |
24,223 | 25,946 | 48,525 | 55,402 | |||||||
Product research and development |
18,650 | 17,611 | 36,923 | 34,859 | |||||||
General and administrative |
12,322 | 13,682 | 24,641 | 32,029 | |||||||
Goodwill impairment |
- |
- |
- |
21,249 | |||||||
Depreciation and amortization |
6,510 | 5,066 | 12,868 | 10,066 | |||||||
Amortization of acquisition-related intangibles |
2,186 | 2,283 | 4,357 | 4,211 | |||||||
Total costs and expenses |
94,568 | 95,975 | 190,222 | 226,284 | |||||||
Income (loss) from operations |
(7,182) | (5,812) | (5,029) | (25,100) | |||||||
Interest income |
647 | 780 | 1,266 | 1,376 | |||||||
Interest expense |
(890) | (1,964) | (2,497) | (3,942) | |||||||
Other income (expense), net |
119 | 6,109 | (204) | 17,013 | |||||||
Loss on extinguishment of debt |
- |
- |
(5,605) |
- |
|||||||
Income (loss) from continuing operations before income taxes |
(7,306) | (887) | (12,069) | (10,653) | |||||||
Income tax expense (benefit) |
(31) | (684) | 923 | 237 | |||||||
Income (loss) from continuing operations |
(7,275) | (203) | (12,992) | (10,890) | |||||||
Income (loss) from discontinued operations, net of tax |
41 | (669) | 174 | (1,347) | |||||||
Net income (loss) |
$ |
(7,234) |
$ |
(872) |
$ |
(12,818) |
$ |
(12,237) | |||
Income (loss) per share - basic: |
|||||||||||
Income (loss) from continuing operations |
$ |
(0.24) |
$ |
(0.01) |
$ |
(0.43) |
$ |
(0.33) | |||
Income (loss) from discontinued operations |
0.00 | (0.02) | 0.01 | (0.04) | |||||||
Net income (loss) per share - basic |
$ |
(0.24) |
$ |
(0.03) |
$ |
(0.42) |
$ |
(0.37) | |||
Income (loss) per share - diluted: |
|||||||||||
Income (loss) from continuing operations |
$ |
(0.24) |
$ |
(0.01) |
$ |
(0.43) |
$ |
(0.33) | |||
Income (loss) from discontinued operations |
0.00 | (0.02) | 0.01 | (0.04) | |||||||
Net income (loss) per share - diluted |
$ |
(0.24) |
$ |
(0.03) |
$ |
(0.42) |
$ |
(0.37) | |||
Shares used in per share calculation - basic |
29,837 | 32,478 | 30,395 | 32,816 | |||||||
Shares used in per share calculation - diluted |
29,837 | 32,478 | 30,395 | 32,816 | |||||||
See accompanying notes to consolidated financial statements.
3
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands; unaudited)
Three Months Ended |
Six Months Ended |
||||||||||
June 30, |
June 30, |
||||||||||
2014 |
2013 |
2014 |
2013 |
||||||||
Net income (loss) |
$ |
(7,234) |
$ |
(872) |
$ |
(12,818) |
$ |
(12,237) | |||
Other comprehensive income (loss): |
|||||||||||
Unrealized foreign exchange gain (loss) on the revaluation of investments in foreign subsidiaries |
1,425 | (20) | (1,019) | (8,225) | |||||||
Unrealized gain (loss) on investments |
224 | (406) | 773 | 3,097 | |||||||
Tax benefit (expense) |
(74) | (1,052) | (287) | (1,053) | |||||||
Other comprehensive income (loss) |
1,575 | (1,478) | (533) | (6,181) | |||||||
Comprehensive income (loss) |
$ |
(5,659) |
$ |
(2,350) |
$ |
(13,351) |
$ |
(18,418) | |||
See accompanying notes to consolidated financial statements.
4
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
Six Months Ended |
|||||
June 30, |
|||||
2014 |
2013 |
||||
OPERATING ACTIVITIES |
|||||
Net income (loss) |
$ |
(12,818) |
$ |
(12,237) | |
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |
|||||
Loss (gain) on disposal of discontinued operations |
(275) |
- |
|||
Amortization of acquisition-related intangibles |
4,357 | 4,211 | |||
Provision for doubtful accounts |
(164) | 928 | |||
Depreciation and amortization |
12,868 | 10,118 | |||
Impairment of goodwill |
- |
21,249 | |||
Debt issuance cost amortization |
538 | 855 | |||
Amortization of investment premiums |
743 | 1,524 | |||
Loss (gain) on disposal of equipment |
(358) | 69 | |||
Gain on sale of investment |
- |
(17,526) | |||
Loss on extinguishment of debt |
5,605 |
- |
|||
Stock-based compensation expense |
8,654 | 11,954 | |||
Deferred and other income taxes |
(440) | (1,765) | |||
Change in operating assets and liabilities, net of acquisitions: |
|||||
Accounts receivable |
12,031 | (9,577) | |||
Prepaid and other assets |
2,334 | 1,843 | |||
Accounts payable |
(18,944) | (70,292) | |||
Deferred revenue |
(2,208) | (1,460) | |||
Income tax payable |
192 | 175 | |||
Other current liabilities |
(9,444) | (4,000) | |||
Net cash provided by (used in) operating activities |
2,671 | (63,931) | |||
INVESTING ACTIVITIES |
|||||
Purchases of investments |
(164,363) | (53,243) | |||
Sales of investments |
117,057 | 66,847 | |||
Cash received (paid) for cost method investments |
(658) | 39,636 | |||
Cash paid for acquisitions, net of cash received |
- |
(55,843) | |||
Proceeds from sale of equipment |
532 |
- |
|||
Purchases of equipment and capitalized software |
(8,152) | (13,167) | |||
Net cash provided by (used in) investing activities |
(55,584) | (15,770) | |||
FINANCING ACTIVITIES |
|||||
Repurchase of senior convertible notes |
(173,298) | (5,354) | |||
Exercise of stock options |
- |
1,273 | |||
Sales of common stock under employee stock purchase plan |
1,020 | 1,183 | |||
Repurchase of common stock |
(28,209) | (31,238) | |||
Repurchase of restricted stock to satisfy tax withholding obligation |
(4,039) | (4,261) | |||
Net cash provided by (used in) financing activities |
(204,526) | (38,397) | |||
EFFECT OF EXCHANGE RATE CHANGES ON CASH |
(1,203) | (1,906) | |||
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |
(258,642) | (120,004) | |||
CASH AND CASH EQUIVALENTS, beginning of period |
483,868 | 542,851 | |||
CASH AND CASH EQUIVALENTS, end of period |
$ |
225,226 |
$ |
422,847 | |
SUPPLEMENTAL DISCLOSURES |
|||||
Cash paid for interest on senior convertible notes |
$ |
2,509 |
$ |
3,068 | |
Cash paid for income taxes |
$ |
2,584 |
$ |
1,357 |
See accompanying notes to consolidated financial statements.
5
The unaudited consolidated financial statements of Digital River, Inc. and our wholly owned subsidiaries (we, our, Digital River, or the Company) included herein have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information, and, accordingly, do not include all financial information and footnotes normally required for a complete set of financial statements. 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, 2013, as filed with the Securities and Exchange Commission.
The unaudited consolidated statements 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. The results of operations for the three and six months ended June 30, 2014, are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire fiscal year ending December 31, 2014, due to seasonality and other factors. The December 31, 2013, information was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP.
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, 2013. There were no material changes in significant accounting policies during the quarter ended June 30, 2014.
Recent Accounting Pronouncements
ASU 2014-09 – Revenue from Contracts with Customers: In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, which revises revenue recognition guidance in order to create a single standard that is intended to improve comparability over a range of industries, companies and geographic areas. The ASU is effective for reporting periods beginning after December 15, 2016, and will be applied retrospectively. We are currently reviewing the revised guidance and assessing the potential impact on our consolidated financial statements.
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. We adopted the new guidance in ASU 2013-11 as of the period ended March 31, 2014, 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, Inc. (CustomCD) and Digital River Education Services, Inc. (DRES), which were sold on September 30, 2013 and October 1, 2013, respectively, have been classified within Discontinued Operations in our Consolidated Statements of Operations for the three and six months ended June 30, 2014. The operations of these entities in the corresponding three and six months ended June 30, 2013, have been reclassified into Discontinued Operations to conform with the current period presentation.
6
2. NET INCOME (LOSS) PER SHARE
The following table summarizes the computation of basic and diluted net income (loss) per share from continuing operations (in thousands, except per share amounts):
Three Months Ended |
Six Months Ended |
||||||||||||
June 30, |
June 30, |
||||||||||||
2014 |
2013 |
2014 |
2013 |
||||||||||
Income (loss) from continuing operations per share - basic |
|||||||||||||
Income (loss) from continuing operations - basic |
$ |
(7,275) |
$ |
(203) |
$ |
(12,992) |
$ |
(10,890) | |||||
Weighted average shares outstanding - basic |
29,837 | 32,478 | 30,395 | 32,816 | |||||||||
Income (loss) from continuing operations per share - basic |
$ |
(0.24) |
$ |
(0.01) |
$ |
(0.43) |
$ |
(0.33) | |||||
Income (loss) from continuing operations per share - diluted |
|||||||||||||
Income (loss) from continuing operations - basic |
$ |
(7,275) |
$ |
(203) |
$ |
(12,992) |
$ |
(10,890) | |||||
Exclude: Interest expense and amortized financing cost of convertible senior notes, net of tax benefit |
- |
- |
- |
- |
|||||||||
Income (loss) from continuing operations - diluted |
$ |
(7,275) |
$ |
(203) |
$ |
(12,992) |
$ |
(10,890) | |||||
Weighted average shares outstanding - basic |
29,837 | 32,478 | 30,395 | 32,816 | |||||||||
Dilutive impact of non-vested stock and options outstanding |
- |
- |
- |
- |
|||||||||
Dilutive impact of 2004 senior convertible notes |
- |
- |
- |
- |
|||||||||
Weighted average shares outstanding - diluted |
29,837 | 32,478 | 30,395 | 32,816 | |||||||||
Income (loss) from continuing operations per share - diluted |
$ |
(0.24) |
$ |
(0.01) |
$ |
(0.43) |
$ |
(0.33) | |||||
Incremental shares of 307,053 and 260,614 for the three months ended June 30, 2014 and 2013, respectively, and 492,214 and 331,017 incremental shares for the six months ended June 30, 2014 and 2013, respectively, related to dilutive securities were not included in the diluted net income (loss) per share calculation because the Company reported a loss for these periods. 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 395,605 and 825,134 shares for the three months ended June 30, 2014 and 2013, respectively, and 395,605 and 825,134 shares for the six months ended June 30, 2014 and 2013 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, 741 and 199,828 weighted average shares for the three months ended June 30, 2014 and 2013, respectively, and weighted average shares of 880 and 199,828 for the six months ended June 30, 2014 and 2013, 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.
The unissued shares underlying our 2010 senior convertible notes, 2,751,414 and 6,076,419 weighted average shares for the three months ended June 30, 2014 and 2013, respectively, and 3,880,414 and 6,096,519 weighted average shares for the six months ended June 30, 2014 and 2013, respectively, were excluded for the
7
purpose of calculating diluted net income (loss) per share, because their effect on diluted net income (loss) per share would have been anti-dilutive.
3. ACCUMULATED OTHER 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) related to cumulative translation adjustments has no tax expense or benefit 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 periods ended June 30, 2014 and 2013, (in thousands):
Foreign currency translation adjustment |
Unrealized gain (loss) on investments |
Total |
|||||||
Balance as of December 31, 2013 |
$ |
3,720 |
$ |
812 |
$ |
4,532 | |||
Other comprehensive income (loss) before reclassifications |
(1,019) | 482 | (537) | ||||||
Reclassified adjustment for net loss included in net income (loss) |
- |
4 | 4 | ||||||
Net current period other comprehensive income (loss) |
(1,019) | 486 | (533) | ||||||
Balance as of June 30, 2014 |
$ |
2,701 |
$ |
1,298 |
$ |
3,999 | |||
Balance as of December 31, 2012 |
$ |
2,565 |
$ |
(5,735) |
$ |
(3,170) | |||
Other comprehensive income (loss) before reclassifications |
(8,225) | 2,048 | (6,177) | ||||||
Reclassified adjustment for net gain included in net income (loss) |
- |
(4) | (4) | ||||||
Net current period other comprehensive income (loss) |
(8,225) | 2,044 | (6,181) | ||||||
Balance as of June 30, 2013 |
$ |
(5,660) |
$ |
(3,691) |
$ |
(9,351) | |||
The following table shows the gross amounts reclassified from accumulated other comprehensive income (loss) into the Consolidated Statements of Operations and the associated financial statement line item, for the periods ended June 30, 2014 (in thousands):
June 30, 2014 |
||||||||||
Reclassification out of accumulated other comprehensive income |
Financial statement line item |
Three months ended |
Six months ended |
|||||||
Realized gains (losses) on investments |
||||||||||
Other income (expense), net |
$ |
- |
$ |
(7) | ||||||
Income tax benefit (expense) |
- |
3 | ||||||||
Net income (loss) |
$ |
- |
$ |
(4) | ||||||
4. 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;
8
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 management’s estimate of market participant assumptions.
Assets and Liabilities that are Measured at Fair Value on a Recurring Basis
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 June 30, 2014 and December 31, 2013, (in thousands):
Fair Value Measurements |
|||||||||||
Total |
Level 1 |
Level 2 |
Level 3 |
||||||||
Balance as of June 30, 2014 |
|||||||||||
Cash and cash equivalents |
$ |
225,226 |
$ |
225,226 |
$ |
- |
$ |
- |
|||
Restricted cash |
2,071 | 2,071 |
- |
- |
|||||||
U.S. Treasury securities |
20,000 | 20,000 |
- |
- |
|||||||
U.S. government sponsored entities |
1,001 |
- |
1,001 |
- |
|||||||
Corporate bonds |
140,862 | 140,862 |
- |
- |
|||||||
Market basis equity investments |
2,754 | 2,754 |
- |
- |
|||||||
Auction rate securities |
43,889 | 5,000 |
- |
38,889 | |||||||
Total assets measured at fair value |
$ |
435,803 |
$ |
395,913 |
$ |
1,001 |
$ |
38,889 | |||
Balance as of December 31, 2013 |
|||||||||||
Cash and cash equivalents |
$ |
483,868 |
$ |
483,868 |
$ |
- |
$ |
- |
|||
Restricted cash |
3,560 | 3,560 |
- |
- |
|||||||
Commercial paper |
9,992 | 9,992 |
- |
- |
|||||||
U.S. government sponsored entities |
4,000 |
- |
4,000 |
- |
|||||||
Corporate bonds |
101,660 | 101,660 |
- |
- |
|||||||
Market basis equity investments |
3,549 | 3,549 |
- |
- |
|||||||
Auction rate securities |
41,993 |
- |
- |
41,993 | |||||||
Total assets measured at fair value |
$ |
648,622 |
$ |
602,629 |
$ |
4,000 |
$ |
41,993 | |||
As discussed further below, $5.0 million of auction rate securities (ARS) were transferred from Level 3 to Level 1 due to a call subsequent to June 30, 2014. There were no further transfers of assets between levels of the hierarchy during the periods ended June 30, 2014 and December 31, 2013.
9
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, 2012 |
$ |
37,001 |
Total unrealized gains (losses) included in other comprehensive income |
5,092 | |
Settlements |
(100) | |
Balance as of December 31, 2013 |
$ |
41,993 |
Total unrealized gains (losses) included in other comprehensive income |
1,896 | |
Settlements |
- |
|
Transfers out of Level 3 |
(5,000) | |
Balance as of June 30, 2014 |
$ |
38,889 |
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, certificates of deposit and money market accounts. The fair value was measured using quoted market prices and is classified as Level 1. The carrying amount approximates fair value.
Restricted Cash. Consist of cash and cash equivalents that are held in escrow accounts and restricted by agreements with third parties for a particular purpose. The carrying amount approximates fair value and is classified as Level 1.
U.S. Treasury securities. Consist of U.S. Treasury bills at quoted market prices with maturity dates within one year and are classified as Level 1.
Commercial Paper. Consist of primarily high grade commercial paper. The fair value of these investments was measured using quoted market prices and is classified as Level 1. As of December 31, 2013, the contractual maturities of these investments were within one year.
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 maturities of these investments are within four 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 maturities of these investments are within six years.
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 June 30, 2014, we held $45.7 million of ARS at par value which we have recorded at $43.9 million fair value. Included in this balance is $5.0 million of ARS that was settled subsequent to June 30, 2014, in July 2014 at par. Due to the subsequent settlement, we have increased the fair value of this
10
investment to par as of June 30, 2014. As of December 31, 2013, we held $45.7 million of ARS at par value which was recorded at $42.0 million fair value. As of June 30, 2014 the ARS are 108— 140% over-collateralized and the underlying student loans are guaranteed by the U.S. government.
Due to the illiquid market conditions, the fair value of our ARS is recorded at a discount to par value of $1.8 million, or 4.0%, as of June 30, 2014. This reduction from par value is considered temporary and is recorded in “Accumulated other comprehensive income (loss)”. The temporary reduction from par value recorded in “Accumulated other comprehensive income (loss)” was $3.7 million, 8.2%, as of December 31, 2013. For the three months ended June 30, 2014 and 2013, unrealized gains on our ARS of $0.9 million and $0.1 million, respectively, are recorded in “Unrealized gain (loss) on investments” in our Consolidated Statements of Comprehensive Income (Loss). $0.4 million of unrealized gain in the three months ended June 30, 2014 was related to the ARS that was settled in July 2014. For the six months ended June 30, 2014 and 2013, unrealized gains on our ARS of $1.9 million and $3.2 million, respectively, are recorded in “Unrealized gain (loss) on investments” in our Consolidated Statements of Comprehensive Income (Loss).
In evaluating our remaining ARS portfolio, we note sustained performance of our securities, strong parity levels, observed market redemption activity, continued receipt of interest and penalty payments, and an increase in fair value at June 30, 2014 compared to December 31, 2013. 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 also anticipate we will have sufficient cash flow from operations to execute our business strategy and fund our operational needs. We do not intend to sell, or believe we will be required to sell, these investments prior to recovery of their amortized cost basis. Accordingly, we treated the fair value decline as temporary.
The discounted cash flow model we used to value these securities included the following assumptions:
June 30, |
December 31, |
||||||||||||
2014 |
2013 |
||||||||||||
Unobservable inputs |
|||||||||||||
Redemption period (in years) |
6 | 7 | |||||||||||
Credit ratings |
A- to AAA |
BB+ to AAA |
|||||||||||
Penalty coupon rate |
1.0 |
% |
to |
1.5 |
% |
1.0 |
% |
to |
1.5 |
% |
|||
Weighted average annualized yield |
1.3 |
% |
1.6 |
% |
|||||||||
Risk adjusted discount rate |
4.1 |
% |
to |
4.9 |
% |
4.7 |
% |
to |
7.8 |
% |
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 30.3 years at June 30, 2014, excluding the ARS that was settled in July 2014, and 29.8 years as of December 31, 2013.
We classify our ARS as Level 3 long-term investments until we receive a call or partial call on the securities. The $5.0 million of ARS that was settled in July 2014 was reclassified to a Level 1 investment and was reported within “Short-term investments” in our consolidated balance sheet as of June 30, 2014. As of June 30, 2014 the remaining ARS portfolio was classified as Level 3 long-term investments. During the year ended December 31, 2013, we settled $0.1 million of ARS due to a partial call at par. As of December 31, 2013, our entire ARS portfolio was classified as Level 3 long-term investments. The amount of Level 3 assets as a percentage of total assets measured at fair value on a recurring basis was 8.9% and 6.5% as of June 30, 2014 and December 31, 2013, respectively.
11
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 only in certain circumstances like evidence of impairment. For the three and six months ended June 30, 2014 and 2013, other than the goodwill impairment recorded during the first quarter of 2013, as further discussed in Note 6 — 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 goodwill impairment fair value calculations fall within Level 3 inputs due to the significant unobservable inputs used to determine fair value.
5. INVESTMENTS
As of June 30, 2014 and December 31, 2013, 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 June 30, 2014 |
|||||||||||||||||||||
U.S. Treasury securities |
$ |
19,999 |
$ |
1 |
$ |
$ |
$ |
20,000 |
$ |
20,000 |
$ |
- |
|||||||||
U.S. government sponsored entities |
1,000 | 1 |
- |
- |
1,001 |
- |
1,001 | ||||||||||||||
Corporate bonds |
140,938 | 9 | (85) |
- |
140,862 | 56,528 | 84,334 | ||||||||||||||
Market basis equity investments |
1,650 | 1,104 |
- |
- |
2,754 |
- |
2,754 | ||||||||||||||
Auction rate securities |
45,725 |
- |
- |
(1,836) | 43,889 | 5,000 | 38,889 | ||||||||||||||
Total available-for-sale securities |
$ |
209,312 |
$ |
1,115 |
$ |
(85) |
$ |
(1,836) |
$ |
208,506 |
$ |
81,528 |
$ |
126,978 | |||||||
Balance as of December 31, 2013 |
|||||||||||||||||||||
Commercial paper |
$ |
9,992 |
$ |
- |
$ |
- |
$ |
- |
$ |
9,992 |
$ |
9,992 |
$ |
- |
|||||||
U.S. government sponsored entities |
4,000 |
- |
- |
- |
4,000 |
- |
4,000 | ||||||||||||||
Corporate bonds |
101,400 | 281 | (21) |
- |
101,660 | 58,280 | 43,380 | ||||||||||||||
Market basis equity investments |
1,668 | 1,881 |
- |
- |
3,549 |
- |
3,549 | ||||||||||||||
Auction rate securities |
45,725 |
- |
- |
(3,732) | 41,993 |
- |
41,993 | ||||||||||||||
Total available-for-sale securities |
$ |
162,785 |
$ |
2,162 |
$ |
(21) |
$ |
(3,732) |
$ |
161,194 |
$ |
68,272 |
$ |
92,922 |
We consider the fair value decline of our investments in corporate bonds and ARS 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 4 — Fair Value Measurements, for further discussion regarding the fair value of ARS. Temporary, unrealized, gains and losses on available for sale securities are recorded in “Accumulated other comprehensive income (loss)”.
Realized gains or losses on investments are recorded in our Consolidated Statements of Operations within “Other income (expense), net”. 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 June 30, 2014 and December 31, 2013, the balance of our cost method equity investment was $11.4 million and $10.5 million, respectively, which is included in “Long-term investments” in our Consolidated Balance
12
Sheets. During the first quarter of 2014, we invested an additional $0.6 million and converted a note receivable of $0.3 million into shares in our cost method equity investment. 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 additional gain of $6.5 million. All gains related to this cost basis investment were recorded in “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 not estimated the fair value of our cost method equity investment as of June 30, 2014 as we are not aware of any facts or circumstances that would indicate a decline in the fair value of this investment below its carrying value.
6. GOODWILL
In the fourth quarter 2012, we determined our goodwill was impaired and recorded a preliminary non-cash pretax goodwill impairment charge. During the first quarter of 2013, we completed our goodwill impairment analysis and recorded an additional non-cash pretax goodwill impairment charge of $21.2 million relating to our single reporting unit. The tax benefit associated with the first quarter impairment was offset by our tax valuation allowance. As previously disclosed, a blended income and market approach was used to determine the applicable impairment changes. The application of goodwill impairment tests is a level 3 fair value measurement and requires management judgment for many of the inputs. Goodwill impairment charges are included as a separate operating expense line item, “Goodwill impairment” within Continuing Operations in our Consolidated Statements of Operations.
7. STOCK-BASED COMPENSATION
The following table summarizes stock-based compensation expense recognized related to employee stock options, restricted and performance stock awards and employee stock purchases (in thousands):
Three Months Ended |
Six Months Ended |
||||||||||
June 30, |
June 30, |
||||||||||
2014 |
2013 |
2014 |
2013 |
||||||||
Costs and expenses |
|||||||||||
Direct cost of services |
$ |
40 |
$ |
47 |
$ |
84 |
$ |
89 | |||
Network and infrastructure |
365 | 327 | 747 | 742 | |||||||
Sales and marketing |
1,575 | 1,799 | 2,577 | 3,631 | |||||||
Product research and development |
809 | 846 | 1,721 | 1,771 | |||||||
General and administrative |
1,877 | 3,360 | 3,525 | 5,721 | |||||||
Stock-based compensation included in costs and expenses |
$ |
4,666 |
$ |
6,379 |
$ |
8,654 |
$ |
11,954 | |||
13
8. INCOME TAXES
The provision (benefit) for income taxes from continuing operations is composed of the following (in thousands):
Three Months Ended |
Six Months Ended |
|||||||||||
June 30, |
June 30, |
|||||||||||
2014 |
2013 |
2014 |
2013 |
|||||||||
Current tax expense (benefit): |
||||||||||||
United States |
$ |
31 |
$ |
(102) |
$ |
292 |
$ |
1,436 | ||||
International |
(62) | (582) | 631 | (1,199) | ||||||||
Total current provision for income taxes |
$ |
(31) |
$ |
(684) |
$ |
923 |
$ |
237 | ||||
Tax Rate |
0.4 |
% |
77.1 |
% |
(7.6) |
% |
(2.2) |
% |
Our quarterly estimate of our annual effective tax rate is subject to variation due to several factors, including our mix of earnings between tax jurisdictions and the corresponding statutory rates, discrete items and the non-recognition of tax benefits generated by net operating losses in jurisdictions with a valuation allowance.
On a quarterly basis, we assess whether a valuation allowance for net operating loss carryforwards and other deferred tax assets is needed. We concluded during the second quarter of 2014 evaluation that we are required to maintain a valuation allowance against our net U.S. tax assets and certain foreign tax assets.
As of June 30, 2014, we had $10.5 million of unrecognized tax benefits, excluding related interest. $9.8 million of these unrecognized tax benefits would affect our effective tax rate if recognized. As of June 30, 2014, we had approximately $1.8 million of accrued interest related to uncertain tax positions. 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 gross unrecognized tax benefits may change within the next twelve months by a range of zero to $8.9 million.
9. COMMITMENTS AND CONTINGENCIES
Litigation
We are subject to legal proceedings, claims and litigation, and other disputes or regulatory inquires arising in the ordinary course of business. In addition, 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. While the final outcome of these matters is currently not determinable, we believe there is no ordinary course litigation or other matters that are currently pending against us that is likely to have, individually or in the aggregate, a material effect on our consolidated financial position, results of operations, stockholders’ equity or cash flows. Because of the uncertainty inherent in litigation, disputes, and intellectual property matters, it is possible that unfavorable resolutions of these lawsuits, proceedings and claims could exceed the amount we have currently reserved for these matters.
On April 4, 2014, we settled two intellectual property lawsuits with DDR Holdings, LLC, each of which was dismissed with prejudice. The full settlement amount was paid in April 2014.
On March 31, 2014, the U.S. District Court for the District of Minnesota certified a class action against the Company of all persons in the United States who purchased Extended Download Service for Norton Products between January 24, 2005, and October 26, 2009. The plaintiffs have sued Symantec Corporation and the Company. The claims against the Company are for alleged violation of the Minnesota Consumer Fraud and False Statement in Advertising Acts and unjust enrichment, based on the Company’s sale of Extended Download Service
14
to purchasers of Norton products. We intend to continue to vigorously defend this matter, but cannot predict the timing or ultimate outcome, nor estimate a range of loss, if any, for this matter.
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.
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.
To date, no significant costs have been incurred, either individually or collectively, in connection with our indemnification provisions
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 $0.6 million in undrawn letters of credit as of June 30, 2014 and December 31, 2013.
10. DEBT
2010 Senior Convertible Notes
For the six months ended June 30, 2014, we repurchased $160.6 million of our 2.00% senior convertible notes (2010 Notes) in the open market for $164.5 million, excluding accrued interest. All repurchases occurred in March 2014. For the six months ended June 30, 2014, the loss on extinguishment of debt, including the premium on repurchase and acceleration of the recognition of deferred financing fees was $5.5 million. For the three and six months ended June 30, 2013, we repurchased $4.0 million and $5.4 million, respectively, of the 2010 Notes in the open market for $4.0 million and $5.3 million, respectively, excluding accrued interest. For the three and six months ended June 30, 2013, the net gain on extinguishment of debt, which is the net of the gain on sale and the loss on acceleration of the recognition of deferred financing fees, was immaterial. Notes repurchased are deemed to be extinguished for accounting purposes.
As of June 30, 2014, the carrying value of our 2010 Notes was $135.2 million and the fair value was $134.7 million. As of December 31, 2013, the carrying value of our 2010 Notes was $295.8 million and the fair value was $298.3 million. Fair values are based on the quoted fair market values 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
On January 1, 2014, holders of $8.7 million of our 1.25% senior convertible notes (2004 Notes) exercised the option to require us to repurchase those notes at par. The acceleration of the recognition of deferred financing fees related to these repurchased Notes resulted in a $0.1 million charge. On June 6, 2014, the remaining balance of
15
our 2004 Notes of $0.1 million was repurchased. The 2004 Notes that were repurchased on January 1, 2014, were classified as current in “Other current liabilities” in our December 31, 2013, Consolidated Balance Sheet due to the subsequent repurchase.
As of December 31, 2013, the carrying value of our 2004 Notes was $8.8 million and the fair value was $8.9 million. Fair values are based on the quoted fair market values of the debt. Debt is classified as a level 3 fair value measurement. We determine fair value based on the market approach.
11. DISCONTINUED OPERATIONS AND DISPOSALS
On September 30, 2013, we sold CustomCD, Inc., which was based in Portland, Oregon in a stock sale to a former employee. On October 1, 2013, we sold Digital River Education Services, Inc., which was based in Plano, Texas in a stock sale to two former employees. The results of operations of these entities, including the income (losses) on their respective sales, have been excluded from the results of continuing operations and are reported as discontinued operations. We do not allocate interest income or interest expense to discontinued operations. The operating results of the discontinued operations included in our Consolidated Statements of Operations, including adjustments to loss on the respective sales, for the three and six months ended June 30, 2014 and 2013, were as follows (in thousands):