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TMCNet:  QUMU CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

[May 09, 2014]

QUMU CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) The following table sets forth, for the periods indicated, selected items from the Company's condensed consolidated statements of operations.

Percentage (%) Percentage (%) of Revenues Inc/(Dec) Three Months Ended Between March 31, Periods 2014 2013 2014 vs. 2013 Revenues 100.0 % 100.0 % (3.6 )% Cost of revenues (54.4 ) (52.6 ) (0.3 ) Gross profit 45.6 47.4 (7.3 ) Operating expenses: Research and development 14.4 17.2 (19.3 ) Selling, general and administrative 52.5 49.8 1.5 Amortization of intangibles 0.8 0.8 - Total operating expenses 67.7 67.9 (3.8 ) Operating loss (22.2 ) (20.5 ) 4.3 Other income (expense), net 1.0 (0.5 ) (294.8 ) Loss before income taxes (21.2 ) (21.0 ) (2.8 ) Income tax benefit (0.3 ) (0.3 ) (9.3 ) Net loss (20.9 ) (20.8 ) (2.7 ) Noncontrolling interest - 0.3 (100.0 ) Net loss attributable to Qumu (20.9 ) (20.4 ) (1.2 ) Overview The Company conducts its operations through two businesses consisting of 1) its enterprise video content management software business and 2) its disc publishing business. Qumu's growing enterprise video content management software business provides the tools businesses need to create, manage, secure, distribute and measure the success of their videos. Qumu's video platform supports both live and on-demand streaming, and also incorporates secure download capabilities.


Qumu helps organizations around the world realize the greatest possible value from video and other rich content they create and publish. Qumu's disc publishing business provides customers with industry-leading systems that label, archive, distribute and protect content on CDs, DVDs and Blu-ray Discs. The Company also distributes related consumables for use with its disc publishing systems, consisting of media kits, ribbons, ink cartridges and blank CD-R, DVD-R and Blu-ray media. The Company markets its products to customers in North America, Europe and Asia.

The Company's enterprise video content management software products are deployed primarily through the sale of software licenses, software on a server appliance, software-enabled devices and a cloud-based Software-as-a-Service (SaaS) platform. Software maintenance contracts, professional services and managed services are also sold with these solutions. The Company's disc publishing business earns revenues through the sale of equipment, consumables and parts as well as maintenance contracts, repair and installation services. Product revenues on the accompanying Condensed Consolidated Statements of Operations include the Company's sale of equipment, appliances, software-enabled devices, consumables, parts and software licenses. Service revenues on the Condensed Consolidated Statements of Operations include revenues from maintenance contracts, repair, installation, software and maintenance subscription arrangements, managed services and professional services. Qumu has no long-term debt and does not require significant capital investment as it outsources to third-party vendors the required fabrication of most of its hardware-related products.

As previously announced, on April 24, 2014, the Company entered into an asset purchase agreement with Equus Holdings, Inc. ("Equus Holdings") and Redwood Acquisition, Inc. ("Buyer") pursuant to which the Company has agreed to sell to Buyer all of the assets primarily used or primarily held for use in connection with its disc publishing business. Buyer is a wholly-owned subsidiary of Equus Holdings. The transactions contemplated by the asset purchase agreement are referred to in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section as the "Asset Sale Transaction." 14-------------------------------------------------------------------------------- Table of Contents For additional information on the asset purchase agreement and the Asset Sale Transaction, please see the Company's Current Report on Form 8-K dated April 24, 2014 and Note 15 "Subsequent Events." In this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section, the Company provides certain information relating to trends in, and factors affecting, future revenue, gross profit margins, operating expense and liquidity and capital resources. This information is "forward-looking" and subject to the risks and uncertainties identified in "Cautionary Note Regarding Forward-Looking Statements" below. Further, this forward-looking information does not reflect the effect of any future sale of the disc publishing business to Buyer or any other party or the effect of the Asset Sale Transaction. This forward-looking information also does not necessarily reflect the future financial performance of the Company or the disc publishing business following the Asset Sale Transaction.

Results of Operations Revenues.

The table below describes Qumu's revenues by business and product category (in thousands): Three Months Ended Inc (Dec) March 31, Between 2014 2013 Periods $ % $ % $ % Enterprise video content management software Software licenses and appliances $ 1,196 6 % $ 2,060 11 % $ (864 ) (42 %) Service 2,733 15 % 2,289 12 % 444 19 % Total enterprise video content management software 3,929 21 % 4,349 22 % (420 ) (10 %) Disc publishing Disc publishing equipment: Producer 2,011 11 % 2,155 11 % (144 ) (7 %) Professional 1,414 8 % 1,293 7 % 121 9 % Desktop 295 2 % 404 2 % (109 ) (27 %) Total disc publishing equipment 3,720 20 % 3,852 20 % (132 ) (3 %) Recurring: Consumables and parts 8,149 43 % 8,157 42 % (8 ) - % Service 2,994 16 % 3,138 16 % (144 ) (5 %) Total recurring 11,143 59 % 11,295 58 % (152 ) (1 %) Total disc publishing 14,863 79 % 15,147 78 % (284 ) (2 %) Total revenues $ 18,792 100 % $ 19,496 100 % $ (704 ) (4 %) Total revenues Product $ 13,065 70 % $ 14,069 72 % $ (1,004 ) (7 %) Service 5,727 30 % 5,427 28 % 300 6 % Total revenues $ 18,792 100 % $ 19,496 100 % $ (704 ) (4 %) Total revenues decreased 4% for the three months ended March 31, 2014 to $18.8 million from $19.5 million in the comparable prior-year period. The decrease in total revenues in the first quarter reflects a $0.4 million decrease in enterprise video content management software business revenues and $0.3 million reduction in disc publishing business revenues. Consolidated product revenues decreased $1.0 million for the three months ended March 31, 2014, while consolidated service revenues increased $0.3 million compared to the same prior-year period. International sales, inclusive of the impact of currency changes, decreased 1% during the three months ended March 31, 2014 and comprised 36% of total revenues compared to 35% of total revenues for the same period in 2013. In the aggregate, currency fluctuations decreased consolidated revenues for the three months ended March 31, 2014 by less than $0.1 million, or less than 1% relative to the same periods in 2013.

Enterprise Video Content Management Software. The $0.4 million decrease in total enterprise video content management software revenues for the three months ended March 31, 2014 consisted of a $0.9 million decline in sales of software licenses and appliances, partially offset by a $0.4 million increase in service revenues.

The decrease in software license and appliance revenues was primarily due to the timing of revenue recognition of contracted commitments. Revenues vary quarter to quarter based on the type of contract the Company enters into with each customer. Contracts for perpetual software licenses generally result in revenue recognized closer to the contract commitment date while contracts for term-based software licenses result in most of the revenue being recognized over the period of the contract. The majority of contracted commitments from the fourth quarter 2013 and the first 15-------------------------------------------------------------------------------- Table of Contents quarter 2014 were term-based licenses for which a high proportion of the associated revenue will be recognized over future quarters. This significant shift in the mix of software contracts reduced the amount of perpetual software license revenue recognized in the first quarter. Contracted commitments for the enterprise video content management software business for the first quarter in 2014 totaled $14.2 million and contracted commitment backlog aggregated $27.0 million as of March 31, 2014. The Company defines contracted commitments as the dollar value of signed customer purchase commitments.

Disc Publishing. The current-year reduction in disc publishing revenues primarily reflects declines of $0.1 million in equipment revenues and also service revenues. The decrease in disc publishing equipment revenues was primarily impacted by a reduced volume of Producer equipment sales in Europe, partially offset by growth in equipment sales in the U.S. relative to the prior year's comparable period. The overall decline in disc publishing equipment revenues reflects a continuation of an expected transition of customers' purchases over time from physical distribution of content on discs to online forms of distribution.

Future consolidated revenues will be dependent upon many factors, including the rate of growth of the Company's enterprise video content management software business, whether software license arrangements with customers are structured as term or perpetual licenses, which impacts the timing of revenue recognition, the rate of technology substitution and associated decline in revenue for disc publishing products, the success of the Company's deployment of a complete disc publishing solution for medical imaging in hospitals in China and the rate of adoption of other new applications for the Company's products in its targeted markets. Other factors that will influence future consolidated revenues include the timing of new product introductions, the performance of the Company's channel partners, the timing of customer orders and related product deliveries, the Company's ability to maintain continuous supply of its products and components, the impact of changes in economic conditions and the impact of foreign currency exchange rate fluctuations.

Gross Profit. Gross profit as a percentage of total revenues was 45.6% for the three months ended March 31, 2014 compared to 47.4% for the same period in 2013.

The decrease in consolidated gross profit as a percentage of total revenues was due to a decline in gross margin generated by the enterprise video content management software business, partially offset by improved margins generated by the disc publishing business. Gross profit as a percentage of revenues for the Company's enterprise video content management software business was 35.4% for the three months ended March 31, 2014, compared to 60.1% for the same period in 2013. The decline in gross margin for the software business was due to less revenue from perpetual software licenses compared to the prior year, and increased customer support and professional services costs required to support growth in the customer base, deployment of a growing base of software contracts and expansion of service offerings. Gross profit as a percentage of revenues for the Company's disc publishing business was 48.2% for the three months ended March 31, 2014, compared to 43.7% for the same period in 2013. The improvement in gross margin was driven by reduced supplier costs for ribbons and certain equipment, sales of higher margin consumables and reduced service costs, partially offset by a reduced volume of sales of higher margin Producer equipment.

The enterprise video content management software margins for the three months ended March 31, 2014 and 2013 are inclusive of the impact of approximately $0.2 million in amortization expense associated with intangible assets acquired as a result of the acquisition of Qumu, Inc. Cost of revenues in 2014 are expected to include approximately $0.6 million of amortization expense for purchased intangibles.

Future gross profit margins will be impacted by the rate of growth of the Company's enterprise video content management software business, which has historically generated higher gross margins than the Company's disc publishing business. Future gross margins will also continue to be affected by many other factors, including product mix, the timing of new product introductions, the timing of customer orders and related product deliveries, changes in material costs and supply sources, manufacturing volume, the growth rate of service-related revenues relative to associated service support costs and foreign currency exchange rate fluctuations.

Operating Expenses. Total operating expenses were $12.7 million for the three months ended March 31, 2014 compared to $13.2 million in the comparable prior-year period. The $0.5 million decline in operating expenses compared to the prior-year period reflects the impact of cost reductions implemented in the disc publishing business in 2013 which reduced expenses by $1.2 million, primarily in research and development and sales and marketing. This decline was partially offset by a $0.7 million increase in enterprise video content management software operating expenses driven primarily by an increase in sales and marketing expenses.

Research and development expenses totaled $2.7 million and $3.4 million for the three months ended March 31, 2014 and 2013, respectively, representing 14.4% and 17.2% of revenues for the respective periods. Expense reductions in the current-year period resulted primarily from headcount reductions implemented during 2013 and reduced project spending in the disc publishing business. Lower employee costs in the enterprise video content management software business also contributed to the reduction in expenses in the current-year period due to the timing of headcount additions.

Selling, general and administrative expenses totaled $9.9 million for the three months ended March 31, 2014, or 52.5% of revenues compared to expenses in the same prior-year period of $9.7 million, or 49.8% of revenues. The $0.2 million increase in expenses 16-------------------------------------------------------------------------------- Table of Contents in the current-year period primarily reflects increased sales and marketing headcount and promotional programs to support growth in the enterprise video content management software business, partially offset by reduced sales and marketing expenses in the disc publishing business achieved as a result of the prior-year headcount reductions and continued cost optimization. Also impacting the increase in selling, general and administrative expense was the inclusion in the first quarter 2014 of $0.2 million of transaction related expenses associated with the Asset Sale Transaction.

Amortization of Purchased Intangibles. Operating expenses for the three months ended March 31, 2014 and 2013 include approximately $0.2 million in each period for the amortization of intangible assets acquired as part of the Company's acquisition of Qumu, Inc. in October 2011. Operating expenses in 2014 are expected to include approximately $0.6 million of amortization expense associated with purchased intangibles, exclusive of the portion classified in cost of revenues.

Other Income, Net. For the three months ended March 31, 2014 and 2013, the Company recognized interest income on cash and marketable securities of $13,000 and $11,000, respectively, and recognized net losses on foreign currency transactions of $35,000 and $107,000 for the respective periods. Additionally, other income for the current year's first quarter included a one-time gain on sale of property totaling $222,000.

Income Taxes. The provision for income taxes represents federal, state, and foreign income taxes or income tax benefit on income or loss. The Company recorded an income tax benefit of $49,000 and $54,000 for the three months ended March 31, 2014 and 2013, respectively.

The tax benefit amounts recorded in the current and prior-year periods reflect a tax benefit recorded in each period for losses incurred by the Company's subsidiary in Europe, partially offset by U.S. state income taxes.

Net Loss / Net Loss Per Share. Resulting net loss attributable to Qumu for the three months ended March 31, 2014 and 2013 was $3.9 million and $4.0 million, respectively. Related net loss per basic and diluted share amounts were $0.45 and $0.46 for the three months ended March 31, 2014 and 2013, respectively.

Segment Operating Results Management evaluates segment performance based on revenue and operating income (loss). The operating income (loss) for the Company's enterprise video content management software and disc publishing segments include all the direct costs of each business and an allocation of corporate expenses incurred to support each reportable segment.

Operating income (loss) for each reportable segment was as follows (in thousands): Enterprise Video Content Management Disc Reportable Segments Software (1) Publishing Total Three months ended March 31, 2014 Operating income (loss) $ (6,650 ) $ 2,484 $ (4,166 ) Three months ended March 31, 2013 Operating income (loss) (4,687 ) 691 (3,996 ) (1) Operating loss for the enterprise video content management software segment for the three months ended March 31, 2014 and 2013 includes amortization expense of $0.3 million in each period for amortization of intangible assets established as part of the acquisition of Qumu, Inc.

Enterprise Video Content Management Software. Operating loss increased $2.0 million during the first quarter of 2014 compared to the first quarter of 2013.

The increase in operating loss in the current year's first quarter was driven by a $1.2 million decline in gross margin and a $0.7 million increase in operating expenses. The decline in gross margin for the software business was due to less revenue from perpetual software licenses compared to the prior year, impacted by a higher mix of term-based arrangements relative to perpetual software license arrangements. Further contributing to the decline in gross margin was an increase in customer support and professional services costs required to support growth in the customer base, deployment of a growing base of software contracts and expansion of service offerings. These factors drove a decline in gross profit as a percentage of revenues to 35.4% for the three months ended March 31, 2014 compared to 60.1% for the three months ended March 31, 2013. The $0.7 million increase in operating expenses was primarily due to an increase in sales and marketing expenses and allocated corporate expenses. The increase in sales and marketing expenses resulted from increased headcount and promotional programs, partially offset by reduced sales commissions from lower sales. The increase in allocated corporate costs was driven primarily by increased 17-------------------------------------------------------------------------------- Table of Contents consumption of existing corporate resources to support the growth initiatives of the enterprise video content management software business.

Disc Publishing. Operating income increased $1.8 million during the first quarter of 2014 compared to the first quarter of 2013. Operating income in the current-year's first quarter increased primarily due to a $0.5 million improvement in gross margin and a $1.2 million reduction in operating expenses.

The improvement in gross margin was primarily driven by reduced supplier costs for ribbons and certain equipment, sales of higher margin consumables and reduced service costs, partially offset by a reduced volume of sales of higher margin Producer equipment. The reduction in operating expenses occurred as a result of headcount reductions during 2013 in research and development and sales and marketing and reduced project spending in research and development. Also contributing to the decline in operating expenses was a reduction in allocated corporate costs as a result of the redirection of a portion of existing corporate resources to support the increasing business requirements of the enterprise video content management software business.

Liquidity and Capital Resources The Company expects it will be able to maintain current operations and anticipated capital expenditure requirements for the foreseeable future through its cash reserves. At March 31, 2014, the Company had working capital of $46.0 million, down $2.8 million from working capital reported at December 31, 2013.

The primary contributors to the decrease in working capital were the generation of a net loss adjusted for non-cash items during the three months ended March 31, 2014 of $3.1 million and purchases of property and equipment of $0.3 million, partially offset by proceeds from the sale of property and equipment of $0.3 million and proceeds from the exercise of employee and director stock options of $0.1 million. Exclusive of a small amount of capital lease obligations and other purchase obligations, Qumu has no long-term debt and does not require significant capital investment for its ongoing operations.

The Company's primary source of cash from operating activities has been cash collections from sales of products and services to customers. The Company expects cash inflows from operating activities to be affected by increases or decreases in sales and timing of collections. The Company's primary use of cash for operating activities has been for personnel costs and purchases of inventory. The Company expects cash flows from operating activities to be affected by fluctuations in revenues, personnel costs and inventory requirements as the Company continues to increase its investment in resources to support the growth of the enterprise video content management software business and optimizes costs and reduces inventory purchases in line with revenues in the disc publishing business.

Net cash used in operating activities totaled $4.5 million and $1.0 million for the three months ended March 31, 2014 and 2013, respectively. The $3.5 million increase in cash used in operating activities in 2014 relative to 2013 resulted from a $1.2 million decrease in the favorable impact of non-cash and non-operating items and $2.4 million in unfavorable changes in operating assets and liabilities partially offset by a $0.1 million increase in net income.

Primarily contributing to the change in operating assets and liabilities compared to the prior year were unfavorable changes of $2.2 million in receivables, $2.2 million in accrued compensation and $1.0 million in prepaid expenses and other assets, partially offset by favorable changes of $2.3 million in deferred revenue and $0.8 million in trade accounts payable.

The unfavorable change in accounts receivable compared to the prior year was due to timing of sales and associated collections from customers. The unfavorable change in accrued compensation was primarily due to cash payments for liabilities associated with the establishment in 2013 of a long-term incentive plan and the achievement of above-target performance under the Company's short-term incentive plan for 2013, with associated payments under both plans occurring in the quarter ended March 31, 2014. The unfavorable change in prepaid expenses and other assets was due to an increase in and related deferral of software royalties, software licenses and hardware costs directly associated with revenues that have not yet been recognized as of March 31, 2014. The favorable change in deferred revenue in the first quarter of 2014 compared to the same period in 2013 was primarily due to an increase in renewals of maintenance contracts for the retail segment of the Company's disc publishing business and by an increase in software related revenue deferrals for the Company's enterprise video content management software business, impacted by a higher mix of term-based software license arrangements relative to perpetual license arrangements.

Net cash provided by (used in) investing activities totaled $(5.0) million and $9.9 million for the three months ended March 31, 2014 and 2013, respectively.

The net cash of $(5.0) million used in 2014 was driven primarily by $5.0 million in purchases of marketable securities, net of related maturities, and $0.3 million in purchases of property and equipment, partially offset by $0.3 million of proceeds from the sale of a parcel of land from the Company's headquarters property. The $9.9 million cash provided in 2013 was driven primarily by $10.5 million of maturities of marketable securities, net of related purchases, partially offset by $0.2 million in purchases of property and equipment and a $0.4 million investment in BriefCam. Capital expenditures in 2014 and 2013 consisted primarily of office equipment to support information technology infrastructure.

Financing activities provided (used) net cash of $0.1 million and $0.0 million in 2014 and 2013, respectively. The net cash provided in 2014 was due to proceeds from stock option exercises.

18-------------------------------------------------------------------------------- Table of Contents Since October 2010, the Company's Board of Directors has approved common stock repurchases of up to 3,500,000 shares. Shares may be purchased at prevailing market prices in the open market or in private transactions, subject to market conditions, share price, trading volume and other factors. The repurchase program has been funded to date using cash on hand. The Company did not repurchase any shares of its common stock during the three months ended March 31, 2014 and 2013, respectively. As of March 31, 2014, the Company had 778,365 shares available for repurchase under the authorizations.

The Company did not declare or pay any dividends during the three months ended March 31, 2014 and 2013, respectively.

Critical Accounting Policies Management utilizes its technical knowledge, cumulative business experience, judgment and other factors in the selection and application of the Company's accounting policies. The accounting policies considered by management to be the most critical to the presentation of the condensed consolidated financial statements because they require the most difficult, subjective and complex judgments include revenue recognition, allowance for doubtful accounts, inventory provisions, deferred tax asset valuation allowances, accruals for uncertain tax positions, stock-based compensation, impairment of long-lived assets and investment in nonconsolidated company. These accounting policies are discussed in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company's Annual Report on Form 10-K for the year ended December 31, 2013. Management made no significant changes to the Company's critical accounting policies during the three months ended March 31, 2014.

In applying its critical accounting policies, management reassesses its estimates each reporting period based on available information. Changes in such estimates did not have a significant impact on the Company's condensed consolidated financial statements for the three months ended March 31, 2014.

Cautionary Note Regarding Forward-Looking Statements This report contains forward-looking statements that involve risks and uncertainties. For this purpose, any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "estimate" or "continue" or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties. The Company's actual results could differ significantly from those discussed in the forward-looking statements.

Factors that could cause or contribute to such differences include, but are not limited to, the following, as well as other factors not now identified: the Company's ability to successfully implement its growth strategy; the economic health of the markets from which Qumu derives its sales and, in particular, the strength of the economies within North America and Europe where the Company has averaged nearly 90% of total sales over the past three years; the Company's ability to keep pace with changes in technology in the Company's targeted markets; increasing competition and the ability of the Company's products to successfully compete with products of competitors; the mature market for disc publishing products, with limited growth potential; the ability of the Company's newly developed products to gain acceptance and compete against products in their markets; the return on the Company's investment in strategic initiatives may be lower or develop more slowly than expected; the significance of the Company's international operations and the risks associated with international operations including currency fluctuations, local economic health and management of these operations over long distances; the Company's ability to protect its intellectual property and to defend claims of others relating to its intellectual property; risks related to open source software incorporated into Qumu's products; the Company's ability to effectively market its products and serve customers through its value-added resellers, distributors, strategic partners and its own sales force; the ability of the Qumu products to deliver fast, efficient and reliable service; the Company's ability to maintain adequate inventory of products; the Company's ability to secure alternative sources of supply given its reliance on single source suppliers for certain key products; the ability of the Company's products to operate effectively with the computer products developed and to be developed by other manufacturers; the compatibility of the Company's disc publishing products with products designed by others; the negative effect upon the Company's business from manufacturing or design defects; the effect of U.S. and international regulation; fluctuations in the Company's operating results; the Company's dependence upon its key personnel; the volatility of the price of the Company's common stock; the negative effect on the Company's common stock price of future sales of common stock; provisions governing the Company relating to a change of control, compliance with corporate governance and securities disclosures rules and other risks, including those set forth in the Company's reports filed with the Securities and Exchange Commission, including Item 1A of Part I of the Company's Annual Report on Form 10-K for the year ended December 31, 2013. These forward-looking statements are made as of the date of this report and the Company assumes no obligation to update such forward-looking statements, or to update the reasons why actual results could differ materially from those anticipated in such forward-looking statements.

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