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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017

OR

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

FOR THE TRANSITION PERIOD FROM                    TO                    

Commission File Number 0-27975

 

Mattersight Corporation

(Exact Name of Registrant as Specified in Its Charter)

 

 

Delaware

 

36-4304577

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

200 W. Madison Street

Suite 3100

Chicago, Illinois 60606

(Address of Principal Executive Offices) (Zip Code)

(877) 235-6925

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or Section 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

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

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

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

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

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

The number of shares of the registrant’s common stock outstanding as of October 25, 2017 was 32,731,950.

 

 

 

 

 


 

TABLE OF CONTENTS

 

 

 


 

Part I. Financial Information

Forward-Looking Statements

Statements in this Quarterly Report on Form 10-Q that are not historical facts are “forward-looking statements” and are made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). A reader can identify these forward-looking statements, because they are not limited to historical fact or they use words such as “scheduled,” “will,” “anticipate,” “project,” “estimate,” “forecast,” “goal,” “objective,” “committed,” “intend,” “continue,” “plan,” “may,” “might,” “believe,” “expect,” “intend,” “could,” “would,” “should,” or “will likely result,” and other similar expressions, and terms of similar meaning, in connection with any discussion of our prospects, financial statements, business, financial condition, revenues, results of operations, or liquidity, involving risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. In addition to other factors and matters contained or incorporated in this document, important factors that could cause actual results or events to differ materially from those indicated by such forward-looking statements include, without limitation, those noted under “Risk Factors” included in Part I Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, as well as the following:

 

Uncertainties associated with the attraction of, and the ability to execute contracts with, new clients, the continuation of existing, and execution of new, engagements with existing clients, the conversion of free pilots to paid subscription contracts, and the timing of related client commitments;

 

Reliance on a relatively small number of clients for a significant percentage of our revenue;

 

Risks involving the variability and predictability of the number, size, scope, cost, and duration of, and revenue from, client engagements;

 

Management of the other risks associated with complex client projects and new service offerings, including execution risk;

 

Cyber-attacks or other privacy or data security incidents, and failure to comply with privacy and data security regulations; and

 

Management of growth and development of, and introduction of, new service offerings.

We cannot guarantee any future results, levels of activity, performance, or achievements. The statements made in this Quarterly Report on Form 10-Q represent our views as of the date of this report, and it should not be assumed that the statements made in this report remain accurate as of any future date. Moreover, we assume no obligation to update forward-looking statements, except as may be required by law. In light of Regulation FD, it is our policy not to comment on earnings, financial guidance, or operations other than through press releases, publicly announced conference calls, or other means that will constitute public disclosure for purposes of Regulation FD.

 

 

 

 


 

Item 1. Financial Statements

MATTERSIGHT CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited and in thousands, except share and per share data)

 

 

 

September 30,

2017

 

 

December 31,

2016

 

ASSETS

 

 

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

7,951

 

 

$

12,538

 

Receivables net of allowances of $39 and $311, at September 30, 2017 and December 31,

   2016, respectively

 

 

7,298

 

 

 

8,508

 

Prepaid expenses

 

 

6,197

 

 

 

4,440

 

Other current assets

 

 

149

 

 

 

296

 

Total current assets

 

 

21,595

 

 

 

25,782

 

Equipment and leasehold improvements, net of accumulated depreciation and

   amortization of $23,781 and $19,748, at September 30, 2017 and December 31, 2016,

   respectively

 

 

9,720

 

 

 

9,576

 

Goodwill

 

 

972

 

 

 

972

 

Intangible assets, net of amortization of $4,214 and $3,820, respectively

 

 

3,041

 

 

 

3,201

 

Other long-term assets (includes $2,975 and $4,210 of restricted cash, at September 30, 2017

   and December 31, 2016, respectively)

 

 

6,721

 

 

 

6,033

 

Total assets

 

$

42,049

 

 

$

45,564

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

Short-term debt

 

$

90

 

 

$

738

 

Accounts payable

 

 

1,970

 

 

 

1,835

 

Accrued compensation and related costs

 

 

3,414

 

 

 

2,302

 

Unearned revenue

 

 

5,071

 

 

 

4,911

 

Capital leases

 

 

2,145

 

 

 

1,982

 

Other current liabilities

 

 

3,275

 

 

 

3,374

 

Total current liabilities

 

 

15,965

 

 

 

15,142

 

Long-term debt

 

 

15,081

 

 

 

20,839

 

Long-term unearned revenue

 

 

706

 

 

 

757

 

Long-term capital leases

 

 

1,559

 

 

 

1,602

 

Other long-term liabilities

 

 

6,754

 

 

 

5,945

 

Total liabilities

 

 

40,065

 

 

 

44,285

 

7% Series B convertible preferred stock, $0.01 par value; 5,000,000 shares authorized and

   designated; 1,637,786 and 1,637,948 shares issued and outstanding at September 30,

   2017 and December 31, 2016, respectively, with a liquidation preference of $11,422

   and $10,985, at September 30, 2017 and December 31, 2016, respectively

 

 

8,353

 

 

 

8,354

 

Stockholders’ Equity:

 

 

 

 

 

 

 

 

Preferred stock, $0.01 par value; 35,000,000 shares authorized; none issued

 

 

 

 

 

 

Common stock, $0.01 par value; 50,000,000 shares authorized; 32,789,806 and

   27,511,361 shares issued at September 30, 2017 and December 31, 2016,

   respectively; 32,731,950 and 26,622,706 shares outstanding at September 30, 2017

   and December 31, 2016, respectively

 

 

328

 

 

 

275

 

Additional paid-in capital

 

 

275,398

 

 

 

264,214

 

Accumulated deficit

 

 

(277,876

)

 

 

(263,062

)

Treasury stock, at cost, 57,856 and 888,655 shares at September 30, 2017 and

   December 31, 2016, respectively

 

 

(145

)

 

 

(4,455

)

Accumulated other comprehensive loss

 

 

(4,074

)

 

 

(4,047

)

Total stockholders’ equity (deficit)

 

 

(6,369

)

 

 

(7,075

)

Total liabilities and stockholders’ equity

 

$

42,049

 

 

$

45,564

 

 

See accompanying notes to the Unaudited Consolidated Financial Statements.

1


 

MATTERSIGHT CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited and in thousands, except per share data)

 

 

 

Quarter Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscription revenue

 

$

10,639

 

 

$

9,574

 

 

$

30,925

 

 

$

27,297

 

Other revenue

 

 

705

 

 

 

838

 

 

 

1,936

 

 

 

2,242

 

Total revenue

 

 

11,344

 

 

 

10,412

 

 

 

32,861

 

 

 

29,539

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of subscription revenue

 

 

2,366

 

 

 

2,781

 

 

 

7,576

 

 

 

7,840

 

Cost of other revenue

 

 

753

 

 

 

662

 

 

 

2,295

 

 

 

2,044

 

Total cost of revenue, exclusive of depreciation and amortization

 

 

3,119

 

 

 

3,443

 

 

 

9,871

 

 

 

9,884

 

Product development

 

 

3,288

 

 

 

2,988

 

 

 

10,195

 

 

 

9,588

 

Sales and marketing

 

 

3,070

 

 

 

4,625

 

 

 

9,538

 

 

 

13,452

 

General and administrative

 

 

2,915

 

 

 

2,912

 

 

 

9,325

 

 

 

8,950

 

Depreciation and amortization

 

 

1,603

 

 

 

1,477

 

 

 

4,874

 

 

 

4,295

 

Total operating expenses

 

 

13,995

 

 

 

15,445

 

 

 

43,803

 

 

 

46,169

 

Operating loss

 

 

(2,651

)

 

 

(5,033

)

 

 

(10,942

)

 

 

(16,630

)

Non-operating income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and other borrowing costs

 

 

(334

)

 

 

(860

)

 

 

(2,353

)

 

 

(1,291

)

Loss on early extinguishment of debt

 

 

 

 

 

 

 

 

(1,834

)

 

 

 

Change in fair value of warrant liability

 

 

(52

)

 

 

58

 

 

 

308

 

 

 

58

 

Other non-operating income

 

 

13

 

 

 

8

 

 

 

54

 

 

 

31

 

Total non-operating income (expense)

 

 

(373

)

 

 

(794

)

 

 

(3,825

)

 

 

(1,202

)

Loss before income taxes

 

 

(3,024

)

 

 

(5,827

)

 

 

(14,767

)

 

 

(17,832

)

Income tax benefit (provision)

 

 

8

 

 

 

(11

)

 

 

(4

)

 

 

(27

)

Net loss

 

 

(3,016

)

 

 

(5,838

)

 

 

(14,771

)

 

 

(17,859

)

Dividends related to 7% Series B convertible preferred stock

 

 

(146

)

 

 

(147

)

 

 

(438

)

 

 

(440

)

Net loss available to common stockholders

 

$

(3,162

)

 

$

(5,985

)

 

$

(15,209

)

 

$

(18,299

)

Per share of common stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic net loss available to common stockholders

 

$

(0.10

)

 

$

(0.24

)

 

$

(0.51

)

 

$

(0.73

)

Diluted net loss available to common stockholders

 

$

(0.10

)

 

$

(0.24

)

 

$

(0.51

)

 

$

(0.73

)

Shares used to calculate basic net loss per share

 

 

31,463

 

 

 

25,244

 

 

 

30,074

 

 

 

25,156

 

Shares used to calculate diluted net loss per share

 

 

31,463

 

 

 

25,244

 

 

 

30,074

 

 

 

25,156

 

Stock-based compensation expense is included in individual line items above:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total cost of revenue

 

$

39

 

 

$

112

 

 

$

276

 

 

$

298

 

Product development

 

 

164

 

 

 

194

 

 

 

493

 

 

 

863

 

Sales and marketing

 

 

95

 

 

 

482

 

 

 

218

 

 

 

1,415

 

General and administrative

 

 

376

 

 

 

463

 

 

 

1,137

 

 

 

1,718

 

 

See accompanying notes to the Unaudited Consolidated Financial Statements.

 

 

2


 

MATTERSIGHT CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited and in thousands)

 

 

 

Quarter Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Net loss

 

$

(3,016

)

 

$

(5,838

)

 

$

(14,771

)

 

$

(17,859

)

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of foreign currency translation

 

 

(1

)

 

 

(10

)

 

 

(27

)

 

 

(17

)

Comprehensive net loss

 

$

(3,017

)

 

$

(5,848

)

 

$

(14,798

)

 

$

(17,876

)

 

See accompanying notes to the Unaudited Consolidated Financial Statements.

 

 

3


 

MATTERSIGHT CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and in thousands)

 

 

 

Nine Months Ended

 

 

 

September 30,

2017

 

 

September 30,

2016

 

Cash Flows from Operating Activities:

 

 

 

 

 

 

 

 

Net loss

 

$

(14,771

)

 

$

(17,859

)

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

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

4,874

 

 

 

4,295

 

Stock-based compensation

 

 

2,124

 

 

 

4,294

 

Discount accretion and other debt-related costs

 

 

1,417

 

 

 

173

 

Provision for uncollectible accounts

 

 

59

 

 

 

25

 

Change in fair value of warrant liability

 

 

(308

)

 

 

(58

)

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Receivables

 

 

1,151

 

 

 

(609

)

Prepaid expenses

 

 

(1,261

)

 

 

(1,448

)

Other current assets

 

 

142

 

 

 

(484

)

Other long-term assets

 

 

(1,718

)

 

 

969

 

Accounts payable

 

 

(464

)

 

 

287

 

Accrued compensation and related costs

 

 

1,112

 

 

 

154

 

Unearned revenue

 

 

109

 

 

 

(4,787

)

Other current liabilities

 

 

1,126

 

 

 

1,471

 

Other long-term liabilities

 

 

765

 

 

 

374

 

Total adjustments

 

 

9,128

 

 

 

4,656

 

Net cash used in operating activities

 

 

(5,643

)

 

 

(13,203

)

Cash Flows from Investing Activities:

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(2,668

)

 

 

(2,364

)

Investment in intangible assets

 

 

(209

)

 

 

(857

)

Net cash used in investing activities

 

 

(2,877

)

 

 

(3,221

)

Cash Flows from Financing Activities:

 

 

 

 

 

 

 

 

Proceeds from line of credit

 

 

19,900

 

 

 

16,246

 

Repayments of line of credit

 

 

(5,000

)

 

 

(16,246

)

Proceeds from term loan and other borrowings

 

 

 

 

28,880

 

Repayments of term loan and other borrowings

 

 

(23,238

)

 

 

(6,030

)

Debt prepayment costs

 

 

(692

)

 

 

(96

)

Fees paid for issuance of debt

 

 

(206

)

 

 

(680

)

Proceeds from issuance of common stock, net of costs

 

 

14,737

 

 

 

 

Cash paid to satisfy tax withholding upon vesting of employee stock awards

 

 

(1,060

)

 

 

(328

)

Principal payments on capital lease obligations

 

 

(1,894

)

 

 

(1,727

)

Proceeds from employee stock purchase plan

 

 

178

 

 

 

223

 

7% Series B convertible preferred stock dividend

 

 

 

 

(3

)

Proceeds from exercise of stock options

 

 

 

 

236

 

Net cash provided by financing activities

 

 

2,725

 

 

 

20,475

 

Effect of exchange rate changes on cash and cash equivalents

 

 

(27

)

 

 

(17

)

(Decrease) increase in total cash

 

 

(5,822

)

 

 

4,034

 

Cash and cash equivalents

 

 

12,538

 

 

 

15,407

 

Restricted cash (included in Other long-term assets on the Consolidated Balance Sheets)

 

 

4,210

 

 

 

Total cash, beginning of period

 

 

16,748

 

 

 

15,407

 

Cash and cash equivalents

 

 

7,951

 

 

 

14,652

 

Restricted cash (included in Other long-term assets on the Consolidated Balance Sheets)

 

 

2,975

 

 

 

4,789

 

Total cash, end of period

 

$

10,926

 

 

$

19,441

 

Non-Cash Investing and Financing Activities:

 

 

 

 

 

 

 

 

Capital lease obligations incurred

 

$

2,014

 

 

$

2,213

 

Capital equipment purchased on credit

 

 

2,014

 

 

 

2,213

 

Issuance of warrant, at fair value

 

 

 

 

 

924

 

Supplemental Disclosures of Cash Flow Information:

 

 

 

 

 

 

 

 

Interest paid

 

$

2,093

 

 

$

758

 

 

See accompanying notes to the Unaudited Consolidated Financial Statements.

4


 

MATTERSIGHT CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Note One — Basis of Presentation

The accompanying interim consolidated financial statements include Mattersight Corporation and its subsidiaries (collectively, Mattersight or the company). The accompanying interim consolidated financial statements have been prepared without audit. Certain notes and other information normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. In the opinion of management, the accompanying consolidated financial statements include all normal recurring adjustments considered necessary to present fairly the financial position of the company at September 30, 2017 and December 31, 2016 and the results of operations and cash flows for the periods indicated. Quarterly results are not necessarily indicative of results for any subsequent period.

On April 1, 2017, the company adopted Accounting Standards Update (ASU) No 2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 addresses the presentation and classification of cash flows related to specific transactions. Upon adoption, the company updated the statement of cash flow for all periods presented. Certain amounts on the statement of cash flows for the nine months ended September 30, 2016 were reclassified in compliance with this ASU.      

On January 1, 2017, the company adopted ASU No. 2016-18, Statement of Cash Flows: Restricted Cash, which requires that a statement of cash flows explain the change in the total of cash, cash equivalents and restricted cash. Certain amounts on the statement of cash flows for the nine months ended September 30, 2016 were reclassified in compliance with this ASU.      

On January 1, 2017, the company adopted ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting (Topic 718). This update is intended to simplify the accounting for share-based payment transactions, including the income tax impacts, classification of awards as either equity or liabilities, and presentation on the statement of cash flows. Under ASU 2016-19, the company has elected to account for forfeitures as they occur rather than on an estimated basis. The standard was adopted using a modified retrospective approach which had an immaterial impact on the accumulated deficit balance on January 1, 2017.    

On January 1, 2017, the company adopted ASU No. 2015-17, Income Taxes (Topic 740). This update simplifies the presentation of deferred income taxes and requires that deferred income tax liabilities and assets be classified as noncurrent in a classified balance sheet. Upon adoption, all deferred tax assets and liabilities were classified as long term.

On January 1, 2017, to better align expenses, the company changed the caption on the Consolidated Statements of Operations from Research and development to Product development. The company believes the revised presentation provides a clearer understanding of the business expenses in this caption. There was no change to the expense classification and the current period is comparable to the prior period.

The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto in Mattersight’s Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission (SEC) on March 16, 2017.

 

 

Note Two — Recent Accounting Pronouncements

In July 2017, the Financial Accounting Standards Board (FASB) issued ASU No. 2017-11—Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception to address narrow issues identified as a result of the complexity associated with applying generally accepted accounting principles for certain financial instruments with characteristics of liabilities and equity. Part I of the update changes the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. Part II of the update re-characterizes the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the codification, to a scope exception. Part II does not have an accounting effect. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The company is currently evaluating the impact of this update on its consolidated financial statements.

5


 

In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting, which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. This ASU is effective for reporting periods beginning after December 15, 2017 and interim periods within those annual periods. The company is currently evaluating the impact of this update on its consolidated financial statements.

In January 2017, FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other, simplifying the test for goodwill impairment. This ASU simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Under this update, goodwill impairment will be measured as the amount by which a reporting unit’s carrying value exceeds its fair value. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is needed. This ASU is effective for reporting periods beginning after December 15, 2019 and interim periods within those annual periods. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The company is evaluating its option to adopt the standard at its December 31, 2017 testing date.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments — Credit Losses: Measurement of Credit Losses on Financial Instruments. This update broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. The update is effective for annual periods beginning after December 15, 2019. The company is currently evaluating the impact of this update on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This update is intended to improve financial reporting of leasing transactions. The ASU will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. This update is effective for periods beginning after December 15, 2018. The company is currently evaluating the impact of this update on its consolidated financial statements.

In May 2014, FASB issued ASU 2014-09: Revenue from Contracts with Customers (Topic 606). This update sets forth a new five-step revenue recognition model that replaces the prior revenue recognition guidance in its entirety and is intended to eliminate numerous industry-specific pieces of revenue recognition guidance that have historically existed. The underlying principle of the new standard is that an organization will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. ASU 2014-09 provides alternative methods of initial adoption and is effective for annual periods beginning after December 15, 2017 and interim periods within those annual periods. The company is continuing to assess the impact of adopting ASU 2014-09. At this time, the company does not expect a significant change in revenue recognition or operating cash flows when ASU 2014-09 is adopted based on contracts reviewed to date. We expect to complete our review of all contracts by December 31, 2017. The company is still evaluating the accounting for the incremental costs of obtaining and fulfilling a contract. The company is working to put additional processes and internal controls in place to enable and maintain compliance with ASU 2014-09’s disclosure requirements. The company has elected to adopt the modified retrospective transition method.

 

 

Note Three Current Prepaid Expenses

Current prepaid expenses primarily consist of deferred deployment costs, prepaid technology maintenance costs and prepaid commissions related to Behavioral Analytics contracts. These costs are recognized over the subscription periods of the respective contracts generally one to three years after the go-live date or, in cases where the company contracts with a client for a short-term pilot of a Behavioral Analytics offering prior to committing to a longer subscription period, if any, the subscription or pilot periods generally range from three to twelve months after the go-live date. Costs included in current prepaid expenses will be recognized within the next twelve months.  

Current prepaid expenses consisted of the following:

 

(In millions)

 

September 30,

2017

 

 

December 31,

2016

 

Deferred deployment costs

 

$

2.0

 

 

$

1.7

 

Prepaid technology maintenance costs

 

 

2.0

 

 

 

0.8

 

Prepaid commissions

 

 

1.3

 

 

 

1.2

 

Other

 

 

0.9

 

 

 

0.7

 

Total

 

$

6.2

 

 

$

4.4

 

 

 

6


 

Note Four Other Long-Term Assets

Other long-term assets includes the long-term portion of restricted cash, prepaid technology and maintenance support, deferred deployment costs, and prepaid commissions related to Behavioral Analytics.  Restricted cash represents cash used to collateralize certain letters of credit issued to support the company’s equipment leasing activities. These costs are recognized over the terms of the respective contracts, generally one to three years. Costs included in long-term assets will be recognized over the remaining term of the contracts beyond the first twelve months.  Other long-term assets consisted of the following:

 

(In millions)

 

September 30,

2017

 

 

December 31,

2016

 

Restricted cash

 

$

3.0

 

 

$

4.2

 

Prepaid technology and maintenance support

 

 

2.1

 

 

 

0.6

 

Deferred deployment costs

 

 

1.2

 

 

 

0.6

 

Prepaid commissions

 

 

0.3

 

 

 

0.5

 

Other

 

 

0.1

 

 

 

0.1

 

Total

 

$

6.7

 

 

$

6.0

 

 

 

Note Five — Other Current Liabilities

Other current liabilities consisted of the following:

 

(In millions)

 

September 30,

2017

 

 

December 31,

2016

 

Accrued vendor payable

 

$

1.8

 

 

$

1.9

 

Warrant liability

 

 

0.5

 

 

 

0.8

 

Deferred rent liability

 

 

0.5

 

 

 

0.4

 

Other

 

 

0.5

 

 

 

0.3

 

Total

 

$

3.3

 

 

$

3.4

 

 

On August 1, 2016, the company issued a warrant to Hercules Capital, Inc. (Hercules) that gives Hercules the right to purchase shares of the company’s common stock at $3.50 per share. The warrant is exercisable for 357,142 shares of common stock and expires on August 1, 2023. The warrant is accounted for as a liability and carried at fair market value using the Black-Scholes model. Changes in the warrant’s fair market value are recognized in non-operating income (expense) in the consolidated statements of operations.

 

 

Note Six — Leases

Capital Leases

Assets under capital leases consist primarily of computer hardware and related equipment. The gross amount of assets recorded under capital leases was $7.7 million and $6.5 million at September 30, 2017 and December 31, 2016, respectively.  Depreciation expense related to assets under capital leases is included in depreciation and amortization expense on the consolidated statements of operations.    

As of September 30, 2017, the future minimum lease payments due under capital leases are expected to be as follows: 

 

(In millions)

 

 

 

 

Year

 

Amount

 

Remainder of 2017

 

$

0.6

 

2018

 

 

2.4

 

2019

 

 

1.2

 

2020

 

 

0.2

 

Total minimum lease payments

 

$

4.4

 

Less: amount representing interest

 

 

(0.7

)

Present value of minimum lease payments

 

$

3.7

 

 

 

7


 

Note Seven — Debt

On June 29, 2017, the company entered into a loan agreement with CIBC Bank USA f/k/a The PrivateBank and Trust Company (CIBC). The loan agreement provides for a revolving line of credit to the company with a maximum credit limit of $20.0 million, which matures on June 29, 2020 (the credit facility). The credit facility is secured by a security interest in the company’s assets. The company, subject to certain limits and restrictions, may from time to time request the issuance of letters of credit under the loan agreement.

The principal amount outstanding under the credit facility will accrue interest at a floating annual rate equal to 1 month, 2 month or 3 month LIBOR (as selected by the company) plus 4.50%, payable monthly. In addition, the company will pay a non-use fee on the credit facility of 25 basis points (0.25%) per annum of the average unused portion of the credit facility.  The amount the company may borrow under the credit facility is limited to five times the company’s monthly recurring revenue (as determined in accordance with the terms and conditions set forth in the loan agreement), multiplied by a dynamic churn factor that is based upon the ratio of recurring revenue retained in the prior twelve month period relative to the total amount of recurring revenue at the beginning of the period.

The loan agreement imposes various restrictions on the company, including usual and customary limitations on the ability of the company to incur debt and to grant liens upon its assets, prohibits certain consolidations, mergers, and sales and transfers of assets by the company and requires the company to comply with total revenue and EBITDA (as adjusted in accordance with the loan agreement) targets. The loan agreement includes usual and customary events of default (with customary grace periods, as applicable) and provides that, upon the occurrence of an event of default, payment of all amounts payable under the loan agreement may be accelerated and/or the lender’s commitments may be terminated. In addition, upon the occurrence of certain insolvency or bankruptcy related events of default, all amounts payable under the loan agreement will automatically become immediately due and payable, and the lender’s commitments will automatically terminate.  

On June 29, 2017, the company drew $13.5 million on the revolving line of credit. The proceeds were used to repay the principal balance of $22.5 million under the company’s prior credit facility with Hercules. Upon repayment, the company terminated its loan agreement with Hercules. The loss on the early extinguishment of Hercules debt totaled $1.8 million. It consisted of a prepayment charge of $0.7 million, acceleration of unaccreted debt discount of $0.6 million, and acceleration of unamortized deferred debt costs of $0.5 million. The average outstanding balance on the revolving line of credit during the third quarter of 2017 was $9.8 million. As of September 30, 2017, $14.9 million remains outstanding on the revolving line of credit with the ability to draw an additional $2.5 million. There was also $0.7 million in letters of credit issued by CIBC against the line of credit. During October 2017, the company repaid $5.0 million of principal on the revolving line of credit.  

Debt consisted of the following:

 

(In millions)

 

September 30,

2017

 

 

December 31,

2016

 

CIBC loan due June 29, 2020, effective

   borrowing rate of 6.68% at September 30, 2017

 

$

14.9

 

 

$

 

Hercules loan effective borrowing rate of 14.50% at

   December 31, 2016

 

 

 

 

22.5

 

Furniture loan due May 2021, effective borrowing rate of 9.10%

 

 

0.1

 

 

 

0.1

 

Furniture loan due May 2021, effective borrowing rate of 9.55%

 

 

0.1

 

 

 

0.1

 

Furniture loan due July 2019, effective borrowing rate of 13.98%

 

 

0.1

 

 

 

0.1

 

Total debt(1)

 

$

15.2

 

 

$

22.8

 

 

(1)

Total debt of $15.2 million at September 30, 2017, includes the current portion of the furniture loans of $0.1 million. As of December 31, 2016, short-term debt was $0.7 million, consisting of $0.6 million related to the current portion of the secured loan with Hercules and $0.1 million related to the current portion of the furniture loans.

 

 

8


 

Note Eight — Other Long-Term Liabilities

Other long-term liabilities consisted of the following:

 

(In millions)

 

September 30,

2017

 

 

December 31,

2016

 

7% Series B convertible preferred stock dividends payable

 

$

3.1

 

 

$

2.6

 

Deferred rent liability

 

 

2.0

 

 

 

2.2

 

Technology service liability

 

 

1.4

 

 

 

Deferred income tax liability

 

 

0.2

 

 

 

0.3

 

Intellectual property purchase liability

 

 

0.1

 

 

 

0.8

 

Total

 

$

6.8

 

 

$

5.9

 

 

Note Nine — Litigation and Other Contingencies

The company is a party to various agreements, including all its client contracts, under which it may be obligated to indemnify the other party with respect to certain matters, including, but not limited to, indemnification against third-party claims of (i) infringement of intellectual property rights with respect to services, software, and other deliverables provided by the company, and (ii) failure to comply with various data security and privacy regulations. These obligations may be subject to various limitations on the remedies available to the other party, including, without limitation, limits on the amounts recoverable and the time during which claims may be made, and may be supported by indemnities given to the company by applicable third parties. Payment by the company under these indemnification clauses is generally subject to the other party making a claim that is subject to challenge by the company. Historically, the company has not been obligated to pay any claim for indemnification under its agreements, and management is not aware of future indemnification payments that it would be obligated to make.

Under its by-laws, subject to certain exceptions, the company has agreed to indemnify its corporate officers and directors for certain events or occurrences while the officer or director is, or was, serving at its request in such capacity or in certain related capacities. The company has separate indemnification agreements with each of its corporate officers and directors that requires it, subject to certain exceptions, to indemnify them to the fullest extent authorized or permitted by its by-laws and the Delaware General Corporation Law. The maximum potential amount of future payments the company could be required to make under these indemnification agreements is unlimited; however, the company has a director and officer liability insurance policy that limits its exposure and enables it to recover a portion of any amounts paid under these indemnification agreements. As a result of its insurance policy coverage, the company believes the estimated fair value of these indemnification agreements is minimal. The company had no liabilities recorded for these agreements as of September 30, 2017.

The company’s products may be subject to sales tax in certain jurisdictions. If a taxing authority were to successfully assert that the company has not properly collected sales or other transaction taxes, or if sales or other transaction tax laws or the interpretation thereof were to change, and the company was unable to enforce the terms of its contracts with customers that give it the right to reimbursement for assessed sales taxes, the company could incur tax liabilities in amounts that could be material. The company has considered the changing nature of tax laws, the terms of its customer contracts and its recent audit experience in assessing its exposure to possible and probable sales tax liabilities. Based on its assessment, the company has recorded a sales tax liability of less than $0.1 million at September 30, 2017.

 

 

Note Ten — Capital Stock

On February 23, 2017, the company entered into a definitive purchase agreement for the sale of 5,328,187 shares of its common stock to certain investors and certain officers and directors in a private placement. Under the terms of the agreement, the company raised approximately $16.0 million in gross proceeds by selling 5,228,187 shares to certain investors at a price of $3.00 per share and by selling 100,000 shares to certain officers and directors (including certain of their affiliates) at a price of $3.45 per share. The shares represented approximately 20% of the issued and outstanding shares of common stock immediately prior to the issuance. On March 1, 2017, the company received aggregate gross proceeds, net of fees, of $14.9 million. Proceeds are being used for general corporate, working capital, and debt repayment purposes.  Craig-Hallum Capital Group LLC, which acted as the sole placement agent for the offering, received a commission of $1.1 million, and was reimbursed for its out-of-pocket expenses. The company’s registration statement on Form S-3 (File No. 333-217290) was filed with the SEC on April 13, 2017 and declared effective by the SEC on April 26, 2017.          

The company’s ability to utilize its net operating losses (NOLs) could become subject to significant limitations under Section 382 of the Internal Revenue Code if the company were to undergo an ownership change. An ownership change would occur if the stockholders who own or have owned, directly or indirectly, 5% or more of the company’s common stock or are otherwise treated as 5% stockholders under Section 382 and the regulations promulgated thereunder, increase their aggregate percentage ownership of

9


 

the company’s stock by more than 50 percentage points over the lowest percentage of the stock owned by these stockholders at any time during the testing period, which is generally the three-year period preceding the potential ownership change. In the event of an ownership change, Section 382 imposes an annual limitation on the amount of taxable income a corporation may offset with NOL carryforwards. Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOL carryforwards. The company has undergone a Section 382 analysis as of December 31, 2016 and does not believe there is currently a limitation on the use of NOLs under Section 382; however, due to ongoing ownership changes, the company may be subject to significant limitations in the future. If a change in ownership is deemed to have occurred during the past three years, then it may be possible that the company’s NOL carryforward could be subject to limitation under Section 382 for tax return purposes. However, since its NOL carryforward is fully reserved with a valuation allowance, there would be no impact for financial statement purposes from a Section 382 limitation.    

 

 

Note Eleven — Loss Per Share

The following table presents the loss per share calculation for the periods presented:

 

 

 

Quarter Ended

 

 

Nine Months Ended

 

(In millions)

 

September 30,

2017

 

 

September 30,

2016

 

 

September 30,

2017

 

 

September 30,

2016

 

Net loss

 

$

(3.0

)

 

$

(5.8

)

 

$

(14.8

)

 

$

(17.9

)

Dividends related to 7% Series B

   convertible preferred stock(1)

 

 

(0.2

)

 

 

(0.2

)

 

 

(0.4

)

 

 

(0.4

)

Net loss available to common

   stockholders

 

$

(3.2

)

 

$

(6.0

)

 

$

(15.2

)

 

$

(18.3

)

Per share of common stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic/diluted net loss available to

   common stockholders

 

$

(0.10

)

 

$

(0.24

)

 

$

(0.51

)

 

$

(0.73

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

   (basic and diluted)

 

 

31,463

 

 

 

25,244

 

 

 

30,074

 

 

 

25,156

 

Anti-dilutive common stock

   equivalents(2)

 

 

1,449

 

 

 

1,772

 

 

 

1,590

 

 

 

1,691

 

 

(1)

Dividends on 7% Series B convertible preferred stock (Series B stock) are cumulative and have been accrued from July 1, 2012 to September 30, 2017. Total accrued dividends were $3.1 million as of September 30, 2017. Dividends will continue to accrue until they are declared by the company’s board of directors. The company has not declared any Series B stock dividends in 2017 or 2016.

(2)

In periods in which there was a loss, the effect of common stock equivalents, which is primarily related to the Series B stock, was not included in the diluted loss per share calculation as it was antidilutive.

 

Note Twelve Fair Value Measurements

The company uses a three-level classification hierarchy of fair value measurements to report certain assets and liabilities at fair value. The first tier, Level 1, uses quoted market prices in active markets for identical assets or liabilities. Level 2 uses observable market data, such as quoted market prices for similar assets and liabilities in active markets, or inputs other than quoted prices that are directly observable. Level 3 uses entity-specific inputs or unobservable inputs that are derived and cannot be corroborated by market data.  A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

10


 

The following table presents financial instruments measured at fair value measured on a recurring basis:

 

 

 

September 30, 2017

 

(In millions)

 

Carrying value

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Cash and cash equivalents -  money market fund

 

$

0.8

 

 

$

0.8

 

 

$

 

 

$

 

Warrant liability

 

 

0.5

 

 

 

 

 

 

 

 

 

0.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016

 

 

 

Carrying value

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Cash and cash equivalents - money market fund

 

$

12.1

 

 

$

12.1

 

 

$

 

 

$

 

Warrant liability

 

 

0.8

 

 

 

 

 

 

 

 

 

0.8

 

 

The carrying values of cash and cash equivalents, accounts receivable, accounts payable, and short-term debt approximated their fair values as of September 30, 2017 due to the short-term nature of these instruments.

The company determined the fair value of the liability for the warrant issued to Hercules, considered a Level 3 liability, using the Black-Scholes model. At September 30, 2017, management used a risk free rate of 2.02%, expected volatility of 53%, and an expected term of 5.84 years. Significant increases or decreases in any of these inputs in isolation would result in a significantly different fair value (See Note 5 – Other Current Liabilities).

 

The fair value of long-term debt was estimated to be $15.1 million at September 30, 2017.

There were no transfers of assets or liabilities between Level 1, Level 2, and Level 3 during the third quarter of 2017. There were no assets or liabilities valued at fair value on a nonrecurring basis during the first nine months of 2017.

 

 

11


 

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

The following discussion is provided as a supplement to, and should be read in conjunction with, the accompanying unaudited consolidated financial statements and notes in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2016.

Background

Mattersight Corporation and its subsidiaries (collectively, we, us, or ours) is a leader in behavioral analytics and a pioneer in personality-based software products. Using a stack of innovative, patented applications, including predictive behavioral routing, performance management, quality assurance, and predictive analytics (collectively, Behavioral Analytics), we analyze and predict customer behavior based on the language exchanged between agents and customers during brand interactions. These insights are then used to facilitate more effective and effortless customer conversations, which, in turn, drive increased customer satisfaction and retention, employee engagement, and operating efficiency. Our analytics are based on millions of proprietary algorithms and the application of unique behavioral models. Our solutions have influenced hundreds of millions of shorter, more satisfying customer interactions for leading companies in the healthcare, insurance, financial services, technology, telecommunications, cable, utilities, education, hospitality, and government industries.

Our multi-channel technology captures the unstructured data of voice interactions (conversations), related customer and employee data, and employee desktop activity, and applies millions of proprietary algorithms against those interactions. Each interaction contains hundreds of attributes that get scored and ultimately detect patterns of behavior or business process that provide the transparency and predictability necessary to enhance revenue, improve the customer experience, improve efficiency, and predict and navigate outcomes. Adaptive across industries, programs, and industry-specific processes, our Behavioral Analytics offerings enable our clients to drive measurable economic benefit through the improvement of contact center performance, customer satisfaction and retention, fraud reduction, and streamlined back office operations. Specifically, through our Behavioral Analytics offerings, we help clients:

 

Identify optimal customer/employee behavioral pairing for call routing;

 

Identify and understand customer personality;

 

Automatically measure customer satisfaction and agent performance on every analyzed call;

 

Improve rapport between agent and customer;

 

Reduce call handle times while improving customer satisfaction;

 

Identify opportunities to improve self-service applications;

 

Improve cross-sell and up-sell success rates;

 

Improve the efficiency and effectiveness of collection efforts;

 

Measure and improve supervisor effectiveness and coaching;

 

Improve agent effectiveness by analyzing key attributes of desktop usage;

 

Predict likelihood of customer attrition;

 

Predict customer satisfaction and Net Promoter Scores® without customer surveys;

 

Predict likelihood of debt repayment;

 

Predict likelihood of a sale or cross-sell; and

 

Identify fraudulent callers and improve authentication processes.

Our mission is to help brands have more effective and effortless conversations with their customers. Using a suite of innovative personality-based software applications, we can analyze and predict customer behavior based on the language exchanged during service and sales interactions. We operate a highly scalable, flexible, and adaptive application platform to enable clients to implement and operate these applications.

12


 

Business Metrics

We regularly review our business metrics to evaluate our business, measure our performance, identify trends in our business, prepare financial projections, and make strategic decisions.

ACV Bookings.  We estimate annual contract value (ACV) of bookings as equal to the projected subscription and other billings for new customer contracts executed in the quarter, realized growth on existing customer accounts beyond the original booking, and committed future growth. We regularly review ACV bookings on a rolling four quarter basis and also review the percentage of ACV bookings generated by new customers. We use this to measure the effectiveness of our sales and marketing investments and as an indicator of potential future billings.  

Backlog.  We calculate backlog as the ACV of bookings for which we have not yet deployed our services to the customer.  We use this to measure the average time to deploy our bookings and as an indicator of potential future billings.

Gross Margin.  We calculate gross margin as the difference between our total revenue and the total cost of revenue, divided by total revenue, expressed as a percentage. We use this to measure the efficiency of our service delivery organization.

Performance Highlights

The following table presents our key metrics for the periods presented:

 

 

 

 

 

 

 

 

 

Quarter Ended

 

(Dollars in millions)

 

 

March 31,

2017

 

 

June 30,

2017

 

 

 

September 30,

2017

 

ACV bookings

 

 

$

3.5

 

 

$

2.5

 

 

 

$

5.2

 

Rolling four quarters ACV bookings

 

 

$

19.0

 

 

$

17.1

 

 

 

$

17.6

 

Backlog

 

 

$

14.5

 

 

$

13.1

 

 

 

$

14.6

 

Gross margin

 

 

 

69

%

 

 

69

%

 

 

 

73

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quarter Ended

 

(Dollars in millions)

 

 

March 31,

2016

 

 

June 30,

2016

 

 

 

September 30,

2016

 

ACV bookings

 

 

$

5.4

 

 

$

4.4

 

 

 

$

4.7

 

Rolling four quarters ACV bookings

 

 

$

25.1

 

 

$

23.7

 

 

 

$

21.5

 

Backlog

 

 

$

17.9

 

 

$

23.1

 

 

 

$

19.2

 

Gross margin

 

 

 

68

%

 

 

65

%

 

 

 

67

%

 

Business Outlook

Based on research from third-party analysts, we believe the call center industry is ripe for disruption and innovation. We believe what the call center was designed to accomplish and how it was measured are parts of an outdated mode of business that is disconnected from the needs of today’s consumer. In fact, research from the Corporate Executive Board suggests that any call center interaction is four times more likely to drive customer disloyalty than increased loyalty. Given a rise in self-service, these interactions are only becoming more complex and fraught with greater risk.

Through our product offerings, we seek to provide our clients with personality-based software applications that mitigate the complexity and reduce the risk of these call center interactions. According to Gartner, Inc., there were six million call center seats in North America in 2015, and less than 1% of this market is penetrated by personality-based software applications. We believe that we are uniquely positioned to capitalize on this opportunity. Our strategy to increase revenue and capture market share includes the following elements:

 

Drive new bookings growth and increase operating leverage;

 

Leverage a “land and expand” model, focused on personality-based routing as the catalyst for new client acquisition;

 

Cross-sell coaching, quality assurance, and analytic products after delivering a routing solution;

 

Continue to invest in innovative linguistic models and behavioral science;

 

Expand our sales and marketing capacity; and

 

Test the applicability of our proprietary personality-based software applications with clients outside of the call center industry.

13


 

Our personality-based software applications, which have been developed through substantial investment over the past decade, are deeply embedded into our clients’ infrastructure and workflows. Our long-term client relationships are made up largely of multi-year contracts with high contract renewal rates. Our aspiration is that our “land and expand” model, focused on our routing product, will continue to accelerate the acquisition of new clients.

Results of Operations

 

 

 

Quarter Ended

 

 

Nine Months Ended

 

(Dollars in millions)

 

Sept. 30, 2017

 

 

Sept. 30, 2016

 

 

Change

 

 

Sept. 30, 2017

 

 

Sept. 30, 2016

 

 

Change

 

Total revenue

 

$

11.3

 

 

$

10.4

 

 

 

9

%

 

$

32.9

 

 

$

29.5

 

 

 

11

%

Total cost of revenue, exclusive of

   depreciation and amortization

 

 

3.1

 

 

 

3.4

 

 

 

(9

)%

 

 

9.9

 

 

 

9.9

 

 

 

Other operating expenses

 

 

10.9

 

 

 

12.0

 

 

 

(9

)%

 

 

33.9

 

 

 

36.3

 

 

 

(6

)%

Operating loss

 

 

2.7

 

 

 

5.0

 

 

 

(47

)%

 

 

10.9

 

 

 

16.6

 

 

 

(34

)%

Non-operating expenses

 

 

0.4

 

 

 

0.8

 

 

 

(53

)%

 

 

3.8

 

 

 

1.2

 

 

 

218

%

Net loss

 

 

3.0

 

 

 

5.8

 

 

 

(48

)%

 

 

14.8

 

 

 

17.9

 

 

 

(17

)%

 

Revenue

Total revenue increased by $0.9 million in the third quarter and by $3.3 million in the first nine months of 2017 compared with the same periods in 2016. Subscription revenue in the third quarter increased by $1.1 million and in the first nine months of 2017 by $3.6 million compared with the same periods in 2016. The increase in the third quarter of 2017 was primarily due to $0.7 million from growth within existing client contracts and $0.8 million from new client contracts, partially offset by a decrease of $0.4 million from terminating contracts. The increase in the first nine months of 2017 was primarily due to $3.5 million from growth within existing client contracts and $1.5 million from new client contracts, partially offset by a decrease of $1.4 million from terminating contracts.

We received a substantial portion of our revenue from a limited number of clients. Higher concentration of revenue with a single client or a limited group of clients creates increased revenue risk if one of these clients significantly reduces its demand for our services.

Highest Revenue Generating Clients:

 

 

 

Quarter Ended

 

 

Nine Months Ended

 

 

 

Sept.  30,

 

 

Sept.  30,

 

 

Sept. 30,

 

 

Sept. 30,

 

(% of total revenue)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Top 5 Clients

 

 

71

%

 

 

76

%

 

 

74

%

 

 

73

%

Top 10 Clients

 

 

88

%

 

 

90

%

 

 

88

%

 

 

89

%

 

 

Clients Accounting for 10% or More of Total Revenue:

 

 

 

Quarter Ended

 

 

Nine Months Ended

 

 

 

Sept. 30,

 

 

Sept. 30,

 

 

Sept. 30,

 

 

Sept. 30,

 

(% of total revenue)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

United HealthCare Services, Inc.

 

 

27

%

 

 

35

%

 

 

29

%

 

 

33

%

CVS Caremark Corporation

 

 

17

%

 

 

15

%

 

 

17

%

 

 

15

%

TriWest Healthcare Alliance Corp

 

 

14

%

 

 

9

%

 

 

15

%

 

 

8

%

Progressive Casualty Insurance Company

 

 

8

%

 

 

13

%

 

 

9

%

 

 

13

%

 

14


 

Total Cost of Revenue, Exclusive of Depreciation and Amortization

Total costs of revenue consisted of $2.4 million of subscription revenue costs and $0.8 million of other revenue costs in the third quarter; and $7.6 million of subscription revenue costs and $2.3 million of other revenue costs in the first nine months of 2017. Cost of subscription revenue was $2.4 million, or 22% of subscription revenue, in third quarter, when compared with $2.8 million, or 29% of subscription revenue, in the same period in 2016. The decrease in cost of subscription revenue in the third quarter was primarily due to an increase in deferrals for deployments as well as a decrease in maintenance costs. Cost of subscription revenue was $7.6 million, or 24% of subscription revenue, in the first nine months of 2017, when compared with $7.8 million, or 29% of subscription revenue, in the same period in 2016. The decrease in cost of subscription revenue in the first nine months of 2017 was primarily due to a decrease in maintenance costs, partially offset by incremental personnel costs.

Other Operating Expenses

Other operating expenses include product development, sales and marketing, general and administrative, and depreciation and amortization.

 

 

 

Quarter Ended

 

 

Nine Months Ended

 

(Dollars in millions)

 

Sept. 30, 2017

 

 

Sept. 30, 2016

 

 

Change

 

 

Sept. 30, 2017

 

 

Sept. 30, 2016

 

 

Change

 

Product development

 

$

3.3

 

 

$

3.0

 

 

 

10

%

 

$

10.2

 

 

$

9.6

 

 

 

6

%

Sales and marketing

 

 

3.1

 

 

 

4.6

 

 

 

(34

)%

 

 

9.5

 

 

 

13.4

 

 

(29

)%

General and administrative

 

 

2.9

 

 

 

2.9

 

 

 

 

 

 

9.3

 

 

 

9.0

 

 

 

4

%

Depreciation and amortization

 

 

1.6

 

 

 

1.5

 

 

 

9

%

 

 

4.9

 

 

 

4.3

 

 

 

14

%

    Other Operating expenses

 

 

10.9

 

 

 

12.0

 

 

 

(9

)%

 

 

33.9

 

 

 

36.3

 

 

 

(6)

%

 

Other operating expenses decreased due to decreases in sales and marketing expenses, partially offset by increases in product development, general and administrative, and depreciation and amortization expense.

Product development expenses increased in the third quarter and in the first nine months of 2017 compared with the same periods in 2016 as a result of higher hardware and software maintenance costs associated with increased investments in technology for customer deployments.

Sales and marketing expenses consist primarily of salaries, incentive compensation, commissions, and employee benefits for business development, account management, and marketing. Sales and marketing expenses decreased by $1.6 million in the third quarter and by $3.9 million in the first nine months of 2017 compared with the same periods in 2016. The decreases are primarily due to a reduction in headcount.

General and administrative expenses increased in the first nine months of 2017 compared with the same period in 2016. The increase in expense is due to relocation expenses associated with the new Austin office location.

Depreciation and amortization increased by $0.1 million in the third quarter and by $0.6 million in the first nine months of 2017 compared with the same periods in 2016. The increase is primarily as a result of increased investments in technology equipment for customer deployments.

Non-Operating Expenses

Non-operating expenses consist primarily of interest and other borrowing costs, loss on early extinguishment of debt, changes in the fair value of the warrant liability and other non-operating income. Non-operating expenses decreased by $0.4 million in the third quarter and increased by $2.6 million in the first nine months of 2017 compared with the same periods in 2016.

Interest and other borrowing costs decreased by $0.5 million in the third quarter and increased by $1.1 million in the first nine months of 2017 compared with the same periods in 2016. The decrease in the third quarter of 2017 is a result of the termination of the Hercules debt at the end of the second quarter of 2017, lower debt subsequent to that termination and more favorable  financing terms on the new revolving debt agreement with CIBC Bank USA f/k/a The PrivateBank and Trust Company (CIBC). The increase in the first nine months of 2017 is a result of the interest expense on the Hercules debt for six months and on the CIBC debt for three months.

15


 

The loss on the early extinguishment of Hercules debt totaled $1.8 million at June 29, 2017. It consisted of a prepayment charge of $0.7 million, acceleration of unaccreted debt discount of $0.6 million, and acceleration of unamortized deferred debt costs of $0.5 million.

Income Tax Provision

Net deferred tax assets consist primarily of U.S. and non-U.S. net operating losses. Due to uncertainty in predicting when we will achieve the profitability required to utilize our operating losses, we have recognized a valuation allowance for the full amount of our net deferred tax assets. As of September 30, 2017 and 2016, total net deferred tax assets of approximately $89.0 million and $82.0 million, respectively, were fully offset by a valuation allowance.

Liquidity and Capital Resources

Sources and Uses of Cash  

Our principal cash requirements are to fund working capital needs, investments in Behavioral Analytics technology and infrastructure, and other revenue-generating and growth investments. Cash and cash equivalents were $8.0 million and $12.5 million at September 30, 2017 and December 31, 2016, respectively.

Net cash used in operating activities decreased by $7.6 million in the first nine months of 2017 when compared with the same period in 2016. This was largely attributable to growth in customer base and a decrease in operating expenses in 2017. The growth in customer base resulted in an additional $3.6 million in earned revenue. Cash provided by collections on accounts receivable improved by $1.8 million and unearned revenue increased by $4.9 million when compared with the first nine months of 2016. Lower headcount in the sales and marketing department contributed to the decreased net loss and net cash used in operating activities. Cash used in investing activities decreased by $0.3 million in the first nine months of 2017 when compared with the same period in 2016 due to lower patent activity. Net cash provided by financing activities decreased by $17.8 million in the first nine months of 2017 when compared with the same period in 2016, primarily as a result of $23.8 million of cash used to repay in full the principal balance and accrued and unpaid interest outstanding under the term loan with Hercules, partially offset by net $14.9 million of proceeds drawn on our credit line with CIBC (see Credit Facility below) and $14.7 million, net of fees received from the sale of 5,328,187 shares of common stock pursuant to a private placement of common stock.

Historically, we have not paid cash dividends on our common stock, and we do not expect to do so in the future. Our 7% Series B convertible preferred stock (Series B stock) accrues dividends at a rate of 7% per year, payable semi-annually in January and July if declared by our board of directors. If not declared, unpaid dividends are cumulative and accrue at the rate of 7% per year. The board of directors has not declared a dividend payment on the Series B stock, which has been accrued, from July 1, 2012 through September 30, 2017 (the aggregate amount of these dividends was approximately $3.1 million). Payment of future dividends on the Series B stock will be determined by the board of directors based on our business outlook and macroeconomic conditions and may not exceed $0.2 million in the aggregate in any calendar year, as per our loan agreement with CIBC. The amount of each dividend accrual will be decreased by any conversions of the Series B stock into common stock, as such conversions require us to pay accrued but unpaid dividends at the time of conversion. Conversions of Series B stock are at the option of the holder.

Liquidity

As of September 30, 2017, our near-term capital resources consisted of our current cash balance, together with anticipated future cash flows, financing from capital leases, and borrowing capacity (see Credit Facility below). We anticipate that our current unrestricted cash resources, together with operating revenue, capital lease financing, and borrowing capacity, should be sufficient to satisfy our short-term working capital and capital expenditure needs for the next twelve months. Management will continue to assess opportunities to maximize cash resources by actively managing our cost structure and closely monitoring the collection of our accounts receivable. If, however, our operating activities, capital expenditure requirements, or net cash needs differ materially from current expectations due to uncertainties surrounding the current capital market, credit and general economic conditions, competition, or the termination of a large client contract, then there is no assurance that we would have access to additional external capital resources on acceptable terms.

Credit Facility

On June 29, 2017, we entered into the loan agreement with CIBC. The loan agreement provides for a revolving line of credit to us with a maximum credit limit of $20.0 million, which matures on June 29, 2020 (the credit facility). The credit facility is secured by a security interest in the company’s assets. We, subject to certain limits and restrictions, may from time to time request the issuance of letters of credit under the loan agreement.

16


 

The principal amount outstanding under the credit facility will accrue interest at a floating annual rate equal to 1 month, 2 month or 3 month LIBOR (as selected by us) plus 4.50%, payable monthly. In addition, we will pay a non-use fee on the credit facility of 25 basis points (0.25%) per annum of the average unused portion of the credit facility.  The amount we may borrow under the credit facility is limited to five times our monthly recurring revenue (as determined in accordance with the terms and conditions set forth in the loan agreement), multiplied by a dynamic churn factor that is based upon the ratio of recurring revenue retained in the prior twelve month period relative to the total amount of recurring revenue at the beginning of the period.

The loan agreement imposes various restrictions on us, including usual and customary limitations on our ability to incur debt and to grant liens upon our assets, prohibits certain consolidations, mergers, and sales and transfers of assets by us and requires us to comply with total revenue and EBITDA (as adjusted in accordance with the loan agreement) targets. The loan agreement includes usual and customary events of default (with customary grace periods, as applicable) and provides that, upon the occurrence of an event of default, payment of all amounts payable under the loan agreement may be accelerated and/or the lender’s commitments may be terminated. In addition, upon the occurrence of certain insolvency or bankruptcy related events of default, all amounts payable under the loan agreement will automatically become immediately due and payable, and the lender’s commitments will automatically terminate.  

Prior to entering into the loan agreement with CIBC, we were party to a loan agreement with Hercules. On June 29, 2017, we drew $13.5 million on the credit facility to repay the principal balance of $22.5 million, $0.7 million of prepayment charges, and $0.6 million of accrued and unpaid interest under our prior credit facility with Hercules. Upon effectiveness of the loan agreement and repayment of the Hercules credit facility, we terminated our loan agreement with Hercules. 

Capital Lease Obligations

We are a party to capital lease agreements with leasing companies to fund our ongoing equipment requirements. Capital lease obligations were $3.7 million as of September 30, 2017 and $3.6 million as of December 31, 2016. We expect to incur new capital lease obligations of approximately $3.0 million for 2017 as we continue to expand our investment in the infrastructure for Behavioral Analytics. Certain leases are collateralized by $3.4 million in letters of credit secured by $3.0 million of restricted cash.

Accounts Receivable Customer Concentration

As of September 30, 2017, two clients, CVS Caremark Corporation and United HealthCare Services, Inc., accounted for 45% and 30% of total gross accounts receivable, respectively. Of these amounts, we have collected 73% from CVS Caremark Corporation and 52% from United HealthCare Services, Inc., through October 31, 2017. Of the total September 30, 2017 gross accounts receivable, we have collected 52% as of October 31, 2017. Because we have a high percentage of our revenue dependent on a relatively small number of clients, delayed payments by a few of our larger clients could result in a reduction of our available cash.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Historically, we have not experienced material fluctuations in our results of operations due to foreign currency exchange rate changes. We do not currently engage, nor is there any plan to engage, in hedging foreign currency risk.

We also have interest rate risk with respect to changes in variable interest rates on our borrowings and cash and cash equivalents. Interest on the loan agreement with CIBC is currently based on the floating annual rate equal to 1 month, 2 month or 3 month LIBOR (as selected by the company) plus 4.50%, payable monthly. Since the LIBOR rate varies in accordance with prevailing market conditions, a change in interest rate impacts interest and other borrowing costs and cash flows.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Management, with the participation of our Chief Executive Officer and Chief Financial Officer, has performed an evaluation of our disclosure controls and procedures that are defined in Rule 13a-15 of the Exchange Act as of the end of the period covered by this report. This evaluation included 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 or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that, as of September 30, 2017, our disclosure controls and procedures were effective.

17


 

Our management, including our Chief Executive Officer and Chief Financial Officer, has concluded that the financial statements included in this Quarterly Report on Form 10-Q present fairly, in all material respects, our financial position, results of operations, and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during the third quarter of 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 

 

 

18


 

Part II. Other Information

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

There are a number of risks and uncertainties that could adversely affect our business and our overall financial performance. In addition to the matters discussed elsewhere in this Quarterly Report on Form 10-Q, we believe the more significant of such risks and uncertainties include the following (for a description of the risk factors, see Item 1A. Risk Factors included in our Annual Report on Form 10-K for the year ended December 31, 2016):

 

We have not realized an operating profit in seventeen years and there is no guarantee that we will realize an operating profit in the foreseeable future.

 

Our financial results are subject to significant fluctuations because of many factors, any of which could adversely affect our stock price.

 

We depend on a limited number of clients for a significant portion of our revenue, and the loss of a significant client or a substantial decline in the size or scope of deployments for a significant client, could have a material adverse effect on our business.

 

We depend on good relations with our clients, and any harm to these good relations may materially and adversely affect our business and our ability to compete effectively.

 

We must maintain our reputation and expand our name recognition to remain competitive.

 

Our industry is very competitive and, if we fail to compete successfully, our market share and business will be adversely affected.

 

We must keep pace with the rapid rate of innovation in our industry in order to build our business.

 

Because our services and solutions are sophisticated, we must devote significant time and effort to our sales and installation processes, with significant risk of loss if we are not successful.

 

A breach of security, disruption or failure of our information technology systems or those of our third-party service providers could adversely impact our business, financial condition and results of operations.

 

The unauthorized disclosure of the confidential customer data that we maintain could result in a significant loss of business and subject us to substantial liability.

 

Our financial results could be adversely affected by economic and political conditions and the effects of these conditions on our clients’ businesses and levels of business activity.

 

We rely heavily on our senior management team for the success of our business.

 

Our ability to recruit talented professionals and retain our existing professionals is critical to the success of our business.

 

We have a limited ability to protect our intellectual property rights, which are important to our success and competitive position.

 

Others could claim that our services, products, or solutions infringe upon their intellectual property rights or violate contractual protections.

 

Increasing government regulation could cause us to lose clients or impair our business.

 

It may be difficult for us to access debt or equity markets to meet our financial needs.

 

The market price of our common stock is likely to be volatile and could subject us to litigation.

 

Because we do not anticipate paying any cash dividends on our common stock in the foreseeable future, capital appreciation, if any, will be your sole source of gains and you may never receive a return on your investment.

 

Our operating results may be negatively affected if we are required to collect sales tax or other transaction taxes on all or a portion of sales in jurisdictions where we are currently not collecting and reporting tax.

19


 

There have been no material changes in these risk factors from those described in our Annual Report on Form 10-K for the year ended December 31, 2016.

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

Repurchase of Equity Securities

The following table provides information relating to our purchase of shares of common stock in the third quarter of 2017. All of these purchases reflect shares withheld to satisfy tax withholding obligations related to vesting of restricted stock. We have not adopted a common stock repurchase plan or program.

 

Period

 

Total Number

of Shares

Purchased (1)

 

 

Average

Price Paid

Per Share

 

July 1, 2017 – July 31, 2017

 

 

753

 

 

$

2.90

 

August 1, 2017 – August 31, 2017

 

 

35,974

 

 

$

2.35

 

September 1, 2017 – September 30, 2017

 

 

 

 

 

 

 

Total

 

 

36,727

 

 

$

2.36

 

 

(1)

The shares reflected in this column were purchased in order to satisfy tax withholding obligations related to the vesting of restricted stock awards issued pursuant to our 1999 Stock Incentive Plan.

 

20


 

Item 6. Exhibits

 

3.1.1

 

Certificate of Incorporation of Mattersight Corporation, as amended (incorporated by reference to Exhibit 3.1 to Amendment No. 1 to Mattersight Corporation’s Registration Statement on Form S-1 (File No. 333-94293) as filed with the Securities and Exchange Commission on February 1, 2000).

 

 

 

3.1.2

 

Certificate of Amendment to Mattersight Corporation’s Certificate of Incorporation effective December 19, 2001 (incorporated by reference to Exhibit 3.3 to Mattersight Corporation’s Annual Report on Form 10-K (File No. 000-27975) as filed with the Securities and Exchange Commission on March 28, 2002).

 

 

 

3.1.3

 

Certificate of Amendment to Mattersight Corporation’s Certificate of Incorporation effective December 19, 2001 (incorporated by reference to Exhibit 3.4 to Mattersight Corporation’s Annual Report on Form 10-K (File No. 000-27975) as filed with the Securities and Exchange Commission on March 28, 2002).

 

 

 

3.1.4

 

Certificate of Amendment to Mattersight Corporation’s Certificate of Incorporation effective May 31, 2011 (incorporated by reference to Exhibit 3.1 to Mattersight Corporation’s Current Report on Form 8-K (File No. 000-27975) as filed with the Securities and Exchange Commission on May 31, 2011).

 

 

 

3.2.1

 

By-Laws of Mattersight Corporation (incorporated by reference to Exhibit 3.2 to Amendment No. 1 to Mattersight Corporation’s Registration Statement on Form S-1 (File No. 333-94293) as filed with the Securities and Exchange Commission on February 1, 2000).

 

 

 

3.2.2

 

Amendment to By-Laws of Mattersight Corporation (incorporated by reference to Exhibit 3.1 to Mattersight Corporation’s Current Report on Form 8-K (File No. 000-27975) as filed with the Securities and Exchange Commission on November 16, 2007).

 

 

 

4.1

 

Reference is made to Exhibits 3.1.1, 3.1.2, 3.1.3, 3.1.4, 3.2.1 and 3.2.2 hereof.

 

 

 

4.2

 

Certificate of Designations of 7% Series B Convertible Preferred Stock of Mattersight Corporation, filed December 19, 2001 (incorporated by reference to Exhibit 3.6 to Mattersight Corporation’s Annual Report on Form 10-K (File No. 000-27975) as filed with the Securities and Exchange Commission on March 28, 2002).

 

 

 

**31.1

 

Certification of Kelly D. Conway under Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

**31.2

 

Certification of David B. Mullen under Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

**32.1

 

Certification of Kelly D. Conway and David B. Mullen under Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

**101   

 

The following materials from our Quarterly Report on Form 10-Q for the quarter ended September 30, 2017 are formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016, (ii) Consolidated Statements of Operations for the quarter ended and nine months ended September 30, 2017 and September 30, 2016, (iii) Consolidated Statements of Comprehensive Loss for the quarter ended and nine months ended September 30, 2017 and September 30, 2016, (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and September 30, 2016, and (v) Notes to the Unaudited Consolidated Financial Statements.

 

**

Filed herewith.

 

 

21


 

SIGNATURES

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, on November 7, 2017.

 

MATTERSIGHT CORPORATION

 

 

 

By

 

/s/ DAVID B. MULLEN

 

 

David B. Mullen

 

 

Senior Vice President and

Chief Financial Officer

 

 

(Duly authorized signatory and

 

 

Principal Financial Officer)

 

 

 

By

 

/s/ ROSE CAMMARATA

 

 

Rose Cammarata

 

 

Vice President and Controller

 

 

(Duly authorized signatory and

 

 

Principal Accounting Officer)

 

 

22