XNAS:GUID Guidance Software Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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 June 30, 2012

 

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.)

 

 

 

215 North Marengo Avenue

 

 

Pasadena, California 91101

 

(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  o    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 July 30, 2012, there were approximately 24,892,000 shares of the registrant’s Common Stock outstanding.

 

 

 


 


Table of Contents

 

GUIDANCE SOFTWARE, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2012

 

Table of Contents

 

 

 

 

Page

PART I - FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

1

 

Condensed Consolidated Balance Sheets at June 30, 2012 and December 31, 2011

 

1

 

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2012 and 2011

 

2

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011

 

3

 

Notes to the Condensed Consolidated Financial Statements

 

4

Item 2.

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

 

19

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

29

Item 4.

Controls and Procedures

 

29

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

29

Item 1A.

Risk Factors

 

30

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

30

Item 3.

Defaults upon Senior Securities

 

31

Item 4.

Removed and Reserved

 

31

Item 5.

Other Information

 

31

Item 6.

Exhibits

 

32

 

 

 

 

Signatures

 

 

33

 



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)

 

 

 

June 30,
2012

 

December 31,
2011

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

23,917

 

$

37,048

 

Trade receivables, net of allowance for doubtful accounts of $785 and $520, respectively

 

19,689

 

19,505

 

Inventory

 

1,961

 

1,394

 

Prepaid expenses and other current assets

 

4,260

 

2,209

 

Total current assets

 

49,827

 

60,156

 

 

 

 

 

 

 

Long-term assets:

 

 

 

 

 

Property and equipment, net

 

9,921

 

9,273

 

Intangible assets, net

 

16,308

 

3,754

 

Goodwill

 

16,132

 

3,711

 

Other assets

 

1,231

 

434

 

Total long-term assets

 

43,592

 

17,172

 

 

 

 

 

 

 

Total assets

 

$

93,419

 

$

77,328

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

3,490

 

$

2,895

 

Accrued liabilities

 

14,305

 

9,774

 

Capital lease obligations

 

506

 

58

 

Deferred revenues

 

32,209

 

33,630

 

Total current liabilities

 

50,510

 

46,357

 

 

 

 

 

 

 

Long-term liabilities:

 

 

 

 

 

Rent incentives

 

396

 

498

 

Capital lease obligations

 

310

 

55

 

Deferred revenues

 

6,181

 

5,952

 

Contingent earn-out, net of current portion

 

3,189

 

 

Deferred tax liabilities

 

251

 

155

 

Other long-term liabilities

 

458

 

 

Total long-term liabilities

 

10,785

 

6,660

 

 

 

 

 

 

 

Contingencies (Note 13)

 

 

 

 

 

 

 

 

 

 

 

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; 26,300,000 and 24,631,000 shares issued, respectively; and 24,879,000 and 23,342,000 shares outstanding, respectively

 

25

 

23

 

Additional paid-in capital

 

88,469

 

74,297

 

Treasury stock, at cost, 1,421,000 and 1,288,000 shares, respectively

 

(7,792

)

(6,594

)

Accumulated deficit

 

(48,578

)

(43,415

)

Total stockholders’ equity

 

32,124

 

24,311

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

93,419

 

$

77,328

 

 

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

 

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Table of Contents

 

GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Revenues:

 

 

 

 

 

 

 

 

 

Product revenue

 

$

12,042

 

$

11,186

 

$

22,551

 

$

20,740

 

Subscription revenue

 

2,843

 

 

4,068

 

 

Services and maintenance revenue

 

16,183

 

12,705

 

30,468

 

26,728

 

Total revenues

 

31,068

 

23,891

 

57,087

 

47,468

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Cost of product revenue

 

1,904

 

1,625

 

3,587

 

2,910

 

Cost of subscription revenue

 

1,283

 

 

1,869

 

 

Cost of services and maintenance revenue

 

6,097

 

5,586

 

11,547

 

11,884

 

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

 

9,284

 

7,211

 

17,003

 

14,794

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling and marketing

 

9,914

 

8,686

 

18,551

 

16,815

 

Research and development

 

6,294

 

4,797

 

11,584

 

9,569

 

General and administrative

 

5,092

 

3,238

 

11,312

 

8,045

 

Depreciation and amortization

 

1,964

 

1,287

 

3,590

 

2,528

 

Total operating expenses

 

23,264

 

18,008

 

45,037

 

36,957

 

Operating income (loss)

 

(1,480

)

(1,328

)

(4,953

)

(4,283

)

Other income and expense:

 

 

 

 

 

 

 

 

 

Interest income

 

8

 

11

 

22

 

20

 

Interest expense

 

(25

)

(2

)

(38

)

(5

)

Other income, net

 

9

 

4

 

15

 

4

 

Total other income and expense

 

(8

)

13

 

(1

)

19

 

Income (loss) before income taxes

 

(1,488

)

(1,315

)

(4,954

)

(4,264

)

Income tax provision

 

75

 

58

 

209

 

154

 

Net income (loss)

 

$

(1,563

)

$

(1,373

)

$

(5,163

)

$

(4,418

)

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.06

)

$

(0.06

)

$

(0.21

)

$

(0.19

)

Diluted

 

$

(0.06

)

$

(0.06

)

$

(0.21

)

$

(0.19

)

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares used in per share calculation:

 

 

 

 

 

 

 

 

 

Basic

 

24,767

 

23,248

 

24,274

 

23,145

 

Diluted

 

24,767

 

23,248

 

24,274

 

23,145

 

 

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

 

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Table of Contents

 

GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

Operating Activities:

 

 

 

 

 

Net loss

 

$

(5,163

)

$

(4,418

)

Adjustments to reconcile net loss to net cash (used in) provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

3,590

 

2,528

 

Provision for doubtful accounts

 

100

 

 

Share-based compensation

 

2,756

 

3,035

 

Deferred taxes

 

96

 

101

 

Loss on disposal of assets

 

18

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Trade receivables

 

2,788

 

768

 

Inventory

 

(567

)

82

 

Prepaid expenses and other assets

 

(29

)

(404

)

Accounts payable

 

(35

)

175

 

Accrued liabilities

 

(1,164

)

(611

)

Deferred revenue

 

(4,492

)

421

 

Net cash (used in) provided by operating activities

 

(2,102

)

1,677

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

Purchase of property and equipment

 

(1,424

)

(1,126

)

Acquisition, net of cash acquired

 

(9,642

)

 

Net cash used in investing activities

 

(11,066

)

(1,126

)

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

Proceeds from the exercise of stock options

 

1,919

 

366

 

Common stock repurchased or withheld

 

(1,198

)

(794

)

Principal payments on capital lease and other obligations

 

(684

)

(40

)

Net cash provided by (used in) financing activities

 

37

 

(468

)

Net (decrease) increase in cash and cash equivalents

 

(13,131

)

83

 

Cash and cash equivalents, beginning of period

 

37,048

 

27,621

 

Cash and cash equivalents, end of period

 

$

23,917

 

$

27,704

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Net cash paid during the period for:

 

 

 

 

 

Interest

 

$

36

 

$

2

 

Income taxes

 

$

47

 

$

33

 

 

 

 

 

 

 

Non-cash activities:

 

 

 

 

 

Purchase of equipment included in accounts payable and accrued expenses

 

$

460

 

$

274

 

 

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

 

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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” 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 defend 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, described below, are built;

 

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

 

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® 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;

 

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

 

CaseCentral®, a cloud-based document review and production software-as-a-service for corporations and law firms.

 

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.

 

Note 2. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying condensed consolidated balance sheet as of June 30, 2012 and the condensed consolidated statements of operations for the three and six months ended June 30, 2012 and 2011 and cash flows for the six months ended June 30, 2012 and 2011 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, 2011, filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 16, 2012. The operating results for the three and six month period ended June 30, 2012 and cash flows for the six month period ended June 30, 2012 are not necessarily indicative of the results that will be achieved for the full fiscal year or for future periods.

 

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 the Annual Report on Form 10-K for the year ended December 31, 2011 and include all adjustments necessary for the fair presentation of our financial position as of June 30, 2012 and our results of operations for the three and six months ended June 30, 2012 and 2011 and our cash flows for the six month period ended June 30, 2012 and 2011. The condensed consolidated balance sheet as of December 31, 2011 has been derived from the December 31, 2011 audited financial statements. The interim financial information contained in this Quarterly Report is not necessarily indicative of the results to be expected for any other interim period or for the entire year.

 

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Table of Contents

 

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 disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate these estimates, including those related to revenue recognition, share-based compensation, bad debts, income taxes, commitments, 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 cash in excess of our daily operating needs 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 date of purchase are classified as cash and cash equivalents.

 

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.

 

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 written down to net realizable value.

 

Business Combinations

 

The purchase price of an acquisition is allocated to the underlying assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. To the extent the purchase price exceeds the fair value of the net identifiable tangible and intangible assets acquired and liabilities assumed, such excess is allocated to goodwill. We determine the estimated fair values after review and consideration of relevant information including discounted cash flows, quoted market prices and estimates made by management. Accordingly, these can be affected by certain performance measurements and other factors over time, which may cause final amounts to differ materially from original estimates. We adjust the preliminary purchase price allocation, as necessary, up to periods of one year after the acquisition closing date as we obtain more information regarding asset valuations and liabilities assumed.  We refer to this preliminary purchase price allocation period as the measurement period.

 

Goodwill acquired in business combinations is assigned to the reporting unit(s) expected to benefit from the combination as of the acquisition date.  Acquisition related costs are recognized separately from the acquisition and are expensed as incurred.

 

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Table of Contents

 

Amortization of Intangible Assets with Finite Lives

 

Intangible assets with finite lives are carried at the implied fair value of such assets at the time of acquisition.  With the exception of our customer relationships intangible asset, which is amortized on a double-declining basis, the implied 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. For the annual goodwill impairment test, the Company has the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If this is not the case, goodwill is not impaired and no further steps are required.  If the Company elects not to first perform the qualitative assessment option, or it performs such assessment and determines that the fair value of a reporting unit is less than its carrying amount, it is required to perform a two-step test 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. If the carrying value of an indefinite-lived intangible asset exceeds its implied fair value, an impairment loss equal to the difference will be recorded.

 

Application of the impairment test requires significant judgment to estimate the fair value. Changes in estimates and assumptions could materially affect the determination of fair value and/or impairment.

 

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 June 30, 2012, 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 $23.1 million as of June 30, 2012.  At June 30, 2012, 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 EnCase®Enterprise and EnCase® Forensic software products.  Revenue associated with the sale of software licenses and revenue associated with forensic hardware sales are referred to as product revenue.  With the acquisition of CaseCentral in February of 2012, we now have 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 revenue.  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 revenue.

 

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),  Software Industry-Revenue Recognition 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.

 

When arrangements involve multiple elements that qualify as separate units of accounting, the consideration is allocated at inception of the arrangement to all deliverables based on the relative selling price method in accordance with the selling price hierarchy, which includes:  1) vendor-specific objective evidence of fair value (“VSOE”), if available, 2) third-party evidence (“TPE”) if VSOE is not available, or 3) best estimate of selling price (“BESP”) if neither VSOE nor TPE is available.

 

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Table of Contents

 

·                  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 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 is unable to 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 was 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.

 

We have established VSOE for our proprietary products and services, but have not established VSOE or TPE for our subscription services or usage-based fee arrangements and therefore we use BESP to allocate the selling price to subscription services and usage-based fee deliverables.

 

Product revenue.  The timing of product revenue recognition is dependent on the nature of the product sold. We do not have any product offerings where software components and non-software components function together to deliver the tangible product’s essential functionality. Product arrangements comprising multiple deliverables including software and hardware are generally categorized into one of the following:

 

·                          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 (“VSOE”) of fair value, is recognized upon delivery, provided that all other criteria for revenue recognition have been met.

 

·                          Hardware: 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, that are determined monthly, are recognized when incurred.

 

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

 

Training revenues are 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.

 

Revenue related to technical support and software updates on a when-and-if available basis is referred to as maintenance revenue. We recognize maintenance revenue ratably over the applicable maintenance period. We determine the amount of maintenance revenue to be deferred 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, is comparable to the normal pricing for maintenance only renewals.

 

Revenue Recognition Criteria. Our basic revenue recognition criteria are as follows:

 

·                          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 evidence of an arrangement.

 

·                          Product delivery: We deem delivery of a product to have occurred when the title and risk of ownership have passed to the buyer. Services revenue is recognized as delivered.

 

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·                          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 revenue as amounts become due and payable 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 a customer will pay amounts due under an arrangement as they become due.

 

Recent Accounting Pronouncements

 

Accounting standards updates effective after June 30, 2012 are not expected to have a material effect on the Company’s consolidated financial position or results of operations.

 

 

Note 3. Business Combination

 

On February 21, 2012, we acquired CaseCentral Inc. (“CaseCentral”), a privately held cloud-based document review and production software-as-a-service (“SAAS”) provider for an aggregate purchase price of approximately $25.6 million, consisting of $9.6 million in cash (net of $1.4 million in cash acquired), $9.5 million of our common stock, consisting of 849,554 shares valued at the market price of $11.18 per share on the closing date of the transaction, and contingent consideration which had a fair value of $5.1 million as of the closing date of the transaction. Both the issuance of shares valued at $9.5 million and the contingent consideration of $5.1 million are reflected as noncash activities in the accompanying condensed consolidated statements of cash flows for the six months ended June 30, 2012. Depending on CaseCentral’s SaaS revenue over the next three years, we may be required to pay up to a maximum of $33.0 million in cash to CaseCentral’s former shareholders over the three 12-month periods starting April 1, 2012.  The estimated fair value of the contingent consideration is determined as described in Note 12.  We incurred $2.2 million in acquisition-related costs during the six months ended June 30, 2012 which were expensed as incurred and included in general and administrative expenses.

 

We acquired CaseCentral to extend our market leadership by delivering a complete and integrated platform solving the e-discovery needs of corporate and government customers. The CaseCentral acquisition closed on February 21, 2012 and the results of operations of CaseCentral have been included in the Company’s condensed consolidated financial statements subsequent to such date.  CaseCentral’s revenues, expenses and net income included in the Condensed Consolidated Statements of Operations from the acquisition date through June 30, 2012 were as follows (in thousands):

 

 

 

Three Months Ended
June 30, 2012

 

Six Months Ended
June 30, 2012

 

Revenue

 

$

4,219

 

$

6,043

 

Expense

 

4,944

 

7,161

 

Net income (loss)

 

$

(725

)

$

(1,118

)

 

The assets and liabilities of CaseCentral have been recorded at their estimated fair values at the date of acquisition. The excess of the purchase price over the estimated fair values of the underlying net tangible and identifiable intangible assets has been recorded as goodwill. The fair value of net tangible assets other than deferred revenue approximate their carrying values on the date of acquisition.  The fair value assigned to deferred revenue was determined based on estimated costs to fulfill the underlying service obligation. The fair value assigned to identifiable intangible assets was determined primarily by using a discounted cash flow method.  The acquisition transaction was a stock purchase in which the income tax attributes of CaseCentral carried over to the Company.  The estimated deferred income tax attributes of CaseCentral, after establishment of deferred income tax liabilities associated with the step-up of the fair values of the net assets acquired over their pre-acquisition tax basis, resulted in a net deferred income tax asset.  Given CaseCentral’s history of reporting net losses, our management concluded that realization of the net deferred income tax asset acquired is not likely and therefore a valuation allowance was established to offset the entire net deferred income tax asset.  As a result, deferred income taxes are not reflected in the table below.  The goodwill recognized for CaseCentral is attributable to intangible assets acquired that do not qualify for separate recognition, expected synergies that are projected to increase revenue and profits and an assembled workforce. The CaseCentral goodwill is assigned to our subscription reporting segment and is not tax deductible.

 

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The Company’s allocation of the purchase price is preliminary as the amounts related to contingent consideration, identifiable intangible assets, deferred revenue, and the effects of income taxes resulting from the transaction, are still being finalized. Any material measurement period adjustments will be recorded retroactively to the acquisition date.  During the quarter ended June 30, 2012, the Company adjusted CaseCentral’s purchase price allocation.  The adjustment was to recognize the final working capital adjustment according to the terms of the original agreement.  The adjustment was not material and had no impact on the condensed consolidated statement of operations; accordingly it is not presented retrospectively.  The purchase price allocation, subject to finalization during the measurement period, is as follows (in thousands):

 

 

 

Weighted Average
Estimated Useful
Life

 

 

 

Fair Market Values

 

Cash and cash equivalents

 

 

 

 

 

$

1,400

 

Accounts receivable

 

 

 

 

 

3,072

 

Prepaids & other assets

 

 

 

 

 

990

 

Property and equipment

 

 

 

 

 

1,101

 

Identifiable intangible assets:

 

 

 

 

 

 

 

Core & developed technology

 

7

 

$

7,500

 

 

 

Customer relationships

 

10

 

5,600

 

 

 

Trade name

 

3

 

600

 

 

 

Covenant not-to compete

 

5

 

200

 

 

 

Total identifiable intangible assets

 

 

 

 

 

13,900

 

Goodwill

 

 

 

 

 

12,421

 

Accounts payable and accrued expenses

 

 

 

 

 

(3,015

)

Capital lease obligations

 

 

 

 

 

(929

)

Deferred revenue

 

 

 

 

 

(3,300

)

Total purchase price

 

 

 

 

 

$

25,640

 

 

The following are the unaudited pro forma condensed consolidated financial statements of the combined entity for the three and six months ended June 30, 2012 and 2011 assuming the business combination had occurred on January 1, 2012 and January 1, 2011, respectively (in thousands, except per share amounts).

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Total revenues

 

$

31,068

 

$

28,554

 

$

59,759

 

$

57,273

 

Total net expenses

 

32,556

 

30,319

 

66,617

 

61,822

 

Loss before income taxes

 

(1,488

)

(1,765

)

(6,858

)

(4,549

)

Income tax provision

 

75

 

58

 

209

 

155

 

Net loss

 

$

(1,563

)

$

(1,823

)

$

(7,067

)

$

(4,704

)

Net loss per share — basic and diluted

 

$

(0.06

)

$

(0.08

)

$

(0.29

)

$

(0.20

)

 

Note 4. Net Income (Loss) Per Share

 

Basic net income (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the reporting period. Diluted net income (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.

 

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Table of Contents

 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(1,563

)

$

(1,373

)

$

(5,163

)

$

(4,418

)

Denominator:

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

24,767

 

23, 248

 

24,274

 

23, 145

 

Effect of dilutive share-based awards

 

 

 

 

 

Diluted weighted average shares outstanding

 

24,767

 

23, 248

 

24,274

 

23,145

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.06

)

$

(0.06

)

$

(0.21

)

$

(0.19

)

Diluted

 

$

(0.06

)

$

(0.06

)

$

(0.21

)

$

(0.19

)

 

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 1,988,000 and 5,472,000 shares as of June 30, 2012 and 2011, respectively.

 

Note 5. 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 June 30, 2012 and December 31, 2011 (in thousands):

 

 

 

June 30,
2012

 

December 31,
2011

 

Inventory:

 

 

 

 

 

Components

 

$

1,077

 

$

565

 

Finished goods

 

884

 

829

 

Total inventory

 

$

1,961

 

$

1,394

 

 

Note 6. Goodwill and Other Intangibles

 

We assess goodwill and indefinite-lived intangible assets for impairment annually as of April 30, or more frequently if circumstances indicate impairment may have occurred. Since the initial recording of the goodwill and indefinite-lived intangible assets balances reflected in the tables below, there have been no impairment charges related to such assets through June 30, 2012. 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 segment will not be deductible for tax purposes. The following table summarizes how goodwill is assigned to our reporting segments (in thousands):

 

 

 

 

Products

 

Subscription

 

Services

 

Maintenance

 

Total

 

Goodwill balance, December 31, 2011

 

$

3,711

 

$

 

$

 

$

 

$

3,711

 

Additions

 

 

12,307

 

 

 

12,307

 

Goodwill balance, March 31, 2012

 

3,711

 

12,307

 

 

 

16,018

 

Additions

 

 

114

 

 

 

114

 

Goodwill balance, June 30, 2012

 

$

3,711

 

$

12,421

 

$

 

$

 

$

16,132

 

 

In-process research and development intangible assets acquired are considered to be indefinite-lived until completion or abandonment of the associated research and development efforts. The Company will determine the estimated useful lives and amortization method of the asset upon completion of the research and development efforts. During the period the assets are considered indefinite-lived, impairment will be assessed annually or whenever events or changes in circumstances indicate that their carrying value may not be recoverable.  During the quarter ended June 30, 2012, the Company adjusted CaseCentral’s purchase price allocation thereby increasing goodwill by approximately $114,000.  The adjustment was to recognize the final working capital adjustment according to the terms of the original agreement.

 

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Table of Contents

 

The following table summarizes goodwill and indefinite-lived intangible assets (in thousands):

 

 

 

Goodwill

 

In-Process
Research and
Development

 

Total

 

Balance, December 31, 2011

 

$

3,711

 

$

332

 

$

4,043

 

Additions

 

12,307

 

 

12,307

 

Balance, March 31, 2012

 

16,018

 

332

 

16,350

 

Additions

 

114

 

 

114

 

Balance, June 30, 2012

 

$

16,132

 

$

332

 

$

16,464

 

 

In February 2012, the Company acquired CaseCentral resulting in acquired intangible assets. With the exception of customer relationships, which are amortized on a double-declining basis, the acquired intangible assets are being amortized over their estimated useful lives as noted in Note 3 above.

 

Amortization expense for intangible assets with finite lives was $0.8 million and $1.3 million, and $0.3 million and $0.2 million for the three and six months ended June 30, 2012 and 2011, respectively. The following table summarizes cumulative amortization expense related to intangible assets subject to amortization as of June 30, 2012 (in thousands):

 

 

 

 

June 30, 2012

 

December 31, 2011

 

 

 

Gross Costs

 

Accumulated
Amortization

 

Net

 

Gross Costs

 

Accumulated
Amortization

 

Net

 

Core technology

 

$

8,600

 

$

(619

)

$

7,981

 

$

1,100

 

$

(181

)

$

919

 

Existing and developed technology

 

1,968

 

(1,549

)

419

 

1,968

 

(1,260

)

708

 

Customer relationships

 

6,175

 

(727

)

5,448

 

575

 

(283

)

292

 

Trade names

 

2,400

 

(458

)

1,942

 

1,800

 

(297

)

1,503

 

Covenant not-to-compete

 

200

 

(14

)

186

 

 

 

 

Total

 

$

19,343

 

$

(3,367

)

$

15,976

 

$

5,443

 

$

(2,021

)

$

3,422

 

 

The following table summarizes the estimated remaining amortization expense through 2016 and thereafter (in thousands):

 

Year ending

 

Amortization
Expense

 

2012

 

$

1,425

 

2013

 

2,698

 

2014

 

2,478

 

2015

 

2,072

 

2016

 

1,910

 

Thereafter

 

5,393

 

Total amortization expense

 

$

15,976

 

 

Note 7. 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 June 30, 2012, 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.

 

In addition to the repurchased shares, the Company withheld approximately 63,000 and 132,000 common shares for the three and six months ended June 30, 2012 from employees to satisfy their personal income tax withholding requirements upon the vesting of restricted stock awards issued under our equity compensation plans. The Company may engage in similar transactions from time to time related to future vesting of employee restricted stock awards. See Part II. Item 2 of this Quarterly Report for further information regarding the share repurchase program.

 

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Table of Contents

 

Note 8. Debt Obligations

 

On July 12, 2012, we entered into a Loan and Security Agreement (the “Loan Agreement”) with a bank.  The Loan Agreement creates a line of credit to provide for one or more revolving loans, non-revolving loans or term loans and up to $3.0 million in standby letters of credit (the “Loans”).  The maximum principal amount of Loans that may be outstanding at any given time under the Loan Agreement, including standby letters of credit, is $7.0 million.  Any borrowings under the Loan Agreement would be collateralized by substantially all our assets.  The Loan Agreement requires that we remain in compliance with certain financial covenants, including that we maintain unrestricted cash and marketable securities of not less than $12.5 million, that we maintain a ratio of total funded indebtedness to Earnings Before Interest, Taxes, Depreciation, Amortization and stock compensation expense ("EBITDA") of not greater than 2.25 to 1, that we maintain a ratio of cash flow to current portion of long-term debt of not less than 1.25 to 1, and that we shall not allow a cumulative net loss of more than $5.0 million during any fiscal year.  Borrowings under the Loan Agreement bear interest at one of the following rates (as selected by us): a rate equal to the bank’s alternate base rate plus 1.00% or LIBOR plus 2.25%. All principal, interest and other amounts owing under the Loan Agreement will be due and payable in full on or prior to June 30, 2014. The Loan Agreement supersedes and replaces our Amended and Restated Credit Agreement, dated as of May 1, 2007, which would have expired on August 31, 2012.

 

As of June 30, 2012, we had an outstanding stand-by letter of credit in the amount of $112,500, related to one of our facility leases and another outstanding stand-by letter of credit in the amount of $150,000, related to equipment leases, both secured by our revolving line of credit with the bank. There were no amounts outstanding under this line of credit at June 30, 2012 or December 31, 2011.

 

During the six months ended June 30, 2012, the Company entered into a $1.5 million third-party software license agreement that authorizes the Company to integrate database software as a component of its products through November 2015.  The agreement also provides maintenance and support covering a two-year period for $0.3 million. Thereafter, maintenance and support can be renewed by the Company.  The $1.8 million is payable in eight quarterly installments of $229,000 through January 2014 and is reflected as a noncash financing activity in the accompanying condensed consolidated statements of cash flows for the six months ended June 30, 2012.  Payments of $0.5 million under the agreement were made during the three months ended June 30, 2012. The license, maintenance and remaining liability have been recorded on the accompanying consolidated balance sheets.

 

Note 9. Equity Incentive Plan

 

At our 2012 Annual Meeting of Stockholders, our stockholders approved the Second Amendment to the Guidance Software, Inc. Second Amended and Restated 2004 Equity Incentive Plan (the “Plan”).  The Second Amendment amended the Plan to:  increase the aggregate number of shares of our common stock available for awards under the Plan by an additional 2,500,000 shares, from 9,088,313 shares to a total of 11,588,313 shares;  prohibits the re-pricing of stock options and the cancellation of underwater options in exchange for cash payments or other awards, without the approval of our stockholders; provide that shares tendered or withheld to satisfy the grant or exercise price or tax withholding obligation pursuant to any award will count against the limit of shares available for awards under the Plan; and modify the initial and annual equity award grants to our non-employee directors.  Our Board of Directors approved the Second Amendment in March 2012, and approved by our stockholders at our 2012 Annual Meeting of Stockholders on May 9, 2012.  At June 30, 2012, approximately 2,463,000 shares were available for grant as options or nonvested share awards under the Plan.

 

The Guidance Software, Inc. First Amended and Restated 2004 Equity Incentive Plan originally became effective on November 10, 2006 and was amended on March 17, 2008 and February 13, 2009 to provide for certain annual equity award grants to non-employee members of the Company’s Board of Directors.  At the Company’s 2008 Annual Meeting of Stockholders the stockholders approved an amendment to the First Amended and Restated Plan that accelerated to July 1, 2008 the automatic increase in the number of shares available under the plan that was scheduled to occur on January 1, 2009.  On April 22, 2010, the stockholders approved the Plan which amended and restated the First Amended and Restated 2004 Equity Incentive Plan.  The Plan was amended on April 22, 2010 by the First Amendment thereto to modify the vesting schedule of the grants of annual restricted stock to non-employee directors.

 

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, 2011

 

3,377,000

 

$

8.39

 

5.1

 

$

2,884,000

 

Granted

 

 

$

 

 

 

 

 

Exercised

 

(375,000

)

$

5.13

 

 

 

 

 

Forfeited or expired

 

(70,000

)

$

12.02

 

 

 

 

 

Outstanding, June 30, 2012

 

2,932,000

 

$

8.72

 

4.67

 

$

6,375,000

 

 

 

 

 

 

 

 

 

 

 

Exercisable, June 30, 2012

 

2,211,000

 

$

8.19

 

4.23

 

$

5,337,000

 

 

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Table of Contents

 

We define in-the-money options at June 30, 2012 as options that had exercise prices that were lower than the $9.51 fair market value of our common stock at that date. The aggregate intrinsic value of options outstanding at June 30, 2012 is calculated as the difference between the exercise price of the underlying options and the fair market value of our common stock for the 1,372,000 shares that were in-the-money at that date, of which 1,151,000 were exercisable.

 

Restricted Stock Awards

 

During 2007, we began issuing restricted stock awards to certain directors, officers and employees under the Plan. 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, 2011

 

1,910,000

 

$

6.16

 

Granted

 

1,244,000

 

9.35

 

Vested

 

(445,000

)

6.42

 

Forfeited

 

(160,000

)

7.90

 

Outstanding, June 30, 2012

 

2,549,000

 

$

7.56

 

 

The total grant date fair value of shares vested under such grants during the six months ended June 30, 2012 was $2,856,000.

 

Note 10. Share-Based Compensation

 

We account for share-based compensation in accordance with Compensation-Stock Compensation (ASC 718). Share-based compensation expense for all share-based awards is recognized using the Black-Scholes option pricing model to determine the grant date fair value of share-based payments. We recognize the cost, net of an estimated forfeiture rate, as compensation expense on a straight-line basis over the vesting period.

 

The fair values of stock option awards granted under the Second Amended and Restated Plan were estimated at the date of grant using the Black-Scholes option pricing model and the following weighted average assumptions (no stock option awards have been issued since January 2011):

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

Risk-free interest rate

 

2.4

%

Dividend yield

 

%

Expected life (years)

 

6.25

 

Volatility

 

65.5

%

Weighted average grant date fair value

 

$

4.27

 

 

The volatility of our common stock is estimated at the date of grant based on a weighted-average of the implied volatility of publicly traded 30-day to 270-day options on the common stock of a select peer group of similar companies (“Similar Companies”), the historical volatility of the common stock of Similar Companies and, beginning in late 2007, the historical volatility of our common stock. The risk-free interest rate is based on the implied yield in effect at the time of each option grant, based on U.S. Treasury zero-coupon issues with equivalent remaining terms. We use an expected dividend yield of zero as we have no intention of paying any cash dividends on our common stock in the foreseeable future. Compensation-Stock Compensation requires us to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. We amortize share-based compensation on a straight-line basis over the requisite service period of the awards, which is generally the vesting period.  The expected term (life) of all stock option awards has been calculated using the weighted average expected life of each tranche of stock options, determined based on the sum of each tranche’s vesting period plus one-half of the period from the vesting date of each tranche to the stock option’s expiration because, due to the limited time our common stock has been publicly traded, we lack sufficient historical data to provide a reasonable basis to estimate the expected term of these options.

 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(in thousands)

 

Stock option awards

 

$

84

 

$

374

 

$

200

 

$

807

 

Restricted stock awards

 

1,375

 

1,107

 

2,556

 

2,228

 

Share-based compensation expense

 

$

1,459

 

$

1,481

 

$

2,756

 

$

3,035

 

 

As of June 30, 2012, there was approximately $0.4 million of total unrecognized share-based compensation cost related to stock options that is expected to be recognized over a weighted-average period of 1.6 years and approximately $17.2 million of total unrecognized share-based compensation cost related to restricted stock awards that is expected to be recognized over a weighted-average period of 3.2 years. We expect to record approximately $3.2 million in share-based compensation for the remainder of fiscal year 2012 related to stock options and restricted stock awards outstanding at June 30, 2012.

 

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Table of Contents

 

Note 11. 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 June 30, 2012, 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 have assumed the historical tax basis of all assets and liabilities, including net deferred tax assets and valuation allowance in our acquisition of CaseCentral.  Deferred taxes have been considered for the difference between fair market value measurement and historical tax basis of the underlying assets and liabilities.   We have adjusted our acquired deferred tax assets and valuation allowance by deferred tax liabilities identified in purchase accounting.  We do not expect any changes to our existing valuation allowance as a result of the business combination.

 

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. During the year ended December 31, 2011, our liability for uncertain tax positions was $0.4 million and the balance was unchanged at June 30, 2012. 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. The tax years 2008 through 2010 remain subject to review by the taxing authorities in several jurisdictions. Most foreign jurisdictions have statute of limitations that range from three to six years.

 

Note 12. Fair Value Measurements

 

We adopted Fair Value Measurements and Disclosures (ASC 820) effective January 1, 2008 for financial assets and liabilities measured at fair value on a recurring basis. Fair Value Measurements and Disclosures (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. Fair Value Measurements and Disclosures(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.

 

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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 June 30, 2012 and December 31, 2011 (in thousands):

 

 

 

Fair Value Measurements at June 30, 2012

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

U.S. Treasury Securities

 

$

5,999

 

$

5,999

 

$

 

$

 

Money market accounts

 

11,995

 

11,995

 

 

 

Total assets

 

$

17,994

 

$

17,994

 

$

 

$

 

Liabilities:

 

 

 

 

 

 

 

 

 

Acquisition contingent consideration earn-out

 

5,100

 

 

 

5,100

 

Total liabilities

 

$

5,100

 

$

 

$

 

$

5,100

 

 

 

 

Fair Value Measurements at December 31, 2011

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

Money market accounts

 

$

31,636

 

$

31,636

 

$

 

$

 

Total assets

 

$

31,636

 

$

31,636

 

$

 

$

 

 

The Company has obligations, to be paid in cash, to the former shareholders of CaseCentral if certain SaaS revenue thresholds are achieved during the three 12-month periods starting April 1, 2012.  The fair value of this contingent consideration is determined using an expected present value technique.  Expected cash flows are determined using the probability - weighted average of possible outcomes that would occur should certain revenue metrics be reached.  There are no market data available to use in valuing the contingent consideration; therefore, the Company developed its own assumptions related to the future financial performance of the businesses to evaluate the fair value of these liabilities.  As such, the contingent consideration is classified within Level 3, as described above.

 

In connection with estimating the fair value of the contingent consideration, the Company 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 will be reviewed quarterly based on the financial performance of the most recently completed fiscal quarter. An analysis will also be 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 will be updated for the latest information available.

 

The significant assumptions 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.

 

The liabilities for the contingent consideration were established at the time of the consummation of the CaseCentral acquisition and will be evaluated at each reporting period.  The current liability is included in the Condensed Consolidated Balance Sheets in accrued liabilities and the non-current portion is included in contingent earn-out, net of current portion.

 

The fair value of the contingent consideration did not change during the period from February 21, 2012, the closing date of the acquisition to, June 30, 2012.

 

Note 13. Contingencies

 

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 alleges 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 seeks 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 seeks injunctive relief barring the Company from the importation of products that allegedly infringe 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.  In April and May 2012, the ITC denied the summary disposition motions of all parties and scheduled a trial date for August 2012.

 

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On March 19, 2012, Lone Star Document Management, LLC (“Lone Star”) filed a complaint against CaseCentral in the United States District Court for the Eastern District of Texas.  The complaint alleges that certain SaaS applications of CaseCentral, which were acquired by us as a result of our acquisition of CaseCentral, infringe one of Lone Star’s patents relating to systems for proofing and reviewing multiple versions of a document simultaneously and notes or annotations made regarding that document.  The complaint seeks a permanent injunction, compensatory damages, interest, costs and attorneys’ fees.

 

We intend to defend the MyKey and Lone Star 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 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.

 

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.

 

Sales Tax Liabilities

 

The Company’s sales and use tax filings are subject to customary audits by authorities in the jurisdictions where it conducts business in the United States, which may result in assessments of additional taxes. During the three months ended March 31, 2011, we determined that additional sales taxes were probable of being assessed by a certain state as a result of the preliminary findings specific to a sales and use tax audit. As a result, we estimated an incremental sales tax liability of approximately $1.3 million, including interest and penalties of approximately $300,000, where applicable, during the three months ended March 31, 2011. The estimated incremental sales and use tax liability was based on a similar model that was being used by the state conducting the sales and use tax audit. The estimated liability is recorded in general and administrative expenses.

 

Note 14.    Stockholders’ Equity

 

During the three months ended March 31, 2012, as part of the purchase price of CaseCentral, the Company issued $9.5 million of Company common stock, consisting of 849,554 shares valued at the market price of $11.18 per share on the closing date of the transaction, as disclosed in Note 3.  As disclosed in Note 9, stock options for 375,000 shares of common stock for the six months ended June 30, 2012, were exercised at an average price per share of $5.13, resulting in an increase in stockholders’ equity of approximately $1.9 million.  During the six months ended June 30, 2012, approximately 445,000 restricted stock awards vested and as a result, the Company withheld approximately 132,000 shares for tax purposes, which are included in treasury stock, resulting in a decrease to stockholders’ equity of $1.2 million.  In addition, as disclosed in Note 10, share-based compensation expense for the three and six months ended June 30, 2012 was $1.5 million and $2.8 million, respectively.

 

Note 15. Related Party Transactions

 

Certain of our stockholders guarantee substantially all of the obligations due under our capital and operating leases as disclosed in Note 11 of our Annual Report on Form 10-K for the year ended December 31, 2011.

 

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Note 16. Segment Information

 

We have adopted Segment Reporting (ASC 280) requiring 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 four operating segments, as summarized below:

 

·                  Products segment—Includes EnCase® Enterprise, EnCase® eDiscovery, EnCase® Cybersecurity, 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.

·                  Services segment—Performs consulting services, implementation and training.

·                  Maintenance segment—Includes maintenance related revenue and costs.

 

We refer to the revenue generated by our services and maintenance segments, collectively, as services revenue. 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 gross profit. The following tables present the results of operations for each operating segment:

 

 

 

Three Months Ended June 30, 2012

 

 

 

Product

 

Subscription

 

Services

 

Maintenance
& Other

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

12,042

 

$

2,843

 

$

6,978

 

$

9,205

 

$

31,068

 

Cost of revenues

 

1,904

 

1,283

 

5,569

 

528

 

9,284

 

Segment profit

 

$

10,138

 

$

1,560

 

$

1,409

 

$

8,677

 

21,784

 

Total operating expenses

 

 

 

 

 

 

 

 

 

23,264

 

Operating loss

 

 

 

 

 

 

 

 

 

$

(1,480

)

 

 

 

Three Months Ended June 30, 2011

 

 

 

Product

 

Subscription

 

Services

 

Maintenance
& Other

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

11,186

 

$

 

$

5,656

 

$

7,049

 

$

23,891

 

Cost of revenues

 

1,625

 

 

4,901

 

685

 

7,211

 

Segment profit

 

$

9,561

 

$

 

$

755

 

$

6,364

 

16,680

 

Total operating expenses

 

 

 

 

 

 

 

 

 

18,008

 

Operating loss

 

 

 

 

 

 

 

 

 

$

(1,328

)

 

 

 

Six Months Ended June 30, 2012

 

 

 

Product

 

Subscription

 

Services

 

Maintenance
& Other

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

22,551

 

$

4,068

 

$

12,626

 

$

17,842

 

$

57,087

 

Cost of revenues

 

3,587

 

1,869

 

10,484

 

1,063

 

17,003

 

Segment profit

 

$

18,964

 

$

2,199

 

$

2,142

 

$

16,779

 

40,084

 

Total operating expenses

 

 

 

 

 

 

 

 

 

45,037

 

Operating loss

 

 

 

 

 

 

 

 

 

$

(4,953

)

 

 

 

Six Months Ended June 30, 2011

 

 

 

Product

 

Subscription

 

Services

 

Maintenance
& Other

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

20,740

 

$

 

$

12,756

 

$

13,972

 

$

47,468

 

Cost of revenues

 

2,910

 

 

10,642

 

1,242

 

14,794

 

Segment profit

 

$

17,830

 

$

 

$

2,114

 

$

12,730

 

32,674

 

Total operating expenses

 

 

 

 

 

 

 

 

 

36,957

 

Operating loss

 

 

 

 

 

 

 

 

 

$

(4,283

)

 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

United States

 

$

24,822

 

$

19,184

 

$

44,842

 

$

38,990

 

Europe

 

2,826

 

2,761

 

6,198

 

5,035

 

Asia

 

2,488

 

877

 

3,314

 

1,418

 

Other

 

932

 

1,069

 

2,733

 

2,025

 

 

 

$

31,068

 

$

23,891

 

$

57,087

 

$

47,468

 

 

Note 17. Subsequent Events

 

On July 12, 2012, we entered into a Loan Agreement with a bank.  The Loan Agreement supersedes and replaces our Amended and Restated Credit Agreement, dated as of May 1, 2007, which would have expired on August 31, 2012.   See Note 8, Debt Obligations, of this quarterly report for more details regarding the Loan Agreement.

 

On July 26, 2012, we entered into an Office Lease Agreement (the “Lease”) to lease 86,790 rentable square feet of an office building located in Pasadena, California. The Lease begins on August 1, 2013 and has an initial term of ten years and ten months. The Lease will allow the Company to consolidate its Pasadena operations into a single location. The total annual rent under the Lease ranges from approximately $2.5 million for the first year to approximately $3.4 million for the final year of the Lease.  The Company has two options to extend the Lease, each for a period of five years.

 

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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, 2011 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 EnCase® Enterprise in 2002, the release of EnCase® eDiscovery in 2005 and the release of EnCase® Information Assurance in 2006 (which was replaced by EnCase® Cybersecurity in 2009), which expanded our customer base into corporate enterprises and federal government agencies. 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.  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.

 

We develop and provide leading software and hardware solutions for digital investigations, including EnCase® Enterprise, a network-enabled product primarily for large corporations and government agencies, and EnCase® Forensic, a desktop-based product primarily for law enforcement agencies.  We anticipate that sales of subscriptions for our cloud-based review and production software, our EnCase® Enterprise products and related services, in particular our EnCase® eDiscovery and EnCase® Cybersecurity solutions, and the sales of our forensic hardware products, will comprise a substantial portion of our future revenues.

 

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.

 

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·                  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, 2011 have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates. There have no significant changes in those critical accounting policies and estimates during the three and six months ended June 30, 2012 other than the addition to revenue recognition mentioned below.

 

With the acquisition of CaseCentral in February 2012, we now also generate revenue from cloud-based document review and production software-as-a-service where customers have the right to access our document review management software via the web; however, they may not take possession of the software at any time during the term of the agreement.  In general, we recognize revenue for subscriptions on a straight-line basis over the contractual 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.

 

When subscription services and usage-based fee arrangements involve multiple elements that qualify as separate units of accounting, we allocate arrangement consideration in multiple deliverable revenue arrangements at the inception of an arrangement to all deliverables based on the relative selling price method in accordance with the selling price hierarchy, which includes:  1) vendor-specific objective evidence of fair value (“VSOE”), if available, 2) third-party evidence (“TPE”) if VSOE is not available; or 3) best estimate of selling price (“BESP”) if neither VSOE nor TPE is available.

 

·                  VSOE.  We determine VSOE 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, we apply judgment 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 our peers and our offerings contain a significant level of differentiation such that comparable pricing of services with similar functionality has not been able to be 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 is unable to 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 was 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.

 

We have not established VSOE or TPE for our subscription services or usage-based fee arrangements and therefore we use BESP to allocate the selling price to subscription services and usage-based fee deliverables.

 

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Results of Operations

 

The following table sets forth our results of operations for the three and six months ended June 30, 2012 and 2011, respectively, expressed as a percentage of total revenues:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Revenues:

 

 

 

 

 

 

 

 

 

Product revenue

 

38.8

%

46.8

%

39.5

%

43.7

%

Subscription revenue

 

9.1

 

 

7.1

 

 

Services and maintenance revenue

 

52.1

 

53.2

 

53.4

 

56.3

 

Total revenues

 

100.0

 

100.0

 

100.0

 

100.0

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

Cost of product revenue

 

6.2

 

6.8

 

6.3

 

6.1

 

Cost of subscription revenue

 

4.1

 

 

3.3

 

 

Cost of services and maintenance revenue

 

19.6

 

23.4

 

20.2

 

25.1

 

Total cost of revenues

 

29.9

 

30.2

 

29.8

 

31.2

 

Gross profit

 

70.1

 

69.8

 

70.2

 

68.8

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling and marketing

 

31.9

 

36.4

 

32.5

 

35.4

 

Research and development

 

20.3

 

20.1

 

20.3

 

20.2

 

General and administrative

 

16.4

 

13.5

 

19.8

 

16.9

 

Depreciation and amortization

 

6.3

 

5.3

 

6.3

 

5.3

 

Total operating expenses

 

74.9

 

75.3

 

78.9

 

77.8

 

Operating loss

 

(4.8

)

(5.5

)

(8.7

)

(9.0

)

 

 

 

 

 

 

 

 

 

 

Other income and expense:

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

 

 

Interest expense

 

 

 

 

 

Other income, net

 

 

 

 

 

Total other income and expense

 

 

 

 

 

Loss before income taxes

 

(4.8

)

(5.5

)

(8.7

)

(9.0

)

Income tax provision

 

0.2

 

0.2

 

0.3

 

0.3

 

Net loss

 

(5.0

)%

(5.7

)%

(9.0

)%

(9.3

)%

 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Non-cash Share Based Compensation Data (1):

 

 

 

 

 

 

 

 

 

Cost of product revenue

 

$

24

 

$

17

 

$

47

 

$

39

 

Cost of subscription revenue

 

50

 

 

70

 

 

Cost of services and maintenance revenue

 

261

 

217

 

479

 

470

 

Selling and marketing

 

432

 

472

 

809

 

909

 

Research and development

 

335

 

364

 

625

 

785

 

General and administrative

 

357

 

411

 

726

 

832

 

Total non-cash share based compensation

 

$

1,459

 

$

1,481

 

$

2,756

 

$

3,035

 

 


(1)                   Non-cash share-based compensation recorded in the three and six month periods ended June 30, 2012 and 2011 relates to stock options and restricted share awards granted to employees measured under the fair value method. See Notes 9 and 10 to the condensed consolidated financial statements.

 

Comparison of Results of Operations for the Three and Six Months Ended June 30, 2012 and 2011

 

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 revenue from cloud-based document review and production software sold as subscription services.  We derive the majority of our revenue 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
June 30,

 

Six Months Ended
June 30,

 

(Dollars in thousands)

 

2012

 

Change
%

 

2011

 

2012

 

Change
%

 

2011

 

Product revenues

 

$

12,042

 

8%

 

$

11,186

 

$

22,551

 

9%

 

$

20,740

 

Subscription revenue

 

2,843

 

100%

 

 

4,068

 

100%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Services and maintenance revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Services

 

6,978

 

23%

 

5,656

 

12,626

 

(1)%

 

12,756

 

Maintenance

 

9,205

 

31%

 

7,049

 

17,842

 

28%

 

13,972

 

Total services and maintenance revenues

 

16,183

 

27%

 

12,705

 

30,468

 

14%

 

26,728

 

Total revenues

 

$

31,068

 

30%

 

$