egan_Current Folio_10Q

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-Q

 


 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

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 No. 001-35314

 


 

eGAIN CORPORATION

(Exact name of registrant as specified in its charter)


 

 

 

 

Delaware

 

77-0466366

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

1252 Borregas Avenue, Sunnyvale, CA

 

94089

(Address of principal executive offices)

 

(Zip Code)

 

(408) 636-4500

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)


 

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 such 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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

 

 

 

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

◻    (Do not check if a smaller reporting company)

  

Smaller reporting company

 

 

Emerging growth company

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

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.

 

 

 

 

Class

  

Outstanding at November 10, 2017

Common Stock $0.001 par value

  

27,232,896

 

 

 

 

 


 

Table of Contents

eGAIN CORPORATION

Quarterly Report on Form 10-Q

For the Quarterly Period Ended September 30, 2017

 

TABLE OF CONTENTS

 

 

 

 

Page

 

 

    

 

PART I. 

FINANCIAL INFORMATION

 

2

Item 1. 

Financial Statements (Unaudited)

 

2

 

Condensed Consolidated Balance Sheets as of September 30, 2017 and June 30, 2017

 

2

 

Condensed Consolidated Statements of Operations for the Three Months ended September 30, 2017 and 2016

 

3

 

Condensed Consolidated Statements of Comprehensive Loss for the Three Months ended September 30, 2017 and 2016

 

4

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended September 30, 2017 and 2016

 

5

 

Notes to Condensed Consolidated Financial Statements

 

6

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

21

Item 3. 

Quantitative and Qualitative Disclosures about Market Risk

 

32

Item 4. 

Controls and Procedures

 

33

PART II. 

OTHER INFORMATION

 

34

Item 1. 

Legal Proceedings

 

34

Item 1A. 

Risk Factors

 

34

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

 

48

Item 6. 

Exhibits

 

49

 

Signatures

 

50

 

 

 

 

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PART I.  FINANCIAL INFORMATION

 

Item 1. Financial Statements

eGAIN CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(in thousands, except par value data)

 

 

 

 

 

 

 

 

 

 

 

September 30, 

 

June 30, 

 

    

2017

    

2017

ASSETS

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

10,724

 

$

10,627

Restricted cash

 

 

 6

 

 

 6

Accounts receivable, less allowance for doubtful accounts of $414 and $357 as of September 30, 2017 and June 30, 2017, respectively

 

 

5,498

 

 

7,201

Deferred commissions

 

 

641

 

 

690

Prepaid expenses

 

 

1,306

 

 

1,737

Other current assets

 

 

386

 

 

370

Total current assets

 

 

18,561

 

 

20,631

Property and equipment, net

 

 

923

 

 

1,059

Deferred commissions, net of current portion

 

 

618

 

 

694

Intangible assets, net

 

 

2,244

 

 

2,748

Goodwill

 

 

13,186

 

 

13,186

Other assets

 

 

1,413

 

 

1,433

Total assets

 

$

36,945

 

$

39,751

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' DEFICIT

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

2,271

 

$

2,363

Accrued compensation

 

 

3,974

 

 

4,339

Accrued liabilities

 

 

2,371

 

 

2,364

Deferred revenue

 

 

20,912

 

 

18,332

Capital lease obligations

 

 

96

 

 

108

Bank borrowings, net of deferred financing costs

 

 

849

 

 

805

Total current liabilities

 

 

30,473

 

 

28,311

Deferred revenue, net of current portion

 

 

6,047

 

 

4,887

Capital lease obligations, net of current portion

 

 

21

 

 

42

Bank borrowings, net of current portion and deferred financing costs

 

 

8,896

 

 

14,802

Other long-term liabilities

 

 

1,319

 

 

1,330

Total liabilities

 

 

46,756

 

 

49,372

Commitments and contingencies (Note 5)

 

 

 

 

 

 

Stockholders' deficit:

 

 

 

 

 

 

Common stock, $0.001 par value - authorized: 50,000 shares; outstanding: 27,231 shares as of September 30, 2017 and 27,127 shares as of June 30, 2017

 

 

27

 

 

27

Additional paid-in capital

 

 

343,798

 

 

343,367

Notes receivable from stockholders

 

 

(84)

 

 

(83)

Accumulated other comprehensive loss

 

 

(1,715)

 

 

(1,663)

Accumulated deficit

 

 

(351,837)

 

 

(351,269)

Total stockholders' deficit

 

 

(9,811)

 

 

(9,621)

Total liabilities and stockholders' deficit

 

$

36,945

 

$

39,751

 

See accompanying notes to condensed consolidated financial statements

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eGAIN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(in thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

September 30, 

 

    

2017

    

2016

Revenue:

 

 

 

 

 

 

Recurring

 

$

11,642

 

$

10,863

Legacy license

 

 

188

 

 

1,650

Professional services

 

 

2,745

 

 

2,232

Total revenue

 

 

14,575

 

 

14,745

Cost of revenue:

 

 

 

 

 

 

  Cost of recurring

 

 

3,020

 

 

2,927

  Cost of legacy license

 

 

18

 

 

 7

  Cost of professional services

 

 

2,388

 

 

2,130

      Total cost of revenue

 

 

5,426

 

 

5,064

Gross profit

 

 

9,149

 

 

9,681

Operating expenses:

 

 

 

 

 

 

Research and development

 

 

3,431

 

 

3,675

Sales and marketing

 

 

4,166

 

 

5,240

General and administrative

 

 

1,806

 

 

2,031

Total operating expenses

 

 

9,403

 

 

10,946

Loss from operations

 

 

(254)

 

 

(1,265)

Interest expense, net

 

 

(344)

 

 

(422)

Other income (expense), net

 

 

(131)

 

 

108

Loss before income tax provision

 

 

(729)

 

 

(1,579)

Income tax benefit (provision)

 

 

161

 

 

(832)

Net loss

 

$

(568)

 

$

(2,411)

Per share information:

 

 

 

 

 

 

Basic and diluted net loss per common share

 

$

(0.02)

 

$

(0.09)

Weighted average shares used in computing basic and diluted net loss per common share

 

 

27,185

 

 

27,108

 

See accompanying notes to condensed consolidated financial statements 

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eGAIN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Unaudited)

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Three months ended 

 

 

September 30, 

 

    

2017

    

2016

Net loss

 

$

(568)

 

$

(2,411)

Other comprehensive loss, net of taxes:

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

(52)

 

 

118

Comprehensive loss

 

$

(620)

 

$

(2,293)

 

See accompanying notes to condensed consolidated financial statements

 

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eGAIN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

September 30, 

 

 

    

2017

    

2016

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net loss

 

$

(568)

 

$

(2,411)

 

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

183

 

 

354

 

Amortization of intangible assets

 

 

504

 

 

579

 

Amortization of deferred commissions

 

 

236

 

 

231

 

Amortization of deferred financing costs

 

 

62

 

 

44

 

Stock-based compensation

 

 

319

 

 

236

 

Provision for doubtful accounts

 

 

52

 

 

262

 

Loss on disposal of fixed assets

 

 

 2

 

 

 —

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

1,819

 

 

4,175

 

Deferred commissions

 

 

(100)

 

 

(306)

 

Prepaid expenses

 

 

439

 

 

295

 

Other current assets

 

 

(6)

 

 

(114)

 

Other non-current assets

 

 

14

 

 

 5

 

Accounts payable

 

 

(106)

 

 

(194)

 

Accrued compensation

 

 

(411)

 

 

(2,469)

 

Accrued liabilities

 

 

(35)

 

 

(978)

 

Deferred revenue

 

 

3,530

 

 

2,496

 

Other long-term liabilities

 

 

(21)

 

 

238

 

Net cash provided by operating activities

 

 

5,913

 

 

2,443

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(32)

 

 

(42)

 

Net cash used in investing activities

 

 

(32)

 

 

(42)

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Payments on bank borrowings

 

 

(8,462)

 

 

(5,250)

 

Proceeds from bank borrowings

 

 

2,538

 

 

618

 

Payments on capital lease obligations

 

 

(34)

 

 

(88)

 

Proceeds from exercise of stock options

 

 

112

 

 

 —

 

Net cash used in financing activities

 

 

(5,846)

 

 

(4,720)

 

Effect of change in exchange rates on cash and cash equivalents

 

 

62

 

 

 8

 

Net increase (decrease) in cash and cash equivalents

 

 

97

 

 

(2,311)

 

Cash and cash equivalents at beginning of period

 

 

10,627

 

 

11,780

 

Cash and cash equivalents at end of period

 

$

10,724

 

$

9,469

 

 

 

 

 

 

 

 

 

Supplemental cash flow disclosures:

 

 

 

 

 

 

 

Cash paid for interest

 

$

284

 

$

383

 

Cash paid for taxes

 

$

66

 

$

76

 

Non-cash items:

 

 

 

 

 

 

 

Purchases of equipment through trade accounts payable

 

$

 3

 

$

19

 

 

See accompanying notes to condensed consolidated financial statements

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eGAIN CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

1. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

 

Organization and Nature of Business

 

eGain Corporation (“eGain”, the “Company”, “our”, “we” or “us”) is a leading provider of cloud-based customer engagement software. We help business-to-consumer (B2C) brands operationalize digital customer engagement strategy. Our suite includes rich applications for digital interaction, knowledge management, and AI-based process guidance. We also provide advanced, integrated analytics for contact centers and digital properties to holistically measure, manage, and optimize resources. Benefits include reduced customer effort, customer satisfaction, connected service processes, converted upsell opportunities, and improved compliance—across mobile, social, web, and phone. Hundreds of global enterprises rely on eGain to transform fragmented customer service systems into unified Customer Engagement Hubs.

 

We have operations in the United States, United Kingdom and India.

 

Basis of Presentation

 

We prepared the condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission and included the accounts of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Certain information and footnote disclosures, normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), have been condensed or omitted pursuant to such rules and regulations although we believe that the disclosures made are adequate to make the information not misleading. In our opinion, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our financial position, results of operations and cash flows for the periods presented.

 

These condensed consolidated financial statements and notes should be read in conjunction with our audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2017, included in our Annual Report on Form 10-K. The condensed consolidated balance sheet as of June 30, 2017 was derived from audited consolidated financial statements as of that date but does not include all the information and footnotes required by GAAP for complete financial statements. The results of our operations for the interim periods presented are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending June 30, 2018.

 

Reclassification

 

Certain reclassifications were made to the condensed consolidated financial statements to conform to the current period presentation. As of June 30, 2017, we classify subscription and support revenue as recurring revenue due to the strategic decision to move to a ratable or cloud delivery business model from the hybrid model that included legacy perpetual licenses. These reclassifications did not result in any change in previously reported net losses, total assets or stockholders’ deficit.

 

Certain reclassifications were made to the condensed consolidated statements of cash flows for the three months ended September 30, 2016 to conform to the presentation of the three months ended September 30, 2017.

 

Business Combinations 

 

Business combinations are accounted for at fair value under the purchase method of accounting. Acquisition costs are expensed as incurred and recorded in general and administrative expenses and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date affect income tax expense. The accounting for business combinations requires estimates and judgment as to expectations for future cash flows of the acquired business, and the

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allocation of those cash flows to identifiable intangible assets, in determining the estimated fair value for assets acquired and liabilities assumed. The fair values assigned to tangible and intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions, as well as other information compiled by management, including valuations that utilize customary valuation procedures and techniques. If the actual results differ from the estimates and judgments used in these estimates, the amounts recorded in the condensed consolidated financial statements could result in a possible impairment of the intangible assets and goodwill, or require acceleration of the amortization expense of finite-lived intangible assets.

 

Segment Information

 

We operate in one segment, the development, license, implementation and support of our customer interaction software solutions. Operating segments are identified as components of an enterprise for which discrete financial information is available and regularly reviewed by the Company’s chief operating decision-makers in order to make decisions about resources to be allocated to the segment and assess its performance. Our chief operating decision-makers, under Accounting Standards Codification (ASC) 280, Segment Reporting, are our executive management team. Our chief operating decision-makers review financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. The Company operates in one operating segment and all required financial segment information can be found in the condensed consolidated financial statements.

 

Information relating to our geographic areas for the three months ended September 30, 2017 and 2016 is as follows (unaudited, in thousands):

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

September 30, 

 

    

2017

    

2016

Total Revenue:

 

 

 

 

 

 

North America

 

$

7,263

 

$

7,262

EMEA

 

 

6,997

 

 

6,978

Asia Pacific

 

 

315

 

 

505

 

 

$

14,575

 

$

14,745

Operating Income (Loss):

 

 

 

 

 

 

North America

 

$

 7

 

$

(2,339)

EMEA

 

 

568

 

 

1,789

Asia Pacific*

 

 

(829)

 

 

(715)

 

 

$

(254)

 

$

(1,265)

 


*Includes costs associated with corporate support.

 

In addition, long-lived assets corresponding to our geographic areas are as follows (unaudited, in thousands):

 

 

 

 

 

 

 

 

 

 

September 30, 

 

June 30, 

 

    

2017

    

2017

Long-Lived Assets:

 

 

 

 

 

 

North America

 

$

367

 

$

463

EMEA

 

 

447

 

 

497

Asia Pacific

 

 

109

 

 

99

 

 

$

923

 

$

1,059

 

Concentration of Credit Risks

 

For the three months ended September 30, 2017, one customer accounted for 14% of total revenue. For the three months ended September 30, 2016, two customers accounted for 12% and 11%, respectively, of total revenue.

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Revenue Recognition

 

We enter into arrangements to deliver multiple products or services (multiple-elements). We apply software revenue recognition rules and multiple-elements arrangement revenue guidance. Significant management judgments and estimates are made and used to determine the revenue recognized in any accounting period. Material differences may result in changes to the amount and timing of our revenue for any period if different conditions were to prevail. We present revenue, net of taxes collected from customers and remitted to governmental authorities.

 

We derive revenue from three sources:

i.

Recurring fees (previously referred to as subscription and support) primarily consist of cloud revenue from customers accessing our enterprise cloud computing services, term and ratable license revenue, and maintenance and support revenue;

ii.

Legacy license fees primarily consist of perpetual software license revenue which we no longer sell to new customers; and

iii.

Professional services primarily consist of consulting, implementation services and training.

Revenue is recognized when all of the following criteria are met:

·

Persuasive evidence of an arrangement exists: Evidence of an arrangement consists of a written contract signed by both the customer and management prior to the end of the period. We use signed software licenses, services agreements and order forms as evidence of an arrangement for sales of software, cloud, maintenance and support. We use signed statement of work as evidence of arrangement for professional services.

·

Delivery or performance has occurred: Software is delivered to customers electronically, and license files are delivered electronically. Delivery is considered to have occurred when we provide the customer access to the software along with a license file and/or login credentials.

·

Fees are fixed or determinable: We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction. Arrangements where a significant portion of the fee is due beyond 90 days from delivery are generally not considered to be fixed or determinable.

·

Collectibility is probable: We assess collectibility based on a number of factors, including the customer’s past payment history and current creditworthiness. Payment terms generally range from 30 to 90 days from invoice date. If we determine that collection of a fee is not reasonably assured, we defer the revenue and recognize it at the time collection becomes reasonably assured, which is generally upon receipt of cash payment.

 

Revenue from sales to resellers is generally recognized upon delivery to the reseller dependent on the facts and circumstances of the transaction, such as our understanding of the reseller’s plans to sell the software, existence of return provisions, price protection or other allowances, the reseller’s financial status and our experience with the reseller. Historically sales to resellers have not included any return provisions, price protections or other allowances.

 

We apply the provisions of Accounting Standards Codification, or ASC, 985-605, Software Revenue Recognition, to all transactions involving the licensing of software products. In the event of a multiple element arrangement for a license transaction, we evaluate the transaction as if each element represents a separate unit of accounting taking into account all factors following the accounting standards. We apply ASC 605, Revenue Recognition, for cloud transactions to determine the accounting treatment for multiple elements. We also apply ASC 605-35 for fixed fee arrangements in which we use the percentage of completion method to recognize revenue when reliable estimates are available for the costs and efforts necessary to complete the implementation services. When such estimates are not available, the completed contract method is utilized. Under the completed contract method, revenue is recognized only when a contract is completed or substantially complete.

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When legacy perpetual licenses were sold together with system implementation and consulting services, legacy license fees were recognized upon shipment, provided that (i) payment of the license fees were not dependent upon the performance of the consulting and implementation services, (ii) the services were available from other vendors, (iii) the services qualified for separate accounting as we have sufficient experience in providing such services, had the ability to estimate cost of providing such services, and we had vendor-specific objective evidence, or VSOE, of fair value, and (iv) the services were not essential to the functionality of the software.

 

We enter into arrangements with multiple-deliverables that generally include subscription, maintenance and support, and professional services. We evaluate whether each of the elements in these arrangements represents a separate unit of accounting, as defined by ASC 605, using all applicable facts and circumstances, including whether (i) we sell or could readily sell the element unaccompanied by the other elements, (ii) the element has stand-alone value to the customer, and (iii) there is a general right of return. For revenue recognition with multiple-deliverable elements, we apply the selling price hierarchy, which includes VSOE, third-party evidence of selling price, or TPE, and best estimate of selling price, or BESP. We determine the relative selling price for a deliverable based on VSOE, if available, or BESP, if VSOE is not available. We determined that TPE is not a practical alternative due to differences in our service offerings compared to other parties and the availability of relevant third-party pricing information.

 

We determine BESP by considering our overall pricing objectives and market conditions. Significant pricing practices taken into consideration include our discounting practices, the size and volume of our transactions, customer demographic, the geographic area where services are sold, price lists, its go-to-market strategy, historical standalone sales and contract prices. The determination of BESP is made through consultation with and approval by our management, taking into consideration the go-to-market strategy. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in relative selling prices, including both VSOE and BESP.

 

Recurring Revenue

 

Cloud Revenue

 

Cloud revenue consists of subscription fees along with bundled maintenance and support revenue from customers accessing our cloud-based service offerings. We recognize cloud services revenue ratably over the period of the applicable agreement as services are provided. Cloud agreements typically have an initial term of 12 to 36 months and automatically renew unless either party cancels the agreement. The majority of the cloud services customers purchase a combination of our cloud service and professional services. In some cases, the customer may also acquire a license for our software.

 

We consider the applicability of ASC 985-605, on a contract-by-contract basis. In cloud based agreements, where the customer does not have the contractual right to take possession of the software, the revenue is recognized on a monthly basis over the term of the contract. Invoiced amounts are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. We consider a software element to exist when we determine that the customer has the contractual right to take possession of our software at any time during the cloud period without significant penalty and can feasibly run the software on its own hardware or enter into another arrangement with a third party to host the software. Additionally, we have established VSOE for the cloud and maintenance and support elements of perpetual license sales, based on the prices charged when sold separately and substantive renewal terms. Accordingly, when a software element exists in a cloud services arrangement, license revenue for the perpetual software license element is determined using the residual method and is recognized upon delivery. Revenue for the cloud and maintenance and support elements is recognized ratably over the contractual time period. Professional services are recognized as described below under Professional Services Revenue. If VSOE of fair value cannot be established for the undelivered elements of an agreement, the entire amount of revenue from the arrangement is recognized ratably over the period that these elements are delivered.

 

Term and Ratable License Revenue

 

Term and ratable license revenue includes arrangements where our customers receive license rights to use our software along with bundled maintenance and support services for the term of the contract or the Company has not established

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VSOE for the bundled multi-year maintenance and support services. The majority of our contracts provide customers with the right to use one or more products up to a specific license capacity. Certain terms of our license agreements stipulate that customers can exceed pre-determined base capacity levels, in which case additional fees are specified in the license agreement. Term license revenue is recognized ratably over the term of the license contract, and ratable license revenue is recognized over the term of the associated bundled maintenance and support contract.

 

Our release of version 15.5 of the perpetual license is a cloud and perpetual license hybrid software which represents a service contract under ASC 605-25. The cloud components are essential to the functionality of the version 15.5 release, and we have a contractual obligation to deliver these cloud components. Per ASC 605-25, a delivered item is considered a separate unit of accounting only if (i) the delivered item has standalone value; and (ii) if the service contract has a general right of return, then delivery and performance of the undelivered item is probable and substantially within the vendor’s control. We cannot separate the cloud components because there is no standalone value of the cloud components. The perpetual license revenue is recognized over the economic life of the software which was determined to be three years.

 

Maintenance and Support Revenue

 

Maintenance and support revenue consists of customers purchasing maintenance and support for our on-premise software. We use VSOE of fair value for maintenance and support to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each element. Maintenance and support revenue is recognized ratably over the term of the maintenance contract, which is typically one year. Maintenance and support is renewable by the customer on an annual basis. Maintenance and support rates, including subsequent renewal rates, are typically established based upon a specified percentage of net license fees as set forth in the arrangement.

 

Legacy License Revenue

 

Legacy license revenue consists of perpetual license rights sold to customers to use our software in conjunction with related maintenance and support services. If an acceptance period is required, revenue is recognized upon the earlier of customer acceptance or the expiration of the acceptance period. In software arrangements that include rights to multiple software products and/or services, we use the residual method for perpetual licenses released as version 15 or prior under which revenue is allocated to the undelivered elements based on VSOE of the fair value of such undelivered elements. The residual amount of revenue is allocated to the delivered elements and recognized as revenue, assuming all other criteria for revenue recognition have been met. Such undelivered elements in these arrangements typically consist of software maintenance and support, implementation and consulting services and, in some cases, cloud services.

 

Professional Services Revenue

 

Professional services revenue includes system implementation, consulting and training. For license transactions, the majority of our consulting and implementation services qualify for separate accounting. We use VSOE of fair value for the services to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each element. Our consulting and implementation service contracts are bid either on a fixed-fee basis or on a time-and-materials basis. Substantially all of our contracts are on a time-and-materials basis. For time-and-materials contracts, where the services are not essential to the functionality, we recognize revenue as services are performed. If the services are essential to functionality, then both the product license revenue and the service revenue are recognized under the percentage of completion method. For a fixed-fee contract, we recognize revenue based upon the costs and efforts to complete the services in accordance with the percentage of completion method, provided we are able to estimate such cost and efforts.

 

Under ASC 605-25, in order to account for deliverables in a multiple-deliverable arrangement as separate units of accounting, the deliverables must have standalone value upon delivery. For cloud services, in determining whether professional services have standalone value, we consider the following factors for each professional services agreement: availability of the services from other vendors, the nature of the professional services, the timing of when the professional services contract was signed in comparison to the subscription service start date and the contractual dependence of the subscription service on the customer’s satisfaction with the professional services work.

 

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We have standalone value for consulting and implementation services. For those contracts that have standalone value, we recognized the services revenue when rendered for time and material contracts, when the milestones are achieved and accepted by the customer for fixed price contracts or by percentage of completion basis if there is no acceptance criteria.

Training revenue that meets the criteria to be accounted for separately is recognized when training is provided.

 

Deferred Revenue

 

Deferred revenue primarily consists of payments received in advance of revenue recognition from cloud, term and ratable license, and maintenance and support services and is recognized as the revenue recognition criteria are met. We generally invoice customers in annual or quarterly installments. The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable cloud or maintenance and support agreements. Deferred revenue is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration, invoice timing and new business linearity within the quarter.

 

Deferred revenue that will be recognized during the succeeding twelve-month period is recorded as current deferred revenue and the remaining portion is recorded as noncurrent.

 

Deferred Commissions

 

Deferred commissions are costs associated with cloud and term license contracts with customers and consist of sales commissions to our sales force.

 

Commission expenses are deferred and amortized over the terms of the related customer contracts, which are typically 12 to 36 months. The deferred commission amounts are recognized as sales and marketing expense in the condensed consolidated statements of operations over the terms of the related customer contracts in proportion to the recognition of the associated revenue.

 

Accounts Receivable and Allowance for Doubtful Accounts

 

We extend unsecured credit to our customers on a regular basis. Our accounts receivable are derived from revenue earned from customers and are not interest bearing. We also maintain an allowance for doubtful accounts to reserve for potential uncollectible trade receivables. We review our trade receivables by aging category to identify specific customers with known disputes or collectibility issues. We exercise judgment when determining the adequacy of these reserves as we evaluate historical bad debt trends, general economic conditions in the U.S. and internationally, and changes in customer financial conditions. If we made different judgments or utilized different estimates, material differences may result in additional reserves for trade receivables, which would be reflected by charges in general and administrative expenses for any period presented. We write off a receivable after all collection efforts have been exhausted and the amount is deemed uncollectible.

 

Deferred Financing Costs

 

Costs relating to obtaining the credit agreement with Wells Fargo Bank are capitalized and amortized over the term of the related debt using the effective interest method. As of September 30, 2017 and June 30, 2017, deferred financing costs were $950,000 and accumulated amortization was $563,000 and $501,000, respectively. Deferred financing costs are included net of bank borrowings in the accompanying condensed consolidated balance sheets. Amortization of deferred financing costs recorded as interest expense was $62,000 and $44,000 for the three months ended September 30, 2017 and 2016, respectively. When a loan is paid in full, any unamortized financing costs are removed from the related accounts and charged to operations as interest expense.

 

Leases

 

Lease agreements are evaluated to determine whether they are capital or operating leases in accordance with ASC 840, Leases. When any one of the four test criteria in ASC 840 is met, the lease then qualifies as a capital lease.

 

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Capital leases are capitalized at the lower of the net present value of the total amount payable under the leasing agreement (excluding finance charges) or the fair market value of the leased asset. Capital lease assets are depreciated on a straight-line basis, over a period consistent with our normal depreciation policy for tangible fixed assets, but not exceeding the lease term. Interest charges are expensed over the period of the lease in relation to the carrying value of the capital lease obligation.

 

Rent expense for operating leases, which may include free rent or fixed escalation amounts in addition to minimum lease payments, is recognized on a straight-line basis over the duration of each lease term.

 

Stock-Based Compensation

 

We account for stock-based compensation in accordance with ASC 718, Compensation—Stock Compensation. Under the fair value recognition provisions of ASC 718, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. Determining the fair value of the stock-based awards at the grant date requires significant judgment and the use of estimates, particularly surrounding Black-Scholes valuation assumptions such as stock price volatility and expected option term.

 

Below is a summary of stock-based compensation included in the costs and expenses (unaudited, in thousands):

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

September 30, 

 

    

2017

    

2016

Stock-Based Compensation:

 

 

 

 

 

 

Cost of revenue

 

$

63

 

$

45

Research and development

 

 

110

 

 

88

Sales and marketing

 

 

63

 

 

58

General and administrative

 

 

83

 

 

45

Total stock-based compensation expense:

 

$

319

 

$

236

 

We utilized the Black-Scholes valuation model for estimating the fair value of the stock-based compensation of options granted. All shares of our common stock issued pursuant to our stock option plans are only issued out of an authorized reserve of shares of common stock which were previously registered with the Securities and Exchange Commission on a Registration Statement on Form S-8.

 

On September 19, 2017, our board of directors approved a repricing to $2.50 of certain outstanding options under our 2005 Stock Incentive Plan held by employees who are not executive officers or directors of the Company. The repricing applied to options held by such employees with an exercise price greater than $2.50 per share which was the closing stock price as reported on Nasdaq on September 19, 2017.

 

In accordance with ASC 718, as applicable to the repricing on September 19, 2017, a modification to the price of an option should be treated as an exchange of the original option for a new option. The calculation of the incremental value associated with the new option is based on the excess of the fair value of the modified option based on current assumptions over the fair value of the original option measured immediately before its price is modified based on current assumptions. We estimated $564,000 in total incremental stock-based compensation expense which is expected to be recognized through September 2020. We recognized $138,000 in incremental stock-based compensation expense during the three months ended September 30, 2017. Unrecognized stock-based compensation expense was $426,000 as of September 30, 2017.

 

During the three months ended September 30, 2017 and 2016, we granted options to purchase 1,115,141 and 40,000 shares of common stock with a weighted-average fair value of $1.14 and $1.26 per share, respectively. Additionally, we repriced options to purchase 996,684 shares of common stock on September 19, 2017, which were previously granted between May 2011 through September 2016, with a weighted-average fair value of $1.19 per share. We used the following assumptions:

 

 

 

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Three Months Ended

 

 

 

September 30, 

 

 

    

2017

    

2016

 

Dividend yield

 

 —

 

 —

 

Expected volatility

 

56

%  

56

%

Average risk-free interest rate

 

1.82

%  

1.13

%

Expected life (in years)

 

4.55

 

4.95

 

 

The dividend yield of zero is based on the fact that we have never paid cash dividends and have no present intention to pay cash dividends. We determined the appropriate measure of expected volatility by reviewing historic volatility in the share price of our common stock, as adjusted for certain events that management deemed to be non-recurring and non-indicative of future events. The risk-free interest rate is derived from the average U.S. Treasury Strips rate with maturities approximating the expected lives of the awards during the period, which approximate the rate in effect at the time of the grant.

 

We base our estimate of expected life of a stock option on the historical exercise behavior, and cancellations of all past option grants made by the Company during the time period which its equity shares have been publicly traded, the contractual term of the option, the vesting period and the expected remaining term of the outstanding options.

 

Total compensation cost, net of forfeitures, of all options granted but not yet vested as of September 30, 2017 was $1.6 million, which is expected to be recognized over the weighted-average period of 1.75 years. There were 103,150 and 0 options exercised during the three months ended September 30, 2017 and 2016, respectively.

 

New Accounting Pronouncements

 

In May 2017, the Financial Accounting Standards Board (FASB) issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting, which provides guidance about which changes to the terms or conditions of a shared-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-09 is effective for annual reporting periods beginning after December 15, 2017 (our fiscal 2019), including interim reporting periods within those annual reporting periods. Early adoption is permitted. We are currently assessing the future impact of this update on our consolidated financial statements and related disclosures.

 

In January 2017, the FASB issued ASU 2017-04 Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which eliminates Step 2 from goodwill impairment testing. The FASB also eliminated requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. ASU 2017-04 is effective for annual reporting periods beginning after December 15, 2019 (our fiscal 2021), including interim reporting periods within those annual reporting periods. Early adoption is permitted. We early adopted this guidance in fiscal year 2017.

 

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which provides specific guidance on how to classify restricted cash. ASU 2016-18 is effective for annual reporting periods beginning after December 15, 2017 (our fiscal 2019), including interim reporting periods within those annual reporting periods. Early adoption is permitted. We are currently assessing the future impact of this update on our consolidated financial statements and related disclosures.

 

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, which provides that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for annual reporting periods beginning after December 15, 2017 (our fiscal 2019), including interim reporting periods within those annual reporting periods. Early adoption is permitted. We are currently assessing the future impact of this update on our consolidated financial statements and related disclosures.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments should be applied using a retrospective transition method to

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each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 (our fiscal 2019), and interim periods within those fiscal years. Early adoption is permitted. We are currently assessing the future impact of this update on our consolidated financial statements and related disclosures.

 

In February 2016, the FASB issued ASU 2016-02, Leases, which requires that we recognize lease assets and liabilities on the balance sheet. This standard is effective for annual periods beginning after December 15, 2018 (our fiscal 2020), and interim periods within those annual periods. Early adoption is permitted. We are currently assessing the future impact of this update on our consolidated financial statements and related disclosures.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which supersedes the revenue recognition requirements in Topic 605, Revenue Recognition and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in this update are effective for annual reporting periods beginning after December 15, 2017 (our fiscal 2019), including interim periods within that reporting period, with early application permitted for periods beginning after December 31, 2016. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606) Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies how to apply the implementation guidance on principal versus agent considerations related to the sale of goods or services to a customer as updated by ASU 2014-09. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers  (Topic 606)  Identifying Performance Obligations and Licensing, which clarifies two aspects of Topic 606: identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas, as updated by ASU 2014-09. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which makes narrow scope amendments to Topic 606 including implementation issues on collectability, non-cash consideration and completed contracts at transition. In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers, which provides technical corrections and improvements to Topic 606 and other Topics amended by ASU 2014-09 to increase stakeholders’ awareness of the proposals and to expedite improvements to ASU 2014-09. The effective date and transition requirements for the amendments are equivalent to those for Topic 606.

 

Topic 606 is effective for our fiscal year 2019 beginning on July 1, 2018 using either one of two transition methods including several practical expedients: (i) full retrospective method, in which the new standard would be applied to each prior reporting period presented; or (ii) the modified retrospective method, in which the cumulative effect of initially applying the new standard would be recognized at the date of initial application and providing certain additional disclosures as defined in the guidance. We have not selected a transition method yet. We are still evaluating the overall effect that the standard will have on our consolidated financial statements and accompanying notes to the consolidated financial statements.    

 

2. NET LOSS PER COMMON SHARE

 

Basic net loss per common share is computed using the weighted-average number of shares of common stock outstanding. In periods where net income is reported, the weighted average number of shares is increased by warrants and options in the money to calculate diluted net income per common share.

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The following table represents the calculation of basic and diluted net loss per common share (unaudited, in thousands, except per share data):

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

September 30, 

 

 

2017

 

2016

Net loss applicable to common stockholders

    

$

(568)

    

$

(2,411)

Basic and diluted net loss per common stock

 

$

(0.02)

 

$

(0.09)

Weighted-average common shares used in computing basic and diluted net loss per common share

 

 

27,185

 

 

27,108

 

Weighted-average shares of stock options to purchase 2,347,808 and 2,478,930 shares of common stock for the three months ended September 30, 2017 and 2016, respectively, were not included in the computation of diluted net loss per common share due to their anti-dilutive effect. Such securities could have a dilutive effect in future periods.

 

 

3. BANK BORROWINGS

 

On November 21, 2014, we entered into a Credit Agreement (the Credit Agreement) with Wells Fargo Bank, as administrative agent and the lenders party thereto. The Credit Agreement provides for the extension of revolving loans (Revolving Loans) in an aggregate principal amount not to exceed $10.0 million, and a term loan (Term Loan) in an aggregate principal amount not to exceed $10.0 million, but in each case limited by an amount not to exceed 60% of our trailing twelve month recurring revenue from subscription and support fees attributable to software, as calculated under the Credit Agreement. The obligations under the Credit Agreement mature on November 21, 2019.

 

Borrowings under the Credit Agreement bear interest, in the case of LIBOR rate loans, at a per annum rate equal to the applicable LIBOR rate, plus 4.75%.  Borrowings under the Credit Agreement that are not LIBOR rate loans bear interest at a per annum rate equal to (i) the greatest of (A) the Federal Funds Rate plus 0.50%, (B) the one month LIBOR rate plus 1.00% per annum, and (C) the rate of interest announced, from time to time, by Wells Fargo Bank, National Association as its “prime rate,” plus (ii) 3.75%.

 

We will pay certain recurring fees with respect to the Credit Agreement, including servicing fees to the administrative agent. Prior to the first anniversary of the closing date of the Credit Agreement, voluntary repayments of the Term Loan, voluntary permanent reductions of the commitment related to the Revolving Loans and certain mandatory prepayments are subject a prepayment premium of 1.0% of the amount prepaid or reduced.

 

Subject to certain exceptions, the loans extended under the Credit Agreement are subject to customary mandatory prepayment provisions with respect to the following: net proceeds from certain asset sales; net proceeds from certain issuances or incurrences of debt (other than debt permitted to be incurred under the terms of the Credit Agreement); net proceeds of certain judgments, settlements and other claims or causes of action of us; and a portion with step-downs based upon the achievement of a financial covenant linked to the Leverage Ratio (as such term is defined in the Credit Agreement) of our annual excess cash flow and our subsidiaries, and with such required prepayment amount to be reduced dollar-for-dollar by any voluntary prepayments of the Term Loans. 

 

The Credit Agreement contains customary representations and warranties, subject to limitations and exceptions, and customary covenants restricting our ability and our subsidiaries to: incur additional indebtedness; incur liens; engage in mergers or other fundamental changes; consummate acquisitions; sell certain property or assets; change the nature of their business; prepay or amend certain indebtedness; pay dividends, other distributions or repurchase our equity interests or our subsidiaries; make investments; or engage in certain transactions with affiliates. In addition, the Credit Agreement contains financial covenants which initially require us to achieve minimum EBITDA and liquidity levels. However, subject to the conditions of the Credit Agreement, once we have achieved a minimum Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of 1.50 to 1.00 and a Leverage Ratio of less than 2.50 to 1.00, we will be required to comply with a minimum Fixed Charge Coverage Ratio and a specific Leverage Ratio.

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The Credit Agreement contains customary events of default, including with respect to: nonpayment of principal, interest, fees or other amounts; failure to perform or observe covenants; monetary judgment defaults; bankruptcy, insolvency and dissolution events; cross-default to other material indebtedness; material inaccuracy of a representation or warranty when made; failure to perfect a lien; actual or asserted invalidity or impairment of any definitive loan documentation or repudiation of guaranties; or a change of control.

 

As a condition to entering into the Credit Agreement, we pledged substantially all assets such as accounts receivable and property and equipment as collateral for the benefit of Wells Fargo Bank.

 

On September 2, 2015, the Company entered into Amendment Number One (the Amendment) to that certain Credit Agreement, dated as of November 21, 2014 (as further amended, restated, supplemented or otherwise modified from time to time), among us, the lenders, and Wells Fargo Bank, as administrative agent. Pursuant to the Amendment, we increased the total maximum Revolving Loan commitments thereunder from $10.0 million to $15.0 million and increased the quarterly amortization payments of the Term Loan under the Credit Agreement to $187,500 for the quarters ended September 30, 2015 through December 31, 2015 and $250,000 in each quarter ending thereafter.  Borrowings under the Amendment bear interest, in the case of LIBOR rate loans, at a per annum rate equal to the applicable LIBOR rate, plus 7.0%.  Borrowings under the Credit Agreement that are not LIBOR rate loans bear interest at a per annum rate equal to the rate of interest announced, from time to time, by Wells Fargo Bank, National Association as its “prime rate,” plus 6.0%. In connection with the Amendment, certain fees were also modified such that prior to the first anniversary of the Amendment, voluntary repayments of the Term Loan, voluntary permanent reductions of the commitment related to the Revolving Loans and certain mandatory prepayments will be subject a prepayment premium of 1.0% of the amount prepaid or reduced.  The financial covenants concerning minimum EBITDA and liquidity levels contained in the Credit Agreement were modified in the Amendment as follows:

 

1.

We were required to achieve minimum EBITDA of not more negative than $1.68 million for the three (3) month period ended September 30, 2015 and not more negative than $2.228 million for the six (6) month period ended December 31, 2015.  Thereafter, minimum EBITDA levels will be based on amounts agreed to by us and the requisite lenders based upon annual projections delivered to the agent, and the failure to reach an agreement on reset minimum EBITDA levels acceptable to the agent in its sole discretion shall constitute an event of default under the Credit Agreement; and

2.

We were required to achieve minimum liquidity of at least $10.0 million for the month ended December 31, 2015 and at all times thereafter.

 

On January 27, 2017, the Company entered into Amendment Number Two to the Credit Agreement (the Amendment No. 2), which amends the Credit Agreement dated as of November 21, 2014, among the Company, Wells Fargo Bank, National Association, as agent, and the lenders party thereto (as amended, the Credit Agreement).  Pursuant to the Amendment, the Applicable Margin (as defined in the Credit Agreement) at which LIBOR loans advanced under the Credit Agreement bear interest may be either the applicable LIBOR rate plus 5.5% per annum or 7.0% per annum, depending on the Company’s “TTM Recurring Revenue Calculation” (as defined in the Credit Agreement).  The TTM Recurring Revenue Calculation is based on the Company’s consolidated trailing twelve months of revenue relating to recurring revenue attributable to the Company’s software.  Loans may also bear interest under the Credit Agreement at the applicable Base Rate (as defined in the Credit Agreement) and the corresponding Applicable Margin for Base Rate loans is 1.0% per annum less than for LIBOR loans.  Under the Amendment No. 2, a 1.0% fee will also be payable until the first anniversary of the Amendment No. 2 on the amount of any voluntary prepayment of the Term Loan advanced under the Credit Agreement or the amount of any voluntary reduction of revolving commitments provided under the Credit Agreement.

 

The Amendment No. 2 modifies the two financial covenants the Company is required to comply with until the Financial Covenant Replacement Date (as defined in the Credit Agreement) has occurred. The Financial Covenant Replacement Date is the first day of the fiscal quarter following the date on which the Company has achieved (i) a Fixed Charge Coverage Ratio equal to or greater than 1.50 to 1.00 and (ii) a Leverage Ratio of less than 2.50 to 1.00 for the immediately preceding two consecutive fiscal quarters (as such terms are defined in the Credit Agreement).  In addition, the Financial Covenant Replacement Date will not be deemed to occur unless the Company is in compliance with the applicable Leverage Ratio as of the last day of the fiscal quarter preceding the test date. As of September 30, 2017, the Fixed Charge

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Coverage Ratio and Leverage Ratio financial covenants were not met, and the Financial Covenant Replacement Date was not deemed to have occurred.

 

Under the Amendment No. 2 the minimum EBITDA (as defined in the Credit Agreement) levels the Company is required to achieve on and prior to the Financial Covenant Replacement Date were modified to be, as of the end of each fiscal quarter, at the least the amount set forth in the table below for the applicable period opposite such amount (unaudited, in thousands):

 

 

 

 

 

For the four quarter period ending

    

Applicable Amount

September 30, 2017

 

$

(6,100)

December 31, 2017

 

 

(5,100)

March 31, 2018

 

 

(3,800)

June 30, 2018

 

 

(3,000)

September 30, 2018

 

 

(1,500)

December 31, 2018

 

 

 —

March 31, 2019

 

 

1,500

June 30, 2019

 

 

3,000

September 30, 2019

 

 

4,000

 

In addition, the amount of Liquidity (as defined in the Credit Agreement) which the Company is required to maintain on and prior to the Financial Covenant Replacement Date was reduced from $10.0 million to $4.0 million. Liquidity is calculated based on available credit under the Revolving Loan commitments and balances in certain bank accounts used for operations. The amount of Liquidity was $22.6 million as of September 30, 2017.

 

As of September 30, 2017, we were in compliance with these financial covenant terms.

 

As of September 30, 2017, balances on the Term Loan, Revolving Loans and debt maturities were (unaudited, in thousands):

 

 

 

 

 

 

 

 

 

September 30, 

 

June 30, 

 

    

2017

    

2017

Bank Borrowings:

 

 

 

 

 

 

Term Loan

 

$

7,625

 

$

7,875

Revolving Loan

 

 

2,507

 

 

8,181

Subtotal of bank borrowings

 

 

10,132

 

 

16,056

Less amounts representing deferred financing costs

 

 

(387)

 

 

(449)

Total bank borrowings

 

 

9,745

 

 

15,607

Less current maturities

 

 

(849)

 

 

(805)

Bank borrowings, net of current portion and deferred financing costs

 

$

8,896

 

$

14,802

 

 

4. INCOME TAXES

 

Income taxes are accounted for using the asset and liability method in accordance with ASC 740, Income Tax (“ASC 740”). Under this method, deferred tax liabilities and assets are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  For the legacy eGain business in the United States, based upon the weight of available evidence, which includes our historical operating performance and the reported cumulative net losses in all prior years, we have provided a full valuation allowance against our net deferred tax assets. For the legacy eGain business in the United Kingdom, the Company has determined based on the positive evidence it would be able to utilize the deferred tax assets and therefore released the valuation allowance against the deferred tax assets in the United Kingdom in fiscal year 2016. The remaining eGain foreign operations including Exony Ltd’s business historically have been profitable, and we believe it is more likely than not that those assets will be realized. Our tax provision primarily relates to foreign operations and

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realized benefits of amortized book intangibles as well as state income taxes. Our income tax rate differs from the statutory tax rates primarily due to the utilization of net operating loss carry-forwards which had previously been valued against as well as different tax rates in our foreign operations.

 

The Company accounts for uncertain tax positions according to the provisions of ASC 740. ASC 740 contains a two-step approach for recognizing and measuring uncertain tax positions. Tax positions are evaluated for recognition by determining if the weight of available evidence indicates that it is probable that the position will be sustained on audit, including resolution of related appeals or litigation. Tax benefits are then measured as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. No material changes have occurred in the Company’s tax positions taken as of September 30, 2017 and in the three months ended September 30, 2017.

 

We adopted ASU 2016-09, Compensation – Stock Compensation: Improvements to Employee Share-Based Accounting, in the first quarter of our fiscal 2018. No cumulative effect adjustment was recorded to our accumulated deficit as the U.S. deferred tax assets from previously unrecognized excess tax benefits were fully offset by a full valuation allowance, and we did not elect to change our policy of estimating expected forfeitures.

 

 

5. COMMITMENTS AND CONTINGENCIES

 

Leases

 

We entered into a sublease agreement that commenced on August 8, 2015 and that expired on August 31, 2016. Rental income from the sublease was approximately $426,000 for the year ended June 30, 2016. The sublease tenant did not renew and in accordance with ASC 420 Exit or Disposal Cost Obligations, we recorded a $305,000 lease exit liability and related rent expense on June 30, 2016 for an expected loss on the sublease for approximately 22,000 square feet of space as we will not receive sublease payments until another sublease tenant is found. The sublease is under our master lease agreement for our Sunnyvale facility. We classified the $305,000 lease exit liability in current liabilities in the accompanying condensed consolidated balance sheets as of June 30, 2016. Future minimum lease payments under non-cancellable operating leases are offset with sublease income when tenancy is secured.

 

In December 2016, we entered into a two-year sublease agreement for the 22,000 square feet of space with a subtenant that commenced on January 1, 2017. As a result, the remaining lease exit liability was reversed as a credit to rent expense during the three months ended December 31, 2016. Rental income from the sublease was $154,000 during the three months ended September 30, 2017.

 

Warranty

 

We generally warrant that the program portion of our software will perform substantially in accordance with certain specifications for a period up to one year from the date of delivery. Our liability for a breach of this warranty is either a return of the license fee or providing a fix, patch, work-around or replacement of the software.

 

We also provide standard warranties against and indemnification for the potential infringement of third party intellectual property rights to our customers relating to the use of our products, as well as indemnification agreements with certain officers and employees under which we may be required to indemnify such persons for liabilities arising out of their duties to us. The terms of such obligations vary. Generally, the maximum obligation is the amount permitted by law. 

 

Historically, costs related to these warranties have not been significant. Accordingly, we have no liabilities recorded for these costs as of September 30, 2017 and June 30, 2017. However, we cannot guarantee that a warranty reserve will not become necessary in the future.

 

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Indemnification

 

We have also agreed to indemnify our directors and executive officers for costs associated with any fees, expenses, judgments, fines and settlement amounts incurred by any of these persons in any action or proceeding to which any of those persons is, or is threatened to be, made a party by reason of the person’s service as a director or officer, including any action by us, arising out of that person’s services as our director or officer or that person’s services provided to any other company or enterprise at our request.

 

Transfer pricing

 

We have received transfer pricing assessments from tax authorities with regard to transfer pricing issues for certain fiscal years, which we have appealed with the appropriate authority. We believe that such assessments are without merit and would not have a significant impact on our condensed consolidated financial statements.

 

Litigation

 

In the ordinary course of business, we are from time to time involved in various legal proceedings and claims related to alleged infringement of third-party patents and other intellectual property rights, commercial, corporate and securities, labor and employment, wage and hour, and other claims.

 

We evaluate all claims and lawsuits with respect to their potential merits, our potential defenses and counterclaims, settlement or litigation potential and the expected effect on us. Our technologies may be subject to injunction if they are found to infringe the rights of a third party. In addition, our agreements require us to indemnify our customers for third-party intellectual property infringement claims, which could increase the cost to us of an adverse ruling on such a claim.

 

6. FAIR VALUE MEASUREMENT

 

ASC 820, Fair Value Measurement (“ASC 820”), defines fair value, establishes a framework for measuring fair value of assets and liabilities, and expands disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the assets or liabilities in an orderly transaction between market participants on the measurement date. Subsequent changes in fair value of these financial assets and liabilities are recognized in earnings or other comprehensive income when they occur. ASC 820 applies whenever other statements require or permit assets or liabilities to be measured at fair value.

 

ASC 820 includes a fair value hierarchy, of which the first two are considered observable and the last unobservable, that is intended to increase the consistency and comparability in fair value measurements and related disclosures. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions.

 

The fair value hierarchy consists of the following three levels:

 

Level 1 – instrument valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets.

 

Level 2 – instrument valuations are obtained from readily-available pricing sources for comparable instruments.

 

Level 3 – instrument valuations are obtained without observable market value and require a high level of judgment to determine the fair value.

 

 

As of September 30, 2017 and June 30, 2017, we did not have any material Level 1, 2, or 3 assets or liabilities.

 

 

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7. SHARE REPURCHASE PROGRAM

 

On September 14, 2009, we announced that our board of directors approved a repurchase program under which we may purchase up to 1,000,000 shares of our common stock. The duration of the repurchase program is open-ended. Under the program, we purchase shares of common stock from time to time through the open market and privately negotiated transactions at prices deemed appropriate by management. The repurchase is funded by cash on hand. No shares were repurchased during the three months ended September 30, 2017 and 2016.

 

8. INTANGIBLE ASSETS

 

Intangible assets will be amortized over the estimated lives, as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

Intangible Asset

    

Gross Carrying Amount

    

Accumulated Amortization

    

Net Balance September 30, 2017

    

Life

    

Income Statement Category  

Developed technology

 

$6,990

 

$(5,510)

 

$1,480

 

 4

 

Research and development expense

Customer relationships - software contracts

 

1,380

 

(1,380)

 

 —

 

 2

 

Sales and marketing expense

Customer relationships - maintenance contracts

 

1,610

 

(846)

 

764

 

 6

 

Cost of sales

Trade name

 

150

 

(150)

 

 —

 

 2

 

General and administrative expense

 

 

$10,130

 

$(7,886)

 

$2,244

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Intangible Asset

    

Gross Carrying Amount

    

Accumulated Amortization

    

Net Balance June 30, 2017

    

Life

    

Income Statement Category  

Developed technology

 

$6,990

 

$(5,073)

 

$1,917

 

 4

 

Research and development expense

Customer relationships - software contracts

 

1,380

 

(1,380)

 

 —

 

 2

 

Sales and marketing expense

Customer relationships - maintenance contracts

 

1,610

 

(779)

 

831

 

 6

 

Cost of sales

Trade name

 

150

 

(150)

 

 —

 

 2

 

General and administrative expense

 

 

$10,130

 

$(7,382)

 

$2,748

 

 

 

 

 

Amortization expense related to the above intangible assets for the three months ended September 30, 2017 and 2016 was $504,000 and $579,000, respectively.   

 

Estimated future amortization expense remaining as of September 30, 2017 for intangible assets acquired is as follows:

 

 

 

 

 

Year Ending June 30, 

    

 

 

2018

 

$

1,512

2019

 

 

438

2020

 

 

268

2021

 

 

26

Total future amortization expense

 

$

2,244

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of financial condition and results of operations should be read together with the condensed consolidated financial statements and the related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q, and with our audited financial statements and the related notes included in our Annual Report on Form 10-K for the year ended June 30, 2017.

 

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of the words such as “aims”, “anticipates,” “believes,” “continue,” “could,” “would,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “potential,” “should,” or “will” and similar expressions or the negative of those terms. The forward-looking statements include, but are not limited to, statements regarding: the effect of changes in macroeconomic factors beyond our control; our hybrid revenue model and its potential impact on our total revenue; our ability to predict subscription renewals or upgrade rates; our lengthy sales cycles and the difficulty in predicting timing of sales or delays; competition in the markets in which we do business and our failure to compete successfully therein; our expectations regarding the composition of our customers and the result of a loss of a significant customer; the adequacy of our capital resources and need for additional financing and the effect of failing to obtain adequate funding; the development and expansion of our strategic and third party distribution partnerships and relationships with systems integrators; our ability to effectively implement and improve our current products; our ability to innovate and respond to rapid technological change and competitive challenges; legal liability or the effect of negative publicity for the services provided to consumers via our technology platforms; legal and regulatory uncertainties and other risks related to protection of our intellectual property assets; our ability to anticipate our competitors; the operational integrity and maintenance of our systems; the effect of unauthorized access to a customer’s data or our data or our IT systems; the uncertainty of demand for our products; the anticipated customer benefits from our products; the actual mix in new business between cloud and license transactions when compared with management’s projections; the ability to increase revenue as a result of the increased investment in sales and marketing; our ability to hire additional personnel and retain key personnel; our ability to expand and improve our sales performance and marketing activities; our ability to manage our expenditures and estimate future expenses, revenue, and operational requirements; our ability to manage our business plans, strategies and outlooks and any business-related forecasts or projections; the effect of changes to management judgments and estimates; the impact of any modification to our pricing practices in the future; risks from our substantial international operations; our inability to successfully detect weaknesses or errors in our internal controls; our ability to manage future growth; the trading price of our common stock; geographical and currency fluctuations; and our expectations with respect to revenue, cost of revenue, expenses and other financial metrics.

 

Forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expected. These risks and uncertainties include, but are not limited to, those risks discussed in “Risk Factors” Item 1A of Part II of this report and in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017 which is incorporated herein by reference. Our actual results could differ materially from those discussed in statements relating to our future plans, product releases, objectives, expectations and intentions, and other assumptions underlying or relating to any of these statements. These forward-looking statements are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Readers are directed to risks and uncertainties identified below, under “Risk Factors” and elsewhere in this report, for factors that may cause actual results to be different than those expressed in these forward-looking statements. Except as required by law, we undertake no obligation to revise or update publicly any forward-looking statements for any reason.

 

All references to “eGain”, the “Company”, “our”, “we” or “us” mean eGain Corporation and its subsidiaries, except where it is clear from the context that such terms mean only the parent company and excludes subsidiaries.

 

eGain and the eGain® are trademarks of eGain Corporation. We also refer to trademarks of other corporations and organizations in this report.

 

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Overview

 

eGain Corporation is a leading provider of cloud-based customer engagement software. We help business-to-consumer (B2C) brands operationalize digital customer engagement strategy. Our suite includes rich applications for digital interaction, knowledge management, and AI-based process guidance. We also provide advanced, integrated analytics for contact centers and digital properties to holistically measure, manage, and optimize resources. Benefits include reduced customer effort, customer satisfaction, connected service processes, converted upsell opportunities, and improved compliance—across mobile, social, web, and phone. Hundreds of global enterprises rely on eGain to transform fragmented customer service systems into unified Customer Engagement Hubs.

 

We have operations in the United States, United Kingdom and India.

 

Unbilled Deferred Revenue

 

Unbilled deferred revenue represents business that is contracted but not yet invoiced or collected and off–balance-sheet and, accordingly, is not recorded in deferred revenue. As such, the deferred revenue balance on our condensed consolidated balance sheets does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. As of September 30, 2017, unbilled deferred revenue decreased to $35.2 million from $37.0 million as of June 30, 2017.

 

Key Financial Measures

 

We monitor the key financial performance measures set forth below as well as cash and cash equivalents and available debt capacity, which are discussed in Liquidity and Capital Resources, to help us evaluate trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational effectiveness and efficiencies. These key financial performance measures include certain non-GAAP metrics, including non-GAAP operating loss as defined below. The presentation of the non-GAAP financial measures is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with generally accepted accounting principles in the United States of America (GAAP).

 

Non-GAAP operating loss, a non-GAAP financial measure, is defined as operating loss, adjusted for the impact of stock-based compensation expense and amortization of acquired intangibles. 

 

Management believes that it is useful to exclude certain non-cash charges and non-core operational charges from non-GAAP operating loss because (i) the amount of such expenses in any specific period may not directly correlate to the underlying performance of our business operations and (ii) such expenses can vary significantly between periods as a result of the timing of new stock-based awards and acquisitions.

 

The following table presents our key financial measures, including a reconciliation of GAAP loss from operations to non-GAAP income (loss) from operations for each of the following periods:

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

September 30,

 

    

2017

    

2016

Loss from operations

 

$

(568)

 

$

(2,411)

Add:

 

 

 

 

 

 

Stock-based compensation

 

 

319

 

 

236

Amortization of acquired intangibles

 

 

504

 

 

579

Non-GAAP income (loss) from operations

 

$

255

 

$

(1,596)

 

Critical Accounting Policies and Estimates

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements

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requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to revenue recognition, allowance for doubtful accounts, goodwill, intangibles, deferred tax valuation allowance, accrued liabilities, long-lived assets and stock-based compensation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

There were no material changes to these estimates for the periods presented in this Quarterly Report on Form 10-Q. For a detailed explanation of the judgments made in these areas, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” within our Annual Report on Form 10-K for the year ended June 30, 2017, which we filed with the Securities and Exchange Commission (SEC) on September 26, 2017.

 

We have reassessed the critical accounting policies as disclosed in our Annual Report on Form 10-K filed with the SEC on September 26, 2017 and determined that there were no significant changes to our critical accounting policies in the three months ended September 30, 2017.

 

Business Combinations

 

Business combinations are accounted for at fair value under the purchase method of accounting. Acquisition costs are expensed as incurred and recorded in general and administrative expenses and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date affect income tax expense. The accounting for business combinations requires estimates and judgment as to expectations for future cash flows of the acquired business, and the allocation of those cash flows to identifiable intangible assets, in determining the estimated fair value for assets acquired and liabilities assumed. The fair values assigned to tangible and intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions, as well as other information compiled by management, including valuations that utilize customary valuation procedures and techniques. If the actual results differ from the estimates and judgments used in these estimates, the amounts recorded in the condensed consolidated financial statements could result in a possible impairment of the intangible assets and goodwill, or require acceleration of the amortization expense of finite-lived intangible assets.

 

Revenue Recognition

 

We enter into arrangements to deliver multiple products or services (multiple-elements). We apply software revenue recognition rules and multiple-elements arrangement revenue guidance. Significant management judgments and estimates are made and used to determine the revenue recognized in any accounting period. Material differences may result in changes to the amount and timing of our revenue for any period if different conditions were to prevail. We present revenue net of taxes collected from customers and remitted to governmental authorities.

 

We derive revenue from three sources:

 

i.

Recurring fees (previously referred to as subscription and support) primarily consist of cloud revenue from customers accessing our enterprise cloud computing services, term and ratable license revenue, and maintenance and support revenue;

 

ii.

Legacy license fees primarily consist of perpetual software license revenue which we no longer sell to new customers; and

 

iii.

Professional services primarily consist of consulting, implementation services and training.

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Revenue is recognized when all of the following criteria are met:

 

·

Persuasive evidence of an arrangement exists: Evidence of an arrangement consists of a written contract signed by both the customer and management prior to the end of the period. We use signed software licenses, services agreements and order forms as evidence of an arrangement for sales of software, cloud, maintenance and support. We use a signed statement of work as evidence of arrangement for professional services.

 

·

Delivery or performance has occurred: Software is delivered to customers electronically, and license files are delivered electronically. Delivery is considered to have occurred when we provide the customer access to the software along with a license file and/or login credentials.

 

·

Fees are fixed or determinable: We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction. Arrangements where a significant portion of the fee is due beyond 90 days from delivery are generally not considered to be fixed or determinable.

 

·

Collectibility is probable: We assess collectibility based on a number of factors, including the customer’s past payment history and current creditworthiness. Payment terms generally range from 30 to 90 days from invoice date. If we determine that collection of a fee is not reasonably assured, we defer the revenue and recognize it at the time collection becomes reasonably assured, which is generally upon receipt of cash payment. 

 

Revenue from sales to resellers is generally recognized upon delivery to the reseller dependent on the facts and circumstances of the transaction, such as our understanding of the reseller’s plans to sell the software, existence of return provisions, price protection or other allowances, the reseller’s financial status and our past experience with the reseller. Historically sales to resellers have not included any return provisions, price protection or other allowances.

 

We apply the provisions of Accounting Standards Codification (ASC) 985-605, Software Revenue Recognition, to all transactions involving the licensing of software products. In the event of a multiple element arrangement for a license transaction, we evaluate the transaction as if each element represents a separate unit of accounting taking into account all factors following the accounting standards. We apply ASC 605, Revenue Recognition, for cloud transactions to determine the accounting treatment for multiple elements. We also apply ASC 605-35 for fixed fee arrangements in which we use the percentage of completion method to recognize revenue when reliable estimates are available for the costs and efforts necessary to complete the implementation services. When such estimates are not available, the completed contract method is utilized. Under the completed contract method, revenue is recognized only when a contract is completed or substantially complete.

 

When legacy perpetual licenses were sold together with system implementation and consulting services, legacy license fees were recognized upon shipment, provided that (i) payment of the license fees were not dependent upon the performance of the consulting and implementation services, (ii) the services were available from other vendors, (iii) the services qualified for separate accounting as we have sufficient experience in providing such services, had the ability to estimate cost of providing such services, and we had vendor specific objective evidence, or VSOE, of fair value, and (iv) the services were not essential to the functionality of the software.

 

We enter into arrangements with multiple-deliverables that generally include subscription, maintenance and support, and professional services. We evaluate whether each of the elements in these arrangements represents a separate unit of accounting, as defined by ASC 605, using all applicable facts and circumstances, including whether (i) we sell or could readily sell the element unaccompanied by the other elements, (ii) the element has stand-alone value to the customer, and (iii) there is a general right of return. For revenue recognition with multiple-deliverable elements, we apply the selling price hierarchy, which includes VSOE, third-party evidence of selling price, or TPE, and best estimate of selling price, or BESP. We determine the relative selling price for a deliverable based on VSOE, if available, or BESP, if VSOE is not available. We determined that TPE is not a practical alternative due to differences in its service offerings compared to other parties and the availability of relevant third-party pricing information.

 

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We determine BESP by considering our overall pricing objectives and market conditions. Significant pricing practices taken into consideration include our discounting practices, the size and volume of our transactions, the customer demographic, the geographic area where services are sold, price lists, its go-to-market strategy, historical standalone sales and contract prices. The determination of BESP is made through consultation with and approval by our management, taking into consideration the go-to-market strategy. As our go-to-market strategies evolve, we may modify its pricing practices in the future, which could result in changes in relative selling prices, including both VSOE and BESP.

 

Recurring Revenue

 

    Cloud Revenue

 

Cloud revenue consists of subscription fees along with bundled maintenance and support revenue from customers accessing our cloud-based service offerings. We recognize cloud revenue ratably over the period of the applicable agreement as services are provided. Cloud agreements typically have an initial term of 12 to 36 months and automatically renew unless either party cancels the agreement. The majority of the cloud services customers purchase a combination of our cloud service and professional services.

 

We consider the applicability of ASC 985-605, on a contract-by-contract basis. In cloud-based agreements, where the customer does not have the contractual right to take possession of the software, the revenue is recognized on a monthly basis over the term of the contract. Invoiced amounts are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. We consider a software element to exist when we determine that the customer has the contractual right to take possession of our software at any time during the cloud period without significant penalty and can feasibly run the software on its own hardware or enter into another arrangement with a third party to host the software. Additionally, we have established VSOE for the cloud and maintenance and support elements of perpetual license sales, based on the prices charged when sold separately and substantive renewal terms. Accordingly, when a software element exists in a cloud services arrangement, license revenue for the perpetual software license element is determined using the residual method and is recognized upon delivery. Revenue for the cloud and maintenance and support elements is recognized ratably over the contractual time period. Professional services are recognized as described below under Professional Services Revenue. If VSOE of fair value cannot be established for the undelivered elements of an agreement, the entire amount of revenue from the arrangement is recognized ratably over the period that these elements are delivered.

 

   Term and Ratable License Revenue

 

Term and ratable license revenue includes arrangements where our customers receive license rights to use our software along with bundled maintenance and support services for the term of the contract or the Company has not established VSOE for the bundled multi-year maintenance and support services. The majority of our contracts provide customers with the right to use one or more products up to a specific license capacity. Certain terms of our license agreements stipulate that customers can exceed pre-determined base capacity levels, in which case additional fees are specified in the license agreement. Term license revenue is recognized ratably over the term of the license contract, and ratable license revenue is recognized over the term of the associated bundled maintenance and support contract.

 

Our release of version 15.5 of the perpetual license is a cloud and perpetual license hybrid software which represents a service contract under ASC 605-25. The cloud components are essential to the functionality of the version 15.5 release, and we have a contractual obligation to deliver these cloud components. Per ASC 605-25, a delivered item is considered a separate unit of accounting only if (i) the delivered item has standalone value; and (ii) if the service contract has a general right of return, then delivery and performance of the undelivered item is probable and substantially within the vendor’s control. We cannot separate the cloud components because there is no standalone value of the cloud components. The perpetual license revenue is recognized over the economic life of the software which was determined to be three years.

 

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    Maintenance and Support Revenue

 

Maintenance and support revenue consists of customers purchasing maintenance and support for our on-premise software. We use VSOE of fair value for maintenance and support to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each element. Maintenance and support revenue is recognized ratably over the term of the maintenance contract, which is typically one year. Maintenance and support is renewable by the customer on an annual basis. Maintenance and support rates, including subsequent renewal rates, are typically established based upon a specified percentage of net license fees as set forth in the arrangement.

 

Legacy License Revenue

 

Legacy license revenue consists of perpetual license rights sold to customers to use our software in conjunction with related maintenance and support services. If an acceptance period is required, revenue is recognized upon the earlier of customer acceptance or the expiration of the acceptance period. In software arrangements that include rights to multiple software products and/or services, we use the residual method for perpetual licenses released as version 15 or prior under which revenue is allocated to the undelivered elements based on VSOE of the fair value of such undelivered elements. The residual amount of revenue is allocated to the delivered elements and recognized as revenue, assuming all other criteria for revenue recognition have been met. Such undelivered elements in these arrangements typically consist of software maintenance and support, implementation and consulting services and, in some cases, cloud services.

 

Professional Services Revenue

 

Professional services revenue includes system implementation, consulting and training. For license transactions, the majority of our consulting and implementation services qualify for separate accounting. We use VSOE of fair value for the services to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each element. Our consulting and implementation service contracts are bid either on a fixed-fee basis or on a time-and-materials basis. Substantially all of our contracts are on a time-and-materials basis. For time-and-materials contracts, where the services are not essential to the functionality, we recognize revenue as services are performed. If the services are essential to functionality, then both the product license revenue and the service revenue are recognized under the percentage of completion method. For a fixed-fee contract, we recognize revenue based upon the costs and efforts to complete the services in accordance with the percentage of completion method, provided we are able to estimate such cost and efforts.

 

Under ASC 605-25, in order to account for deliverables in a multiple-deliverable arrangement as separate units of accounting, the deliverables must have standalone value upon delivery. For cloud services, in determining whether professional services have standalone value, we consider the following factors for each professional services agreement: availability of the services from other vendors, the nature of the professional services, the timing of when the professional services contract was signed in comparison to the subscription service start date and the contractual dependence of the subscription service on the customer’s satisfaction with the professional services work.

 

We have standalone value for consulting and implementation services. For those contracts that have standalone value, we recognized the services revenue when rendered for time and material contracts, when the milestones are achieved and accepted by the customer for fixed price contracts or by percentage of completion basis if there is no acceptance criteria.

Training revenue that meets the criteria to be accounted for separately is recognized when training is provided.

 

Deferred Revenue

 

Deferred revenue primarily consists of payments received in advance of revenue recognition from cloud, term and ratable license, and maintenance and support services and is recognized as the revenue recognition criteria are met. We generally invoice customers in annual or quarterly installments. The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable cloud or maintenance and support agreements. Deferred revenue is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration, invoice timing and new business linearity within the quarter.

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Deferred revenue that will be recognized during the succeeding twelve-month period is recorded as current deferred revenue and the remaining portion is recorded as noncurrent.

 

Deferred Commissions

 

Deferred commissions are costs associated with cloud and term license contracts with customers and consist of sales commissions to our sales force.

 

Commission expenses are deferred and amortized over the terms of the related customer contracts, which are typically 12 to 36 months. The deferred commission amounts are recognized as sales and marketing expense in the consolidated statements of operations over the terms of the related customer contracts in proportion to the recognition of the associated revenue.

 

Results of Operations

 

The following table sets forth certain items reflected in our condensed consolidated statements of operations expressed as a percent of total revenue for the periods indicated:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

September 30, 

 

 

    

 

2017

    

2016

 

Revenue:

 

 

 

 

 

 

Recurring

 

 

80

%  

74

%

Legacy license

 

 

 1

%  

11

%

Professional services

 

 

19

%  

15

%

Total revenue

 

 

100

%  

100

%

Cost of revenue:

 

 

 

 

 

 

  Cost of recurring

 

 

21

%  

20

%

  Cost of legacy license

 

 

 —

%  

 —

%

  Cost of professional services

 

 

16

%  

14

%

        Total cost of revenue

 

 

37

%  

34

%

Gross profit

 

 

63

%  

66

%

Operating expenses:

 

 

 

 

 

 

Research and development

 

 

24

%  

25

%

Sales and marketing

 

 

29

%  

36

%

General and administrative

 

 

12

%  

14

%

Total operating expenses

 

 

65

%  

75

%

Loss from operations

 

 

(2)

%

(9)

%

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

September 30, 

 

 

 

 

 

 

(in thousands)

    

2017

    

2016

    

Change

 

Recurring

 

$

11,642

 

$

10,863

 

$

779

 

 7

%

Legacy license

 

 

188

 

 

1,650

 

 

(1,462)

 

(89)

%

Professional services

 

 

2,745

 

 

2,232

 

 

513

 

23

%

Total revenue

 

$

14,575

 

$

14,745

 

$

(170)

 

(1)

%

 

Total revenue, which consists of recurring, legacy license and professional services revenue, decreased 1% to $14.6 million in the quarter ended September 30, 2017 from $14.7 million in the comparable year-ago quarter. The decrease in total revenue was related to the shift from a perpetual license model toward a cloud delivery model resulting in decreased legacy

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license revenue partially offset by an increase in recurring revenue. We also generated increased professional services revenue which was related to the increased implementation of customer projects.

 

The impact of the foreign exchange fluctuation between the U.S. Dollar and the Euro and British Pound resulted in an insignificant net increase in total revenue in the three months ended September 30, 2017. To exclude the impact of foreign exchange rate fluctuation, we recalculate current period results using the comparable prior period exchange rate.

 

Recurring revenue, which includes cloud, term and ratable licenses, software maintenance and support revenue, increased 7% to $11.6 million in the quarter ended September 30, 2017 from $10.9 million in the comparable year-ago quarter. Excluding an insignificant net impact of foreign exchange fluctuation, recurring revenue increased by 7% or $778,000. The increase in recurring revenue relates to the strategic decision to move to a ratable or cloud delivery business model from the hybrid model that included legacy perpetual licenses.

 

Excluding the impact from any future foreign currency fluctuation, we expect recurring revenue to increase during fiscal year 2018 due to the shift from a legacy perpetual license business toward a cloud delivery model.

 

Legacy license revenue decreased 89% to $188,000 in the quarter ended September 30, 2017 from $1.7 million in the comparable year-ago quarter. Excluding an insignificant net impact of foreign exchange fluctuation, legacy license revenue decreased by 88% or $1.5 million. The decrease in legacy license revenue related to the transition from a perpetual license model toward a cloud delivery model.

 

We no longer sell legacy licenses to new customers and are actively working to migrate all existing legacy license customers to our cloud delivery model. Excluding the impact from any future foreign currency fluctuation, we anticipate legacy license revenue to decrease during fiscal year 2018 compared to fiscal year 2017.

 

Professional services revenue increased 23% to $2.7 million in the quarter ended September 30, 2017 from $2.2 million in the comparable year-ago quarter. Excluding an insignificant net impact of foreign exchange fluctuation, professional services increased by 23% or $507,000. The increase in professional services revenue was related to the increased implementation of customer projects.

 

Excluding the impact from any future foreign currency fluctuation, we expect professional services revenue to increase or remain relatively constant during fiscal year 2018.

 

Revenue by Geography

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

September 30, 

 

 

 

 

 

 

(in thousands)

    

2017

    

2016

    

Change

 

Domestic

 

$

7,263

 

$

7,262

 

$

 1

 

 —

%

International

 

 

7,312

 

 

7,483

 

 

(171)

 

(2)

%

Total revenue

 

$

14,575