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BPHX > SEC Filings for BPHX > Form 10-K on 28-Mar-2014All Recent SEC Filings

Show all filings for BLUEPHOENIX SOLUTIONS LTD

Form 10-K for BLUEPHOENIX SOLUTIONS LTD


28-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with the consolidated financial statements and related notes that are included elsewhere in this Annual Report on Form 10-K. This discussion contains 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 under Item 1A,"Risk Factors" and in other parts of this Annual Report on Form 10-K. See"Special Note Regarding Forward-Looking Statements"in this Annual Report on Form 10-K.

Overview

We engage in the IT modernization solutions business and provide professional services. During 2012 and 2013, we pursued our strategic plan in order to focus on the legacy modernization business. Accordingly, we sold certain activities and our holdings in certain subsidiaries, and shut down certain of our operations as described below.

In May 2012, we completed the sale of our 51% share holdings in Liacom Systems Ltd. for an aggregate consideration of $1.7 million. The proceeds from the sale were used to repay loans.

In June 2012, we entered into an agreement for the sale of our holdings in BluePhoenix Knowledge Management Systems Ltd., for an aggregate consideration of $550,000.

In February 2013, we executed an agreement for the sale of the operations of BridgeQuest, Inc. and its subsidiary. The total consideration that we received from the sale was $6,500.

We have experienced a significant decline in our revenues from $10.6 million in 2012 to $8.5 million in 2013. The decline in our revenues is primarily attributable to a softening in the monetary value of the average deal size, mostly in our legacy modernization projects

Based on the continuing decline in revenues in 2012 and 2013, we continued to assess our infrastructure costs and reduce workforce and labor costs as they constitute a substantial portion of our costs of revenues, selling and administrative expenses and research and development expenses. The number of our full-time employees has decreased from approximately 108 as of December 31, 2012 to 96 full-time employees and four full-time consultants as of December 31, 2013. In January and February of 2014, we continued to reduce our work force by approximately 27, bringing the total number of employees to 69 full-time employees and four full-time consultants as of March 21, 2014.

In 2013, our investment in research and development amounted to $1.5 million compared to $691,000 in 2012. The increase was the result of additional research and development activities and the associated allocation of professional human resources to these activities.


Challenges and opportunities

In a market that continues to innovate and evolve, new technologies and practices, by definition, render existing technology deployments out-of-date or legacy. By the same measure, however, in order for us to capitalize on the constant source of legacy solutions, we must evolve our solutions portfolio to deal with the changing definition of what constitutes "leading edge" technologies and the growing set that is deemed to be "legacy." Over time, as one legacy set of technologies is gradually replaced, we must be capable of addressing the modernization needs of the next set of aging technologies. However, these cycles are slow and provide us with the time to update our technology and products and build the necessary knowledge in house.

The fact that the modernization needs of the market are evolving on a constant basis, necessitates that we be capable of tracking and predicting changes in technologies. Anticipating the needs of the IT modernization market and delivering new solutions that satisfy the emerging needs is a critical success factor.

However, even if we develop modernization solutions that address the evolving needs of the legacy IT modernization market, we cannot assure that there will be a predictable demand for our offerings. Variables ranging from the macro-economic climate, to the competitive landscape, and to the perceived need that the enterprise market has for a specific modernization solution, may have an impact of a longer sales cycle or increased pricing pressure.

To keep up with the anticipated growing demand for our solution, we must retain our skilled personnel in the fields of project management, legacy systems, and leading modern technologies. Maintaining and growing the requisite skill base can be problematic. Personnel with an understanding of legacy technologies are a finite resource and the market for recruiting and retaining such workforce can be highly competitive.

Critical Accounting Policies

We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States. Accordingly, we are required to make certain estimates, judgments, and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

Revenue recognition. Our revenue recognition policy is significant because our revenue is a key component of our results of operations. We follow specific and detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue policy. Revenue results are difficult to predict and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in future operating losses. Should changes in conditions cause management to determine that these guidelines are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected.

We recognize revenues from consulting fees based on the number of hours performed. Revenues from maintenance services are recognized ratably over the term of the maintenance period. The Company presents revenues from products and revenues from services in separate line items. The product revenues line item includes revenues generated from standalone software products. In the services revenue line item, the Company includes (i) revenues generated from maintenance and consulting fees, and revenues accounted for pursuant to ASC 605-35-Tax collected from customers and remitted to governments authorities (including VAT) which are presented in the income statement on a net basis.

Revenues derived from direct software license agreements are recognized in accordance with FASB ASC Topic 985 "Software" ("ASC 985"), upon delivery of the software, when collection is probable, the license fee is otherwise fixed or determinable, and persuasive evidence of an arrangement exists.

Long term contracts accounted for pursuant to FASB ASC Topic 605-35-25 (prior authoritative literature: SOP 81-1, "Accounting for Performance of Construction-Type Contracts") are contracts in which we sell our software framework, on which material modifications, developments and customizations are performed, to provide the customer with a new and modern IT application with enhanced capabilities that were unavailable in its former legacy system. The services are essential to the functionality of the software and to its compliance with customers' needs and specifications. Under this method, estimated revenue is generally accrued based on costs incurred to date, as a percentage of total updated estimated costs. Changes in our estimates may affect the recognition of our long-term contract revenues. We recognize contract losses, if any, in the period in which they first become evident. Some of our contracts include client acceptance clauses. In these contracts, we follow the guidance of ASC 985-605-55 (formerly TPA 5100.67) and SAB 104. In determining whether revenue can be recognized, when an acceptance clause exists, we consider our history with similar arrangements, the customer's involvement in the negotiation process, and the existence of other service providers and the payment terms.


The Company recognizes revenues from consulting fees based on the number of hours performed. Revenues from maintenance services are recognized ratably over the term of the maintenance. When a project involves significant production, modification or customization of software, revenue is recognized according to the percentage of completion method in accordance with the provisions of FASB ASC Topic 605-35-25. Under this method, estimated revenue is generally accrued based on costs incurred to date, as a percentage of total updated estimated costs. The Company recognizes contract losses, if any, in the period in which they first become evident. There are no rights of return, price protection or similar contingencies in the Company's contracts. Our software framework and these kinds of modifications and customizations are not sold separately. Therefore, we cannot appropriately justify reflecting the product portion separately in our statement of operations.

Impairment of goodwill and intangible assets. Our business acquisitions resulted in goodwill and other intangible assets. We periodically evaluate our goodwill, intangible assets, for potential impairment indicators. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions, and operational performance of our acquired businesses and investments.

In accordance with FASB ASC Topic 350 "Intangible - goodwill and other," indefinite life intangible assets and goodwill are not amortized but rather subject to periodic impairment testing.

Goodwill and intangible assets are tested for impairment by comparing the fair value of the reporting unit with its carrying value. These write downs may have an adverse effect on our operating results. Future events could cause us to conclude that impairment indicators exist and that additional intangible assets associated with our acquired businesses are impaired. In addition, we evaluate a reporting unit for impairment if events or circumstances change between annual tests, indicating a possible impairment. Examples of such events or circumstances include: (i) a significant adverse change in legal factors or in the business climate; (ii) an adverse action or assessment by a regulator;
(iii) a more likely than not expectation that a portion of the reporting unit will be sold; (iv) continued or sustained losses at a reporting unit; (v) a significant decline in our market capitalization as compared to our book value; or (vi) the testing for recoverability of a significant asset group within the reporting unit.

We have one operating segment and one reporting unit related to overall IT modernization. We utilize a two-step method to perform a goodwill impairment review in the fourth quarter of each fiscal year or when facts and circumstances indicate goodwill may be impaired. In the first step, we determine the fair value of the reporting unit. If the net book value of the reporting unit exceeds its fair value, we would then perform the second step of the impairment test which requires allocation of the reporting unit's fair value of all of our assets and liabilities in a manner similar to an acquisition cost allocation, with any residual fair value being allocated to goodwill. The implied fair value of the goodwill is then compared to the carrying value to determine impairment, if any. In 2013 and 2012, we determined the fair value of a reporting unit using the market approach which is based on the market capitalization by using our share price in the NASDAQ Global Market and an appropriate control premium. As of December 31, 2013 and 2012, our market capitalization was significantly higher than the net book value of the reporting unit and therefore there was no need to continue to step 2.

Stock Based Compensation. We account for stock-based compensation to employees in accordance with FASB ASC Topic 718 "Compensation - Stock Compensation." In the past two years, most of the awards were of restricted stock units ("RSUs"). RSUs are valued based on the market value of the underlying stock at the date of grant. A small portion of the awards are share options. We measure and recognize compensation expense with respect to share options based on estimated fair values on the date of grant using the Black-Scholes option-pricing model. This option pricing model requires that we make several estimates, including the option's expected life and the price volatility of the underlying stock.

Income taxes. As a multinational corporation, we are subject to taxation in many jurisdictions, and the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various taxing jurisdictions. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Accounting for uncertainty in income taxes requires that tax benefits recognized in the financial statements must be at least more likely than not of being sustained based on technical merits. The amount of benefits recorded for these positions is measured as the largest benefit more likely than not to be sustained. Significant judgment is required in making these determinations. As of December 31, 2013, there were no unrecognized tax benefits. Deferred taxes are determined utilizing the "asset and liability" method, whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and the tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. We provide a valuation allowance, when it is more likely than not that deferred tax assets will not be realized in the foreseeable future. In calculating our deferred taxes we are taking into account various estimations, which are examined and if necessary adjusted on a quarterly basis, regarding our future utilization of future carry forward losses.


Accounts receivable and Allowances for Doubtful Accounts. Our trade receivables include amounts due from customers. We perform ongoing credit evaluations of our customers' financial condition and we require collateral as deemed necessary. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make payments. In judging the adequacy of the allowance for doubtful accounts, we consider multiple factors including the aging of our receivables, historical bad debt experience and the general economic environment. Management applies considerable judgment in assessing the realization of receivables, including assessing the probability of collection and the current credit worthiness of each customer. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Derivative Instruments. Under the provisions of FASB ASC Topic 815 "Derivatives and hedging," all derivatives are recognized on the balance sheet at their fair value.

Recently Issued Accounting Pronouncements

In July 2013, the Financial Accounting Standards Board ("FASB") issued guidance that requires that a non-recognized tax benefit be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. This net presentation is required unless a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date or the tax law of the jurisdiction does not require, and the entity does not intend to use, the deferred tax asset to settle any additional income tax that would result from the disallowance of the unrecognized tax benefit. This guidance is effective for fiscal years beginning after December 15, 2013, with early adoption permitted. We are assessing whether the adoption of this standard will have a material impact on our consolidated financial statements.

In March 2013, the FASB issued guidance on accounting for the release of a cumulative translation adjustment into net income when a parent company either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets and provides guidance for the acquisition in stages of a controlling interest in a foreign entity. This guidance is effective for fiscal years beginning after December 15, 2013, with early adoption permitted. We are assessing whether the adoption of this standard will have a material impact on our consolidated financial statements

Our Reporting Currency

The currency of the primary economic environment in which we, and most of our subsidiaries operate, is the U.S. dollar. In addition, a substantial portion of our revenues and costs are incurred in dollars. Thus, the dollar is our functional and reporting currency.

We follow FASB ASC Topic 830 "Foreign currency translation" and accordingly non-monetary transactions denominated in currencies other than the dollar are measured and recorded in dollar at the exchange rates prevailing at transaction date. Monetary assets and liabilities denominated in currencies other than the dollar are translated at the exchange rate on the balance sheet date. Exchange gain or losses on foreign currency translation are recorded as income.

Following is a summary of the most relevant monetary indicators for the reported periods:

                                                            Revaluation
                                                          (Devaluation) of        Revaluation
                                         Inflation rate         NIS          (Devaluation) of euro
For the Year ended December 31,            in Israel      against the US$       against the US$
                                               %                 %                     %
2013                                          1.82                (7.0)              (5.0)
2012                                          1.63                (2.3)              (2.0)


Operating Results

The following table presents the percentage relationships of certain items from our consolidated statement of operations, as a percentage of total revenues for the periods indicated:

Statement of Operations Data as a Percentage of Revenues:

                                                                   Year ended December 31,
                                                                  2013               2012
                                                                    %                  %
Revenues                                                             100.0               100.0
Cost of revenues                                                      52.6                66.4
Gross profit                                                          47.4                33.6
Research and development costs                                        17.7                 6.5
Selling, general, and administrative expenses                         73.9                81.7
Gain on sale of subsidiary and AppBuilder                             (9.2 )             (11.2 )
Operating loss                                                       (34.9 )             (43.4 )
Financial expenses, net                                                1.3                50.4
Other income, net                                                        -                (5.5 )
Loss before taxes on income                                          (36.2 )             (88.4 )
Income tax benefit                                                     3.5                 2.1
Net loss from continued operation                                    (39.7 )             (90.4 )
Loss from discontinued operation                                       4.7                13.8
Net loss                                                             (44.4 )            (104.3 )
Net results attributable to non-controlling interests                  2.8                 3.3
Net loss attributable to BluePhoenix' shareholders                   (47.2 )            (107.6 )

Years Ended, 2013 and 2012

Revenues. Revenues decreased by 19% from $10.6 million in 2012 to $8.5 million in 2013. The decrease is primarily attributable to a decrease in the monetary value of the average deal size, mostly in our legacy modernization projects.

We depend upon our customers making capital investments in information technology products. These spending levels are impacted by the worldwide level of demand for enterprise legacy IT modernization solutions and services. Demand for these is normally a function of prevailing global or regional economic conditions and is negatively affected by a general economic slow-down as consumers reduce discretionary spending on information technology upgrades.

We currently concentrate our resources on providing legacy modernization solutions and services. Our revenues are generated from fixed-price projects, consulting fees, and long-term maintenance contracts. Revenues generated from fixed price projects decreased by 13% from $6.5 million in 2012 to $5.6 million in 2013. This decrease stems from a decrease in the monetary value of the average deal size.

Revenues generated from our consulting services decreased by 33% from $1.4 million in 2012 to $954,000 in 2013, due to the sale of some of our technology in early 2013.

Revenues generated from our long-term maintenance contract services decreased by 28% from $1.8 million in 2012 to $1.3 million in 2013, due to a decrease in the number of long-term maintenance projects.

Gross profit. Gross profit increased by 13% from $3.6 million in 2012 to $4 million in 2013. The increase is mainly attributable to the significant reduction in cost of revenues due to the reduction in our overall workforce, the reallocation of human resources to research and development, and a decrease in amortization of our intangible assets.


Gross profit as a percentage of revenues, was 47% in 2013 compared to 34% in 2012. The increase is mainly attributable to the reduction in our cost of revenues.

Cost of revenues. Cost of revenues consists of salaries, amortization of intangible assets, fees paid to independent subcontractors and other direct costs. Cost of revenues decreased by 36% from $7.1 million in 2012 to $4.5 million in 2013. This decrease resulted primarily from the reduction in our overall workforce, the reallocation of human resources to research and development, and a decrease in amortization of our intangibles assets. Cost of revenues as a percentage of revenues was 53% in 2013 compared to 66% in 2012. This decrease is attributable to the reduction in salary costs due to the reduction in our workforce.

Research and development costs. Research and development costs consist of salaries and consulting fees that we pay to professionals engaged in the development of new software and related methodologies. Our development costs are allocated among our modernization suite of solutions and are charged to operations as incurred. Research and development costs increased by 118% from $691,000 in 2012 to $1.5 million in 2013.
The increase was the result of additional research and development activities and the associated allocation of professional human resources to these activities. As a percentage of revenues, research and development costs increased to 18% in 2013 compared to 7% in 2012.

Selling, general, and administrative expenses. Selling, general, and administrative expenses consist primarily of wages and related expenses, travel expenses, sales commissions, selling expenses, marketing and advertising expenses, rent, insurance, utilities, professional fees, depreciation and amortization. Selling, general, and administrative expenses decreased by 27% from $8.7 million in 2012 to $6.3 million in 2013. Most of the decrease is attributable to the dismissal of employees as part of the continued implementation of our cost saving plan in 2013. As a percentage of revenues, selling, general and administrative expenses decreased to 74% in 2013 compared to 82% in 2012. The decrease is also attributable to reduced computer and software amortization costs, professional fees, and overhead costs. Expenses for doubtful accounts decreased from $178,000 in 2012 to zero in 2013.

Gain on sales of subsidiaries and AppBuilder. Gain on sale of AppBuilder, in 2013, amounted to $786,000, and constitutes proceeds previously received as part of the AppBuilder transaction that were subject to fulfillment of certain conditions that have been met. Gain on sale of subsidiaries and AppBuilder, in 2012, amounted to $2.3 million, and mainly constitute proceeds previously received at the AppBuilder transaction that were subject to fulfillment of certain conditions that have been met. This amount was partially offset against $1.1 million loss on sale of subsidiaries.

Financial expenses, net. Our financial expenses decreased from $5.4 million in 2012 to $114,000 in 2013. Financial expenses include interest paid on a loan extended by a third party and an expense due to derivative financial instruments. Financial expenses also include accounting charges related to warrants previously issued by us, which we record as a derivative, and expenses from fluctuations in foreign currency exchange rate. The decrease in financial expenses is mostly attributable to (a) accounting charges related to warrants issued by us in prior years, which we record as a derivative; and (b) increase in fair value of embedded derivative in connection with the loans received from our three major shareholders. This derivative was converted into shares in 2012 with no influence over 2013 finance expense.

Other income. There was no other income in 2013. Other income in 2012 was $580,000 and constitutes the repayment of a loan extended by us to Cicero Inc.

Taxes on income. In 2013, we had income tax expense of $297,000 compared to income tax expense of $221,000 in 2012. The tax expense in 2013 is comprised of $42,000 current tax expense and $255,000 tax expenses related to previous years.

Net loss from discontinued operation. Net loss from discontinued operation in 2013 was attributable to BridgeQuest, Inc. and amounted to $399,000. Net loss from discontinued operation in 2012 was attributable to Liacom Systems Ltd. and BridgeQuest, Inc. and amounted to $1.5 million.

Net result attributable to non-controlling interest. Net loss attributable to non-controlling interest in 2013 was $243,000 compared to net loss of $351,000 in 2012, and represented the non-controlling share in the net loss of our subsidiary, Zulu Software Inc.


Liquidity and Capital Resources

How We Have Financed Our Business

Public Offerings

In 1997, we consummated two public offerings, and received net proceeds of $33.9 million after deducting underwriting discounts and commissions and offering expenses.

In February 2006, we completed an underwritten public offering in Israel of series A convertible notes in an aggregate principal amount of NIS 54.0 million . . .

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