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 three months ended March 31, 2017 and 2016, the Company recognized $6,001,000 and $5,348,000, 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 March 31, 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 $16,000 for the three months ended March 31, 2017 and a $51,000 gain for the three months ended March 31, 2016.
Results of Operations
Comparison of Three Months Ended March 31, 2017 and 2016
Revenues
Total revenues increased by $653,000 or 12%, to $6,001,000 for the three months ended March 31, 2017 from $5,348,000 for the three months ended March 31, 2016. Software license fee revenues decreased $601,000, or 71%, from the same quarter in 2016. Subscription revenues increased $265,000 or 53% to $767,000 from the same period last year. Services and maintenance revenue for the three months ended March 31, 2017 increased $968,000 or 24% from the same quarter in 2016.
Software license fee revenues decreased 71% to $243,000 in the first quarter of 2017 from $844,000 in the first quarter of 2016. Astea Alliance license revenues decreased $546,000 or 69%, to $243,000 in the first quarter of 2017 from $789,000 in the first quarter of 2016. The decrease was primarily due to lower perpetual license sales in the U.S. and EMEA. Several opportunities that were targeted to be completed by the end of the first quarter of 2017 were delayed.
Subscription revenue increased 53% to $767,000 in the first quarter of 2017 from $502,000 in the first quarter of 2016. The increase resulted from a number of hosted customers who went live in late 2016 and the first quarter of 2017. The Company continues to add new hosting customers. Even though the Company signed new Software as a Service (SaaS) customers in the first quarter of 2017, the associated hosting revenue may not be recognized until the new customers go-live.
Services and maintenance revenues increased by 25% to $4,991,000 in the first quarter of 2017 compared to $4,002,000 in the first quarter of 2016. Astea Alliance service and maintenance revenues increased by $1,054,000 or 31% compared to the first quarter of 2016. The increase was mainly attributable to an increase in services in all regions of the Company.
One UK hosting customer went live in the first quarter 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 quarterly 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 $65,000 or 11% to $518,000 in the first quarter of 2017 compared to $583,000 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 customers compared to the first quarter in 2016.
Costs of Revenues
Cost of software license fees increased 23% to $717,000 in the first quarter of 2017 from $583,000 in the first 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 $706,000 for the quarter ended March 31, 2017 compared to $565,000 for the same quarter in 2016. This increase primarily resulted from the release of Version 14 at the end of the third quarter of 2016 which generated additional amortization, partially offset by the completion of amortization on Version 11.5 in the first quarter of 2016. The gross margin percentage on software license sales was (195%) in the first quarter of 2017 compared to 31% in the first quarter of 2016. The decline in the license margin resulted primarily from the decrease in software license fees and the increase in the amortization of capitalized software development costs.
Cost of subscriptions decreased 8% to $208,000 in the first quarter of 2017 from $227,000 in the first quarter 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 73% in the first quarter of 2017 compared to 55% in the first quarter of 2016. The improvement is due to the increase in subscription revenue resulting from customers going live and a decrease in subscription costs due to a customer that terminated their agreement in the fourth quarter of 2016.
Cost of services and maintenance increased 11% to $3,554,000 in the first quarter of 2017 from $3,191,000 in the first quarter of 2016. The increase in cost of service and maintenance is mainly attributed to increased headcount and travel
expenses in all regions.
The gross margin percentage was 28% in the first quarter of 2017 compared to 20% in the first quarter of 2016. The improvement in services and maintenance gross margin was primarily due to the increase in service and maintenance revenue offset by an increase in service and maintenance costs.
Gross Profit
Gross profit increased 13% to $1,522,000 in the first quarter of 2017 from $1,347,000 in the first quarter of 2016.As a percentage of revenue, gross profit remained 25% in both first quarters of 2017 and 2016.
Operating Expenses
Product Development
Product development expenses increased 342% to $562,000 in the first quarter of 2017 from $127,000 in the first 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 $608,000 were capitalized in the first quarter of 2017 compared to $832,000 during the same period in 2016. Gross product development expense was $1,170,000 in the quarter ended March 31, 2017 which is 22% higher than $959,000 during the same quarter in 2016.
The increase was primarily due to termination costs and currency losses from Israel. Most of the Company's development occurs in Israel.
Product development expense as a percentage of revenues increased to 9% for the quarter ended March 31, 2017 compared to 2% for the quarter ended March 31, 2016.
Sales and Marketing
Sales and marketing expense decreased 11% to $927,000 in the first quarter of 2017 from $1,040,000 in the first quarter of 2016. The decrease in sales and marketing expense is attributable to the decreased headcount in sales and lower commissions compared to the same period in 2016. Marketing costs were flat in the first quarter of 2017 compared to the same period in 2016. The Company
continues to focus on expanding its market presence in all regions by expanding awareness of the Company's products, including SaaS 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 expense was 16% in the quarter ended March 31, 2017 compared to 19% in the same period of 2016. This reduction is due to both the overall increase in revenues and reduction in marketing expenses.
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, bad debt expense and various costs associated with the Company's status as a public company.
General and administrative expenses decreased 21% to $663,000 during the first quarter of 2017 from $840,000 in the first quarter of 2016. The decrease is primarily due to
third party professional fees and less travel compared to the same period in 2016. As a percentage of revenue, general and administrative expenses was 11% for the quarter ended March 31,2017 compared to 16% in the first quarter of 2016.
Net Interest Expense
Net interest expense was $42,000 in the first quarter of 2017 compared to $25,000 in the first quarter of 2016. The Company incurred interest expense resulting from borrowing against its line of credit with SVB Bank. The increase is due to additional borrowing on the line of credit in the first quarter of 2017 compared to the first quarter of 2016 as well as an increase in the interest rate charged by SVB to the Company.
Income Tax Expense
The Company reported a provision for income tax of $7,000 for first quarter of 2017 compared to $12,000 for the first quarter of 2016. The tax expense is due to a tax provision recognized in Israel.
International Operations
The Company's international operations contributed revenues of $2,577,000 in the first quarter of 2017 compared to $2,199,000 during the first quarter of 2016, an increase of 17%. The Company's revenues from international operations amounted to 43% of the total Company revenue for the first quarter in 2017, compared to 41% 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 an increase in revenues from the Asia Pacific region from new customers, partially offset by a decrease in revenue from Europe due to no license sales in the first quarter of 2017.
Liquidity and Capital Resources
Operating Activities
The Company generated $1,222,000 of cash from operating activities in the first three months of 2017 compared to $851,000 for the first three months of 2016. The increase in operating cash flows of $371,000 was due to an increase in non-cash expenses of $122,000, cash provided by accounts receivable of $234,000, an increase in cash provided by prepaid expenses of $72,000, an increase in cash provided by deferred revenues of $53,000, an increase in cash provided by other assets of $26,000 and a decrease in net loss of $18,000, partially offset by an increase in cash used in accounts payable and accrued expenses of $154,000.
Investing Activities
The Company used $608,000 for investing activities in the first three months of 2017 compared to $847,000 used in the first three months of 2016. The decrease in cash used in investing activities of $239,000 is attributable to a decrease of $224,000 in cash used for capitalized software development costs and a decrease in cash used for capital expenditures of $15,000.
Financing Activities
The Company used $296,000 of cash in financing activities in the first three months of 2017 compared to using $171,000 of cash in financing activities in the first three months of 2016. Payments of preferred stock dividends were $250,000 for the first three months of 2017 compared to $110,000 in the first three months of 2016. The Company paid deferred financing costs of $13,000 in the first quarter of 2016.
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, which resulted in a decrease of cash of $12,000 in 2017 compared to a decrease of $11,000 in 2016.
At March 31, 2017, the Company had a working capital ratio of approximately 0.49:1 compared to 0.53:1 at December 31, 2016. The Company had $965,000 in cash and cash equivalents at March 31, 2017, compared to $661,000 at December 31, 2016.
At March 31, 2017, the Company owed $1,880,000 against the line of credit from Silicon Valley Bank ("SVB"). The availability under the SVB line of credit is tied to a borrowing base formula that is based on 80% of the Company's eligible domestic accounts receivable. As of March 31, 2017, the availability under the line of credit was $120,000. 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 operations.
The Company has projected revenues that management believes will provide sufficient funds along with available borrowings under its lines of credit to sustain its continuing operations through at least June 30, 2018. In addition, the SVB line of credit expires in April 2018.
If the Company were unable to extend the SVB line of credit, it would need to obtain alternative sources of financing prior to the April 2018 expiration of the SVB line of credit, or institute additional cost cutting strategies, including headcount reduction and repurposing additional development staff to billable engagements to increase professional services revenue.
The Company was in compliance with the financial covenants for the line of credit with SVB as of March 31, 2017. In the event the Company does not meet its financial covenants in the future, SVB does not extend a waiver or forbearance agreement, and the Company does not believe that it has adequate liquidity to operate, the Company will implement additional cost adjustments, if necessary, that would reduce 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 need and cash flows are subject to risks and uncertainty.
Management's current operating plan includes a significant reduction in operating expenses in order to be aligned with expected revenues. The primary area of cost reduction is to reduce company headcount during 2017 by eliminating non-revenue generating personnel throughout the Company. The Company remains focused on maximizing revenue from its revenue generating resources, even repurposing certain personnel to become billable so the Company can generate sufficient operating cash. The Company has a substantial professional services backlog that resulted from the new customers added in the second half of 2016 as well as upgrade projects for our existing customers as they move to the latest version of Alliance. Management has 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 other than to replace our existing laptops and servers as they become obsolete. Overall, we have already implemented steps to reduce total operating expenses without impairing our ability to grow the business by obtaining new customers and additional sales to existing customers.
We expect our revenues and cost reductions to
generate sufficient cash from operations.
As noted above, if our actual results fall short of expectations, we will make further cost adjustments, if necessary, to improve our 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 net income and uncertainty of future profitability, and possible fluctuations in financial results. The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates continuity of operations, realization of assets, and satisfaction of liabilities in the ordinary course of business. The propriety of using the going-concern basis is dependent upon, among other things, the achievement of future profitable operations, the ability to generate sufficient cash from operations, and potential other funding sources for our current line of credit, including cash on hand, to meet our obligations as they become due.
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.