AMBIENT CORP /NY - 10-K - MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
(Edgar Glimpses Via Acquire Media NewsEdge) Overview
Ambient Corporation is an award-winning provider of smart grid communications
technology for utilities. Our innovative platform enables utilities to deploy
and integrate multiple smart grid applications and technologies, in parallel on
a single communications infrastructure, supporting smart metering, distribution
automation, distribution management, demand response, distributed generation and
We were incorporated in 1996 in the state of Delaware. Through the third quarter
of 2008, we were a development stage company. We are focused on the development
of a communications platform that meets the needs of utilities, including
specifically for the implementation of smart grid applications.
On July 18, 2011, we implemented a reverse stock split of our issued and
outstanding shares of common stock at a ratio of 1-for-100 shares (the "Reverse
Split"). On August 3, 2011, our common stock began to trade on the NASDAQ
Capital Market under our new ticker symbol "AMBT."
Duke Energy Relationship
Since 2005, we have maintained a strategic relationship with Duke Energy. The
utility is actively deploying our communications nodes and is licensing our
AmbientNMS ® for its deployment in Ohio. We believe that we are the predominant
provider of communications nodes and network management system software for Duke
Energy's Ohio deployment.
We believe that we have demonstrated that our technology is secure, two-way,
flexible, open, scalable, reliable and cost-effective through the total
deployment of approximately 125,000 communications nodes in the field with Duke
Energy. We believe that Duke Energy will continue to predominantly use our
communications platform for the remainder of its Ohio smart grid deployment
through 2013. Furthermore, Duke Energy's pilot deployment of approximately 3,000
communications nodes in the Carolinas predominantly uses our communications
platform as well. Throughout the past five years, we have worked with Duke
Energy to develop our communications platform, which has enabled Duke Energy's
ability to deploy its smart grid initiatives.
We believe that we have a substantial opportunity to grow our business with Duke
Energy. In addition to the communications nodes scheduled for deployment in
Ohio, we estimate that Duke Energy would potentially require hundreds of
thousands of communications nodes if it implements a full deployment of smart
grid communications nodes in Indiana, Kentucky and the Carolinas. Duke Energy is
using information from its North Carolina pilot programs and its Ohio deployment
to enhance its customer experience in its other service territories.
Since we established our relationship with Duke Energy, we have been focused on
developing our technology to meet the needs of their smart grid communications
platform. Based upon the success of the relationship and our ability to prove
our technology, we have recently begun to expand our infrastructure to focus on
new business development, marketing and sales programs and further technology
development in order to expand our customer base, and we expect to increase
investment in our marketing and sales efforts over the next twelve months.
We define our backlog as products that we are obligated to deliver based on firm
commitments relating to purchase orders received from customers. As of December
31, 2012, we had backlog of approximately $10 million, entirely from Duke
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Critical Accounting Policies and Use of Estimates
The discussion and analysis of our financial condition and results of operations
are based upon our financial statements, which have been prepared in accordance
with generally accepted accounting principles in the United States. The
preparation of these financial statements 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
on-going basis, we evaluate our estimates, including those related to revenue
recognition, bad debts, investments, intangible assets and income taxes. Our
estimates are based on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances. Actual results may
differ from these estimates.
We have identified the accounting policies below as critical to our business
operations and the understanding of our results of operations.
Total revenue consists primarily of sales of hardware, software, and maintenance
services. The Company recognizes revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the sales price is fixed or
determinable, and collection is reasonably assured. Product is considered
delivered to the customer once it has been shipped and title and risk of loss
have been transferred. For most of the Company's product sales, these criteria
are met at the time the product is shipped. The Company records deferred revenue
when it receives payments in advance of the delivery of products or the
performance of services.
Hardware sales consist of our Ambient Smart Grid® communications nodes which are
physical boxes that contain the hardware and embedded software needed for
communications and data collection in support of smart grid assets. The system
software embedded in our communications nodes is used solely in connection with
the operation of the physical boxes.
Our proprietary software AmbientNMS® is our smart grid network management system
that controls the large numbers of communications nodes, devices and customers
on a smart grid. NMS software is offered on a stand-alone basis.
We generally include a period of free maintenance services beginning from the
sale of the communication nodes and NMS Software. As such, we recognize a
portion of the revenue from the sales of our products upon delivery to the
customer. The revenue allocated to the free period of maintenance services is
deferred and recognized ratably over the period of performance.
We offer additional software maintenance service, on a fee basis, that entitles
the purchasers of our products and AmbientNMS® software to post-contract
customer support including help desk support and, unspecified updates and
upgrades to our products on a when-and-if available basis. Maintenance services
are recognized ratably over the period of performance.
The Company recognizes revenue from the sale of (i) hardware products and (ii)
software bundled with hardware that is essential to the functionality of the
hardware in accordance with revenue recognition for multiple element
arrangements. The Company recognizes revenue in accordance with applicable
industry specific software accounting guidance for (i) standalone sales of
software products, (ii) maintenance renewals, and (iii) sales of software
bundled with hardware not essential to the functionality of the hardware.
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Revenue Recognition for Arrangements with Multiple Deliverables
In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue
Arrangements, (amendments to ASC Topic 605, Revenue Recognition) (''ASU
2009-13'') (formerly EITF Issue 08-1) and ASU No. 2009-14, Certain Arrangements
That Include Software Elements, (amendments to FASB ASC Topic 985, Software)
(''ASU 2009-14'') (formerly EITF 09-3). ASU 2009-13 eliminates the residual
method and requires arrangement consideration to be allocated using the relative
selling price method, which requires entities to allocate revenue in an
arrangement using the best estimated selling price ("BESP") of each element when
a vendor does not have vendor-specific objective evidence of selling price
("VSOE") or third party evidence of selling price ("TPE"). ASU 2009-14 removes
tangible products from the scope of software revenue guidance and provides
guidance on determining whether software deliverables in an arrangement that
includes a tangible product are within the scope of the software revenue
guidance. ASU 2009-13 and ASU 2009-14 are effective for arrangements entered
into or materially modified in fiscal years beginning on or after June 15, 2010.
The Company adopted ASU 2009-13 and 2009-14 effective January 1, 2011.
We evaluate each deliverable in an arrangement to determine whether it should be
accounted for as a separate unit of accounting. The delivered items or item
shall be considered a separate unit of accounting if it has standalone value to
the customer and there are no customer-negotiated refunds or return rights.
We allocate the total arrangement consideration to each unit of accounting in a
multiple-element arrangement based on its relative selling price, and include
our bundled hardware and software component as one unit of accounting and the
free period of maintenance as a separate unit of accounting. The Company uses a
hierarchy to determine the selling price to be used for allocating revenue to
each of the deliverables. We determine the selling price for each deliverable
using vendor specific objective evidence (VSOE), if it exists or third party
evidence (TPE) if VSOE does not exist. If neither VSOE nor TPE of selling price
exists for a deliverable, we use our best estimate of selling price (BESP) for
that deliverable. Revenue allocated to each element is then recognized when the
basic revenue recognition criteria are met for each element.
We determine VSOE of a deliverable based on the price at which we sell the
deliverable on a standalone basis to third parties or from the stated renewal
rate for the elements contained in the initial arrangement. VSOE has been
established for our software maintenance element. When VSOE cannot be
established for all deliverables in an arrangement with multiple elements, we
attempt to estimate the selling price of each element based on TPE. When we are
unable to establish a selling price using VSOE or TPE, we establish the 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 product or service
were sold on a standalone basis. BESP has been established for our bundled
hardware and software portion of the arrangement.
When establishing BESP the Company considers multiple factors including, but not
limited to, the relative value of the features and functionality being delivered
to the customer, and general pricing practices. Based on our analysis of pricing
stated in contractual arrangements for our hardware products in historical
multiple-element transactions, we have concluded that we typically price our
hardware and embedded software at the contractually agreed upon
amounts. Therefore, we have determined that, for our hardware and embedded
software for which VSOE or TPE is not available, our BESP is generally comprised
of prices based on our contractually agreed upon rates. We have established an
annual review process around VSOE, TPE and BESP.
The Company accounts for multiple element arrangements that consist only of
software or software-related products, including the sale of maintenance
services to previously sold software, in accordance with industry specific
software accounting guidance. For such multiple element software transactions,
revenue is allocated to each element based on the residual method when VSOE has
been established for the undelivered element. If the Company cannot objectively
determine the VSOE of any undelivered element included in such multiple-element
arrangements, the Company defers revenue until VSOE is established for any
remaining undelivered elements, or all elements are delivered and services have
Inventory Valuation. We value inventory at the lower of cost or market
determined on a first-in, first-out basis. Certain factors may impact the net
realizable value of our inventory, including technological changes, market
demand, new product introductions and significant changes to our cost structure.
We make estimates of reserves for obsolescence based on the current product mix
on hand and its expected net realizable value. If actual market conditions are
less favorable or other factors arise that are significantly different than
those anticipated by us, additional inventory write-downs or increases in
obsolescence reserves may be required. We consider lower of cost or market
adjustments and inventory reserves as an adjustment to the cost basis of the
underlying inventory. Accordingly, we do not record favorable changes in market
conditions to inventory in subsequent periods.
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Software Development Costs. We have historically expensed costs incurred in the
research and development of new software products and enhancements to existing
software products as incurred. After we establish technological feasibility, we
capitalize additional development costs. No software development costs have been
capitalized as of December 31, 2012 or 2011.
Stock-Based Compensation. We account for stock-based compensation in accordance
with accounting guidance now codified as Financial Accounting Standards Board,
or FASB, Accounting Standards Codification, or ASC, 718, "Compensation - Stock
Compensation (formerly known as SFAS No. 123(R))." Under the fair value
recognition provision of ASC 718, stock-based compensation cost is estimated at
the grant date based on the fair value of the award. We estimate the fair value
of stock options granted using the Black-Scholes option pricing model. Key input
assumptions used to estimate the fair value of stock options include the
exercise price of the award, the expected option term, the expected volatility
of our stock price over the option's expected term, the risk-free interest rate
over the stock option's expected term and the annual dividend yield.
Fair Value of Warrants. Warrants are recorded as liabilities at their estimated
fair value at the date of issuance, with subsequent changes in estimated fair
value recorded in other income (expense) in the statement of operations in each
subsequent period. Fair value of the warrants is determined by management using
a multiple scenario, probability-weighted option-pricing model using the
following inputs: the fair value of the underlying common stock at the valuation
measurement date; the risk-free interest rates; the expected dividend rates; the
remaining contractual terms of the warrants; the expected volatility of the
price of the underlying common stock; and the probability of certain events
occurring. The assumptions used in calculating the estimated fair value of the
warrants represent our best estimates; however, these estimates involve inherent
uncertainties and the application of management judgment. As a result, if
factors change and different assumptions are used, the warrant liabilities and
the change in their estimated fair values could be materially different.
Deferred Income Taxes. We recognize deferred income taxes for the tax
consequences of "temporary differences" by applying enacted statutory rates
applicable to future years to differences between the financial statement
carrying amounts and the tax basis of existing assets and liabilities. At
December 31, 2012, our deferred income tax assets consisted primarily of net
operating loss and tax credit carryforwards and stock-based compensation charges
that have been fully offset with a valuation allowance due to the uncertainty
that a tax benefit will be realized from the assets in the future. At
December 31, 2012, we had available approximately $71.7 million of net operating
loss carryforwards, for U.S. income tax purposes which expire at various dates
through 2031. However, due to changes in stock ownership resulting from
historical investments, the use of the U.S. net operating loss carryforwards are
significantly limited under Section 382 of the Internal Revenue Code. As such,
approximately $61.4 million of our net operating loss carryforwards will expire
and will not be available to use against future tax liabilities.
Warranties. We account for our warranties under the FASB ASC 450,
"Contingencies." Our current standard product warranty includes a one-year
warranty period for defects in material and workmanship. We currently accrue a
liability of approximately 0.5% of current communications node revenues for the
estimated future costs of meeting our warranty obligation, based on our actual
historical return rate for repair of products within the one-year warranty
period. We make and revise this estimate based on the number of communications
nodes delivered and our historical experience with warranty claims. We
continually monitor the rate of actual product returns for repair and the
quality of our products including the quality of the products produced by our
U.S.-based contract manufacturer in China.
We engage in product quality programs and processes, including monitoring and
evaluating the quality of component suppliers, in an effort to ensure the
quality of our products and reduce our warranty exposure. The warranty
obligation will be affected not only by product failure rates, but also the
costs to repair or replace failed products and potential service and delivery
costs incurred in correcting a product failure. If our actual product failure
rates, repair or replacement costs, or service or delivery costs differ from
these estimates, accrued warranty costs would be adjusted in the period that
such events or costs become known.
Our software license agreements generally include provisions for indemnifying
customers against liabilities if our software infringes upon a third party's
intellectual property rights. We have not provided for any reserves for such
warranty liabilities. Our software license agreements also generally include a
warranty that our software will substantially operate as described in the
applicable program documentation. We also warrant that we will perform services
in a manner consistent with industry standards. To date, we have not incurred
any material costs associated with these product and service performance
warranties, and as such we have not provided for any reserves for any such
warranty liabilities in our operating results.
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RESULTS OF OPERATIONS
Comparison of the Year Ended December 31, 2012 and the Year Ended December 31,
Total Revenue.Total revenue for 2012 was $42.8 million compared to $62.1 million
in 2011, representing a decrease of approximately 31%. Substantially all revenue
from 2012 and 2011 was derived from one customer. The decrease in total revenue
is primarily attributable to our primary customer's decision to modify its node
deployment schedule which extended installations of nodes further into 2013. We
expect that our primary customer will continue to be the source of a substantial
portion of our revenue for the next twelve months.
Cost of Goods Sold.Cost of goods sold for 2012 was $24.5 million compared to
$35.3 million in 2011. The decrease in cost of goods sold primarily reflected a
decrease in sales volume to Duke Energy. Cost of goods sold includes all costs
related to the manufacture of our products by our contract manufacturer,
accruals for warranty and other overhead costs. Our contract manufacturer is
responsible for substantially all aspects of manufacturing, including procuring
most of the key components required for assembly.
Gross Profit.Gross profit for 2012 was $18.3 million compared to $26.8 million
in 2011, a decrease of approximately 32%. Gross margin for 2012 and 2011 has
remained flat at approximately 43%.
Research and Development Expenses. Research and development expenses were
approximately $14.3 million for 2012 compared to approximately $11.7 million in
2011. The increase in research and development was primarily due to increased
personnel and consultant expenses required for the continued development of our
communications nodes, enhancements of our AmbientNMS ®, and other product
development efforts. We believe that our continued development efforts are
critical to our strategic objectives of enhancing our technology while
simultaneously reducing costs. We expect that our research and development
expenses will increase in 2013 as we continue to develop and improve our
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for 2012 were approximately $9.6 million compared to
$8.2 million for 2011. The increase in selling, general and administrative
expenses was due to an increase in personnel and related costs related to our
increased efforts to market and commercialize our communications platform.
Selling, general and administrative expenses consisted primarily of salaries and
other related costs for personnel in executive and other administrative
functions. Other significant costs included professional fees for legal,
accounting and other services. In 2013, we expect our selling, general and
administrative expenses to increase as we continue to increase our efforts to
market and commercialize our communication platform to additional customers.
Write-off of Deferred Financing Costs. In August 2011, we filed a Form S-1
registration statement with the Securities and Exchange Commission for a
proposed public offering of our common stock, for which we had incurred
approximately $389,000 in expenses as of December 31, 2011. Such costs were
capitalized and were to be charged to additional paid-in capital upon completion
of our proposed public offering. In April 2012, we voluntarily filed an
application with the Securities and Exchange Commission requesting the
withdrawal of such registration statement. We requested withdrawal of the
registration statement based on then current market conditions and management's
ensuing determination to not proceed with the contemplated offering at that
time. Accordingly, previously capitalized deferred financing costs of
approximately $389,000 were written off in the three months ended March 31,
Other Income, net. Other income for 2012 was approximately $197,000 compared to
approximately $19,000 for the corresponding period in 2011, primarily
representing the partial recovery of loans made by us to an unrelated company
during 2000 and 2001, which had been previously written off in 2001.
Mark-to-Market Adjustment of Warrant Liability. Changes in the fair value of
warrant liabilities resulted in a net non-cash gain of $452,000 in 2012 and $3.3
million in 2011.
Provision for Income Taxes. As a result of our loss before taxes of $5.4
million, the Company did not record a provision for income taxes in 2012. As a
result of our income before taxes of $10.3 million in 2011, we recorded a
provision for income taxes of approximately $204,000 in 2011, primarily
reflecting federal alternative minimum taxes.
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Liquidity and Capital Resources
Since inception, we have funded our operations with proceeds from the sale of
our securities and, more recently, with revenue from sales of our products. At
December 31, 2012, we had working capital of $12.1 million, including cash and
cash equivalents of $13.3 million.
Net cash used in operating activities during the year ended December 31, 2012
was approximately $4.4 million and net cash provided by operating activities
during 2011 was approximately $12.1 million. Cash used in operations for the
year ended December 31, 2012 was due primarily to a net loss of $5.4 million
(partially offset by stock-based compensation expense of $2.5 million) and an
increase in accounts receivable of $2.0 million (which were subsequently
collected in January 2013) and a reduction in accounts payable of $1.2 million.
Net cash provided by operating activities in 2011 was primarily due to net
income of $10.1 million (plus stock based compensation of $3.5 million, which
was substantially offset by mark-to-market adjustments of warrant liabilities of
$3.3 million), as well as a decrease in accounts receivable of $1.4 million.
Net cash used in investing activities for the year ended December 31, 2012 was
approximately $659,000 as compared to approximately $962,000 for the same period
in 2011. Net cash used in investing activities for each period was for additions
of fixed assets.
Net cash provided by financing activities for the year ended December 31, 2012
was approximately $376,000 as compared to net cash used by financing activities
of approximately $129,000 in 2011. For the year ended December 31, 2012 net cash
provided by financing activities consisted primarily of proceeds from exercises
of warrants. For the year ended December 31, 2011, net cash used by financing
activities consisted primarily of approximately $389,000 in deferred financing
costs offset by proceeds from exercises of warrants and stock options.
We believe that our business plan will provide sufficient liquidity to fund our
operating needs for the next 12 months. However, there are factors that can
impact our ability continue to fund our operating needs, including:
Our expectations regarding the continued favorable relationship with Duke
Energy, which we expect will continue to be a substantial source of our
Our ability to maintain product pricing as expected, particularly in light
of increased competition and its unknown effects on market dynamics;
Our and our contract manufacturer's ability to reduce manufacturing costs as
Our ability to expand sales volume, which is highly dependent on the smart
grid implementation plans of Duke Energy and other utilities; and
The need for us to continue to invest in operating activities in order to
remain competitive or acquire other businesses and technologies in order to
complement our products, expand the breadth of our business, enhance our
technical capabilities or otherwise offer growth opportunities.
If we cannot effectively manage these factors, we may need to raise additional
capital in order to fund our operating needs. If we are unable to obtain
adequate financing or financing on terms satisfactory to us when we require it,
our ability to continue to grow or support our business and to respond to
business challenges could be significantly limited and we may be required to
implement spending reduction measures in order to preserve cash.
Off-Balance Sheet Arrangements
As of December 31, 2012 and 2011, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. Other than our operating
leases for office space and certain other capital lease obligations, we do not
engage in off-balance sheet financing arrangements. In addition, we do not
engage in trading activities involving non-exchange traded contracts. As such,
we are not materially exposed to any financing, liquidity, market or credit risk
that could arise if we had engaged in these relationships.
Contractual Obligations and Commitments
The following table summarizes our contractual obligations as of December 31,
2012 and the effect such obligations are expected to have on our liquidity and
cash flow in future periods:
(in thousands) Less Than 1-3 3-5 More Than
Total 1 Year Years Years 5 Years
Rent obligations $ 583 $ 583
Insurance premium obligations 237 237
Total $ 820 $ 820 $ - $ - $ -
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Recently Issued Accounting Pronouncements
In May 2011, the Financial Accounting Standards Board (FASB) issued ASU No.
2011-04: Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair
Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (ASU
2011-04). ASU 2011-04 clarifies application of fair value measurement and
disclosure requirements and was effective for annual periods beginning after
December 15, 2011. The Company adopted the provisions of ASU 2011-04 which did
not have a material effect on its financial position and results of operations.
In February 2013, the FASB issued guidance requiring disclosure of amounts
reclassified out of accumulated other comprehensive income by component. In
addition, an entity is required to present either on the face of the statement
of operations or in the notes, significant amounts reclassified out of
accumulated other comprehensive income by the respective line items of net
income but only if the amount reclassified is required to be reclassified to net
income in its entirety in the same reporting period. For amounts not
reclassified in their entirety to net income, an entity is required to
cross-reference to other disclosures that provide additional detail about those
amounts. This guidance is effective prospectively for the Company for annual and
interim periods beginning January 1, 2013. The Company will comply with the
disclosure requirements of this guidance for the quarter ending March 30, 2013.
We do not believe that any other recently issued, but not yet effective,
accounting standard if currently adopted would have a material effect on our
accompanying financial statements.
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