Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
This document contains various forward-looking statements and information that are based on management's beliefs, assumptions made by management and information currently available to management. Such statements are subject to various risks and uncertainties, which could cause actual results to vary materially from those contained in such forward-looking statements. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected or projected. Certain of these, as well as other risks and uncertainties are described in more detail herein and in Astea International Inc.'s ("Astea or the Company") Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
Astea is a global provider of service management software that addresses the unique needs of companies who manage capital equipment, mission critical assets and human capital. Clients include Fortune 500 to mid-size companies which Astea services through company facilities in the United States, United Kingdom, Australia, Japan, the Netherlands and Israel. Since its inception in 1979, Astea has licensed applications to companies in a wide range of sectors including information technology, telecommunications, instruments and controls, business systems, and medical devices.
Astea Alliance, the Company's service management suite of solutions, supports the complete service lifecycle, from lead generation and project quotation to service and billing through asset retirement. It integrates and optimizes critical business processes for Campaigns, Call Center, Depot Repair, Field Service, Logistics, Projects and Sales, and Order Processing applications. Astea extends its application suite with mobile workforce management, dynamic scheduling optimization, third party vendor and customer self-service portals, and business intelligence. In order to ensure customer satisfaction, Astea also offers infrastructure tools and services. Astea Alliance provides service organizations with technology-enabled business solutions that improve profitability, stabilize cash-flows, and reduce operational costs through automating and integrating key service, sales and marketing processes.
The FieldCentrix Enterprise is a service management solution that runs on a wide range of mobile devices (handheld computers, laptops and PCs, and Pocket PC devices), and integrates seamlessly with popular customer relationship management ("CRM") and ERP applications. Add-on features include a web-based customer self-service portal, workforce optimization capabilities, and equipment-centric functionality. FieldCentrix has licensed applications to companies in a wide range of sectors including HVAC, building and real estate services, manufacturing and process instruments and controls, and medical equipment.
The Company's sales and marketing efforts are primarily focused on new software licensing (on premise and cloud solutions) and support services for its latest generation of Astea Alliance and FieldCentrix products.
Critical Accounting Policies and Estimates
The Company's significant accounting policies are described in its "Summary of Accounting Policies," Note 2, in the Company's 2016 Annual Report on Form 10-K. The preparation of financial statements in conformity with accounting principles generally accepted within the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying financial statements and related notes. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. The Company does not believe there is a great likelihood that materially different amounts would be reported related to the accounting policies described below; however, application of these accounting policies involves the exercise of judgments and the use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.
Revenue Recognition
Astea's revenue is principally recognized from three sources: (i) licensing arrangements, (ii) subscription services and (iii) services and maintenance.
The Company markets its products primarily through its direct sales force and resellers. License agreements do not provide for a right of return, and historically, product returns have not been significant.
The Company recognizes revenue from license sales when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the license fee is fixed and determinable and the collection of the fee is probable. The Company utilizes written contracts as a means to establish the terms and conditions by which our products, services and maintenance support are sold to our customers. Delivery is considered to have occurred when title and risk of loss have been transferred to the customer, which generally occurs after a license key has been delivered electronically to the customer. Revenue for arrangements with extended payment terms in excess of one year is recognized when the payments become due, provided all other recognition criteria are satisfied. If collectability is not considered probable, revenue is recognized when the fee is collected. Our typical end user license agreements do not contain acceptance clauses. However, if acceptance criteria are required, revenues are deferred until customer acceptance has occurred.
If these criteria are not met, then revenue is deferred until such criteria are met or until the period(s) over which the last undelivered element is delivered. If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit's relative fair value. There may be cases, however, in which there is objective and reliable evidence of fair value of the undelivered item(s) but no such evidence for the delivered item(s). In those cases, the residual method is used to allocate the arrangement consideration. Under the residual method, the amount of consideration allocated to the delivered item(s) equals the total arrangement consideration less the aggregate fair value of the undelivered item(s). We apply the revenue recognition policies discussed below to each separate unit of accounting.
Astea allocates revenue to each element in a multiple-element arrangement based on the elements' respective fair value, determined by the price charged when the element is sold separately. Specifically, Astea determines the fair value of the maintenance portion of the arrangement based on the price, at the date of sale, if sold separately, which is generally a fixed percentage of the software license selling price. The professional services portion of the arrangement is based on hourly rates which the Company charges for those services when sold separately from software. If evidence of fair value of all undelivered elements exists, but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. If an undelivered element for which evidence of fair value does not exist, all revenue in an arrangement is deferred until the undelivered element is delivered or fair value can be determined. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. The proportion of the revenue recognized upon delivery can vary from quarter-to-quarter depending upon the determination of vendor-specific objective evidence (VSOE) of fair value of undelivered elements. The residual value, after allocation of the fee to the undelivered elements based on VSOE of fair value, is then allocated to the perpetual software license for the software products being sold.
When appropriate, the Company may allocate a portion of its software revenue to post-contract support activities or to other services or products provided to the customer free of charge or at non-standard rates when provided in conjunction with the licensing arrangement. Amounts allocated are based upon standard prices charged for those services or products which, in the Company's opinion, approximate fair value. Software license fees for resellers or other members of the indirect sales channel are based on a fixed percentage of the Company's standard prices. The Company recognizes software license revenue for such contracts based upon the terms and conditions provided by the reseller to its customer. The Company regularly communicates with its resellers and recognizes revenue based on information from its resellers regarding possible returns and collectability. However, the Company does not have a history of returns from the resellers.
In subscription based arrangements, even though customers use the software element, they generally do not have a contractual right to take possession of the software at any time during the hosting period without significant penalty to either run the software on its own hardware or contract with an unrelated third party to host the software. Accordingly, these software as a service (SaaS) arrangements, including the software license fees within the arrangements, are accounted for as subscription services provided all other revenue recognition criteria have been met. The subscription revenue is recognized on a straight-line basis over the service period. A SaaS contract is generally 1 to 3 years in duration. In accordance with generally accepted accounting principles, the Company may not recognize any SaaS revenue before the customer goes live, to ensure that the revenue will match the use of services. The implementation period is typically between 8 and 10 months. When upfront implementation, consulting and training services are bundled with the subscription based arrangement, these services are recognized over the life of the initial contract, once the project goes live.
The post-contract support on perpetual licenses provides for technical support and unspecified updates to the Company's software products. Post-contract support is charged separately for renewals of annual maintenance in subsequent years.
Fair value for maintenance is based upon either renewal rates stated in the contracts or separate sales of renewals to customers. Revenue is recognized ratably, or monthly, over the term of the maintenance period, which is typically one year.
Consulting and training service revenue are generally unbundled and, therefore, recognized at the time the services are performed except when these services are bundled with subscription revenues. If the Company has any fixed-price arrangements for services, the revenue is recognized using the proportional performance method based on direct labor hours incurred to date as a percentage of total estimated direct labor hours required to complete the project. Fees from licenses sold together with consulting services are generally recognized upon shipment, provided that the contract has been executed, delivery of the software has occurred, fees are fixed and determinable and collection is probable.
The Company offers a variety of consulting services that include project management, implementation, data conversion, integration, custom report writing and training. Our professional services are generally billed on a time and materials basis using hourly rates together with reimbursement for travel and accommodation expenses. We recognize revenue as these professional services are performed. On rare occasions these consulting service arrangements involve acceptance criteria. In such cases, revenue is recognized upon acceptance.
We believe that our accounting estimates used in applying our revenue recognition are critical because:
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the determination that it is probable that the customer will pay for the products and services purchased is inherently judgmental;
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the allocation of proceeds to certain elements in multiple-element arrangements is complex;
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the determination of whether a service is essential to the functionality of the software is complex;
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establishing company-specific fair values of elements in multiple-element arrangements requires adjustments from time-to-time to reflect recent prices charged when each element is sold separately; and
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the determination of the stage of completion for certain consulting arrangements is complex.
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Changes in the aforementioned items could have a material effect on the type and timing of revenue recognized.
For the nine months ended September 30, 2017 and 2016, the Company recognized $18,439,000 and $16,722,000, respectively, of revenue related to software license fees, subscription revenue, and services and maintenance.
We present taxes assessed by a governmental authority including sales, use, value added and excise taxes on a net basis and therefore the presentation of these taxes is excluded from our revenues and is included in accrued expenses in the accompanying consolidated balance sheets until such amounts are remitted to the taxing authority.
Capitalized Software Research and Development Costs
The Company capitalizes software development costs incurred during the period subsequent to the establishment of technological feasibility through the product's availability for general release. Costs incurred prior to the establishment of technological feasibility are charged to product development expense as they are incurred. Product development expense includes payroll, employee benefits, other headcount-related costs associated with product development and any related costs to third parties under sub-contracting or net of any collaborative arrangements.
Capitalized software development costs are amortized on a product-by-product basis over the greater of the ratio of current revenues to total anticipated revenues or on a straight-line basis over the estimated useful lives of the products beginning with the initial release to customers. The Company's estimated life for its capitalized software products is two years based on current sales trends and the rate of product release. The Company continually evaluates whether events or circumstances have occurred that indicate that the remaining useful life of the capitalized software development costs should be revised or that the remaining balance of such assets may not be recoverable. The Company evaluates the recoverability of capitalized software based on the net realizable value of each product, which includes the estimated future gross revenues from that product reduced by the estimated future costs of completing and disposing of that product, including the costs of performing maintenance and customer support required to satisfy the Company's responsibility set forth at the time of sale. As of September 30, 2017, management believes that no revisions to the remaining useful lives or write-downs of capitalized software development costs are required.
Currency Translation
The international subsidiaries and foreign branch operations translate their assets and liabilities from international operations by using the exchange rate in effect at the balance sheet date. The results of operations are translated at average exchange rates during the period. The effects of exchange rate fluctuations in translating assets and liabilities of international operations into U.S. dollars are accumulated and reflected as a currency translation adjustment as a component of other comprehensive loss in the accompanying consolidated statements of changes in stockholders' deficit. Foreign exchange transaction gains and losses are included in general and administrative expenses in the consolidated statements of operations. General and administrative expenses include an exchange transaction loss of $25,000 for the nine months ended September 30, 2017 and a $109,000 gain for the nine months ended September 30, 2016.
Results of Operations
Comparison of Three Months Ended September 30, 2017 and 2016
Revenues
Total revenues increased by $794,000 or 14%, to $6,482,000 for the three months ended September 30, 2017 from $5,688,000 for the three months ended September 30, 2016. Software license fee revenues increased $285,000, or 44%, from the same quarter in 2016. Subscription revenues decreased $71,000 or 11% to $592,000 from $663,000 from the same period last year. Services and maintenance revenue for the three months ended September 30, 2017 increased $580,000 or 13% from the same quarter in 2016.
Software license fee revenue increased 44% to $933,000 in the third quarter of 2017 from $648,000 in the third quarter of 2016. The increase was primarily due to sales licenses to existing customers in the U.S. and Japan. Certain expected sales of Astea Alliance licenses which had been expected to close in the third quarter of 2017, have slipped into the fourth quarter of 2017.
Subscription revenue decreased 11% to $592,000 in the third quarter of 2017 from $663,000 in the third quarter of 2016. The primary reason for the decrease resulted from a hosted customer that converted from hosting to perpetual at the end of 2016 for which there was no annual hosting revenue in the third quarter of 2017. The Company continues to sell Software as a Service (SaaS) for which hosting revenue may not be recognized until the customers go-live.
Services and maintenance revenues increased by 13% to $4,957,000 in the third quarter of 2017 compared to $4,377,000 in the third quarter of 2016. Astea Alliance service and maintenance revenues increased by $617,000 or 16% compared to the third quarter of 2016. The increase was mainly attributable to a strong backlog of professional services required by new customer implementations and upgrades of current customers in all regions.
Service and maintenance revenues generated by FieldCentrix decreased by $37,000 or 6% to $538,000 in the third quarter of 2017 compared to $575,000 during the same period in 2016. T
he decrease is due to a reduction in maintenance revenue compared to the third quarter in 2016.
Costs of Revenues
Cost of software license fees increased 29% to $526,000 in the third quarter of 2017 from $408,000 in the third quarter of 2016. Included in the cost of software license fees are the costs of capitalized software amortization and the cost of all third party software embedded in the Company's software licenses which are sold to customers. Amortization of capitalized software development costs was $525,000 for the quarter ended September 30, 2017 compared to $395,000 for the same quarter in 2016. The gross margin percentage on software license sales was 44% in the third quarter of 2017 compared to 37% in the third quarter of 2016. The improvement in the license margin resulted primarily from the increase in software license fees revenue in the third quarter of 2017.
Cost of subscriptions decreased less than 1% to $193,000 in the third quarter of 2017 from $195,000 in the third quarter of 2016. The decrease in cost of subscriptions is mainly attributed to cost savings of hosting fees eliminated after the cancelation of a customer that converted to perpetual license, partially offset by increased
costs for hosting compliance costs
. The gross margin percentage on hosting was 67% in the third quarter of 2017 compared to 71% in the third quarter of 2016. The decline in the gross margin is mainly due to the decrease in subscription revenue.
Cost of services and maintenance increased 19% to $3,760,000 in the third quarter of 2017 from $3,148,000 in the third quarter of 2016. The increase in cost of service and maintenance is mainly attributed to an increase in contracted headcount who provide consulting services in Japan, increased labor costs and increased travel expense in all regions partially offset by headcount reductions in the U.S. The gross margin percentage was 24% in the third quarter of 2017 compared to 28% in the third quarter of 2016. The decrease in services and maintenance gross margin was primarily due to the increased service and maintenance costs in U.S and Japan offset by service revenue increases primarily in Japan.
Gross Profit
Gross profit increased 3% to $2,003,000 in the third quarter of 2017 from $1,937,000 in the third quarter of 2016 primarily due to an increase in software license and service and maintenance revenues partially offset by an increase in cost of revenues and an 11% decrease in in subscription revenue.
As a percentage of revenue, gross profit in the third quarter of 2017 was 31% compared to 34% in the third quarter of 2016.
Operating Expenses
Product Development
Product development expenses decreased 30% to $150,000 in the third quarter of 2017 from $215,000 in the third quarter of 2016.
Fluctuations in product development expense from period to period result from the amount of product development expense that is capitalized. Development costs of $741,000 were capitalized in the third quarter of 2017 compared to $731,000 during the same period in 2016. Gross product development expense was $891,000 in the quarter ended September 30, 2017 which is 6% lower than $946,000 during the same quarter in 2016.
The decrease was primarily due to lower headcount partially offset by salary increases and currency translation adjustments. Most of the Company's development occurs in Israel.
Product development expense as a percentage of revenues was 2% in the third quarters of 2017 and 4% in the third quarter of 2016.
Sales and Marketing
Sales and marketing expense decreased 10% to $853,000 in the third quarter of 2017 from $948,000 in the third quarter of 2016. The decrease in sales and marketing expense resulted from reduced headcount in marketing partially offset by an increased headcount, higher commissions on sales and an increase in third party marketing costs. The Company
continues to focus on expanding its market presence in all regions by expanding awareness of the Company's products, which occurs through the use of Webinars focused in the vertical industries in which the Company operates, attendance at selected trade shows, and increased efforts in lead generation for its sales force.
As a percentage of revenues, sales and marketing expense was 13% in the third quarter of 2017 compared to 17% in the same period of 2016. The decrease is sales and marketing expense as a percentage of revenue is due to less headcount in marketing as well as higher revenues in 2017.
General and Administrative
General and administrative expenses consist of salaries, benefits and related costs for the Company's finance, administrative and executive management personnel, legal costs, accounting costs, and various costs associated with the Company's status as a public company.
General and administrative expenses increased 25% to $737,000 during the third quarter of 2017 from $590,000 in the third quarter of 2016 mainly due to hiring and retaining inside legal counsel in the third quarter of 2017 for which we did not have the same cost during 2016. As a percentage of revenue, general and administrative expenses were 11% in the third quarter of 2017 compared to 10% in the third quarter of 2016.
Net Interest Expense
Net interest expense was $70,000 in the third quarter of 2017 compared to $30,000 in the third quarter of 2016. The increase in interest expense resulted from the Company canceling its line of credit with SVB Bank and as a result, fully amortized the remaining deferred financing costs of $35,000 related to the line of credit. The remaining increase of $5,000 in interest expense resulted from the term loan with Bridge Bank that started in August 2017.
Income Tax Expense
The Company reported a provision for income tax of $7,000 for third quarter of 2017 compared to $6,000 for the same quarter in 2016. The tax provisions result from operations in Israel.
International Operations
The Company's international operations generated revenues of $3,052,000 in the third quarter of 2017, an increase of 14% over the same quarter in 2016. Revenues from international operations comprised 47% of the Company's total revenue for the third quarter in 2017, compared to 47% of total revenues for the same quarter in 2016. The increase in international revenues compared to the same period in 2016 is primarily due to increases in Japan and APAC service revenue partially offset by a decline in license and subscription revenues in Europe.
Comparison of Nine Months Ended September 30, 2017 and 2016
Revenues
Total revenues increased $1,717,000, or 10%, to $18,439,000 for the nine months ended September 30, 2017 from $16,722,000 for the nine months ended September 30, 2016. Software license revenues decreased 9% from the same period last year. Subscription revenue decreased 16% from the same period last year and service and maintenance revenues for the nine months ended September 30, 2017 amounted to $14,998,000, an 18% increase from the same period in 2016.
Software license fees revenue decreased 9% to $1,578,000 in the first nine months of 2017 from $1,740,000 in the first nine months of 2016. Astea Alliance license revenues decreased $320,000 to $1,365,000 or 19% in the first nine months of 2017 from $1,685,000 in the first nine months of 2016. The decrease resulted from a decline in Astea license sales in Europe partially offset by an increase in license sales in the U.S. and Japan.
A number of sales that had been expected to close in the first nine months of 2017 slipped into the fourth quarter of 2017 and first quarter of 2018. FieldCentrix license revenue increased $158,000 to $213,000 in the first nine months of 2017 from $55,000 in the first nine months of 2016. FieldCentrix sales consisted of additional user licenses sold to existing customers in 2017.
Subscription revenue decreased 16% to $1,863,000 in the first nine months of 2017 from $2,231,000 in the first nine months of 2016.
Subscription revenue was larger in 2016 because a customer, who went live in 2016, had an unusually long implementation period, which caused many months of hosting revenue to be recognized in the period they went live on Astea Alliance. Because of the extended implementation period for this customer, future hosting revenue from this customer was not of the same magnitude it was during 2016. Included in subscription revenue for the nine months of 2016 was $295,000 which was accumulated from periods prior to going live. In addition, a customer converted from hosting to perpetual at the end of 2016 which eliminated $90,000 of annual reccuring hosting revenue in 2017 and future periods The decrease in subscription revenue was partially offset by completion of the implementation process for certain customers which allowed them to go live on the SaaS solution in the first nine months of 2017. Revenue for subscription services may not be recognized until the customers go-live. The implementation period is typically between 8 to 10 months.
Services and maintenance revenues increased 18% to $14,998,000 in the first nine months of 2017 from $12,751,000 in the first nine months of 2016. Astea Alliance service and maintenance revenues were $13,399,000 for the first nine months of 2017, an increase of 22% from $11,020,000 for the nine months ended September 30, 2016.
The increase was mainly attributable to an increase in services in all regions of the Company. Japan service revenue increased significantly due to all the new license deals signed over the past 12 months. In addition, a
UK hosting customer went live in the first six months of 2017 and the U.S. and APAC regions had several customers which went live in the last quarter of 2016, which also added to the increase. Once a hosted customer goes live, we start to recognize deferred implementation fees over the remaining life of the contract. In addition, increases in services revenue and a slight increase in maintenance revenue from license sales that closed in the last quarter of 2016 also contributed to the increase.
Service and maintenance revenues generated by FieldCentrix decreased by $131,000 or 8% to $1,600,000 in the first nine months of 2017 compared to $1,731,000 during the same period in 2016. T
he decrease is due to a reduction in upgrade projects, customers transitioning to Alliance and the loss of some small customers compared to the first nine months in 2016.
Costs of Revenues
Cost of software license fees increased 15% to $1,816,000 in the first nine months of 2017 from $1,576,000 in the first nine months of 2016.
Included in the cost of software license fees are the costs of capitalized software amortization and all third party software embedded in the Company's software licenses which are sold to customers.
Amortization of capitalized software development costs was $1,796,000 for the nine months ended September 30, 2017, an increase of 18% compared to the same period in 2016.
The increase resulted primarily from amortization of Version 14 after its release in October 2016 partially offset by Version 11.5 being fully amortized as of June 30, 2016, Version 12 being fully amortized by February 2017 and Version 12.5 fully amortized by September 30, 2017.
The gross margin percentage on software licenses was (15%) in the first nine months of 2017 compared to 9% in the first nine months of 2016. The decrease in gross margin is a reflection of the decreased license revenue and increased amortization in 2017.
Cost of subscriptions decreased 6% to $626,000 in the first nine months of 2017 from $664,000 in the first nine months of 2016. The decrease in cost of subscriptions is mainly attributed to reduced hosting fees from a customer who cancelled their agreement in the fourth quarter of 2016, offset by an increase in
costs from adding new customers
. The gross margin percentage was 66% in the first nine months of 2017 compared to 70% in the first nine months of 2016. The slight decline was due to the reduced revenue from a large customer who canceled their hosting contract in the last quarter of 2016 which lowered revenue, partially offset by the reduction in hosting costs.
Cost of services and maintenance increased 9% to $10,913,000 in the first nine months of 2017 from $10,051,000 in the first nine months of 2016.
The increase in cost of service and maintenance is attributed primarily to increases in contracted headcount who provided consulting services in Japan, increased travel expenses and salary increase in all regions partially offset by headcount reductions in the U.S.
The services and maintenance gross margin percentage was 27% in 2017 and 21% in 2016. The improvement in the gross margin is due to the increase in service revenue in Japan and headcount reductions in the U.S. partially offset by increase in headcount in Japan and travel expenses and salary increases in all regions.
Gross Profit
Gross profit increased 15% to $5,084,000 in the first nine months of 2017 from $4,431,000 in the first nine months of 2016. As a percentage of revenue, gross profit was 28% in the first nine months of 2017 compared to 26% in the first nine months of 2016. The year-over-year increase in gross profit was largely driven by the increase in service and maintenance revenue as well as a slight decrease in cost of subscriptions. Partially offsetting these components was a decrease in license and subscription revenues, and increases in cost of software license fees and cost of services and maintenance.
Operating Expenses
Product Development
Product development expense increased 55% to $947,000 in the first nine months of 2017 from $610,000 in the first nine months of 2016. Fluctuations in product development expense from period to period can vary due to the amount of development expense which is capitalized. Software development costs of $1,987,000 were capitalized in the first nine months of 2017 compared to $2,323,000 during the same period in 2016, a decrease of $336,000. Gross development expense was $2,934,000 during the first nine months of 2017, essentially unchanged, compared to $2,933,000 for the same period in 2016. Product development expense as a percentage of revenues was 5% in first nine months of 2017 compared to 4% during the same period in 2016.
Sales and Marketing
Sales and marketing expense decreased 18% to $2,587,000 in the first nine months of 2017 from $3,166,000 in the first nine months of 2016.
The decrease in sales and marketing expense is attributable to decreases in marketing headcount and lower commissions on sales due to the decline in license sales partially offset by an increase in headcount in sales and
marketing costs related to the ACE Conference held by the Company in June 2017.
The Company continues to focus on expanding its market presence through intensified marketing efforts to increase awareness of the Company's products, including its newest product, SaaS and its subscription services. This occurs through the use of Webinars focused in the vertical industries in which the Company operates, attendance at selected trade shows, and increased efforts in lead generation for its sales force.
As a percentage of revenues, sales and marketing expenses was 14% in the first nine months of 2017 compared with 19% in the first nine months of 2016. The decrease in costs relative to revenues is due to higher revenues in the first nine months of 2017.
General and Administrative
General and administrative expenses consist of salaries, benefits and related costs for the Company's finance, administrative and executive management personnel, legal costs, accounting costs, foreign currency exchange, bad debt expense and various costs associated with the Company's status as a public company. General and administrative expenses decreased 2% to $2,105,000 in the first nine months of 2017 from $2,147,000 in the first nine months of 2016. The decrease was mainly driven by reduced executive management costs and lower travel expenses partially offset by costs to hire and retain inside legal counsel. As a percentage of revenues, general and administrative expenses were 11% for the nine months ended September 30, 2017 and 13% in the first nine months of 2016. The decrease in costs relative to revenues is due to higher revenues in the first nine months of 2017.
Interest Expense, Net
Interest expense was $144,000 in the first nine months of 2017 compared to $76,000 of interest expense in the first nine months of 2016. The increase in interest expense resulted from the Company canceling its line of credit with SVB Bank and fully amortizing the remaining $35,000 deferred financing costs related to that line of credit. In addition, increased interest expense resulted the term loan and line of credit from Bridge Bank, with an increased borrowing capacity, that started in August 2017.
Income Tax Expense
The Company recorded income tax expense of $21,000 for the nine months ended September 30, 2017 compared to $30,000 for the nine months ended September 30, 2016.
The tax expense resulted from the tax provision in Israel.
Liquidity and Capital Resources
Operating Activities
The Company generated $2,051,000 of cash from operating activities in the first nine months of 2017 compared to $1,396,000 for the first nine months of 2016. The increase in operating cash flows of $655,000 was due to a reduction in net loss by $878,000, an increase in non-cash expenses of $307,000, an increase in accounts payable and accrued expenses of $657,000 and an increase in cash provided by other assets of $34,000; partially offset by increased accounts receivable of $869,000, increased prepaid expenses of $115,000 and a decrease of deferred revenues of $225,000.
Investing Activities
The Company used $1,991,000 for investing activities in 2017, $406,000 less than the same period in 2016. Most of the reduction, $336,000, is due to lower capitalized software development costs. The remainder of the difference results from lower capital expenditures of $44,000 and reduced short-term investments of $26,000.
Financing Activities
The Company generated $622,000 of cash from financing activities in the first nine months of 2017 compared to generating $122,000 in the first nine months of 2016. The increase in cash provided by financing activities in 2017 was due to reduced payments of preferred stock dividends of $250,000 in 2017. In addition, the Company borrowed $6,734,000 and repaid $8,661,000 during the first nine months of 2017 compared to borrowing $500,000 and repaying $48,000 in the same quarter last year on its line of credit from SVB. The Company borrowed $2,723,000 on its line of credit and term note with WAB during the first nine months ended September 30, 2017.
The effect of exchange rates on cash related to the U.S. dollar exchange rates for most other currencies in which the Company operates, primarily the Australian dollar, Japanese yen, the Euro, the British pound sterling and Israel shekel, resulted in a decrease of cash of $8,000 in 2017 compared to an increase of $39,000 in 2016.
The Company has a history of net losses and an accumulated deficit of $36,157,000 as of September 30, 2017. In the first nine months of 2017, the Company generated a net loss of $720,000 compared to a net loss of $1,598,000 in the first nine months of 2016. Further, at September 30, 2017, the Company had a working capital ratio of 0.55:1, with cash and cash equivalents of $1,328,000 compared to December 31, 2016 when the Company had cash and cash equivalents of $661,000. The increase in cash and cash equivalents for the first nine months of 2017 was primarily driven by increases in cash provided by operations and net cash provided by financing activities offset by cash used for the Company's capitalized software development costs. The increase in cash provided by operating activities was primarily due to a decrease in the net loss as well as increased collections and billings of accounts receivable and an increase in deferred revenues.
As of September 30, 2017 the Company owed $2,323,000 against the line of credit from
Western Alliance Bank ("WAB")
. As of September 30, 2017, the availability under the line of credit was $39,000. In April 2017,
the Company extended its Revolving Loan Agreement and associated Revolving Promissory Note with its Chief Executive Officer/Director. The loan provides an unsecured $1,000,000 revolving line of credit to the Company. The proceeds of the borrowings, if needed, will be used by the Company for operating activities. If an extension of the line of credit is appropriate and agreed to by the Chief Executive Officer/Director, we will then obtain the necessary approvals from
WAB
.
As of September 30, 2017, there are no amounts outstanding with the
Chief Executive Officer/Director.
In addition, the Company has a
term loan with WAB for $400,000 that is extended through August 2019.
The Company has projected revenues that management believes will provide sufficient funds along with available borrowings under its lines of credit and term loan to sustain its continuing operations through at least December 31, 2018.
The Company was in compliance with the earnings covenant, but not in compliance with the liquidity covenant for the line of credit with WAB as of September 30, 2017. However, WAB provided a forbearance agreement which defers its right to exercise the default provision of the line of credit until December 1, 2017. During the forbearance period, WAB shall have no further obligation to make any additional borrowings available to the Company or to provide any other extensions of credit during the forbearance period. However, the Company agrees that, if in the sole and absolute discretion of WAB, they make any discretionary financial accommodation during the forbearance period, such act shall not constitute (i) a waiver of any of the existing default covenants, which may now exist or which may occur after the date of the forbearance agreement, or (ii) an agreement on the part of WAB to make any further extensions of credit of any kind to the Company at a later date.
The Company was in compliance with the liquidity covenant as of October 31, 2017 and expects to be able to continue to comply with required covenants under the agreement with WAB for at least the next year. As a result, the amounts due to WAB under the line of credit and term loan as of September 30, 2017 were classified in the accompanying consolidated balance sheet in accordance with the repayment terms stipulated in the agreement with WAB. In addition, the Company is currently working with WAB to change the financial covenants in the existing loan agreement to better reflect the liquidity of the Company. In the event the Company does not meet its covenants after December 1, 2017 and WAB does not extend a waiver or forbearance agreement, and the Company believes that it does not have adequate liquidity to operate, if necessary, the Company will implement a cost cutting plan that reduces its expenditures to the appropriate level that matches its operating cash flows.
Our primary cash requirements are to fund operations
which mainly include personnel-related costs, marketing costs, third party costs related to hosting and software, general and administrative costs associated with being a public company, travel costs, and quarterly preferred stock dividends. The Company expects to continue to incur operating expenses for research and development and investment in software development costs to achieve its projected revenue growth. We continually evaluate our operating cash flows which can vary subject to the actual timing of expected new sales compared to our expectations of those sales and are sensitive to many factors, including changes in working capital and our results of operations.
However, projections of future cash needs and cash flows are subject to risks and uncertainty.
Management's current operating plan reflects a reduction in operating expenses which occurred at the end of the first quarter of 2017 in order to align its expenditures with its expected revenues. The primary area of cost reduction, which occurred at the end of the first quarter of 2017, was to reduce company headcount by eliminating non-revenue generating personnel throughout the Company. The Company remains focused on maximizing revenue from its revenue generating resources, including repurposing certain personnel to become revenue generators to help the Company improve its liquidity. The Company has a substantial professional services backlog that resulted from the acquisition of new customers in the second half of 2016 as well as upgrade projects for existing customers as they move to the latest version of Alliance. Management also initiated cost containment programs in other areas including the elimination or reduction of non-essential marketing activities, space reduction in areas in which the Company has excess office capacity, focusing marketing activities only on those programs that directly drive new business and eliminating contractors who are not essential to growth. In addition, we do not expect to spend a significant amount on capital expenditures. Overall, we have already implemented steps to reduce total operating expenses without impairing our ability to grow the business by obtaining new customers and increasing sales to existing customers.
We expect our revenues and cost reductions to
generate sufficient cash from operations.
As noted above, if the Company's actual results fall short of expectations, the Company will make further cost adjustments to improve the Company's operating cash flows.
Our operations are subject to certain risks and uncertainties including, among others, current and potential competitors with greater resources, dependence on our significant and existing customer base, closing license and subscription sales in a timely manner, lack of a history of consistently generating net income and uncertainty of future profitability, and possible fluctuations in financial results.
Off-Balance Sheet Arrangement Transactions
The Company is not involved in off-balance sheet arrangements that have or are reasonably likely to have a material current or future impact on our financial condition, changes in financial condition, revenues or expenses result in operations, liquidity, capital expenditures or capital resources.