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IPAS > SEC Filings for IPAS > Form 10-K on 11-Mar-2014All Recent SEC Filings

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Form 10-K for IPASS INC


11-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

This section is organized as follows:

Key Corporate Objectives         Our overall strategy and goals
Significant Trends and  Events   Operating, financial and other material
                                 highlights affecting our company
Key Operating Metrics            Discussion of key metrics and measures that we
                                 use to evaluate our operating performance
Segment Financial Information    Discussion of the two segments of our business:
and Geographic Information       Mobility Services and iPass Unity
Critical Accounting Policies and Accounting policies and estimates that we
Estimates                        believe are most important to understanding the
                                 assumptions and judgments incorporated in our
                                 reported financial results
Results of Operations            An analysis of our financial results comparing
                                 the years ended December 31, 2013, December 31,
                                 2012 and December 31, 2011
                                 An analysis of changes in our balance sheets and
Liquidity and Capital            cash flows, and discussion of our financial
Resources                        condition and potential sources of liquidity

Overview
We provide global enterprises and telecommunication carriers with cloud-based mobility management and network connectivity services. As announced on February 12, 2014, we are exploring a potential sale or other strategic alternative for our Unity business. For a detailed discussion of our business, see "Item 1. Business."


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Key Corporate Objectives
We are focused on driving revenue growth and profitability by adding new customers through increased brand awareness, improving our customer activation rates, and increasing user demand in smartphone and tablets with optimized end user experience. Our plan is to continue to expand the strategic value of our business by leveraging our mobility assets to address both large and compelling market opportunities and to execute on key growth initiatives in our businesses. For a detailed discussion regarding our key corporate objectives, see section entitled "Our Strategy" under "Item 1. Business."

Significant Trends and Events
The following describes significant trends and events that impacted our financial condition, results of operations, and/or the direction of our business in 2013:
Continued Focus on our Open Mobile Enterprise Business We have continued to show solid progress against two key metrics for our OME business: (i) the number of active Open Mobile Platform users; and (ii) the number of Open Mobile Wi-Fi Network users. During 2013, we steadily increased our percentage of Open Mobile Platform users as a percentage of total platform users from 55% for the fourth quarter of 2012 to 83% for the fourth quarter of 2013. In addition, we grew our percentage of Open Mobile Wi-Fi Network users as a percentage of total Wi-Fi network users from 43% for the fourth quarter of 2012 to 79% for the fourth quarter of 2013. Our Open Mobile growth has been driven by a combination of legacy platform customer migrations, migrated customer user and usage ramps, and new customer acquisition. We continue to release updates to our Open Mobile platform, creating enhanced user experiences on a variety of operating systems. We expect to grow Wi-Fi revenues in the future based on our ability to grow Open Mobile platform and Wi-Fi network users, primarily through the continued focus on the deployment of our Open Mobile platform on smartphone and tablet devices. See "Key Operating Metrics" below for a full discussion of our user metrics.

Successful Deployments in our Open Mobile Exchange Business We are continuing to develop our OMX business, adding functionality and building-out the network of key partners including telecommunication carriers and service providers. During 2013, we began to see signs of successful deployments. In 2014, we expect these deployments to scale and begin to provide network user and platform user metrics consistent with how we describe the OME business. Total OMX revenue grew from $0.8 million in 2012 to $2.4 million in 2013, representing 2.1% of our total 2013 revenue. In addition, we expect to narrow the focus to our OM business as a whole and view the OME and OMX businesses together.
Continued Decline in our Legacy Revenues We define our legacy revenue to include Dial-up and 3G network, our iPC platform, and related platform services, as well as iPC driven network usage, including iPC user driven Wi-Fi, and minimum commit shortfall. As we exit 2013 with roughly 85% of our platform and Wi-Fi network users on the OM platform, expect that we will discontinue discussions of our stand-alone legacy business in 2014, focusing most of our metrics on the OM business. We have continued to effectively manage the wind down of our legacy revenue streams, with legacy declining 55% year over year and representing less than 20% of revenue in the fourth quarter of 2013. We expect legacy revenue to represent a smaller percentage of mobility revenue in 2014.

Key Operating Metrics
Described below are key metrics that we use to evaluate our operating performance and our success in transforming our business and driving future growth.
OM Wi-Fi Network Users
OM Wi-Fi Network Users is the number of our platform users each month in a given quarter that paid for Wi-Fi network services from iPass. OM Platform Active Users
OM Platform Active Users is the number of users who were billed Open Mobile platform fees and who have used or deployed Open Mobile.


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The following table summarizes our key operating metrics in relation to the Average Number of Monthly Monetized Users(1) (in thousands):

                                                     For the Quarter Ended
                         December 31,     September 30,     June 30,       March 31,     December 31,
                             2013             2013            2013           2013            2012
Open Mobile Users:
Wi-Fi Network Users(2)           67               59              56            46              35
Platform Users:
Active                          622              574             517           444             355
Gross(3)                      1,017            1,019           1,019           955             822
Legacy Users:
Wi-Fi Network Users(2)           18               21              31            40              46
Other Network Users(4)           19               20              23            26              28
Platform Users(5)               125              151             201           246             286
Total AMMU(1):
Total Network Users             104              100             110           112             109
Open Mobile as a
Percentage of Total
Wi-Fi Network Users              79 %             74 %            64 %          53 %            43 %
Open Mobile as
Percentage of Total
Network Users                    64 %             59 %            51 %          41 %            32 %
Total Platform Users            747              725             718           690             641
Open Mobile as
Percentage of Total
Platform Users                   83 %             79 %            72 %          64 %            55 %

(1) We have presented Average Monthly Monetized Users (referred to as "AMMU") as a metric that we use to track and evaluate the operating performance of our overall Mobility business. The AMMU metric is based on the number of active users of our network and platform services across both our Open Mobile Enterprise offering and legacy iPC offerings. Network users are billed for their use of our Wi-Fi, Dial-up or 3G network services. Platform users are billed for their use of our legacy iPC client or our Open Mobile client. AMMU is defined as the average number of users per month, during a given quarter, for which a fee was billed by us to a customer for such users.

(2) Wi-Fi Network Users represent unique users of Wi-Fi network.

(3) Open Mobile Platform Gross Users is the total number of unique Active and Paying-Undeployed monetized users on the OM platform.

(4) Other Network Users represents unique users of Dial-up and 3G network.

(5) Legacy Platform Users represents unique users of the legacy iPC platform.

Smartphone and Tablet Users
Smartphone and Tablet Users mean users who have deployed Open Mobile on their smartphone or tablet and used those devices to access Wi-Fi network services from iPass. Our focus is to increase the adoption of OM on smartphones and tablets to drive additional Wi-Fi network users and network usage. As we continue to focus on accelerating the adoption of smartphone and tablet users on our Open Mobile platform, we expect users of these devices to become an increasing percentage of our network users. Users grew as a percentage of total Open Mobile Wi-Fi Network Users from approximately 24% in December 2012 to 31% in 2013.
Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA")
Adjusted EBITDA is used by our management as a measure of operating efficiency, financial performance and as a benchmark against our peers and competitors. In addition, we also used this metric to determine a portion of our incentive compensation payouts. Management also believes that Adjusted EBITDA is useful to investors because it is frequently used by securities analysts, investors and other interested parties to understand our performance excluding the impact of items which may obscure trends in our core operating performance. Furthermore, the use of Adjusted EBITDA facilitates comparisons with other companies in our industry which may use similar financial measures to supplement their GAAP (accounting principles generally accepted in the United States) results. We defined Adjusted EBITDA as net loss adjusted for: interest, income taxes, depreciation and amortization, stock-based compensation, restructuring charges, and certain state sales and federal tax charges. We adjust for these excluded items because we believe that, in general, these items possess one or more of the following characteristics: their magnitude and timing is largely outside of our control; they are unrelated to the ongoing operation of the business in the ordinary course; they are unusual or infrequent and we do not expect them to occur in the ordinary course of business; or non-cash expenses involving stock option grants. Adjusted EBITDA is not a measure determined in accordance


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with GAAP and should not be considered in isolation or as a substitute for operating income (loss), net income (loss) or any other measure determined in accordance with GAAP.

The following table reconciles Adjusted EBITDA to GAAP net loss (in thousands):

                                                        Year Ended December 31,
                                                    2013          2012         2011
Adjusted EBITDA income (loss)                    $  (5,143 )   $    960     $   (196 )
Interest income (expense)                              (18 )         19          112
Income tax expense                                    (569 )       (642 )       (290 )
Depreciation of property and equipment              (2,776 )     (2,110 )     (2,259 )
Amortization of intangible assets                        -         (169 )       (239 )
Stock-based compensation                            (3,163 )     (2,418 )     (1,725 )
Restructuring (charges) benefit                       (653 )        (26 )        151
Certain state sales tax and other discrete items        10            8        1,438
Net loss                                         $ (12,312 )   $ (4,378 )   $ (3,008 )

Segment Financial Information and Geographic Information We operate our business and report under two segments: Mobility Services and iPass Unity. We allocate resources and assess the performance of each operating segment using information about its revenue and operating loss. The Mobility Services segment reflects our two primary areas of mobility services, (i) enterprise mobility services that consist of Open Mobile Enterprise services, our legacy enterprise mobility services and other ancillary services including professional consulting and other value-add services, and
(ii) our Open Mobile Exchange services that were launched in 2011. Open Mobile Enterprise services have evolved from our Enterprise Mobility Services offerings as we focus on our Open Mobile business and migrate away from our legacy iPC services. For a more complete discussion of business risks that these segments face, both combined and individually, see the discussion that appears in Part I, "Item 1A. Risk Factors," of this Form 10-K.
For further financial information on the Mobility Services and iPass Unity segments and geographic information, refer to the information contained in Note 14, "Segment and Geographic Information," in the Notes to the Consolidated Financial Statements included in Item 15. For risks attendant to foreign operations, see the risk entitled "Because a meaningful portion of our business is international, we encounter additional risks, which may impact our revenues and profitability" in "Item 1A. Risk Factors" of this Form 10-K.

Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on our historical experience, knowledge of current conditions and our belief of what could occur in the future considering available information, including assumptions that are believed to be reasonable under the circumstances. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results could differ materially from the amounts reported based on these policies. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition. We believe our most significant estimates, judgments and assumptions used in the preparation of our consolidated financial statements are used in the following critical accounting policies. Revenue Recognition
Our revenue recognition policy requires us to make certain estimates and judgments, for example, in the recognition of monthly minimum commitment ("MMC") revenue and upfront fees for iPass Unity contracts.
For customers that have agreed to a MMC fee in connection with network usage, such customer's monthly invoice reflects the greater of the customer's actual usage during the month or the customer's contractually committed monthly minimum for that month. If the MMC exceeds actual usage ("Shortfall"), we determine whether the Shortfall is fixed or determinable in accordance with the revenue recognition criteria. If we conclude that the Shortfall is fixed or determinable,


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based upon customer specific collection history, and all other revenue recognition criteria have been met, we recognize as revenue the amount of the Shortfall which is invoiced. If the customer is in a Shortfall situation and it is determined that the Shortfall is not fixed or determinable, we recognize revenue only when the Shortfall is collected. iPass Unity contracts are monthly flat fee contracts combined with certain other upfront fees such as, one-time non-recurring fees, which include equipment fees, installation, management set up, and shipping fees. The monthly flat usage fee is recognized on a monthly basis, while other fees are recognized ratably over the estimated life of the end point. An end point represents a separate physical location, such as a branch office, retail office or virtual office. End point lives are estimated based on historical average end point life by product group. We periodically perform an analysis of estimated lives of the end points and revise the remaining term over which revenue will be recognized, if needed. As of December 31, 2013, the expected period of performance for end points approximates four years.
Performance -Based Restricted Stock Awards Certain restricted stock awards have performance-based goals based on the the achievement of targeted quarterly revenue of Open Mobile, targeted EBITA or targeted number of active Open Mobile monetized users, which require an assessment of the probability and timing of vesting. We amortize stock-based compensation expense for performance-based awards on a graded vesting basis over the vesting period, after assessing probability of achieving the requisite performance criteria. Estimating the time in which we expect to achieve the requisite performance criteria requires judgment. If events or circumstances occur that cause us to revise our estimated vest dates, we recognize the unamortized expense prospectively over the revised estimated vesting period. Such a change in estimated vest dates could have a material impact on our financial statements. We believe vesting of all performance-based restricted stock awards is probable.
Recently Issued Accounting Standards
In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-11, Income Taxes (Topic 740):
Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss carryforward, or similar tax loss or tax credit carryforward, rather than as a liability when (1) the uncertain tax position would reduce the net operating loss or other carryforward under the tax law of the applicable jurisdiction and (2) the entity intends to use the deferred tax asset for that purpose. This ASU is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. The Company will adopt ASU 2013-11 for its fiscal year, and interim periods within the year ending December 31, 2014. We do not expect that this guidance will materially impact our Consolidated Financial Statements.

Results of Operations

Sources of Revenues
From a broad perspective, we report and analyze revenue under two primary
offerings reflecting our operating segments: Mobility Services and iPass Unity.
Within Mobility Services, we differentiate and analyze our Open Mobile and
legacy generated revenues separately.
Open Mobile generated revenues include:
                   Network-Wi-Fi and minimum customer commitments based on the
                    number of network users sourced from the Open Mobile
                    platform.


                   Platform-Fees based on the number of Active Open Mobile
                    monetized platform users and fees for fully dedicated Open
                    Mobile carrier arrangements.


                   Other Fees and Revenue-Fees specific to providing additional
                    value add services to Open Mobile customers.

OMX-Revenues generated from our OMX customers.

Legacy generated revenues include:

                   Network-Wi-Fi and minimum customer commitments based on the
                    number of network users sourced from the legacy iPC platform.
                    In addition, network revenues derived from our 3G and Dial-up
                    products are categorized as legacy network revenues.


                   Platform-Fees based on the number of legacy iPC monetized
                    platform users and fees related to legacy add-on platform
                    products and related services.


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                   Other Fees and Revenue-Fees specific to providing additional
                    value add service to legacy iPC customers.


                                                       For the Year Ended December 31,
                                                     2013             2012           2011
                                                           (Dollars in thousands)
Mobility Services                               $    77,868       $   92,674     $  110,808
Operating Loss (1)                                  (11,113 )         (2,750 )       (2,013 )
Open Mobile Enterprise:                              45,692           26,271          8,206
Network                                              29,710           13,963          1,724
Platform                                             15,048           11,585          5,834
Other Fees                                              934              723            648
Open Mobile Exchange                                  2,362              786            678
Legacy iPC                                           29,814           65,617        101,924
Network                                              22,380           53,180         85,743
Platform                                              3,954            9,785         13,387
Other Fees                                            3,480            2,652          2,794
iPass Unity Network Services                         33,247           33,404         29,953
Operating Income (Loss) (1)                             556             (542 )       (1,753 )
Total Revenue                                       111,115          126,078        140,761
Service Offering Revenue as a Percentage of
Total Revenue:
Mobility Services                                        70 %             74 %           79 %
Open Mobile Enterprise                                   41 %             21 %            6 %
Open Mobile Exchange                                      2 %              1 %            1 %
Legacy iPC                                               27 %             52 %           72 %
iPass Unity Network Services                             30 %             26 %           21 %
Total Revenue                                           100 %            100 %          100 %

(1) See Note 14 Segment and Geographic Information for reconciliation of segment operating loss. Mobility Services Revenue
For the year ended December 31, 2013 compared to 2012, Mobility Service revenue decreased $14.8 million or 16% as the decrease in legacy iPC revenue of $35.8 million outpaced the increase in Open Mobile ("OM") revenue of $21.0 million. Legacy iPC declines were attributed to continued migrations to OM, customer terminations, and anticipated usage reductions in our 3G and Dial-up services. The net decline of $14.8 million for Mobility Services revenue was driven by a $5.0 million decline in Wi-Fi revenue, a $6.4 million decline in Dial-up and 3G revenue, a $3.6 million decline in MMC, and a $2.4 million decline in platform revenue offset by an increase in OMX and other revenues of $1.6 million and $1.0 million, respectively. The decrease in Wi-Fi, Dial-up and 3G revenues were driven by the continued and expected decline in usage and termination of legacy iPC customers. In addition, the ongoing pricing platform dynamics as user mix shifts away from laptops to less expensive smartphone and tablet pricing options also contributed to the platform revenue decline.
For the year ended December 31, 2012 compared to 2011, Mobility Service revenue decreased $18.1 million or 16% as the decrease in legacy iPC revenue of $36.3 million outpaced the increase in Open Mobile Enterprise revenue of $18.1 million. Legacy iPC declines were attributed to migrations, customer terminations, and anticipated usage reductions in our 3G and Dial-up services. The net decline of $18.1 million for Mobility Services revenue was driven by a $11.8 million decline in Wi-Fi revenue, a $6.9 million decline in Dial-up and 3G revenue, and a $1.6 million decline in MMC offset by an increase in platform revenues of $2.2 million. The decrease in Wi-Fi revenues was primarily driven by legacy iPC customer terminations and ongoing usage pattern shifts from laptops to smartphones and tablets. Additionally, as we migrate customers from the iPC platform to the Open Mobile platform, we experience delays in fully deploying the agent to the customer user community which typically results in lagging Wi-Fi usage patterns.
Mobility Service Operating Loss
The increase in Mobility Services operating loss by $8.4 million for the year ended December 31, 2013, compared to 2012 was primarily due to the decrease in Mobility Service revenue of $14.8 million, partially offset by the decrease in mobility network access cost of $3.5 million and the decrease in mobility service operating expense of $2.9 million.


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The increase in Mobility Services operating loss by $0.7 million or 37% for the year ended December 31, 2012 compared to 2011 was primarily due to the decrease in Mobility Service revenue of $18.1 million, partially offset by the decrease in mobility network access cost of $13.3 million and the decrease in mobility service operating expense of $2.6 million and non-recurring incremental benefit of $1.3 million in 2011 on collections of previously billed and accrued historical sales tax liabilities.
iPass Unity Network Services Revenue
iPass Unity Network Services revenues were relatively consistent for the year ended December 31, 2013 compared to 2012.
For the year ended December 31, 2012 compared to 2011, iPass Unity revenue increased $3.5 million or 12% mainly due to growth in the number of installed customer endpoints.
iPass Unity Network Services Operating Income and Loss The increase in iPass Unity operating income of $1.1 million for the year ended December 31, 2013 compared to 2012 was mainly due to ongoing cost reduction initiatives and a decrease in iPass Unity network access costs.
The decrease in iPass Unity operating loss of $1.2 million for the year ended December 31, 2012 compared to 2011 was primarily due to the increase in iPass Unity revenue of $3.5 million, partially offset by an increase in iPass Unity network access cost of $1.3 million and $1.0 million in higher operating expenses.
Network Gross Margin
We use network gross margin as a metric to assist us in assessing the profitability of our various network services. Our overall network gross margin is defined as Mobility Services Network revenue plus iPass Unity revenue less network access costs divided by Mobility Services Network revenue plus iPass Unity revenue.

                            Year Ended December 31,
                           2013         2012      2011
Network Gross Margin (%)   43.1 %       47.0 %   44.4 %

The 3.9% decrease in network gross margin from 2012 to 2013 was primarily due to decreases in higher margin revenues products such as monthly minimum commitment . . .

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