Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - Guidance Software, Inc.Financial_Report.xls
EX-31.2 - EX-31.2 - Guidance Software, Inc.a14-19774_1ex31d2.htm
EX-32.1 - EX-32.1 - Guidance Software, Inc.a14-19774_1ex32d1.htm
EX-31.1 - EX-31.1 - Guidance Software, Inc.a14-19774_1ex31d1.htm
EX-32.2 - EX-32.2 - Guidance Software, Inc.a14-19774_1ex32d2.htm

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

x

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

 

FOR THE QUARTERLY PERIOD ENDED September 30, 2014

 

OR

 

o

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

 

For the transition period from                      to                     

 

Commission File Number 001-33197

 


 

GUIDANCE SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware

 

95-4661210

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

1055 E. Colorado Blvd.

 

 

Pasadena, California 91106

 

(626) 229-9191

(Address of principal executive offices)

 

Registrant’s telephone number, including area code

 

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $0.001 par value per share.

 

Securities registered pursuant to Section 12(g) of the Act:

None.

 


 

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 x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non- accelerated filer x

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

As of November 10, 2014, there were approximately 29,474,000 shares of the registrant’s Common Stock outstanding.

 

 

 



Table of Contents

 

GUIDANCE SOFTWARE, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED September 30, 2014

 

Table of Contents

 

 

 

Page

 

 

PART I. FINANCIAL INFORMATION

3

 

 

Item 1.

Financial Statements

3

 

Condensed Consolidated Balance Sheets at September 30, 2014 and December 31, 2013

3

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2013

4

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013

5

 

Notes to the Condensed Financial Statements

6

Item 2.

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

20

Item 3.

Quantitative and Qualitative Disclosure about Market Risk

31

Item 4.

Controls and Procedures

31

 

 

 

PART II. OTHER INFORMATION

32

 

 

Item 1.

Legal Proceedings

32

Item 1A.

Risk Factors

33

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

33

Item 3.

Defaults upon Senior Securities

33

Item 4.

Removed and Reserved

33

Item 5.

Other Information

33

Item 6.

Exhibits

33

 

 

 

SIGNATURE

34

 

2



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1.                                  Financial Statements

 

GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

(Unaudited)

 

 

 

September 30,
2014

 

December 31,
2013

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

15,612

 

$

19,919

 

Restricted cash

 

415

 

 

Trade receivables, net of allowance for doubtful accounts of $719 and $815, respectively

 

23,551

 

19,027

 

Inventory

 

2,498

 

1,928

 

Prepaid expenses and other current assets

 

5,301

 

4,148

 

Total current assets

 

47,377

 

45,022

 

 

 

 

 

 

 

Long-term assets:

 

 

 

 

 

Property and equipment, net

 

15,448

 

18,464

 

Intangible assets, net

 

8,287

 

9,953

 

Goodwill

 

14,632

 

14,632

 

Other assets

 

1,182

 

1,160

 

Total long-term assets

 

39,549

 

44,209

 

 

 

 

 

 

 

Total assets

 

$

86,926

 

$

89,231

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

5,350

 

$

5,517

 

Accrued liabilities

 

10,071

 

10,148

 

Capital lease obligations

 

76

 

182

 

Deferred revenues

 

39,087

 

37,316

 

Total current liabilities

 

54,584

 

53,163

 

 

 

 

 

 

 

Long-term liabilities:

 

 

 

 

 

Rent incentives

 

7,297

 

7,058

 

Other long-term liabilities

 

152

 

158

 

Deferred revenues

 

5,511

 

4,347

 

Deferred tax liabilities

 

533

 

465

 

Total long-term liabilities

 

13,493

 

12,028

 

 

 

 

 

 

 

Commitments and contingencies (Note 11)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value: 10,000,000 shares authorized; no shares issued or outstanding

 

 

 

Common stock, $0.001 par value; 100,000,000 shares authorized; 31,038,000 and 30,539,000 shares issued, respectively; and 29,259,000 and 28,760,000 shares outstanding, respectively

 

25

 

25

 

Additional paid-in capital

 

108,866

 

102,392

 

Treasury stock, at cost, 1,779,000 and 1,779,000 shares, respectively

 

(11,479

)

(11,479

)

Accumulated deficit

 

(78,563

)

(66,898

)

Total stockholders’ equity

 

18,849

 

24,040

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

86,926

 

$

89,231

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

3



Table of Contents

 

GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Revenues:

 

 

 

 

 

 

 

 

 

Product revenue

 

$

9,458

 

$

9,728

 

$

25,207

 

$

24,953

 

Subscription revenue

 

1,677

 

2,711

 

5,899

 

8,202

 

Services and maintenance revenues

 

16,712

 

15,875

 

49,302

 

49,409

 

Total revenues

 

27,847

 

28,314

 

80,408

 

82,564

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues (excluding amortization and depreciation, shown below):

 

 

 

 

 

 

 

 

 

Cost of product revenue

 

2,497

 

2,164

 

6,135

 

5,665

 

Cost of subscription revenue

 

1,128

 

1,109

 

3,580

 

3,289

 

Cost of services and maintenance revenues

 

5,634

 

6,432

 

17,194

 

19,961

 

Total cost of revenues (excluding amortization and depreciation, shown below)

 

9,259

 

9,705

 

26,909

 

28,915

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling and marketing

 

9,898

 

10,494

 

29,695

 

30,359

 

Research and development

 

5,289

 

6,771

 

17,915

 

21,438

 

General and administrative

 

4,134

 

4,271

 

12,354

 

14,155

 

Depreciation and amortization

 

1,811

 

1,983

 

5,652

 

5,673

 

Total operating expenses

 

21,132

 

23,519

 

65,616

 

71,625

 

Operating loss

 

(2,544

)

(4,910

)

(12,117

)

(17,976

)

Other income and expense:

 

 

 

 

 

 

 

 

 

Interest income

 

5

 

4

 

10

 

20

 

Interest expense

 

(2

)

(5

)

(8

)

(24

)

Gain on sale of domain name (Note 10)

 

 

 

630

 

 

Other income, net

 

6

 

10

 

31

 

22

 

Total other income and expense

 

9

 

9

 

663

 

18

 

Loss before income taxes

 

(2,535

)

(4,901

)

(11,454

)

(17,958

)

Income tax provision

 

51

 

67

 

211

 

183

 

Net loss

 

$

(2,586

)

$

(4,968

)

$

(11,665

)

$

(18,141

)

 

 

 

 

 

 

 

 

 

 

Net loss per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.10

)

$

(0.19

)

$

(0.44

)

$

(0.71

)

Diluted

 

$

(0.10

)

$

(0.19

)

$

(0.44

)

$

(0.71

)

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares used in per share calculation:

 

 

 

 

 

 

 

 

 

Basic

 

26,977

 

25,914

 

26,703

 

25,713

 

Diluted

 

26,977

 

25,914

 

26,703

 

25,713

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

4



Table of Contents

 

GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

Operating Activities:

 

 

 

 

 

Net loss

 

$

(11,665

)

$

(18,141

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

5,652

 

5,673

 

Provision for doubtful accounts

 

 

350

 

Share-based compensation

 

5,406

 

5,654

 

Gain on sale of domain name

 

(630

)

 

Deferred taxes

 

69

 

69

 

Loss on disposal of assets

 

84

 

107

 

Changes in operating assets and liabilities:

 

 

 

 

 

Restricted cash

 

(415

)

 

Trade receivables

 

(4,524

)

1,401

 

Inventory

 

(570

)

208

 

Prepaid expenses and other assets

 

(545

)

217

 

Accounts payable

 

354

 

2,680

 

Accrued liabilities

 

162

 

2,620

 

Deferred revenues

 

2,936

 

(2,990

)

Net cash used in operating activities

 

(3,686

)

(2,152

)

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

Purchase of property and equipment

 

(1,522

)

(11,921

)

Net cash used in investing activities

 

(1,522

)

(11,921

)

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

Proceeds from the exercise of stock options

 

1,067

 

1,456

 

Common stock repurchased or withheld

 

 

(2,161

)

Principal payments on capital lease obligations and other obligations

 

(166

)

(1,025

)

Net cash provided by (used in) financing activities

 

901

 

(1,730

)

Net decrease in cash and cash equivalents

 

(4,307

)

(15,803

)

Cash and cash equivalents, beginning of period

 

19,919

 

32,606

 

Cash and cash equivalents, end of period

 

$

15,612

 

$

16,803

 

 

 

 

 

 

 

Non-cash investing and financing activities:

 

 

 

 

 

Purchase of equipment included in accounts payable and accrued expenses

 

$

161

 

$

1,087

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

5



Table of Contents

 

GUIDANCE SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Description of the Business

 

General

 

Guidance Software, Inc. was incorporated in the state of California in 1997 and reincorporated in Delaware on December 11, 2006.  Guidance and its subsidiaries are collectively referred to herein as “Guidance,” “we,” “our,” or the “Company.”  Headquartered in Pasadena, California, Guidance is the leading global provider of digital investigative solutions.  Our EnCase® platform provides an investigative infrastructure that enables our customers to search, collect and analyze electronically stored information in order to address human resources matters, litigation matters, allegations of fraud, suspicious network endpoint activity and to defend and secure their organization’s data assets.

 

Our main products and services are:

 

EnCase® Enterprise, a comprehensive, network-enabled digital investigative solution that enables corporations and government agencies to search, collect, preserve and analyze data across all of the servers, desktops and laptops that comprise their entire network from a single location.  It also serves as a platform on which more powerful electronic discovery and cybersecurity products, as described below, are built;

 

EnCase® Cybersecurity, which provides the ability to identify and analyze undiscovered threats, such as polymorphic or metamorphic malware, and other advanced hacking techniques that evade traditional network or host-based defenses and includes investigative capabilities that target confidential or sensitive data and perform risk mitigation by wiping sensitive data from unauthorized locations;

 

EnCase® Analytics, a security intelligence product designed to derive insights from the data generated by endpoint activity.  EnCase Analytics leverages kernel-level access for endpoint data collection providing a repository of the most reliable data for insights into undetected risks and threats.  Through its interactive visual interface, EnCase Analytics exposes suspicious patterns, commonalities, and anomalies, to proactively identify threats and minimize damage;

 

EnCase® eDiscovery, which automates the search, collection, preservation and processing of electronically stored information for litigation and compliance purposes;

 

EnCase® eDiscovery Review, a cloud-based document review and production software-as-a-service (“SaaS”) for corporations and law firms;

 

EnCase® Forensic, a desktop-based product primarily used by law enforcement, government agencies, and consultancies, for collecting, preserving, analyzing and authenticating electronic computer forensic data for use in criminal and civil court proceedings;

 

EnCase® Portable, a triage and collection solution, delivered on a USB device, that allows forensic professionals and non-experts to quickly and easily triage and collect digital evidence in a forensically sound and court proven manner;

 

EnCase® App Central, an online marketplace that allows development and investigation professionals the opportunity to share and discover the latest apps that complement the Company’s EnCase solutions; and

 

Tableau ™, a family of data acquisition forensic hardware products, including forensic duplicators, multiple write blockers and other hardware.

 

In addition, we complement these offerings with a comprehensive array of professional and training services including technical support and maintenance services to help our customers implement our solutions, conduct investigations and train their IT and legal professionals to effectively and efficiently use our products.

 

6



Table of Contents

 

Note 2. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying condensed consolidated balance sheets as of September 30, 2014 and the condensed consolidated statements of operations for the three and nine months ended September 30, 2014 and 2013 and cash flows for the nine months ended September 30, 2014 and 2013 are unaudited.  These statements should be read in conjunction with the audited consolidated financial statements and related notes, together with management’s discussion and analysis of financial position and results of operations, contained in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 24, 2014.

 

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or (“GAAP”), and pursuant to the rules and regulations of the SEC for interim financial reporting.  In the opinion of our management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2013 and include all normal and recurring adjustments necessary for the fair presentation of our financial position as of September 30, 2014 and our results of operations for the three and nine months ended September 30, 2014 and 2013 and our cash flows for the nine months ended September 30, 2014 and 2013.  The condensed consolidated balance sheet as of December 31, 2013 has been derived from the December 31, 2013 audited financial statements.  The operating results for the three and nine months period ended September 30, 2014 are not necessarily indicative of the results that will be achieved for the full fiscal year or for future periods.

 

The condensed consolidated financial statements include the accounts of Guidance and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

 

Use of Estimates and Assumptions

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures.  On an ongoing basis, we evaluate these estimates, including those related to revenue recognition, share-based compensation, bad debts, income taxes, contingent consideration, commitments, impairment considerations, contingencies and litigation.  We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances.  Actual results may differ from these estimates.

 

Cash and Cash Equivalents

 

We invest excess cash in money market funds and highly liquid debt instruments of the US government and its agencies. Highly liquid investments with stated maturities of three months or less from the date of purchase are classified as cash and cash equivalents.

 

Restricted Cash

 

At September 30, 2014, we had $0.4 million of restricted cash held as collateral on outstanding letters of credit.

 

Fair Value of Financial Instruments

 

The carrying amounts of cash equivalents, accounts receivable and accounts payable approximate fair value because of the short-term maturities of these instruments.  Based on borrowing rates currently available to us for borrowings with similar terms, the carrying values of our capital lease obligations also approximate fair value.

 

Trade Receivables

 

Trade receivables are carried at original invoice amount less an allowance for doubtful accounts.  The allowance is established through a provision for bad debt expense, which is included in general and administrative expenses.  We determine the adequacy of this allowance by evaluating individual customer accounts receivable, through consideration of the customer’s financial condition, credit history and current economic conditions.  In addition, we analyze our historical credit loss history and apply these loss rates to our current accounts receivable balances to verify the reasonableness of our allowance.  Trade receivables are written off when deemed uncollectible.  A trade receivable is generally considered past due if any portion of the receivable balance is outstanding for more than 30 days unless alternate terms are provided.

 

7



Table of Contents

 

Inventory

 

Inventory is comprised of hardware components, packaged software components and finished goods and is valued at the lower of cost or market, using the weighted average cost method.  We conduct quarterly inventory reviews for obsolescence, and inventory considered unlikely to be sold is adjusted to net realizable value.

 

Amortization of Intangible Assets with Finite Lives

 

Intangible assets with finite lives are recorded at their fair value at the time of acquisition.  With the exception of our customer relationships intangible asset, which is amortized on a double-declining basis, the acquisition date fair values of such assets are amortized on a straight-line basis over the estimated useful lives.

 

Goodwill and Indefinite-Lived Intangibles

 

Goodwill represents the excess of purchase price over fair value of net assets acquired and is assigned to a reporting unit at the date the goodwill is initially recorded.  Goodwill and indefinite-lived intangible assets are not amortized but evaluated for impairment annually, or whenever events or changes in circumstances indicate that the value may not be recoverable.  Commencing on January 1, 2013, the Company adopted the ASU 2011-08 issued by the Financial Accounting Standards Board (“FASB”) for the revised guidance on “Testing of Goodwill for Impairment.”  Under this guidance, the Company has the option to choose whether it will apply the qualitative assessment first before the quantitative assessment.  If a quantitative assessment is necessary, a two-step test is performed at the reporting unit level to assess goodwill for impairment.  First, the fair value of the reporting unit is compared to its carrying value.  If the fair value exceeds the carrying value, the reporting unit is not impaired and no further testing is performed. The second step is performed if the carrying value exceeds the fair value.  If the carrying value of the reporting unit exceeds its implied fair value, an impairment loss equal to the difference will be recorded.  Indefinite-lived intangible assets are assessed for impairment by comparing the carrying value of the assets with their fair values.

 

Concentrations of Credit Risk

 

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable.  We restrict our investments in cash and cash equivalents to financial institutions, US government or federal agency instruments and obligations of corporations with high credit ratings.  At September 30, 2014, the majority of our cash balances were held at financial institutions located in California in accounts that are insured by the Federal Deposit Insurance Corporation for up to $250,000. Uninsured balances aggregate approximately $15.5 million as of September 30, 2014.  At September 30, 2014 all of our cash equivalents consisted of financial institution obligations.  We periodically perform credit evaluations of our customers and maintain reserves for potential losses on our accounts receivable.  We do not believe we are subject to concentrations of credit risk with respect to such receivables.

 

Revenue Recognition

 

We generate revenues principally from the sale of our EnCase® Enterprise and EnCase® Forensic software products.  Our Enterprise products include perpetual licenses and are related to our EnCase® Enterprise, EnCase® Cybersecurity, and eDiscovery products.  Our Forensic products include revenues related to EnCase® Forensic, EnCase® Portable, and forensic hardware sales.  Revenue associated with the sale of software licenses and revenue associated with forensic hardware sales are referred to as product revenue.  Revenue associated with cloud-based document review and production software-as-a-service which is referred to as subscription revenue.  Revenues are also generated from training courses, implementation services and consulting services in which we assist customers with the performance of digital investigations and train their IT and legal professionals in the use of our software products, which we collectively refer to as services revenues.  Our proprietary products are generally sold with one to three years of maintenance, which can be renewed at a stated renewal rate and is referred to as maintenance revenues.

 

We recognize revenue in accordance with Accounting Standards Update (“ASU”) 2009-13, Multiple-Deliverable Revenue Arrangements, (amendment to Accounting Standards Codification (“ASC”) Topic 605, Revenue Recognition), Revenue Recognition - Software topic (ASC 985-605) and Revenue Recognition (ASC 605).  While the standards govern the basis for revenue recognition, significant judgment and the use of estimates are required in connection with the allocation of revenue between product, subscription, services and maintenance revenues, as well as the amount of deferred revenue to be recognized in each accounting period.

 

8



Table of Contents

 

Revenue Recognition Criteria: In general, we recognize revenue when the following criteria have been met:

 

·                          Persuasive evidence of an arrangement: If we either enter into contracts or receive written purchase orders issued by a customer that legally bind us and the customer, we consider that as persuasive evidence of an arrangement.

 

·                          Delivery: We deem delivery of products to have occurred when the title and risk of ownership have passed to the buyer. Services revenues are considered delivered as they are performed.

 

·                          Fixed or determinable fee: We consider the fee to be fixed or determinable if the fee is not subject to refund or adjustment and the payment terms are within normal established practices.  If the fee is not fixed or determinable, we recognize revenues as amounts become due and payable with respect to transactions with extended payment terms, or as refund rights lapse with respect to transactions containing such provisions, provided all other revenue recognition criteria have been met.

 

·                          Collection is deemed probable: We conduct a credit review for all significant transactions at the time of the arrangement to determine the credit-worthiness of the customer.  Collection is deemed probable if we have a reasonable basis to expect that the customer will pay amounts under the arrangement as payments become due.

 

Revenue Recognition for Software Products and Software-Related Services (Software Elements)

 

Software product revenue.  The timing of software product revenue recognition is dependent on the nature of the product sold or the structure of the license.

 

EnCase® Enterprise Solutions and EnCase® Forensic Solutions: Revenue associated with these arrangements, exclusive of amounts allocated to maintenance and other undelivered elements, for which we have vendor-specific objective evidence of fair value (“VSOE”), is recognized upon delivery, provided that all other criteria for revenue recognition have been met.  Revenue associated with term licenses are recognized ratably over the term of the license because we have not established VSOE for post-contract customer support in term license arrangements.

 

Services and maintenance revenues. The majority of our consulting and implementation services are performed under per hour, or fixed fee arrangements.  Revenues from such services are recognized as the services are provided or upon expiration of the contractual service period.

 

Training revenue is either recognized on a per-class basis upon a participant’s attendance or, for those customers who have subscribed to our Annual Training Passport program, revenue is recognized ratably over the annual period.

 

Maintenance revenue includes technical support and software updates on a when-and-if-available basis.  We recognize maintenance revenue ratably over the applicable maintenance period.  We determine the amount of maintenance revenue to be allocated through reference to substantive maintenance renewal provisions contained in multiple element arrangements.  We consider substantive maintenance provisions to be provisions where the cost of the maintenance renewal, stated in the contract with our customer as a percentage of the product fee.

 

Revenue Recognition for Multiple-Element Arrangements — Software Products and Software-Related Services (Software Arrangements)

 

We often enter into arrangements with customers that purchase both software products and software-related services from us at the same time, or within close proximity of one another (referred to as software-related multiple-element arrangements).  Such software-related multiple-element arrangements may include the sale of our software products, software maintenance services, which include license updates and product support, consulting/implementation services and training whereby the software license delivery is followed by the subsequent delivery of the other elements.  For those software-related multiple-element arrangements, we have applied the residual method to determine the amount of software license revenues to be recognized pursuant to ASC 985-605.  Under the residual method, if VSOE exists for the undelivered elements, this amount is deferred with the remaining, or residual, portion of the arrangement consideration recognized upon delivery of the software license, provided all other revenue recognition criteria are met.

 

Revenue Recognition for Hardware and Subscription Revenues (Nonsoftware Elements)

 

Hardware product revenue. Revenue associated with the sale of forensic hardware is recognized upon shipment to the customers, which include certain resellers, provided that all other criteria for revenue recognition have been met.

 

Subscription revenue.  Customers pay subscription fees to access our cloud-based document review and production software; however, they may not take possession of the software at any time during the term of the agreement.  In general, we recognize revenue for subscription fees on a straight-line basis over the contract period commencing on the date the subscription is made available to the customer.  Usage-based fees, which are determined monthly, are recognized when incurred.

 

Revenue Recognition for Multiple-Element Arrangements — Hardware, SaaS and Nonsoftware-Related Services (Nonsoftware Arrangements)

 

9



Table of Contents

 

We enter into arrangements with customers that purchase both nonsoftware-related SaaS subscription and nonsoftware-related services, such as consulting services, at the same time or within close proximity of one another (referred to as nonsoftware multiple-element arrangements).  Each element within a nonsoftware multiple-element arrangement is accounted for as a separate unit of accounting provided the following criteria are met: the delivered products or services have value to the customer on a standalone basis; and for an arrangement that includes a general right of return relative to the delivered products or services, delivery or performance of the undelivered product or service is considered probable and is substantially controlled by us.  We consider a deliverable to have standalone value if the product or service is sold separately by us or another vendor, or could be resold by the customer.  Further, our revenue arrangements generally do not include a general right of return relative to the delivered products. Where the aforementioned criteria for a separate unit of accounting are not met, the deliverable is combined with the undelivered element and treated as a single unit of accounting for the purposes of allocation of the arrangement consideration and revenue recognition.  For those units of accounting that include more than one deliverable but are treated as a single unit of accounting, we generally recognize revenues over the delivery period.  For the purposes of revenue classification of the elements that are accounted for as a single unit of accounting, we allocate revenue to the respective revenue line items within our consolidated statements of operations based on a rational and consistent methodology utilizing our best estimate of relative selling prices of such elements.

 

For our nonsoftware multiple-element arrangements, we allocate revenue to each element based on a selling price hierarchy at the arrangement’s inception.  The selling price for each element is based upon the following selling price hierarchy: VSOE, if available; third party evidence (“TPE”) if VSOE is not available; or best estimate of selling price (“BESP”) if neither VSOE nor TPE are available.  A description as to how we determine VSOE, TPE and BESP is provided below:

 

· VSOE. VSOE is determined based on its historical pricing and discounting practices for the specific product or service when sold separately.  In determining VSOE, we require that a substantial majority of the selling prices for these services fall within a reasonably narrow pricing range.

 

· TPE. When VSOE cannot be established for deliverables in a multiple element arrangement, judgment is applied with respect to whether we can establish a selling price based on TPE.  TPE is determined based on competitor prices for similar deliverables when sold separately.  Generally, our go-to-market strategy differs from that of our peers and our offerings contain a significant level of differentiation such that comparable pricing of services with similar functionality has not been obtained.  Furthermore, we have been unable to reliably determine selling prices of similar competitive services on a stand-alone basis.  As a result, we have not been able to establish selling prices based on TPE.

 

· BESP. When VSOE or TPE cannot be established, we use BESP in our allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact a sale if the service were sold on a stand-alone basis.  We determine BESP for deliverables by considering multiple factors including but not limited to prices we charge for similar offerings, market conditions, competitive landscape and pricing practices.

 

Revenue Recognition for Multiple-Element Arrangements — Arrangements with Software and Nonsoftware Elements

 

We also enter into multiple-element arrangements that may include a combination of our various software-related and nonsoftware-related products and services.  In such arrangements, we first allocate the total arrangement consideration based on the relative selling prices to the software group of elements as a whole and to the nonsoftware group of elements.  We then further allocate consideration allocated to the software group and nonsoftware group to the respective elements within that group following the guidance in ASC 985-605, ASC 605-25, and our policies described above.  After the arrangement consideration has been allocated to the elements, we recognize revenue for each respective element in the arrangement as described above.

 

Recently Issued Accounting Pronouncements

 

In May 2014, the FASB and IASB jointly issued ASU No. 2014-09, Revenue from Contracts with Customers, which supercedes the revenue recognition requirements in ASC 605 Revenue Recognition.  ASU 2014-09 is a comprehensive new revenue recognition standard that will supercede nearly all existing revenue recognition guidance under US GAAP.  The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  In doing so, companies will need to use more judgment and make more estimates than under current authoritative guidance.  These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.  The standard is effective beginning after December 15, 2016, and early adoption is not permitted under US GAAP.  We are currently evaluating the financial statement impact of the new revenue recognition standard.

 

10



Table of Contents

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This standard sets forth management’s responsibility to evaluate, each reporting period, whether there is substantial doubt about our ability to continue as a going concern, and if so, to provide related footnote disclosures. The standard is effective for annual and interim reporting periods ending after December 15, 2016.  We are currently evaluating this new standard and expect it to have no impact on our financial position and results of operations.

 

Realignment Expense

 

As a result of reducing headcount during the nine months ended September 30, 2014, we incurred approximately $1.6  million in severance and related expenses in cost of services and maintenance revenues, selling and marketing, research and development and general administrative expenses.

 

Note 3. Net Loss Per Share

 

Basic net loss per common share is calculated by dividing the net loss by the weighted average number of common shares outstanding during the reporting period.  Diluted net loss per share is calculated based on the weighted average number of common shares and dilutive potential common shares outstanding during the period.  Dilutive potential common shares consist of the shares issuable upon the exercise of stock options and upon the vesting of restricted stock awards under the treasury stock method.  In net loss periods, basic net loss per share and diluted net loss per share are identical since the effect of potential common shares is anti-dilutive and therefore excluded.

 

The following table sets forth the computation of basic and diluted net loss per share (in thousands, except per share amounts):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Basic loss per common share:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net loss

 

$

(2,586

)

$

(4,968

)

$

(11,665

)

$

(18,141

)

Net income allocated to participating securities

 

 

 

 

 

Net loss allocated to common stockholders

 

$

(2,586

)

$

(4,968

)

$

(11,665

)

$

(18,141

)

Denominator:

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

26,977

 

25,914

 

26,703

 

25,713

 

Net loss per basic common share

 

$

(0.10

)

$

(0.19

)

$

(0.44

)

$

(0.71

)

 

 

 

 

 

 

 

 

 

 

Diluted loss per common share:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net loss

 

$

(2,586

)

$

(4,968

)

$

(11,665

)

$

(18,141

)

Net income allocated to participating securities

 

 

 

 

 

Net loss allocated to common stockholders

 

$

(2,586

)

$

(4,968

)

$

(11,665

)

$

(18,141

)

Denominator:

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

26,977

 

25,914

 

26,703

 

25,713

 

Effect of dilutive share-based awards

 

 

 

 

 

Diluted weighted average shares outstanding

 

26,977

 

25,914

 

26,703

 

25,713

 

Net loss per diluted common share

 

$

(0.10

)

$

(0.19

)

$

(0.44

)

$

(0.71

)

 

Antidilutive securities, which consist of stock options and restricted stock awards that are not included in the diluted net loss per share calculation, consisted of an aggregate of approximately 2,739,000 and 1,977,000 shares for the three and nine months ended September 30, 2014, respectively, and 2,335,000 and 2,226,000 shares for the three and nine months ended September 30, 2013, respectively.

 

11



Table of Contents

 

Note 4. Inventory

 

Inventory is comprised of hardware components, packaged software components and finished goods and is valued at the lower of cost or market, using the weighted average cost method.  The following table sets forth, by major classes, inventory as of September 30, 2014 and December 31, 2013 (in thousands):

 

 

 

September 30,
2014

 

December 31,
2013

 

Inventory:

 

 

 

 

 

Components

 

$

1,486

 

$

777

 

Finished goods

 

1,012

 

1,151

 

Total inventory

 

$

2,498

 

$

1,928

 

 

Note 5. Goodwill and Other Intangibles

 

We evaluate goodwill and indefinite-lived intangible assets for impairment on an annual basis, or more frequently if circumstances indicate impairment may have occurred, and there has been no impairment charges related to such assets through September 30, 2014.  We expect the balance of goodwill assigned to our products segment to be deductible for tax purposes while the balance of goodwill assigned to our subscription and services segments will not be deductible for tax purposes.

 

Intangible assets are amortized on a straight-line basis over their estimated useful lives, with the exception of customer relationships, which are amortized on a double-declining basis.  Amortization expense for intangible assets with finite lives was $0.5 million and $1.7 million, and $0.6 million and $1.9 million for the three and nine months ended September 30, 2014, and 2013, respectively. The following table summarizes cumulative amortization expense related to intangible assets subject to amortization as of September 30, 2014 and December 31, 2013 (in thousands):

 

 

 

September 30, 2014

 

December 31, 2013

 

 

 

Gross Costs

 

Accumulated
Amortization

 

Net

 

Gross Costs

 

Accumulated
Amortization

 

Net

 

Core technology

 

$

5,800

 

$

(2,234

)

$

3,566

 

$

5,800

 

$

(1,648

)

$

4,152

 

Existing and developed technology

 

2,300

 

(2,248

)

52

 

2,300

 

(2,042

)

258

 

Customer relationships

 

6,475

 

(2,950

)

3,525

 

6,475

 

(2,315

)

4,160

 

Trade names

 

2,100

 

(1,052

)

1,048

 

2,100

 

(843

)

1,257

 

Covenant not-to-compete

 

200

 

(104

)

96

 

200

 

(74

)

126

 

Total

 

$

16,875

 

$

(8,588

)

$

8,287

 

$

16,875

 

$

(6,922

)

$

9,953

 

 

The following table summarizes the estimated remaining amortization expense through 2018 and thereafter (in thousands):

 

Year ending

 

Amortization
Expense

 

2014

 

$

521

 

2015

 

1,652

 

2016

 

1,499

 

2017

 

1,399

 

2018

 

1,392

 

Thereafter

 

1,824

 

Total amortization expense

 

$

8,287

 

 

Note 6. Share Repurchase Program

 

In August 2008, our Board of Directors authorized a program to repurchase shares of our common stock having an aggregate value of up to $8.0 million.  As of September 30, 2014, we had approximately $3.6 million remaining under this authorization.  The authorization allows us to repurchase our common stock from time to time through open market purchases and negotiated transactions, or otherwise.  The timing, nature and amount of such transactions will depend on a variety of factors, including market conditions, and the program may be suspended, discontinued or accelerated at any time.  The sources of funds for the purchases under the remaining authorization are our existing cash on hand and cash from operations.  Purchases are made in the open market, through block trades and other negotiated transactions.  Repurchased shares are held in Treasury Stock and have not been retired.  The Company did not repurchase any shares during the three and nine months ended September 30, 2014, or 2013.

 

12



Table of Contents

 

Beginning January 1, 2014, the Company no longer withholds common shares from employees to satisfy the minimum statutory income tax withholding requirements upon the vesting of restricted stock awards issued under our equity compensation plans.  As a result, the number of shares withheld for the three and nine months ended September 30, 2014 are zero compared to 9,000 and 209,000 for the same periods in 2013, respectively.

 

Note 7. Debt Obligations

 

On July 12, 2012, we entered into a Loan and Security Agreement (as amended or supplemented from time to time, the “Loan Agreement”) with a bank.  On October 31, 2013, we entered into a modification agreement (“Modification Agreement”) of the Loan Agreement with the bank to modify certain financial covenants pertaining to the Loan Agreement.  On September 30, 2014, the Loan Agreement expired.  To secure our remaining letters of credit outstanding, we established a cash collateral account with the bank in the amount of $0.4 million.

 

On August 29, 2014, we entered into a three year, Senior Secured Revolving Line of Credit (“Revolver”) with another bank.  The maximum principal amount that may be outstanding at any given time under the Revolver, which includes up to $3.0 million of standby letters of credit, is $10.0 million.  Any borrowings under the Revolver would be collateralized by substantially all of our assets, as well as pledges of capital stock.  The Revolver requires that, if we suffer an event of default or have borrowed more than 75% of the maximum principal amount permitted to be outstanding, we maintain an Adjusted Quick Ratio of at least 1.15 to 1.0.  If the Adjusted Quick Ratio falls below 1.5 to 1.0, any collections received by the bank on behalf of the Company will be applied to outstanding loan balances before being remitted to the Company’s operating account.  The Adjusted Quick Ratio is calculated by dividing Quick Assets (cash less restricted cash plus accounts receivable) by current liabilities (current liabilities plus outstanding standby letter of credit less the current portion of deferred revenue).  Borrowings under the Revolver bear interest at a floating rate ranging from 1.25% to 3.25% above the Prime Rate depending on the Company’s Adjusted Quick Ratio.  We are obligated to pay a commitment fee of $0.2 million over the three year term of the Revolver. All principal, interest and any other fees will be due and payable in full on or prior to August 29, 2017.

 

As of September 30, 2014, we were in compliance with all the covenants of the Revolver.  We had letters of credit outstanding against the Revolver in the amount of $1.3 million, resulting in the maximum available borrowing under the Revolver to be $8.7 million.  Availability is calculated as 80% of eligible accounts receivable, with a maximum of $10.0 million.  To date we have not borrowed under the Revolver.

 

13



Table of Contents

 

Note 8. Employee Benefit Plans

 

At September 30, 2014, approximately 1,354,000 shares were available for grant as options or nonvested share awards under the Guidance Software, Inc. Second Amended and Restated 2004 Equity Incentive Plan (the “Plan”).

 

Stock Options

 

The terms of the options granted under the Plan are determined at the time of grant, and generally vest 25% annually over a four-year service period and typically must be exercised within 10 years from the date of grant.  A summary of stock option activity follows:

 

 

 

Number of
Options

 

Weighted
Average
Exercise
Price

 

Weighted Average
Remaining
Contractual Term
(in years)

 

Aggregate
Intrinsic Value

 

Outstanding, December 31, 2013

 

2,169,000

 

$

9.34

 

3.5

 

$

4,432,000

 

Exercised

 

(220,000

)

$

4.85

 

 

 

 

 

Forfeited or expired

 

(98,000

)

$

11.79

 

 

 

 

 

Outstanding, September 30, 2014

 

1,851,000

 

$

9.74

 

3.0

 

$

1,155,000

 

 

 

 

 

 

 

 

 

 

 

Exercisable, September 30, 2014

 

1,351,000

 

$

8.61

 

2.9

 

$

1,155,000

 

 

We define in-the-money options at September 30, 2014 as options that had exercise prices that were lower than the $6.73 fair market value of our common stock at that date.  The aggregate intrinsic value of options outstanding at September 30, 2014 is calculated as the difference between the exercise price of the underlying options and the fair market value of our common stock for the 624,000 shares that were in-the-money at that date, all of which were exercisable.

 

Restricted Stock Awards

 

We issue restricted stock awards to certain directors, officers and employees.  Compensation expense for such awards, based on the fair market value of the awards on the grant date, is recorded during the vesting period.  Restricted stock awards generally vest 25% annually over a four-year service period.  A summary of restricted stock awards activity follows:

 

 

 

Number of
Shares

 

Weighted Average
Fair Value

 

Outstanding, December 31, 2013

 

2,653,000

 

$

9.17

 

Granted

 

763,000

 

9.28

 

Vested

 

(680,000

)

8.62

 

Forfeited

 

(484,000

)

9.41

 

Outstanding, September 30, 2014

 

2,252,000

 

$

9.32

 

 

The total grant date fair value of shares vested under such grants during the nine months ended September 30, 2014 was $5,858,000.

 

Share-Based Compensation

 

We account for share-based compensation in accordance with Compensation-Stock Compensation (ASC 718).  We use the Black-Scholes option pricing model to determine the fair value of stock options on the grant date.  We determine the fair value of our restricted stock grants as the market value on the date of grant.  We recognize the cost, net of an estimated forfeiture rate, as compensation expense on a straight-line basis over the vesting period.  We estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates.  We recognize share-based compensation on a straight-line basis over the requisite service period of the awards, which is generally the vesting period.

 

The following table summarizes the share-based compensation expense we recorded (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Stock option awards

 

$

 

$

32

 

$

21

 

$

123

 

Restricted stock awards

 

1,825

 

1,987

 

5,385

 

5,531

 

Share-based compensation expense

 

$

1,825

 

$

2,019

 

$

5,406

 

$

5,654

 

 

14



Table of Contents

 

As of September 30, 2014, all share-based compensation cost related to stock options had been recognized.  Approximately $16.4 million of total unrecognized share-based compensation cost related to restricted stock awards is expected to be recognized over a weighted-average period of 2.7 years.  We expect to record approximately $2.0 million in share-based compensation for the remainder of fiscal year 2014 related to restricted stock awards outstanding at September 30, 2014.

 

Note 9. Income Taxes

 

We account for income taxes in accordance with Income Taxes (ASC 740).  Deferred income taxes are recorded for the expected tax consequences of temporary differences between the tax bases of assets and liabilities for financial reporting purposes and amounts recognized for income tax purposes.  We record a valuation allowance to reduce our deferred tax assets to the amount of future tax benefit that is more likely than not to be realized.  As of September 30, 2014, we have recorded a valuation allowance against our net deferred tax assets resulting in a carrying value of zero.

 

Management’s judgment is required in assessing the realizability of future deferred tax assets.  We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance.  If we later determine that it is more likely than not that the net deferred tax assets would be realized, we would reverse the applicable portion of the previously provided valuation allowance.  Likewise, in the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such a determination.

 

We file income tax returns with the Internal Revenue Service and the taxing authorities of various state and foreign jurisdictions.  We periodically perform a review of our uncertain tax positions.  An uncertain tax position represents our expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes.  At September 30, 2014, our liability for uncertain tax positions was $0.7 million.  We do not expect there to be any material changes to the estimated amount of liability associated with our uncertain tax positions over the next twelve months.  Due to the net operating loss carryforwards, the Company’s U.S. federal and state returns are generally open to examination by the Internal Revenue Service and state jurisdictions when such net operating losses are utilized.  Most foreign jurisdictions have statute of limitations that range from three to six years.

 

We recorded an income tax provision for the three and nine months ended September 30, 2014 of $51,000 and $211,000 as compared to $67,000 and $183,000 for the same period in 2013.  Our income tax provision for the nine months ended September 30, 2014 and 2013 differs from the U.S. statutory rate of 34% primarily due to state taxes, foreign taxes, the tax impact of certain share-based compensation charges, and the impact of providing a valuation allowance against research and development credits and deferred tax assets.

 

15



Table of Contents

 

Note 10. Fair Value Measurements

 

In accordance with Fair Value Measurements and Disclosures (ASC 820), we measure our financial assets and liabilities at fair value on a recurring basis.  ASC 820 requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements.  Under this standard, fair value is defined as the price that would be received in exchange for selling an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.  ASC 820 establishes a hierarchy for inputs used in measuring fair value that minimizes the use of unobservable inputs by requiring the use of observable market data when available.  Observable inputs are inputs that market participants would use in pricing the asset or liability based on active market data.  Unobservable inputs would be inputs that reflect our assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.  The statement requires fair value measurements be classified and disclosed in one of the following three categories:

 

Level 1:

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities.

Level 2:

Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly, and corroborated by market data.

Level 3:

Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

 

The following table sets forth, by level within the fair value hierarchy, financial assets and liabilities that are accounted for at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 (in thousands):

 

 

 

Fair Value Measurements at September 30, 2014

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

U.S. Treasury Securities

 

$

2,006

 

$

2,006

 

$

 

$

 

Money market accounts

 

6,278

 

6,278

 

 

 

Total assets

 

$

8,284

 

$

8,284

 

$

 

$

 

 

 

 

Fair Value Measurements at December 31, 2013

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

U.S. Treasury Securities

 

$

2,005

 

$

2,005

 

$

 

$

 

Money market accounts

 

269

 

269

 

 

 

Total assets

 

$

2,274

 

$

2,274

 

$

 

$

 

 

Sale of Domain Name

 

On May 1, 2014, we entered into an agreement with one of our vendors, acquiring the rights to distribute certain of their software products, which are to be combined with certain of our own products, in exchange for a domain name owned by the Company.  The term of the agreement extends through December 31, 2018, and includes a one-year renewal option for the larger of 1% of the maintenance revenue of certain of the Company’s products, or $450,000.

 

Market data to determine the fair value of the domain name was not readily available and therefore we used the more clearly evident fair value of the acquired distribution rights to determine the fair value of the agreement.

 

To estimate the fair value of the distribution rights, we developed our own assumptions related to the domain name’s future financial performance and projected maintenance revenue of certain of its products.  We developed various scenarios (base case, downside case, and upside case) and evaluated each case according to the probability of occurrence.  Expected cash flows were determined using the probability weighted average of possible outcomes we expect to occur.  The fair value of the acquired distribution rights was determined to be $0.6 million and was based on the present value of these projected scenarios.

 

As the domain name had zero book value as of the date of sale, we recorded a gain on the sale of $0.6 million.  The acquired distribution right has been recorded in other assets on the accompanying condensed consolidated balance sheet.  Given the significant unobservable inputs to the calculation, the other asset recognized for the distribution rights falls within Level 3 of the ASC 820 hierarchy, as defined above.  The other asset will be expensed to cost of goods sold ratably over the term of the agreement.

 

16



Table of Contents

 

CaseCentral Contingent Consideration

 

The Company has obligations, to be paid in cash, to the former shareholders of CaseCentral if certain SaaS and EnCase® eDiscovery revenue thresholds are achieved during the 12-month period starting April 1, 2014.  The Company also had contingent consideration obligations to the former CaseCentral shareholders with respect to the two 12-month periods that ended on March 31, 2013 and 2014, but the revenue thresholds for those periods were not met and consequently no contingent consideration was due.  The fair value of this contingent consideration is determined using a present value calculation.  Expected cash flows are determined using the probability-weighted average of possible outcomes that would occur should certain revenue metrics be reached.  There is no market data available to use in valuing the contingent consideration; therefore, we developed our own assumptions related to the future financial performance of the businesses to evaluate the fair value of these liabilities.  As such, the contingent consideration would be classified within Level 3, as described above.

 

In connection with estimating the fair value of the contingent consideration, we developed various scenarios (base case, downside case, and upside case) and weighted each case according to the probability of occurrence.  The probabilities ranged from 20 percent to 50 percent, with the most significant weighting given to the base case at 50 percent.  These scenarios were developed based on the expected financial performance of CaseCentral, with SaaS revenue growth rates being a primary input in the calculation.  An increase or decrease in the probability of achievement of any of the scenarios could result in a significant increase or decrease to the estimated fair value.

 

The fair value is reviewed quarterly based on the financial performance of the most recently completed fiscal quarter. An analysis is performed at the end of each fiscal quarter to compare actual results to forecasted financial performance.  If performance has deviated from projected levels, the valuation is updated for the latest information available.

 

The amount of contingent consideration payable with respect to each of the earn-out periods is equal to 35% of certain qualifying CaseCentral SaaS revenues and EnCase® eDiscovery revenues in excess of $11.1 million during each of the three earn-out periods and is limited to $3.0 million for the first earn-out period, a cumulative total of $13.0 million for the first and second earn-out periods and a cumulative total of $33.0 million for all three earn-out periods.  Any earn-out consideration is payable within 65 days after the end of the applicable earn-out period.  We did not pay any contingent consideration with respect to the first two 12-month periods ending March 31, 2014 and 2013.  At March 31, 2014, the fair value of the contingent consideration for the remaining 12-month period, which is calculated by summing the present values of various probability-weighted possible outcomes, was estimated to be zero.

 

The significant assumptions noted in the items above that may materially affect fair value are developed in conjunction with the guidance of our senior management to ensure that the most accurate and latest financial projections are used and compared with the most recent financial results in the fair value measurement.

 

Note 11. Commitments and Contingencies

 

Office Lease

 

On July 3, 2014, we entered into an Office Lease Agreement (the “San Francisco Lease”) to lease approximately 6,000 rentable square feet of an office building located in San Francisco, California.  The office building will be the new location for our San Francisco office.  The San Francisco Lease is anticipated to commence on January 1, 2015 and expires in January 2020.  The total annual rent under the San Francisco Lease ranges from approximately $295,000 for the first year to approximately $332,000 for the final year.

 

Data Center Lease

 

Effective April 1, 2014, we entered into a Colocation Lease Agreement (the “Colocation Lease”) to rent space in a building located in Chandler, Arizona.  The Colocation Lease expires on June 30, 2018.  The Colocation Lease will serve as our new data center, replacing our former San Francisco location obtained in the Case Central acquisition.  Rent is based on power allocation and ranges from approximately $236,000 for the first year to approximately $265,000 for the final year.

 

17



Table of Contents

 

Legal Matters

 

On May 20, 2011, MyKey Technology Inc. (“MyKey”) filed a complaint against us and certain other parties for patent infringement in the United States District Court for the District of Delaware.  With respect to the Company, the complaint alleged that certain of our data acquisition forensic hardware products that we acquired as a result of our acquisition of certain assets of Tableau, LLC (“Tableau”) infringe three of MyKey’s patents relating to write blocking, duplication and data removal technologies, respectively.  The complaint sought a declaration of infringement, a finding of willful infringement, compensatory damages, treble damages, injunctive relief, interest, expenses, costs and attorneys’ fees.

 

On July 22, 2011, MyKey also filed a complaint with the United States International Trade Commission (the “ITC”), alleging infringement by the Company and certain other parties of the three patents discussed in the preceding paragraph and requesting that the ITC commence an investigation pursuant to Section 337 of the Tariff Act of 1930.  The complaint sought injunctive relief barring the Company from the importation of products that allegedly infringed the three patents of MyKey.  On August 24, 2011, the ITC commenced an investigation of the Company and certain other parties related to the complaint by MyKey.  On August 31, 2011 the proceeding in the District Court was stayed pending the resolution of the ITC matter.  On August 1, 2012, MyKey amended its ITC complaint to remove allegations that its duplication patent had been infringed by the Company and to reduce the number of claims it alleges the Company has infringed related to MyKey’s data removal patent.  In August 2012, the parties completed a trial on the remaining patent claims at issue.

 

On December 28, 2012, the ITC released a final determination and Order holding that no violation of Section 337 of the Tariff Act of 1930 occurred as a result of the Company’s importation into the United States and sale of the products at issue.  This Order effectively ended the ITC proceeding in the Company’s favor.

 

On February 20, 2013, the U.S. District Court of Delaware lifted the stay of the proceedings in the MyKey matter.  Effective April 8, 2013, the parties stipulated to a transfer of the matter to the U.S. District Court for the Central District of California.  On April 16, 2013, the Company filed its Answer and Counterclaim.  MyKey filed a petition to consolidate a number of related cases, including the case against the Company in the Central District of California, into a Multi-District Litigation (“MDL”) proceeding.  On August 16, 2013, the MDL panel approved the petition and assigned the MDL consolidated cases to the judge who is also presiding over the individual case against the Company.  The MDL case will dispose of certain issues common to the consolidated cases, such as the validity of patents being asserted against the joint defendants.  On May 23, 2014, the parties completed a Markman hearing related to claim construction of the patents at issue.

 

On March 26, 2014, MyKey also filed a complaint against the United States of America alleging that the United States has infringed U.S. Patents No. 6,813,682, 7,159,086 and 7,228,379 by or through its acceptance, receipt and/or use of write blocker products, data duplication products and data removal products.  The complaint alleges that such products were supplied to the government by the Company and certain of its co-defendants in the MDL proceeding.  No damages amount is stated in the complaint.  The government could assert a claim for indemnification against the Company but has not done so yet.  Although a financial loss is reasonably possible, the Company is unable to estimate the range of potential loss at this time.

 

On October 16, 2014, MyKey filed a Notice of Status on Claim Construction Issues in which it acknowledged that MyKey will not be able to prove that the Company’s data duplication products infringed U.S. Patent 7,159,086.  In the same filing, MyKey acknowledged that certain claims of United States Patent 6,813,682 are invalid and therefore cannot be infringed by any product.

 

We intend to defend the remaining MyKey matters vigorously and, at this time, are unable to estimate what, if any, liability we may have in connection with these matters.  We are unable to estimate a range of reasonably possible financial losses due to various reasons, including, among others, that (1) certain of the proceedings are at an early stage, (2) there is uncertainty as to the outcome of pending appeals, motions, or settlements, (3) there are significant factual issues to be resolved, (4) there are unresolved negotiations with certain indemnitors or indemnitees of the Company, related to the actions, and (5) we have meritorious defenses that we intend to assert.

 

From time to time, we may become involved in various other lawsuits and legal proceedings that arise in the ordinary course of business.  Litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.  We are not currently aware of any such other legal proceedings or claims that are likely to have a material impact on our business.

 

18



Table of Contents

 

Indemnifications

 

We have agreed to indemnify our directors and executive officers for costs associated with any fees, expenses, judgments, fines and settlement amounts incurred by them in any action or proceeding to which any of them is, or is threatened to be, made a party by reason of his or her services in their role as a director or officer.

 

Note 12. Segment Information

 

In accordance with ASC 280, Segment Reporting, our segmentation based on our internal organization and reporting of revenue and other performance measures. Our segments are designed to allocate resources internally and provide a framework to determine management responsibility.  Operating segments are defined as components of an enterprise about which discrete financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.  Our chief operating decision maker is our Chief Executive Officer.  We have five operating segments, as summarized below:

 

·                  Products segment—Includes EnCase® Enterprise, EnCase® Cybersecurity, EnCase® Analytics, EnCase® eDiscovery, EnCase® Forensic, EnCase® Portable, Premium License Support Program and hardware sales.

 

·                  Subscription segment—Includes subscription services for cloud-based document review and production software.  The subscription segment is new as of February 2012 due to our acquisition of CaseCentral.

 

·                  Professional services segment—Performs consulting services and implementations.

 

·                  Training segment—Provides training classes by which we train our customers to effectively and efficiently use our software products.

 

·                  Maintenance segment—Includes maintenance related services.

 

We present the revenues generated by our services and maintenance segments collectively.  Currently, we do not separately allocate operating expenses to these segments, nor do we allocate specific assets, with the exception of goodwill, to these segments. Therefore, the segment information reported includes only revenues, cost of revenues and segment profit.  The following tables present the results of operations for each operating segment (in thousands):

 

 

 

Three Months Ended September 30, 2014

 

 

 

Products

 

Subscription

 

Professional
services

 

Training

 

Maintenance

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

9,458

 

$

1,677

 

$

4,228

 

$

2,266

 

$

10,218

 

$

27,847

 

Cost of revenues

 

2,497

 

1,128

 

3,713

 

1,381

 

540

 

9,259

 

Segment profit

 

$

6,961

 

$

549

 

$

515

 

$

885

 

$

9,678

 

18,588

 

Total operating expenses

 

 

 

 

 

 

 

 

 

 

 

21,132

 

Operating loss

 

 

 

 

 

 

 

 

 

 

 

$

(2,544

)

 

 

 

Three Months Ended September 30, 2013

 

 

 

Products

 

Subscription

 

Professional
services

 

Training

 

Maintenance

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

9,728

 

$

2,711

 

$

4,198

 

$

2,231

 

$

9,446

 

$

28,314

 

Cost of revenues

 

2,164

 

1,109

 

4,340

 

1,591

 

501

 

9,705

 

Segment profit (loss)

 

$

7,564

 

$

1,602

 

$

(142

)

$

640

 

$

8,945

 

18,609

 

Total operating expenses

 

 

 

 

 

 

 

 

 

 

 

23,519

 

Operating loss

 

 

 

 

 

 

 

 

 

 

 

$

(4,910

)

 

 

 

Nine Months Ended September 30, 2014

 

 

 

Products

 

Subscription

 

Professional
services

 

Training

 

Maintenance

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

25,207

 

$

5,899

 

$

13,169

 

$

6,527

 

$

29,606

 

$

80,408

 

Cost of revenues

 

6,135

 

3,580

 

11,176

 

4,400

 

1,618

 

26,909

 

Segment profit

 

$

19,072

 

$

2,319

 

$

1,993

 

$

2,127

 

$

27,988

 

53,499

 

Total operating expenses

 

 

 

 

 

 

 

 

 

 

 

65,616

 

Operating loss

 

 

 

 

 

 

 

 

 

 

 

$

(12,117

)

 

19



Table of Contents

 

 

 

Nine Months Ended September 30, 2013

 

 

 

Products

 

Subscription

 

Professional
services

 

Training

 

Maintenance

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

24,953

 

$

8,202

 

$

14,750

 

$

6,436

 

$

28,223

 

$

82,564

 

Cost of revenues

 

5,665

 

3,289

 

13,563

 

4,889

 

1,509

 

28,915

 

Segment profit

 

$

19,288

 

$

4,913

 

$

1,187

 

$

1,547

 

$

26,714

 

53,649

 

Total operating expenses

 

 

 

 

 

 

 

 

 

 

 

71,625

 

Operating loss

 

 

 

 

 

 

 

 

 

 

 

$

(17,976

)

 

Revenues, classified by the major geographic areas in which we operate, are as follows (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Revenues

 

 

 

 

 

 

 

 

 

United States

 

$

21,589

 

$

23,105

 

$

62,586

 

$

65,995

 

Europe

 

3,665

 

3,104

 

10,425

 

9,701

 

Asia

 

1,462

 

1,114

 

4,013

 

3,329

 

Other

 

1,131

 

991

 

3,384

 

3,539

 

 

 

$

27,847

 

$

28,314

 

$

80,408

 

$

82,564

 

 

Note 13. Subsequent Event

 

On November 6, 2014, we announced the departure of President and Chief Executive Officer, Victor Limongelli, and his resignation from our Board of Directors, effective November 5, 2014.  Barry Plaga, our current Chief Financial Officer, will serve as Interim Chief Executive Officer. Mr. Plaga’s appointment is effective as of November 5, 2014 and he will serve as both Chief Financial Officer and Interim Chief Executive Officer until a permanent Chief Executive Officer is named.

 

In addition to severance benefits payable to Mr. Limongelli under the Amended and Restated Employment Agreement between Mr. Limongelli and the Company, dated February 23, 2011, as an additional severance benefit, the Board unanimously agreed to extend the post-employment exercisability period of 360,135 vested stock options held by Mr. Limongelli until the earlier of the expiration of the term of such options or May 5, 2015. The Board also unanimously agreed to accelerate the vesting of 84,894 shares of restricted stock previously granted to Mr. Limongelli that were otherwise scheduled to vest between January 25, 2015 and February 5, 2015. The Company expects to record a one-time charge in the fourth quarter of 2014 of approximately $1.0 million, or $0.04 per share, related to Mr. Limongelli’s separation compensation.

 

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

 

The following discussion of our financial condition and results of operations should be read together with the financial statements and related notes that are included elsewhere in this Quarterly Report. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in this Quarterly Report under “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2013 under “Risk Factors” and in other parts of this Quarterly Report.

 

Overview

 

We were incorporated and commenced operations in 1997.  From 1997 through 2002, we generated a substantial portion of our revenues from the sale of our EnCase® Forensic products and related services.  We have experienced increases in our revenue as a result of the release of our EnCase® Enterprise product in late 2002, which expanded our customer base into corporate enterprises and federal government agencies.  In addition, the releases of our EnCase® eDiscovery solution in late 2005 and EnCase® Information Assurance solution in late 2006 (which was replaced by our EnCase® Cybersecurity solution in 2009) have increased our revenues.  In May 2010, we added a family of data acquisition forensic hardware products including forensic duplicators, multiple write blockers and other hardware through our acquisition of Tableau, LLC (“Tableau”).  In February 2012, we added cloud-based document review and production software-as-a-service for corporations and law firms through our acquisition of CaseCentral, Inc. (“CaseCentral”).  In September 2013, we introduced EnCase® Analytics, a security intelligence solution that exposes threats that evade detection using insights from endpoint data.  We anticipate that sales of our EnCase Enterprise products and related services, in particular our EnCase Cybersecurity and EnCase eDiscovery solutions, sales of our forensic hardware products and sales of subscriptions for cloud-based document review and production SaaS will comprise a substantial portion of our future revenues.

 

20



Table of Contents

 

Factors Affecting Our Results of Operations

 

There are a number of trends that may affect our business and our industry. Some of these trends or other factors include:

 

·                  Legislative and regulatory developments. Our digital investigation solutions allow law enforcement agencies, government organizations and corporations to conduct investigations within the legal and regulatory framework.  Historically, the implementation of new laws and regulations surrounding digital investigations has helped create demand for our products. Future changes in applicable laws or regulations could enhance or detract from the desirability of our products.

 

·                  Information technology budgets. Deployment of our solutions may require substantial capital expenditures by our customers. Budgets for information technology-related capital expenditures at corporations and all levels of government organizations are typically cyclical in nature, with generally higher budgets in times of improving economic conditions and lower budgets in times of economic slowdowns.

 

·                  Law enforcement agency budgets. We sell our EnCase® Forensic products and training services primarily to law enforcement agencies.  Because of the limited nature of law enforcement budgets, funds are typically initially allocated toward solving issues perceived to be the most pressing.  Sales of our products could be impacted by changes in the budgets of law enforcement agencies or in the relative priority assigned to digital law enforcement investigations.

 

·                  Prevalence and impact of hacking incidents and spread of malicious software. The increasing sophistication of hacking attacks on government and private networks and the global spread of malicious software, such as viruses, worms and rootkits, have increased the focus of corporations and large government organizations on digital investigations and other aspects of network security, which has, in turn, increased demand for our products.  Future changes in the number and severity of such attacks or the spread of malicious software could have an effect on the demand for our products.

 

·                  Seasonality in revenues. We experience seasonality in our revenues, with the third and fourth quarters typically having the highest revenues for the year.  We believe that this seasonality results primarily from our customers’ budgeting cycles. The federal government’s budget year ends in the third calendar quarter of the year and a majority of corporate budget years end in the fourth calendar quarter of the year.  In addition, our customers also tend to make software purchases near the end of a particular quarter, which tends to make our revenues for a particular quarter unpredictable for a significant portion of that quarter.  We expect that this seasonality in our revenues and unpredictability of our revenues within particular quarterly periods will continue for the foreseeable future.

 

·                  Amount of commercial litigation. Because commercial litigation often involves eDiscovery, an increase in commercial litigation could increase demand for our products and services, while a decrease in commercial litigation could decrease demand.

 

Critical Accounting Policies and Estimates

 

In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our net revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet.  We believe that the estimates, assumptions and judgments involved in the accounting policies described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2013 have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates.

 

In May 2014, the FASB and IASB jointly issued ASU No. 2014-09, Revenue from Contracts with Customers, which supercedes the revenue recognition requirements in ASC 605 Revenue Recognition.  ASU 2014-09 is a comprehensive new revenue recognition standard that will supercede nearly all existing revenue recognition guidance under US GAAP.  The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  In doing so, companies will need to use more judgment and make more estimates than under current authoritative guidance.  These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.  The standard is effective beginning after December 15, 2016, and early adoption is not permitted under US GAAP.  We are currently evaluating the financial statement impact of the new revenue recognition standard.

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This standard sets forth management’s responsibility to evaluate, each reporting period, whether there is substantial doubt about our ability to continue as a going concern, and if so, to provide related footnote disclosures. The standard is effective for annual and interim reporting periods ending after December 15, 2016.  We are currently evaluating this new standard and expect it to have no impact on our financial position and results of operations.

 

21



Table of Contents

 

Results of Operations

 

The following table sets forth our results of operations for the three and nine months ended September 30, 2014 and 2013, respectively, expressed as a percentage of total revenues:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Revenues:

 

 

 

 

 

 

 

 

 

Product revenues

 

34.0

%

34.4

%

31.4

%

30.2

%

Subscription revenues

 

6.0

 

9.6

 

7.3

 

9.9

 

Services and maintenance revenues

 

60.0

 

56.0

 

61.3

 

59.9

 

Total revenues

 

100.0

 

100.0

 

100.0

 

100.0

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

Cost of product revenues

 

9.0

 

7.6

 

7.6

 

6.9

 

Cost of subscription revenues

 

4.1

 

4.0

 

4.5

 

4.0

 

Cost of services and maintenance revenues

 

20.2

 

22.7

 

21.4

 

24.1

 

Total cost of revenues

 

33.3

 

34.3

 

33.5

 

35.0

 

Gross profit

 

66.7

 

65.7

 

66.5

 

65.0

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling and marketing

 

35.5

 

37.1

 

36.9

 

36.8

 

Research and development

 

19.0

 

23.9

 

22.3

 

26.0

 

General and administrative

 

14.8

 

15.1

 

15.4

 

17.1

 

Depreciation and amortization

 

6.5

 

6.9

 

7.0

 

6.9

 

Total operating expenses

 

75.8

 

83.0

 

81.6

 

86.8

 

Operating loss

 

(9.1

)

(17.3

)

(15.1

)

(21.8

)

 

 

 

 

 

 

 

 

 

 

Other income and expense:

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

 

 

Interest expense

 

 

 

 

 

Gain on sale of domain name

 

 

 

0.8

 

 

Other income, net

 

 

 

 

 

Total other income and expense

 

 

 

0.8

 

 

Loss before income taxes

 

(9.1

)

(17.3

)

(14.3

)

(21.8

)

Income tax provision

 

0.2

 

0.2

 

0.3

 

0.2

 

Net loss

 

(9.3

)%

(17.5

)%

(14.6

)%

(22.0

)%

 

The following table sets forth share-based compensation expense recorded in each of the respective periods (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Non-cash Share-Based Compensation Data (1):

 

 

 

 

 

 

 

 

 

Cost of product revenues

 

$

28

 

$

35

 

$

101

 

$

100

 

Cost of subscription revenues

 

24

 

51

 

100

 

141

 

Cost of services and maintenance revenues

 

371

 

368

 

1,054

 

1,039

 

Selling and marketing

 

384

 

539

 

1,296

 

1,518

 

Research and development

 

495

 

544

 

1,376

 

1,479

 

General and administrative

 

523

 

482

 

1,479

 

1,377

 

Total non-cash share-based compensation

 

$

1,825

 

$

2,019

 

$

5,406

 

$

5,654

 

 


(1)                  Non-cash share-based compensation recorded in the three and nine month periods ended September 30, 2014 and 2013 relates to stock options and restricted share awards granted to employees measured under the fair value method.  See Note 8 to the condensed consolidated financial statements.

 

22



Table of Contents

 

Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2014 and 2013

 

Sources of Revenues

 

Our software product sales transactions typically include the following elements: (i) a software license fee paid for the use of our products under a perpetual license term, or for a specific term; (ii) an arrangement for first-year support and maintenance, which includes unspecified software updates, upgrades and post-contract support; (iii) and professional services for installation, implementation, consulting and training.  With our acquisition of CaseCentral in February 2012, we began to generate revenues from cloud-based document review and production software sold as subscription services.  We derive the majority of our revenues from sales of our software products.  We sell our software products and services primarily through our direct sales force and in some cases we utilize resellers.  We sell our hardware products primarily through resellers.

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(Dollars in thousands)

 

2014

 

Change
%

 

2013

 

2014

 

Change
%

 

2013

 

Product revenues

 

$

9,458

 

(3)%

 

$

9,728

 

$

25,207

 

1%

 

$

24,953

 

Subscription revenues

 

1,677

 

(38)%

 

2,711

 

5,899

 

(28)%

 

8,202

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Services and maintenance revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Professional services

 

4,228

 

1%

 

4,198

 

13,169

 

(11)%

 

14,750

 

Training

 

2,266

 

2%

 

2,231

 

6,527

 

1%

 

6,436

 

Maintenance

 

10,218

 

8%

 

9,446

 

29,606

 

5%

 

28,223

 

Total services and maintenance revenues

 

16,712

 

5%

 

15,875

 

49,302

 

(1)%

 

49,409

 

Total revenues

 

$

27,847

 

(2)%

 

$

28,314

 

$

80,408

 

(3)%

 

$

82,564

 

 

Product Revenues

 

We generate product revenue principally from two product categories: Enterprise and Forensic products.  Our Enterprise products include perpetual licenses and are related to our EnCase® Enterprise, Cybersecurity, Analytics and eDiscovery products. Our Forensic products include revenues related to EnCase® Forensic, EnCase® Portable, and forensic hardware sales.  During the first two quarters of each fiscal year, we typically experience our lowest levels of product sales due to the seasonal budgetary cycles of our customers.

 

Product revenues decreased by $0.2 million, or 3%, from $9.7 million to $9.5 million for the three months ended September 30, 2014, as compared to the same period in 2013, and increased by $0.2 million, or 1%, from $25.0 million to $25.2 million for the nine months ended September 30, 2014, as compared with the same period in 2013.  The decrease in product revenues for the three months ended September 30, 2014, as compared to the same period in 2013, was primarily due to a decrease of approximately $0.7 million in spending by our government customers on enterprise products, partially offset by a $0.4 million increase in forensic product revenues, primarily as a result of certain new forensic hardware products released during the period.  The increase in revenues for the nine months ended September 30, 2014, as compared to the same period in 2013, is primarily a result of a $0.5 million increase in Enterprise revenues as a result of our new pricing strategy resulting in a higher number of new Enterprise customer deals, offset by a $0.2 million decrease in forensic products revenues.

 

During the three months ended September 30, 2014, we added 133 new EnCase® Enterprise customers, as compared to 51 for the comparable period in the prior year.  During the nine months ended September 30, 2014, we added 435 new EnCase® Enterprise customers, as compared to 194 for the comparable period in the prior year.  During the three months ended September 30, 2014, 70% of Enterprise product revenues were the result of sales to existing customers, compared to 79% in the comparable period in the prior year.  During the nine months ended September 30, 2014, 58% of Enterprise product revenues were the result of sales to existing customers, compared to 66% in the comparable period in the prior year.

 

Subscription Revenues

 

Subscription service customers have the right to access our cloud-based document review and production software; however, they may not take possession of the software at any time during the term of the agreement.  We generate subscription revenue principally from two types of customers: corporate or large enterprise customers who typically use our cloud-based software to host multiple legal cases on an ongoing basis, and law firm customers, who typically use our cloud-based software to host single cases.  In general, we recognize revenues for subscriptions on a straight-line basis over the contract period commencing on the date the subscription is made available to the customer.  Usage-based fees, which are determined monthly, are recognized when incurred.

 

23



Table of Contents

 

Subscription revenues decreased $1.0 million, or 38%, from $2.7 million to $1.7 million and decreased $2.3 million, or 28%, from $8.2 million to $5.9 million for the three and nine months ended September 30, 2014, respectively, as compared with the same periods in 2013.  These decreases are due to downward pricing pressure in the eDiscovery sector and lower usage of the service when customers move their cases from production to archive status.

 

Services and Maintenance Revenues

 

Services and maintenance revenues increased by $0.8 million, or 5%, from $15.9 million to $16.7 million for the three months ended September 30, 2014, as compared to the same period in 2013, and decreased by $0.1 million, or less than 1%, from $49.4 million to $49.3 million for the nine months ended September 30, 2014, respectively, as compared with the same periods in 2013.

 

The increase in services and maintenance revenues for the three months ended September 30, 2014, was due to an increase in maintenance revenues of $0.8 million, or 8%, from $9.4 million to $10.2 million as compared to the same period in 2013.  The increase in our maintenance revenues was primarily a result of sustained increases in our installed product base and customers desiring to continue maintenance support on our products.

 

The slight decrease in services and maintenance revenues for the nine months ended September 30, 2014, was primarily due to a decrease in professional services revenue of $1.6 million, or 11%, from $14.8 million to $13.2 million as compared to the same period in 2013, partially offset by an increase in maintenance revenues of $1.4 million, or 5%, from $28.2 million to $29.6 million as compared with the same period in 2013.  The decrease in professional services revenue was primarily a result of a decrease in case work and incident response work for our cloud-based subscriptions due to lower cyclical demand for services from certain of our large enterprise hosting customers.  The increase in maintenance revenues was primarily a result of sustained increases in our installed product base and customers desiring to continue maintenance support on our products.  Our installed product base increased primarily through the addition of 133 new Encase Enterprise customers and sales of 49 new EnCase Cybersecurity, 27 new EnCase Analytics, and 38 new EnCase eDiscovery modules to EnCase Enterprise customers.

 

Cost of Revenues

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(Dollars in thousands)

 

2014

 

Change %

 

2013

 

2014

 

Change %

 

2013

 

Cost of product revenues

 

$

2,497

 

15%

 

$

2,164

 

$

6,135

 

8%

 

$

5,665

 

Cost of subscription revenues

 

1,128

 

2%

 

1,109

 

3,580

 

9%

 

3,289

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of services and maintenance revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Professional services revenues

 

3,713

 

(14)%

 

4,340

 

11,176

 

(18)%

 

13,563

 

Training

 

1,381

 

(13)%

 

1,591

 

4,400

 

(10)%

 

4,889

 

Maintenance revenues

 

540

 

8%

 

501

 

1,618

 

7%

 

1,509

 

Total cost of services and maintenance revenues

 

5,634

 

(12)%

 

6,432

 

17,194

 

(14)%

 

19,961

 

Total cost of revenues

 

$

9,259

 

(5)%

 

$

9,705

 

$

26,909

 

(7)%

 

$

28,915

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Share-based compensation included above:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of product revenues

 

$

28

 

 

 

$

35

 

$

101

 

 

 

$

100

 

Cost of subscription revenues

 

$

24

 

 

 

$

51

 

$

100

 

 

 

$

141

 

Cost of services and maintenance revenues

 

$

371

 

 

 

$

368

 

$

1,054

 

 

 

$

1,039

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross Margin Percentage

 

 

 

 

 

 

 

 

 

 

 

 

 

Products

 

73.6

%

 

 

77.8

%

75.7

%

 

 

77.3

%

Subscriptions

 

32.7

%

 

 

59.1

%

39.3

%

 

 

59.9

%

Services and maintenance

 

66.3

%

 

 

59.5

%

65.1

%

 

 

59.6

%

Total

 

66.8

%

 

 

65.7

%

66.5

%

 

 

65.0

%

 

24



Table of Contents

 

Cost of Product Revenues

 

Cost of product revenue consists principally of the cost of producing our software products, the cost of manufacturing our hardware products and product distribution costs, including the cost of compact discs, packaging, shipping, customs duties, and, to a lesser extent, compensation and related overhead expenses.  While these costs are primarily variable with respect to sales volumes, they remain low in relation to the revenues generated and result in higher gross margins than our services and training businesses.  Our gross margins can be affected by product mix, as our enterprise products are generally higher margin products than our forensic products, which include software and hardware.

 

Cost of product revenues increased $0.3 million, or 15%, from $2.2 million to $2.5 million, and increased $0.5 million, or 8%, from $5.7 million to $6.1 million for the three and nine months ended September 30, 2014, respectively, compared with the same periods in 2013.  The increases were primarily due to increases in certain hardware costs associated with higher sales of forensic hardware, offset by reductions in various costs of goods sold.

 

Cost of Subscription Revenues

 

The cost of subscription revenues consists principally of employee compensation costs, including share-based compensation and related overhead, software maintenance paid to third party vendors, and SaaS hosting infrastructure costs.  The cost of subscription revenues was flat at $1.1 million and increased $0.3 million or 9% from $3.3 million to $3.6 million for the three and nine months ended September 30, 2014, respectively, compared with the same periods in 2013.  The increase for the nine months ended September 30, 2014, as compared to the same period in 2013, was primarily due to the allocation of our costs of subscription revenues.  Due to the realignment of our headcount, a larger portion of certain expenses are being allocated to cost of subscription revenues in the current year compared to the prior year.  The increase was partially offset by a reduction in employee-related costs due to the reduction in headcount.

 

Cost of Services and Maintenance Revenues

 

The cost of services and maintenance revenues is largely comprised of employee compensation costs, including share-based compensation, and related overhead, travel and facilities costs.  The cost of maintenance revenues is primarily outsourced, but also includes employee compensation cost for customer technical support and related overhead costs.

 

Total cost of services and maintenance revenues decreased $0.8 million, or 12%, from $6.4 million to $5.6 million and decreased $2.8 million, or 14%, from $20.0 million to $17.2 million, for the three and nine months ended September 30, 2014, respectively, as compared with the same periods in 2013.

 

The decrease in cost of services and maintenance revenues for the three months ended September 30, 2014, as compared with the same period in 2013, was due to a decrease in the cost of professional services revenue of $0.6 million, or 14%, from $4.3 million to $3.7 million and a decrease in the cost of training revenue of $0.2 million, or 13%, from $1.6 million to $1.4 million, offset by an increase in the cost of maintenance revenues of $39,000, or 8%, from $501,000 to $540,000.

 

The decrease in cost of services and maintenance revenues for the nine months ended September 30, 2014, as compared with the same period in 2013, was due to a decrease in the cost of professional services revenue of $2.4 million, or 18%, from $13.6 million to $11.2 million and a decrease in the cost of training revenue of $0.5 million, or 10%, from $4.9 million to $4.4 million, offset by an increase in the cost of maintenance revenues of $0.1 million, or 7%, from $1.5 million to $1.6 million.

 

The decrease in the cost of professional services revenue and cost of training revenue for the three and nine months ending September 30, 2014, as compared to the same periods in 2013, were primarily due to a decrease in compensation and related expenses due to a reduction in headcount in these two areas.  The increase in the cost of maintenance revenues for the three and nine months ending September 30, 2014, as compared to the same periods in 2013, was primarily related to an increase in the number of customers and maintenance contracts.

 

25



Table of Contents

 

Operating Expenses

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(Dollars in thousands) 

 

2014

 

Change %

 

2013

 

2014

 

Change
%

 

2013

 

Selling and marketing expenses

 

$

9,898

 

(6)%

 

$

10,494

 

$

29,695

 

(2)%

 

$

30,359

 

Research and development expenses

 

$

5,289

 

(22)%

 

$

6,771

 

$

17,915

 

(16)%

 

$

21,438

 

General and administrative expenses

 

$

4,134

 

(3)%

 

$

4,271

 

$

12,354

 

(13)%

 

$

14,155

 

Depreciation and amortization expenses

 

$

1,811

 

(9)%

 

$

1,983

 

$

5,652

 

(1)%

 

$

5,673

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Share-based compensation included above:

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and marketing expenses

 

$

384

 

 

 

$

539

 

$

1,296

 

 

 

$

1,518

 

Research and development expenses

 

$

495

 

 

 

$

544

 

$

1,376

 

 

 

$

1,479

 

General and administrative expenses

 

$

523

 

 

 

$

482

 

$

1,479

 

 

 

$

1,377

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As a percentage of revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and marketing expenses

 

35.5

%

 

 

37.1

%

36.9

%

 

 

36.8

%

Research and development expenses

 

19.0

%

 

 

23.9

%

22.3

%

 

 

26.0

%

General and administrative expenses

 

14.8

%

 

 

15.1

%

15.4

%

 

 

17.1

%

Depreciation and amortization expenses

 

6.5

%

 

 

6.9

%

7.0

%

 

 

6.9

%

 

Selling and Marketing Expenses

 

Selling and marketing expenses consist primarily of personnel costs and costs related to our sales force and marketing staff. Selling and marketing expenses also include expenses relating to advertising, brand building, marketing promotions and trade show events (net of amounts received from sponsors and participants), product management, and travel and allocated overhead.

 

Selling and marketing expenses decreased $0.6 million, or 6%, from $10.5 million to $9.9 million for the three months ended September 30, 2014, as compared with the same period in 2013 and decreased $0.7 million, or 2%, from $30.4 million to $29.7 million for the nine months ended September 30, 2014, as compared with the same period in 2013.

 

The decrease for the three months ended September 30, 2014, as compared to the same period in 2013, was primarily due to a $1.6 million decrease in compensation and other employee-related costs due to lower headcount, offset by a $1.0 million increase in sales commissions due to new sales compensation plans with quarterly targets and accelerators introduced at the beginning of the year, as compared to annual-based compensation plans in place in the same period in prior year.

 

The decrease for the nine months ended September 30, 2014, as compared to the same period in 2013, was primarily due to a $4.2 million decrease in compensation and other employee-related costs due to lower headcount, offset by $0.5 million of related realignment expense, and a $3.0 million increase in sales commissions due to new compensation plans with quarterly targets and accelerators introduced at the beginning of the year, as compared to annual-based compensation plans in place in the same period in prior year.

 

26



Table of Contents

 

Research and Development Expenses

 

Research and development expenses consist primarily of compensation, including share-based compensation and related overhead expenses.  Research and development expenses decreased $1.5 million, or 22%, from $6.8 million to $5.3 million, and $3.5 million, or 16%, from $21.4 million to $17.9 million for the three and nine months ended September 30, 2014, respectively, as compared with the same periods in 2013.

 

The decrease for the three months ended September 30, 2014, as compared to the same period in 2013, was primarily due to a decrease in compensation costs and other employee-related expenses primarily due to headcount reductions.  The decrease for the nine months ended September 30, 2014, as compared to the same period in 2013, was primarily due to a $4.3 million decrease in compensation and other employee-related costs due to lower headcount, partially offset by an $0.8 million increase in severance expense associated with the headcount reductions.

 

General and Administrative Expenses

 

General and administrative expenses consist of personnel and related costs for accounting, legal, information systems, human resources and other administrative functions.  In addition, general and administrative expenses include professional service fees, bad debt expense, and other corporate expenses and related overhead.

 

General and administrative expenses decreased $0.2 million, or 3%, from $4.3 million to $4.1 million, and decreased $1.8 million, or 13%, from $14.2 million to $12.4 million for the three and nine months ended September 30, 2014, respectively, as compared with the same periods in 2013.

 

The decrease in general and administrative expenses for the three months ended September 30, 2014, as compared to the same period in 2013, was primarily attributable to a $0.2 million decrease in bad debt expense, as compared to the same period in prior year, and a $0.1 million decrease in compensation costs and other employee-related expenses associated with a lower headcount, partially offset by a $0.1 million increase in legal fees associated with the recent activity in the MyKey case.

 

The decrease in general and administrative expenses for the nine months ended September 30, 2014, as compared to the same period in 2013, was primarily attributable to a $1.4 million decrease in compensation costs, rent and other employee-related expenses associated with a lower headcount and a $0.4 million decrease in bad debt expense.

 

Depreciation and Amortization Expenses

 

Depreciation and amortization expenses consist of depreciation and amortization of our leasehold improvements, furniture, computer hardware and software, and intangible assets.  Depreciation and amortization expenses decreased $172,000, or 9%, from $1,983,000 to $1,811,000, and decreased $21,000, or less than 1%, from $5,673,000 to $5,652,000 for the three and nine months ended September 30, 2014, respectively, as compared with the same periods in 2013.

 

The decrease for the three months ended September 30, 2014, as compared to the same period in 2013, was primarily due to certain of our fixed assets related to the acquisition of CaseCentral, as well as various general use and training computers, being fully depreciated within the last twelve months.  The decrease for the nine months ended September 30, 2014, as compared to the same period in 2013, was primarily as a result of the review of the viability of certain acquired technology in the first quarter of 2014, resulting in the acceleration of the amortized life of some of our acquired technology, partially offset by an increase in depreciation expense related to our relocation to new headquarters in June 2013.

 

Other Income and Expense

 

Total other income and expense consists of interest earned on cash balances, interest expense paid and other miscellaneous income and expense items.  For the three months ended September 30, 2014, income remained flat as compared to the same period in 2013.  For the nine months ended September 30, 2014, we recorded income of $663,000 as compared with $18,000 for the same period in 2013. The increase was primarily due to a $630,000 gain related to the sale of a domain name in May of 2014 that did not occur in the same period in 2013.

 

27



Table of Contents

 

Income Tax Provision

 

We recorded an income tax provision for the three and nine months ended September 30, 2014 of $51,000 and $211,000, respectively, as compared to $67,000 and $183,000, respectively for the same periods in 2013.  The income tax provision is based on our estimated effective annual tax rate and taxable income (loss) for the respective years.  Our income tax provision for the three and nine months ended September 30, 2014 and 2013 differs from the U.S. statutory rate of 34% primarily due to state taxes, foreign taxes, the tax impact of certain share-based compensation charges, and the impact of providing a valuation allowance against research and development credits and deferred tax assets.

 

Liquidity and Capital Resources

 

Since inception, we have largely financed our operations from the cash flow generated from the sale of our products and services. As of September 30, 2014, we had $15.6 million in cash and cash equivalents.  We believe that our cash flow from operations and our cash and cash equivalents are sufficient to fund our working capital and capital expenditure requirements for at least the next 12 months.

 

28



Table of Contents

 

Changes in Cash Flow

 

We generate cash from operating activities primarily from cash collections related to the sale of our products and services. Net cash used in operating activities was $3.7 million for the nine months ended September 30, 2014, as compared to $2.2 million for the same period in 2013.  The increase in cash used in operating activities was primarily a result of an increase of $4.5 million in trade receivables during the nine months ended September 30, 2014, compared to a decrease of $1.4 million for the same period in 2013, an increase of $0.2 million in accrued liabilities compared to an increase of $2.6 million for the same period in 2013, an increase of $0.4 million in accounts payable compared to an increase of $2.7 million for the same period in 2013, offset by a decrease in the net loss of $11.7 million for the nine months ended September 30, 2014 compared to the net loss of $18.1 million for the same period in 2013 and an increase in deferred revenues of $2.9 million for the nine months ended September 30, 2014 compared to a decrease of $3.0 million for the same period in 2013.

 

Net cash used in investing activities was $1.5 million for the nine months ended September 30, 2014, as compared to $11.9 million for the same period in 2013.  The decrease in cash used in investing activities was primarily due to the purchase of property and equipment related to the build out of our new headquarters building during the nine months ended September 30, 2013, that did not occur during the same period in 2014.

 

Net cash provided by financing activities was $0.9 million for the nine months ended September 30, 2014, as compared to net cash used in financing activities of $1.7 million for the same period in 2013.  The change in financing activities was primarily due to no cash being withheld from employees to satisfy their personal income tax withholding requirement upon the vesting of share awards issued under our equity compensation plans for the nine months ended September 30, 2014, compared to $2.2 million that was withheld from employees for the same period in 2013, $1.1 million in proceeds from the exercise of stock options compared to $1.5 million for the same period in 2013, and $0.2 million in principal payments made on capital leases and other obligations, as compared to $1.0 million in principal payments in the same period in 2013.

 

On July 12, 2012, we entered into a Loan and Security Agreement (as amended or supplemented from time to time, the “Loan Agreement”) with a bank.  On October 31, 2013, we entered into a modification agreement (“Modification Agreement”) of the Loan Agreement with the bank to modify certain financial covenants pertaining to the Loan Agreement.  On September 30, 2014, the Loan Agreement expired.  To secure our remaining letters of credit outstanding, we established a cash collateral account with the bank in the amount of $0.4 million.

 

29



Table of Contents

 

On August 29, 2014, we entered into a three year, Senior Secured Revolving Line of Credit (“Revolver”) with another bank.  The maximum principal amount that may be outstanding at any given time under the Revolver, which includes up to $3.0 million of standby letters of credit, is $10.0 million.  Any borrowings under the Revolver would be collateralized by substantially all of our assets, as well as pledges of capital stock.  The Revolver requires that, if we suffer an event of default or have borrowed more than 75% of the maximum principal amount permitted to be outstanding, we maintain an Adjusted Quick Ratio of at least 1.15 to 1.0.  If the Adjusted Quick Ratio falls below 1.5 to 1.0, any collections received by the bank on behalf of the Company will be applied to outstanding loan balances before being remitted to the Company’s operating account.  The Adjusted Quick Ratio is calculated by dividing Quick Assets (cash less restricted cash plus accounts receivable) by current liabilities (current liabilities plus outstanding standby letter of credit less the current portion of deferred revenue.)  Borrowings under the Revolver bear interest at a floating rate ranging from 1.25% to 3.25% above the Prime Rate depending on the Company’s Adjusted Quick Ratio.  We are obligated to pay a commitment fee of $0.2 million over the three year term of the Revolver. All principal, interest and any other fees will be due and payable in full on or prior to August 29, 2017.

 

As of September 30, 2014, we were in compliance with the covenants of the Revolver. We had letters of credit outstanding against the Revolver in the amount of $1.3 million, resulting in the maximum available borrowing under the Revolver to be $8.7 million.  To date, we have not borrowed under the Revolver.

 

Contractual Obligations and Commitments

 

In connection with the CaseCentral acquisition, we entered into an earn-out arrangement with the former CaseCentral shareholders with respect to the three 12-month periods (“earn-out periods”) that started April 1, 2012.  The amount of contingent consideration payable with respect to each of the earn-out periods is equal to 35% of certain qualifying CaseCentral SaaS revenues and EnCase® eDiscovery revenues in excess of $11.1 million during each of the three earn-out periods and is limited to $3.0 million for the first earn-out period, a cumulative total of $13.0 million for the first and second earn-out periods and a cumulative total of $33.0 million for all three earn-out periods.  Any earn-out consideration is payable within 65 days after the end of the applicable earn-out period.  We did not pay any contingent consideration with respect to the first two 12-month periods ending March 31, 2014.  At March 31, 2014, the fair value of the contingent consideration for the remaining 12-month period, which is calculated by summing the present values of various probability-weighted possible outcomes, was estimated to be zero.

 

On July 3, 2014, we entered into an Office Lease Agreement (the “San Francisco Lease”) to lease approximately 6,000 rentable square feet of an office building located in San Francisco, California.  The office building will be the new location for our San Francisco office.  The San Francisco Lease is anticipated to commence on January 1, 2015 and expires in January 2020.  The total annual rent under the San Francisco Lease ranges from approximately $295,000 for the first year to approximately $332,000 for the final year.

 

Effective April 1, 2014, we entered into a Colocation Lease Agreement (the “Colocation Lease”) to rent space in a building located in Chandler, Arizona.  The Colocation Lease expires on June 30, 2018.  The Colocation Lease will serve as our new data center, replacing our former San Francisco location obtained in the Case Central acquisition.  Rent is based on power allocation and ranges from approximately $236,000 for the first year to approximately $265,000 for the final year.

 

30



Table of Contents

 

At September 30, 2014, other than the CaseCentral contingent consideration, our outstanding contractual cash commitments were largely limited to our non-cancellable lease obligations, primarily relating to office facilities. In “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2013, we reported that our contractual obligation for these non-cancellable lease obligations as of December 31, 2013 was approximately $33.5 million, of which $3.6 million is due during 2014.  Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our selling and marketing activities, the timing and extent of research and development spending to support product development and enhancement efforts, costs associated with expansion into new territories or markets, the timing of the introduction of new products and services, the enhancement of existing products and the continuing market acceptance of our products and services.  To the extent that our existing cash, cash from operations or the availability of cash under our line of credit are insufficient to fund our future activities and planned growth, we may need to raise additional funds through public or private equity or debt financings.  Additional funds may not be available on terms favorable to us or at all.  Furthermore, although we cannot accurately anticipate the effect of inflation or foreign exchange markets on our operations, we do not believe these external economic forces have had, or are likely in the foreseeable future to have, a material impact on our results of operations.

 

Other than the items stated above, we currently have no other material cash commitments, except our normal recurring trade payables, expense accruals, leases and license obligations, all of which are currently expected to be funded through existing working capital and future cash flows from operations.

 

Off-Balance Sheet Arrangements

 

At September 30, 2014, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of the SEC’s Regulation S-K.  We do not have material relationships or transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties except as disclosed in this report.

 

Item 3.                                   Quantitative and Qualitative Disclosure about Market Risk

 

Market Risk. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates.  Our market risk exposure is primarily a result of fluctuations in foreign exchange rates, interest rates and credit risk.  We do not hold or issue financial instruments for trading purposes.

 

Foreign Currency Risk. To date, substantially all of our international sales have been denominated in US dollars, and therefore, the majority of our revenues are not subject to foreign currency risk.  Our operating expenses and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, but such changes have historically had relatively little impact on our operating results and cash flows.  A strengthening of the dollar could make our products and services less competitive in foreign markets and therefore could reduce our revenues. In the future, an increased portion of our revenues and costs may be denominated in foreign currencies.  We do not enter into derivative instrument transactions for trading or speculative purposes.

 

Interest Rate Risk.  Our investment portfolio, consisting of highly liquid debt instruments of the US government at September 30, 2014, is subject to interest rate risk.  The fair value of our investment portfolio would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of our investment portfolio.

 

Item 4.                                  Controls and Procedures

 

Management, with the participation of the President and Chief Executive Officer and Chief Financial Officer, has performed an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934).  This evaluation includes consideration of the controls, processes and procedures that are designed to ensure that information required to be disclosed by us in the reports we file under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on such evaluation, our President and Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2014, our disclosure controls and procedures were effective.

 

31



Table of Contents

 

Changes in Internal Control Over Financial Reporting

 

There have been no changes in our internal control over financial reporting during the nine months ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

PART II. OTHER INFORMATION

 

Item 1.                                  Legal Proceedings

 

On May 20, 2011, MyKey Technology Inc. (“MyKey”) filed a complaint against us and certain other parties for patent infringement in the United States District Court for the District of Delaware.  With respect to the Company, the complaint alleged that certain of our data acquisition forensic hardware products that we acquired as a result of our acquisition of certain assets of Tableau, LLC (“Tableau”) infringe three of MyKey’s patents relating to write blocking, duplication and data removal technologies, respectively.  The complaint sought a declaration of infringement, a finding of willful infringement, compensatory damages, treble damages, injunctive relief, interest, expenses, costs and attorneys’ fees.

 

On July 22, 2011, MyKey also filed a complaint with the United States International Trade Commission (the “ITC”), alleging infringement by the Company and certain other parties of the three patents discussed in the preceding paragraph and requesting that the ITC commence an investigation pursuant to Section 337 of the Tariff Act of 1930.  The complaint sought injunctive relief barring the Company from the importation of products that allegedly infringed the three patents of MyKey.  On August 24, 2011, the ITC commenced an investigation of the Company and certain other parties related to the complaint by MyKey.  On August 31, 2011 the proceeding in the District Court was stayed pending the resolution of the ITC matter.  On August 1, 2012, MyKey amended its ITC complaint to remove allegations that its duplication patent had been infringed by the Company and to reduce the number of claims it alleges the Company has infringed related to MyKey’s data removal patent.  In August 2012, the parties completed a trial on the remaining patent claims at issue.

 

On December 28, 2012, the ITC released a final determination and Order holding that no violation of Section 337 of the Tariff Act of 1930 occurred as a result of the Company’s importation into the United States and sale of the products at issue.  This Order effectively ended the ITC proceeding in the Company’s favor.

 

On February 20, 2013, the U.S. District Court of Delaware lifted the stay of the proceedings in the MyKey matter.  Effective April 8, 2013, the parties stipulated to a transfer of the matter to the U.S. District Court for the Central District of California.  On April 16, 2013, the Company filed its Answer and Counterclaim.  MyKey filed a petition to consolidate a number of related cases, including the case against the Company in the Central District of California, into a Multi-District Litigation (“MDL”) proceeding.  On August 16, 2013, the MDL panel approved the petition and assigned the MDL consolidated cases to the judge who is also presiding over the individual case against the Company.  The MDL case will dispose of certain issues common to the consolidated cases, such as the validity of patents being asserted against the joint defendants.  On May 23, 2014, the parties completed a Markman hearing related to claim construction of the patents at issue.

 

On March 26, 2014, MyKey also filed a complaint against the United States of America by alleging that the United States has infringed U.S. Patents No. 6,813,682, 7,159,086 and 7,228,379 by or through its acceptance, receipt and/or use of write blocker products, data duplication products and data removal products.  The complaint alleges that such products were supplied to the government by Guidance and certain of its co-defendants in the MDL proceeding.  No damages amount is stated in the complaint.  The government could assert a claim for indemnification against Guidance but has not done so yet.  Although a financial loss is reasonably possible, the Company is unable to estimate the range of potential loss at this time.

 

On October 16, 2014, MyKey filed a Notice of Status on Claim Construction Issues in which it acknowledged MyKey will not be able to prove that the Company’s data duplication products infringed U.S. Patent 7,159,086.  In the same filing, MyKey acknowledged that certain claims of United States Patent 6,813,682 are invalid and therefore cannot be infringed by any product.

 

We intend to defend the remaining MyKey matters vigorously and, at this time, are unable to estimate what, if any, liability we may have in connection with these matters.  We are unable to estimate a range of reasonably possible financial losses due to various reasons, including, among others, that (1) certain of the proceedings are at an early stage, (2) there is uncertainty as to the outcome of pending appeals, motions, or settlements, (3) there are significant factual issues to be resolved, (4) there are unresolved negotiations with certain indemnitors or indemnitees of the Company, related to the actions, and (5) we have meritorious defenses that we intend to assert.

 

32



Table of Contents

 

From time to time, we may become involved in various other lawsuits and legal proceedings that arise in the ordinary course of business.  Litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.  We are not currently aware of any such other legal proceedings or claims that are likely to have a material impact on our business.

 

Item 1A.                         Risk Factors

 

There have been no material changes to the risk factors as presented in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the U.S. Securities and Exchange Commission on February 24, 2014.

 

Item 2.                                 Unregistered Sales of Equity Securities and Use of Proceeds

 

There have been no material changes to the Unregistered Sales of Equity Securities and Use of Processed as presented in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the U.S. Securities and Exchange Commission on February 24, 2014.

 

Item 3.                                  Defaults upon Senior Securities

 

No information is required in response to this item.

 

Item 4.                                  [Removed and Reserved]

 

No information is required in response to this item.

 

Item 5.                                  Other Information

 

No information is required in response to this item.

 

Item 6.         Exhibits

 

Exhibit
Number

 

Description of Documents

10.32*

 

Loan and Security Agreement, dated August 29, 2014, by and among Guidance Software, Inc., Guidance Tableau LLC, CaseCentral, Inc. and Silicon Valley Bank.

10.33**

 

Departure of Principal Executive Officer, President and Director, dated November 6, 2014, by Guidance Software, Inc.

31.1

 

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

 

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1†

 

Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2†

 

Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS

 

XBRL Instance Document

101.SCH

 

XBRL Taxonomy Extension Schema Document

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 


*                          Incorporated by reference to Guidance Software, Inc.’s Current Report on Form 8-K filed on September 5, 2014.

**                   Incorporated by reference to Guidance Software, Inc.’s Current Report on Form 8-K filed on November 6, 2014.

                          These certifications are being furnished solely to accompany this Quarterly Report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Guidance Software, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

 

33



Table of Contents

 

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

Guidance Software, Inc.

 

 

 

 

By:

/s/ Barry J. Plaga

 

 

Barry J. Plaga

 

 

Chief Financial Officer

 

 

(Principal Financial Officer)

 

Dated: November 12, 2014

 

34