UNITED
STATES
|
SECURITIES
AND EXCHANGE COMMISSION
|
Washington,
D.C. 20549
|
|
FORM
10-Q
|
(Mark
One)
|
|
þ
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|
|
For
the quarterly period ended June 30, 2009.
|
|
|
o
|
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
.
|
For
the transition period from ____ to
____.
|
Commission
file number 1-15117.
|
On2
Technologies, Inc.
|
(Exact
name of registrant as specified in its
charter)
|
Delaware
|
|
84-1280679
|
(State
or other jurisdiction of incorporation or organization)
|
|
(I.R.S.
Employer Identification No.)
|
|
|
3
Corporate Drive, Suite 100, Clifton Park, New York
|
12065
|
(Address
of principal executive offices)
|
(Zip
Code)
|
|
|
(518)
348-0099
|
(Registrant’s
telephone number, including area code)
|
|
(Former
name, former address and former fiscal year, if changed since last
report)
|
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Indicated
by check mark whether the registrant has submitted electronically and posted on
its corporate web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or such shorter period that the registrant was required to submit and
post such files).
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definition of “accelerated filer”, “large accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act (Check one).
|
|
|
|
o
Large
accelerated filer
|
þ
Accelerated filer
|
|
o
Non-accelerated filer
|
o
Smaller
reporting company
|
APPLICABLE
ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Indicate
by check mark whether the registrant has filed all documents and reports
required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act
of 1934 subsequent to the distribution of securities under a plan confirmed by a
court.
o
Yes
o
No
APPLICABLE
ONLY TO CORPORATE ISSUERS:
Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest applicable date:
The
number of shares of the Registrant’s Common Stock, par value $0.01 (“Common
Stock”), outstanding as of July 30, 2009 was 175,504,000.
Table
of Contents
PART
I — FINANCIAL INFORMATION
|
|
|
|
|
Page
|
Item
1. Consolidated Financial Statements.
|
|
|
|
|
|
Condensed
Consolidated Balance Sheets at June 30, 2009 (unaudited) and December 31,
2008
|
|
2
|
Unaudited
Condensed Consolidated Statements of Operations Three and Six Months Ended
June 30, 2009 and 2008
|
|
3
|
Unaudited
Condensed Consolidated Statements of Comprehensive Income (Loss) Three and
Six Months Ended June 30, 2009 and 2008
|
|
4
|
Unaudited
Condensed Consolidated Statements of Cash Flows Three and Six Months Ended
June 30, 2009 and 2008
|
|
5
|
Notes
to Unaudited Condensed Consolidated Financial Statements
|
|
7
|
|
|
|
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
|
|
23
|
|
|
|
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
|
|
41
|
|
|
|
Item
4. Controls and Procedures
|
|
42
|
|
|
|
PART
II — OTHER INFORMATION
|
|
|
|
|
|
Item
1. Legal Proceedings
|
|
42
|
|
|
|
Item
1A. Risk Factors
|
|
43
|
|
|
|
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
|
43
|
|
|
|
Item
4. Submission of Matters to a Vote of Security Holders
|
|
44
|
|
|
|
Item
6. Exhibits
|
|
45
|
|
|
|
Signatures
|
|
46
|
|
|
|
Certifications
|
|
|
PART
I — FINANCIAL INFORMATION
Item
1.
|
Consolidated
Financial
Statements
|
ON2
TECHNOLOGIES, INC.
|
CONDENSED
CONSOLIDATED BALANCE SHEETS
|
|
(In
thousands, except par value and share
amounts)
|
|
|
|
|
|
|
|
|
|
June
30,
2009
|
|
|
December
31,
2008
|
|
|
|
(unaudited)
|
|
|
|
|
|
ASSETS
|
Current
assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
2,666
|
|
|
$
|
4,157
|
|
Short-term
investments
|
|
|
131
|
|
|
|
132
|
|
Accounts
receivable, net of allowance for doubtful accounts of $385 at June 30,
2009 and $623 at December 31, 2008
|
|
|
2,199
|
|
|
|
2,730
|
|
Prepaid
and other current assets
|
|
|
290
|
|
|
|
439
|
|
Total
current assets
|
|
|
5,286
|
|
|
|
7,458
|
|
Property
and equipment, net
|
|
|
700
|
|
|
|
715
|
|
Capital
leases, net
|
|
|
372
|
|
|
|
686
|
|
Acquired
software, net
|
|
|
1,859
|
|
|
|
2,212
|
|
Other
acquired intangibles, net
|
|
|
4,945
|
|
|
|
5,276
|
|
Goodwill
|
|
|
9,068
|
|
|
|
9,099
|
|
Other
assets
|
|
|
402
|
|
|
|
430
|
|
Total
assets
|
|
$
|
22,632
|
|
|
$
|
25,876
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
1,323
|
|
|
$
|
1,352
|
|
Accrued
expenses
|
|
|
4,203
|
|
|
|
4,368
|
|
Accrued
restructuring expenses
|
|
|
785
|
|
|
|
—
|
|
Deferred
revenue
|
|
|
1,484
|
|
|
|
2,133
|
|
Short-term
borrowings
|
|
|
190
|
|
|
|
63
|
|
Current
portion of long-term debt
|
|
|
171
|
|
|
|
1,148
|
|
Capital
lease obligation
|
|
|
254
|
|
|
|
260
|
|
Total
current liabilities
|
|
|
8,410
|
|
|
|
9,324
|
|
Long-term
debt
|
|
|
1,979
|
|
|
|
1,802
|
|
Capital
lease obligation, excluding current portion
|
|
|
311
|
|
|
|
432
|
|
Warrant
derivative liability
|
|
|
139
|
|
|
|
—
|
|
Total
liabilities
|
|
|
10,839
|
|
|
|
11,558
|
|
Commitments
and contingencies
|
|
|
—
|
|
|
|
—
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
|
Preferred
stock, $0.01 par value; 20,000,000 authorized and -0-
outstanding
|
|
|
—
|
|
|
|
—
|
|
Common
stock, $0.01 par value; 250,000,000 shares authorized; 175,504,000 and
171,769,000 shares issued, and outstanding at June 30, 2009 and December
31, 2008, respectively
|
|
|
1,755
|
|
|
|
1,718
|
|
Additional
paid-in capital
|
|
|
196,392
|
|
|
|
196,371
|
|
Accumulated
other comprehensive loss
|
|
|
(1,247
|
)
|
|
|
(1,073
|
)
|
Accumulated
deficit
|
|
|
(185,107
|
)
|
|
|
(182,698
|
)
|
Total
stockholders’ equity
|
|
|
11,793
|
|
|
|
14,318
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
22,632
|
|
|
$
|
25,876
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements
ON2
TECHNOLOGIES, INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
June
30,
|
|
|
Six
Months Ended
June
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|
|
(In
thousands except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
4,996
|
|
|
$
|
3,265
|
|
|
$
|
9,012
|
|
|
$
|
7,717
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs
of revenue (1)
|
|
|
445
|
|
|
|
1,194
|
|
|
|
1,018
|
|
|
|
2,624
|
|
Research
and development (2)
|
|
|
1,721
|
|
|
|
3,009
|
|
|
|
3,885
|
|
|
|
5,817
|
|
Sales
and marketing (2)
|
|
|
926
|
|
|
|
1,875
|
|
|
|
1,902
|
|
|
|
3,764
|
|
General
and administrative (2)
|
|
|
1,548
|
|
|
|
3,926
|
|
|
|
3,622
|
|
|
|
6,694
|
|
Restructuring
expense
|
|
|
—
|
|
|
|
—
|
|
|
|
1,032
|
|
|
|
—
|
|
Costs
associated with proposed merger
|
|
|
420
|
|
|
|
—
|
|
|
|
420
|
|
|
|
—
|
|
Litigation
settlement costs
|
|
|
523
|
|
|
|
|
|
|
|
523
|
|
|
|
|
|
Equity-based
compensation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development
|
|
|
173
|
|
|
|
105
|
|
|
|
311
|
|
|
|
224
|
|
Sales
and marketing
|
|
|
70
|
|
|
|
74
|
|
|
|
119
|
|
|
|
112
|
|
General
and administrative
|
|
|
194
|
|
|
|
258
|
|
|
|
426
|
|
|
|
471
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
|
6,020
|
|
|
|
10,441
|
|
|
|
13,258
|
|
|
|
19,706
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from operations
|
|
|
(1,024
|
)
|
|
|
(7,176
|
)
|
|
|
(4,246
|
)
|
|
|
(11,989
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expense), net:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
(expense) income, net
|
|
|
(33
|
)
|
|
|
(14
|
)
|
|
|
(70
|
)
|
|
|
61
|
|
Other
income, net
|
|
|
164
|
|
|
|
15
|
|
|
|
435
|
|
|
|
14
|
|
Gain
from forgiveness of debt
|
|
|
669
|
|
|
|
—
|
|
|
|
669
|
|
|
|
—
|
|
Total
other income
|
|
|
800
|
|
|
|
1
|
|
|
|
1,034
|
|
|
|
75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
(224
|
)
|
|
|
(7,175
|
)
|
|
|
(3,212
|
)
|
|
|
(11,914
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss attributable to common stockholders
|
|
$
|
(224
|
)
|
|
$
|
(7,175
|
)
|
|
$
|
(3,212
|
)
|
|
$
|
(11,914
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted net loss attributable to common stockholders per common
share
|
|
$
|
0.00
|
|
|
$
|
(0.04
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.07
|
)
|
Weighted
average basic and diluted common shares outstanding
|
|
|
175,507
|
|
|
|
170,971
|
|
|
|
174,440
|
|
|
|
170,729
|
|
(1)
|
Includes
equity-based compensation of $59,000 and $130,000 for the three and six
months ended June 30, 2009. Includes equity-based compensation of $79,000
and $162,000 for the three and six months ended June 30,
2008.
|
|
|
(2)
|
Excludes
equity-based compensation, which is presented
separately.
|
See
accompanying notes to unaudited condensed consolidated financial
statements
ON2
TECHNOLOGIES, INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
June
30,
|
|
|
Six
Months Ended
June
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|
|
(In
thousands)
|
|
|
(In
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(224
|
)
|
|
$
|
(7,175
|
)
|
|
$
|
(3,212
|
)
|
|
$
|
(11,914
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments
|
|
|
520
|
|
|
|
(57
|
)
|
|
|
(174
|
)
|
|
|
3,423
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income (loss)
|
|
$
|
296
|
|
|
$
|
(7,232
|
)
|
|
$
|
(3,386
|
)
|
|
$
|
(8,491
|
)
|
See
accompanying notes to unaudited condensed consolidated financial
statements
ON2
TECHNOLOGIES, INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
Six
Months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(In
thousands)
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(3,212
|
)
|
|
$
|
(11,914
|
)
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Gain
from forgiveness of debt
|
|
|
(669
|
)
|
|
|
—
|
|
Equity-based
compensation
|
|
|
986
|
|
|
|
969
|
|
Depreciation
|
|
|
296
|
|
|
|
281
|
|
Amortization
|
|
|
630
|
|
|
|
1,562
|
|
Bad
debt expense
|
|
|
(226
|
)
|
|
|
(131
|
)
|
Asset
impairments from restructuring
|
|
|
175
|
|
|
|
—
|
|
Change
in fair value of warrant derivative liability
|
|
|
18
|
|
|
|
—
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
725
|
|
|
|
4,016
|
|
Prepaid
expenses and other current assets
|
|
|
144
|
|
|
|
62
|
|
Other
assets
|
|
|
25
|
|
|
|
12
|
|
Accounts
payable and accrued expenses
|
|
|
(126
|
)
|
|
|
(679
|
)
|
Accrued
restructuring expense
|
|
|
746
|
|
|
|
—
|
|
Deferred
revenue
|
|
|
(617
|
)
|
|
|
1,745
|
|
|
|
|
|
|
|
|
|
|
Net
cash used in operating activities
|
|
|
(1,105
|
)
|
|
|
(4,077
|
)
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds
from the sale of short-term investments
|
|
|
132
|
|
|
|
23,074
|
|
Purchase
of short-term investments
|
|
|
(131
|
)
|
|
|
(17,684
|
)
|
Purchases
of property and equipment
|
|
|
(168
|
)
|
|
|
(204
|
)
|
|
|
|
|
|
|
|
|
|
Net
cash (used in) provided by investing activities
|
|
|
(167
|
)
|
|
|
5,186
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal
payments on capital lease obligations
|
|
|
(122
|
)
|
|
|
(95
|
)
|
Net
proceeds from short-term borrowings
|
|
|
127
|
|
|
|
(2,281
|
)
|
Principal
payments on long-term debt
|
|
|
(113
|
)
|
|
|
(183
|
)
|
Purchase
of treasury stock
|
|
|
(4
|
)
|
|
|
(52
|
)
|
Proceeds
from the exercise of common stock options and warrants
|
|
|
—
|
|
|
|
49
|
|
|
|
|
|
|
|
|
|
|
Net
cash used in financing activities
|
|
|
(112
|
)
|
|
|
(2,562
|
)
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
(107
|
)
|
|
|
(122
|
)
|
|
|
|
|
|
|
|
|
|
Net
decrease in cash and cash equivalents
|
|
|
(1,491
|
)
|
|
|
(1,575
|
)
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of period
|
|
|
4,157
|
|
|
|
9,573
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
2,666
|
|
|
$
|
7,998
|
|
ON2
TECHNOLOGIES, INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
Supplemental
disclosure of cash flow information:
|
|
Six Months Ended June
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(In
thousands)
|
|
|
|
|
|
Cash
paid during the period for interest
|
|
$
|
61
|
|
|
$
|
76
|
|
Warrant
derivative liability - opening balance adjustment for
liability
|
|
$
|
121
|
|
|
|
—
|
|
Warrant
derivative liability - opening balance adjustment additional paid-in
capital
|
|
$
|
(924
|
)
|
|
|
—
|
|
Warrant
derivative liability - opening balance adjustment retained
earnings
|
|
$
|
803
|
|
|
|
—
|
|
Acquisition
of fixed assets under capital lease
|
|
|
—
|
|
|
$
|
461
|
|
Retirement
of treasury stock
|
|
$
|
4
|
|
|
$
|
52
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements
ON2
TECHNOLOGIES, INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1)
Description of On2
Technologies, Inc.
On2
Technologies, Inc. (“the Company”, “we”, “us” or “our”) is a developer of video
compression technology and technology that enables the creation, transmission,
and playback of multimedia in resource-limited environments, such as cellular
networks transmitting to battery operated mobile handsets or High Definition
(HD) video transmitted over the Internet. We have developed a proprietary
technology platform and the On2® Video VPx family (e.g., VP6, VP7, and VP8) of
video compression/decompression (“codec”) software to deliver high quality video
at the lowest possible data rates over proprietary networks and the Internet to
personal computers, wireless devices, set-top boxes and other devices. In
addition, through our wholly-owned subsidiary, On2 Technologies Finland Oy, we
license to chip and mobile handset manufacturers, and other developers of
multimedia consumer products the hardware and software designs that make the
encoding or decoding of video possible on mobile handsets, set top boxes,
portable media players, cameras and other devices. We offer a suite of products
and services based on our proprietary compression technology and mobile video
technology. Our service offerings include customized engineering, consulting
services, and technical support. In addition, we license our software products,
which include video and audio codecs and encoding software, for use with video
delivery platforms. We also license software that encodes video in the Adobe®
Flash® 8 format and other formats; the Flash 8 format uses our VP6 video codec.
We also license our hardware video codecs to companies that incorporate our
technology into semi conductors and devices.
The
Company’s business is characterized by rapid technological change, new product
development and evolving industry standards. Inherent in the Company’s business
model are various risks and uncertainties, including its limited operating
history, unproven business model and the limited history of the industry in
which it operates. The Company’s success may depend, in part, upon the wide
adoption of video delivery media, prospective product and service development
efforts, and the acceptance of the Company’s technology solutions by the
marketplace.
The
Company has experienced significant operating losses and negative operating cash
flows to date. At June 30, 2009, the Company had negative working capital of
$3,124,000. For the six months ended June 30, 2009, the Company incurred a net
loss of $3,212,000, which included non-cash charges of $1,210,000. Cash used in
operating activities was $1,105,000 for the six months ended June 30,
2009.
During
2008, the Company implemented a restructuring program, including a reduction of
its workforce, a reduction in overhead costs, and the identification of one time
charges for professional fees. Additionally, on January 28, 2009 the Company
notified its employees at On2 Finland that it intended to further reduce its
personnel costs there through furloughs, terminations and/or moving some
full-time employees to part-time. In accordance with Finnish law, the Company
negotiated with the representative of the On2 Finland employees and On2
Finland’s management team to obtain consensus on the reduction in workforce
plan. On March 18, 2009 the cost reduction plan was finalized and communicated
to On2 Finland employees. We are continuing to focus our efforts on marketing
our compression and video technology to strengthen the demand for our product
and services.
Additionally,
On2 Finland may borrow funds up to a maximum of €450,000 ($632,000 based on
exchange rates as of June 30, 2009) under a line of credit. As of June 30, 2009,
the balance outstanding on this line of credit was $190,000. On July 30, 2009,
the limit on the line of credit was reduced to €300,000. Given our cash and
short-term investments of $2,797,000 at June 30, 2009, and the Company’s
forecasted cash requirements, the Company’s management anticipates that the
Company’s existing capital resources will be sufficient to satisfy our cash flow
requirements for the next 12 months. We have based our forecasts on assumptions
we have made relating to, among other things, the market for our products and
services, economic conditions and the availability of credit to us and our
customers. If these assumptions are incorrect, or if our sales are less than
forecasted and/or expenses higher than expected, we may not have sufficient
resources to fund our operations for this entire period. In that event, the
Company may need to seek other sources of funds by issuing equity or incurring
debt, or may need to implement further reductions of operating expenses, or some
combination of these measures, in order for the Company to generate positive
cash flows to sustain the operations of the Company. However, because of the
recent tightening in global credit markets, we may not be able to obtain
financing on favorable terms, or at all.
(2)
Basis of
Presentation
The
unaudited condensed consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
The
interim condensed consolidated financial statements are unaudited. However, in
the opinion of management, such financial statements contain all adjustments
(consisting of normally recurring accruals) necessary to present fairly the
financial position of the Company and its results of operations and cash flows
for the interim periods presented. The condensed consolidated financial
statements included herein have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission (“SEC”). Certain
information and footnote disclosures normally included in consolidated financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
rules and regulations. The Company believes that the disclosures included herein
are adequate to make the information presented not misleading. These condensed
consolidated financial statements should be read in conjunction with the annual
financial statements and notes thereto included in the Company’s Annual Report
on Form 10-K for the fiscal year ended December 31, 2008, filed with the SEC on
March 12, 2009.
(3)
Recently Adopted
Accounting Pronouncements
In
June 2009, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) 168, The
FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles.
SFAS 168 establishes the
FASB
Accounting Standards Codification
(Codification)
as the single source of authoritative U.S. generally accepted accounting
principles (U.S. GAAP) recognized by the FASB to be applied by nongovernmental
entities. Rules and interpretive releases of the SEC under authority of federal
securities laws are also sources of authoritative U.S. GAAP for SEC registrants.
SFAS 168 and the Codification are effective for financial statements issued for
interim and annual periods ending after September 15, 2009. There will be no
change to the Company’s condensed consolidated financial position and results of
operations due to the implementation of this Statement.
When
effective, the Codification will supersede all existing non-SEC accounting and
reporting standards. All other non-grandfathered non-SEC accounting literature
not included in the Codification will become non-authoritative. Following SFAS
168, the FASB will not issue new standards in the form of Statements, FASB Staff
Positions, or Emerging Issues Task Force Abstracts. Instead, the FASB will issue
Accounting Standards Updates, which will serve only to: (
a
)
update the Codification; (
b
)
provide background information about the guidance; and (
c
)
provide the bases for conclusions on the change(s) in the
Codification.
In
June 2009, the FASB issued the following two standards which change the way
entities account for securitizations and special-purpose entities:
|
|
|
|
●
|
SFAS 166,
Accounting
for Transfers of Financial Assets;
|
|
●
|
SFAS 167,
Amendments
to FASB Interpretation No.
46(R).
|
SFAS 166
is a revision to FASB SFAS 140,
Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities,
and will require more information about transfers of
financial assets, including securitization transactions, and where entities have
continuing exposure to the risks related to transferred financial assets. It
eliminates the concept of a “qualifying special-purpose entity,” changes the
requirements for derecognizing financial assets and requires additional
disclosures. SFAS 167 is a revision to FASB Interpretation No. 46 (Revised
December 2003),
Consolidation
of Variable Interest Entities,
and changes how a reporting entity
determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. The
determination of whether a reporting entity is required to consolidate another
entity is based on, among other things, the other entity’s purpose and design
and the reporting entity’s ability to direct the activities of the other entity
that most significantly impact the other entity’s economic performance. The new
standards will require a number of new disclosures. Statement 167 will require a
reporting entity to provide additional disclosures about its involvement with
variable interest entities and any significant changes in risk exposure due to
that involvement. A reporting entity will be required to disclose how its
involvement with a variable interest entity affects the reporting entity’s
financial statements. Statement 166 enhances information reported to users of
financial statements by providing greater transparency about transfers of
financial assets and an entity’s continuing involvement in transferred financial
assets. SFAS 166 and 167 will be effective at the start of a reporting entity’s
first fiscal year beginning after November 15, 2009, or January 1, 2010, for a
calendar year-end entity. Early application is not permitted. The Company is
currently evaluating the impact of adopting SFAS 166 and SFAS 167 on its
condensed consolidated financial position and results of
operations.
In
May 2009, the FASB issued SFAS 165,
Subsequent
Events.
SFAS 165 establishes general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. Specifically,
SFAS 165 provides:
|
|
|
|
●
|
The
period after the balance sheet date during which management of a reporting
entity should evaluate events or transactions that may occur for potential
recognition or disclosure in the financial statements.
|
|
●
|
The
circumstances under which an entity should recognize events or
transactions occurring after the balance sheet date in its financial
statements.
|
|
●
|
The
disclosures that an entity should make about events or transactions that
occurred after the balance sheet
date.
|
SFAS 165
is effective for interim or annual financial periods ending after June 15, 2009,
and shall be applied prospectively. The Company adopted this statement as of
June 30, 2009. This Statement did not impact the condensed consolidated
financial results. Management has evaluated subsequent events through August 7,
2009, the date the financial statements were issued.
During
the second quarter of 2009, the FASB issued FASB Staff Position (FSP) FAS 157-4,
Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not
Orderly.
This FSP:
|
|
|
|
●
|
Affirms
that the objective of fair value when the market for an asset is not
active is the price that would be received to sell the asset in an orderly
transaction.
|
|
●
|
Clarifies
and includes additional factors for determining whether there has been a
significant decrease in market activity for an asset when the market for
that asset is not active.
|
|
●
|
Eliminates
the proposed presumption that all transactions are distressed (not
orderly) unless proven otherwise. The FSP instead requires an entity to
base its conclusion about whether a transaction was not orderly on the
weight of the evidence.
|
|
●
|
Includes
an example that provides additional explanation on estimating fair value
when the market activity for an asset has declined
significantly.
|
|
●
|
Requires
an entity to disclose a change in valuation technique (and the related
inputs) resulting from the application of the FSP and to quantify its
effects, if practicable.
|
|
●
|
Applies
to all fair value measurements when
appropriate.
|
FSP
FAS 157-4 must be applied prospectively and retrospective application is not
permitted. FSP FAS 157-4 is effective for interim and annual periods ending
after June 15, 2009, with early adoption permitted for periods ending after
March 15, 2009. An entity early adopting FSP FAS 157-4 must also early adopt FSP
FAS 115-2 and FAS 124-2,
Recognition
and Presentation of Other-Than-Temporary Impairments.
The Company has
complied with the requirements FSP FAS 157-4.
During
the second quarter of 2009, the FASB issued FSP FAS 115-2 and FAS 124-2,
Recognition
and Presentation of Other-Than-Temporary Impairments.
This
FSP:
|
|
|
|
●
|
Changes
existing guidance for determining whether an impairment is other than
temporary to debt securities.
|
|
●
|
Replaces
the existing requirement that the entity’s management assert it has both
the intent and ability to hold an impaired security until recovery with a
requirement that management assert: (
a
)
it does not have the intent to sell the security; and (
b
)
it is more likely than not it will not have to sell the security before
recovery of its cost basis.
|
|
●
|
Incorporates
examples of factors from existing literature that should be considered in
determining whether a debt security is other-than-temporarily
impaired.
|
|
●
|
Requires
that an entity recognize noncredit losses on held-to-maturity debt
securities in other comprehensive income and amortize that amount over the
remaining life of the security in a prospective manner by offsetting the
recorded value of the asset unless the security is subsequently sold or
there are additional credit losses.
|
|
●
|
Requires
an entity to present the total other-than-temporary impairment in the
statement of earnings with an offset for the amount recognized in other
comprehensive income.
|
|
●
|
When
adopting FSP FAS 115-2 and FAS 124-2, an entity is required to record a
cumulative-effect adjustment as of the beginning of the period of adoption
to reclassify the noncredit component of a previously recognized
other-temporary impairment from retained earnings to accumulated other
comprehensive income if the entity does not intend to sell the security
and it is not more likely than not that the entity will be required to
sell the security before
recovery.
|
FSP
FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending after
June 15, 2009, with early adoption permitted for periods ending after March 15,
2009. An entity may early adopt this FSP only if it also elects to early adopt
FSP FAS 157-4. The Company adopted this FSP for the quarter ended June 30,
2009, and there was no material impact on the Company’s condensed consolidated
results of operations or financial position.
During
the second quarter of 2009, the FASB issued FSP FAS 107-1 and APB 28-1,
Interim
Disclosures about Fair Value of Financial Instruments.
This FSP amends
FASB Statement No. 107,
Disclosures
about Fair Value of Financial Instruments,
to require an entity to
provide disclosures about fair value of financial instruments in interim
financial information. This FSP also amends APB Opinion No. 28,
Interim
Financial Reporting,
to require those disclosures in summarized financial
information at interim reporting periods. Under this FSP, a publicly traded
company shall include disclosures about the fair value of its financial
instruments whenever it issues summarized financial information for interim
reporting periods. In addition, an entity shall disclose in the body or in the
accompanying notes of its summarized financial information for interim reporting
periods and in its financial statements for annual reporting periods the fair
value of all financial instruments for which it is practicable to estimate that
value, whether recognized or not recognized in the statement of financial
position, as required by Statement 107.
FSP
107-1 and APB 28-1 is effective for interim periods ending after June 15, 2009,
with early adoption permitted for periods ending after March 15, 2009. However,
an entity may early adopt these interim fair value disclosure requirements only
if it also elects to early adopt FSP FAS 157-4 and FSP FAS 115-2 and FAS 124-2.
The company adopted this FSP in the quarter ended June 30, 2009. There was
no impact on the condensed consolidated financial position and results of
operations as it relates only to additional disclosures. The Company has
complied with the disclosure requirements of FSP FAS 107-1 and APB
28-1.
On
April 1, 2009, the FASB issued FSP FAS 141(R)-1,
Accounting
for Assets Acquired and Liabilities Assumed in a Business Combination That Arise
from Contingencies.
This FSP amends the guidance in FASB Statement No.
141 (Revised December 2007),
Business
Combinations,
to:
|
|
|
|
●
|
Require that assets
acquired and liabilities assumed in a business combination that arise from
contingencies be recognized at fair value if fair value can be reasonably
estimated. If fair value of such an asset or liability cannot be
reasonably estimated, the asset or liability would generally be recognized
in accordance with FASB Statement No. 5,
Accounting
for Contingencies,
and FASB Interpretation (FIN) No. 14,
Reasonable
Estimation of the Amount of a Loss.
Further, the FASB decided to
remove the subsequent accounting guidance for assets and liabilities
arising from contingencies from Statement 141R, and carry forward without
significant revision the guidance in FASB Statement No. 141,
Business
Combinations.
|
|
●
|
Eliminate
the requirement to disclose an estimate of the range of outcomes of
recognized contingencies at the acquisition date. For unrecognized
contingencies, the FASB decided to require that entities include only the
disclosures required by Statement 5 and that those disclosures be included
in the business combination footnote.
|
|
●
|
Require
that contingent consideration arrangements of an acquiree assumed by the
acquirer in a business combination be treated as contingent consideration
of the acquirer and should be initially and subsequently measured at fair
value in accordance with Statement
141R.
|
This
FSP is effective for assets or liabilities arising from contingencies in
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008 (i.e., January 1, 2009 for a calendar year-end company). This FSP was
adopted effective January 1, 2009. There was no material impact upon
adoption, and its effects on future periods will depend on the nature and
significance of business combinations subject to this statement.
In
June 2008, the Emerging Issues Task Force (“EITF”) reached a consensus in
Issue No. 07-5,
Determining
Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own
Stock
(“EITF 07-5”). This Issue addresses the determination of whether an
instrument (or an embedded feature) is indexed to an entity’s own stock, which
is the first part of the scope exception in paragraph 11(a) of SFAS 133,
Accounting for Derivative Instruments and Hedging Activities
. EITF 07-5
is effective for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. Early application is not permitted.
The Company has adopted EITF 07-05 and has made a cumulative adjustment as of
January 1, 2009. As of March 31, 2009 the Company had 1.6 million warrants to
purchase common stock outstanding at exercise prices ranging from $0.57 to
$0.75. The existence of a “subsequent equity sales (anti-dilution)” provision in
the warrants prevented the warrants from being considered to be indexed to the
Company’s own stock, which is the first part of the scope exception in paragraph
11(a) of Statement of Financial Accounting Standards No. 133. Accordingly,
pursuant to SFAS 133, the Company was required to record a cumulative adjustment
to increase retained earnings as of January 1, 2009 of $803,000, a decrease to
additional paid-in capital of $924,000, and an increase to warrant derivative
liability of $121,000 to account for the impact of EITF 07-5.
In
December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141R,
Business
Combinations
(“SFAS 141R”), which replaces SFAS No. 141,
Business
Combinations
. SFAS 141R establishes principles and requirements for
determining how an enterprise recognizes and measures the fair value of certain
assets and liabilities acquired in a business combination, including
non-controlling interests, contingent consideration, and certain acquired
contingencies. SFAS 141R also requires acquisition-related transaction expenses
and restructuring costs be expensed as incurred rather than capitalized as a
component of the business combination. SFAS 141R will be applicable
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. The implementation of SFAS 141R did not have a material
effect on the Company’s condensed consolidated financial position and results of
operations and its effects on future periods will depend on the nature and
significance of business combinations subject to this statement.
In
April 2009, the FASB issued FASB Staff Position (FSP) Financial Accounting
Standard (FAS) 157-4,
Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not
Orderly
. Based on the guidance, if an entity determines that the level of
activity for an asset or liability has significantly decreased and that a
transaction is not orderly, further analysis of transactions or quoted prices is
needed, and a significant adjustment to the transaction or quoted prices may be
necessary to estimate fair value in accordance with SFAS No. 157, “Fair
Value Measurements.” This FSP is to be applied prospectively and is effective
for interim and annual periods ending after June 15, 2009 with early
adoption permitted for periods ending after March 15, 2009. The company
adopted this FSP in the quarter ended June 30, 2009, and there was no
material impact on the Company’s condensed consolidated financial position and
results of operations.
(4)
Stock-Based
Compensation
The
Company adopted the provision of SFAS No. 123R effective January 1, 2006, using
the modified prospective transition method. Under this method, non-cash
compensation expense is recognized under the fair value method for the portion
of outstanding share based awards granted prior to the adoption of SFAS 123R for
which service has not been rendered, and for any share based awards granted or
modified after adoption. Accordingly, periods prior to adoption have not been
restated. Prior to the adoption of SFAS 123R, the Company accounted for stock
based compensation using the intrinsic value method. The Company recognizes
share-based compensation cost associated with awards subject to graded vesting
in accordance with the accelerated method specified in FASB Interpretation No.
28 pursuant to which each vesting tranche is treated as a separate award. The
compensation cost associated with each vesting tranche is recognized as expense
evenly over the vesting period of that tranche.
The
following table summarizes the activity of the Company’s stock options for the
three months ended June 30, 2009:
|
|
Shares
|
|
|
Weighted-
average
Exercise
Price
|
|
|
Weighted-
average
Remaining
Contractual
Life
|
|
|
Aggregate
Intrinsic
Value
|
|
|
|
(Thousands)
|
|
|
|
|
|
(Years)
|
|
|
(Thousands)
|
|
Number
of shares under option:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at January 1, 2009
|
|
|
12,760
|
|
|
$
|
0.78
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
105
|
|
|
|
0.32
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Canceled
or expired
|
|
|
(499
|
)
|
|
|
0.53
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at June 30, 2009
|
|
|
12,366
|
|
|
$
|
0.78
|
|
|
|
5.70
|
|
|
$
|
106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested
and expected to vest at June 30, 2009
|
|
|
12,288
|
|
|
$
|
0.78
|
|
|
|
5.70
|
|
|
$
|
105
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at June 30, 2009
|
|
|
6,424
|
|
|
$
|
0.97
|
|
|
|
4.52
|
|
|
$
|
17
|
|
Stock
based compensation expense recognized in the Unaudited Condensed Consolidated
Statement of Operations was $496,000 and $986,000 for the three and six months
ended June 30, 2009, respectively. Stock based compensation from restricted
stock grants for the three and six months ended June 30, 2009 was $301,000 and
$600,000, respectively. Stock based compensation expense recognized in the
unaudited condensed consolidated statement of operations was $516,000 and
$969,000 for the three and six months ended June 30, 2008, respectively. Stock
based compensation from restricted stock grants for the three and six months
ended June 30, 2008 was $341,000 and $604,000.
The
following table summarizes the activity of the Company’s non-vested stock
options for the three months ended June 30, 2009:
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted-
average
Grant
Date
Fair
Value
|
|
|
|
(Thousands)
|
|
|
|
|
Non-vested
at January 1, 2009
|
|
|
6,429
|
|
|
$
|
0.30
|
|
Granted
|
|
|
105
|
|
|
|
0.19
|
|
Cancelled
or expired
|
|
|
(474
|
)
|
|
|
0.27
|
|
Vested
during the period
|
|
|
(118
|
)
|
|
|
0.28
|
|
|
|
|
|
|
|
|
|
|
Non-vested
at June 30, 2009
|
|
|
5,942
|
|
|
$
|
0.30
|
|
As
of June 30, 2009, there was $1,255,000 of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under
existing stock option plans. This cost is expected to be recognized over a
weighted-average period of 1.79 years.
The
Company uses the Black-Scholes option-pricing model to determine the
weighted-average fair value of options. There were no options granted during the
three months ended June 30, 2009 and 2008. The fair value of options at date of
grant and the assumptions utilized to determine such values for options granted
during the six months ended June 30, 2009 and June 30, 2008 are indicated in the
following table:
|
|
|
|
|
|
|
|
|
Six
Months
Ended
June
30, 2009
|
|
|
Six
Months
Ended
June
30, 2008
|
|
|
|
|
|
|
|
|
|
|
Weighted
average fair value at date of grant for options granted during the
period
|
|
$
|
0.19
|
|
|
$
|
0.48
|
|
|
|
|
|
|
|
|
|
|
Expected
stock price volatility
|
|
|
98
|
%
|
|
|
80
|
%
|
Expected
life of options
|
|
3
years
|
|
|
3
years
|
|
Risk
free interest rates
|
|
|
1.02
|
%
|
|
|
2.27
|
%
|
Expected
dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
The
following summarizes the activity of the Company’s non-vested restricted common
stock for the three months ended June 30, 2009:
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted-
average
Grant
Date
Fair
Value
|
|
|
|
(Thousands)
|
|
|
|
|
Non-vested
at January 1, 2009
|
|
|
1,192
|
|
|
$
|
1.07
|
|
Granted
|
|
|
3,831
|
|
|
|
0.32
|
|
Cancelled
or expired
|
|
|
(89
|
)
|
|
|
0.65
|
|
Vested
during the period
|
|
|
(489
|
)
|
|
|
1.18
|
|
|
|
|
|
|
|
|
|
|
Non-vested
at June 30, 2009
|
|
|
4,445
|
|
|
$
|
0.42
|
|
During
the six months ended June 30, 2009, the Company granted 1,157,000 shares of
restricted common stock to its Board of Directors, which shares vest in January
2010, and 2,674,000 shares of restricted common stock to its employees, which
shares vest in March 2012. The compensation expense related to these grants was
$159,000 and $242,000 for the three and six months ended June 30, 2009, and
there was $942,000 of unrecognized compensation cost which will be recognized
through the first quarter of 2012.
(5) Cash
and cash equivalents and short-term investments
As
of June 30, 2009, the Company held $131,000 in short-term securities, all of
which are in a certificate of deposit in a United States bank.
(6)
Intangible Assets and Goodwill
In
connection with the Company’s acquisition of On2 Finland on November 1, 2007,
the Company acquired intangible assets of $53,354,000, which included goodwill
in the amount of $36,075,000. During 2008, the value of these intangible assets
were reduced by $33,268,000, including a $26,481,000 reduction for goodwill, as
a result of an impairment analysis. There were no intangible asset or goodwill
impairment losses recorded during the three or six months ended June 30,
2009.
Goodwill
represents the excess of the purchase price over the fair value of net assets
acquired in a business combination. Goodwill is required to be tested for
impairment at the reporting unit level on an annual basis and between annual
tests when circumstances indicate that the recoverability of the carrying amount
of such goodwill may be impaired. Application of the goodwill impairment test
requires exercise of judgment, including the estimation of future cash flows,
determination of appropriate discount rates and other important assumptions.
Changes in these estimates and assumptions could materially affect the
determination of fair value and/or goodwill impairment for each reporting
unit.
The
assets recognized with respect to acquired software, trademarks, customer
relationships and non-compete agreements are being amortized over their
estimated lives. Amortization expense related to these intangible assets was
$300,000 and $630,000 for the three and six months ended June 30, 2009,
respectively, and $757,000 and $1,562,000 for the three and six months ended
June 30, 2008, respectively. The intangible assets and goodwill increased by
$943,000 and decreased by $85,000 for the three and six months ended June 30,
2009, respectively, and decreased by $59,000 and increased by $3,853,000 for the
three and six months ended June 30, 2008, respectively, for the effects of the
foreign currency translation adjustment. There were no other additions of
intangible assets during the six months ended June 30, 2009.
Based
on the current amount of intangibles subject to amortization, the estimated
future amortization expense related to our intangible assets at June 30, 2009 is
as follows (in thousands):
For
the Year Ending June 30,
|
|
|
Future
Amortization
|
|
2010
|
|
$
|
1,151
|
|
2011
|
|
|
1,151
|
|
2012
|
|
|
1,151
|
|
2013
|
|
|
779
|
|
2014
|
|
|
593
|
|
Thereafter
|
|
|
1,979
|
|
Total
|
|
$
|
6,804
|
|
(7)
Short-Term
Borrowings
At
June 30, 2009, short-term borrowings consisted of the following:
A
line of credit with a Finnish bank for $632,000 (€450,000 at June 30, 2009). The
line of credit has no expiration date. Borrowings under the line of credit bear
interest at one month EURIBOR plus 1.25% (total of 2.163% at June 30, 2009). The
bank also requires a commission payable at .45% of the loan principal.
Borrowings are collateralized by substantially all assets of On2 Finland and a
guarantee by the Company. The outstanding balance on the line of credit was
$190,000 at June 30, 2009. On July 30, 2009 the limit on the line of credit was
reduced to €300,000.
Term
Loan
During
July 2008, the Company renewed its Directors and Officers Liability Insurance
and financed the premium with a $140,000, nine-month term-loan that carries an
effective annual interest rate of 4.75%. The balance at June 30, 2009 was
$-0-.
(8)
Long-Term
Debt
During
May 2009, the Company received approval for the modification of terms on three
notes payable to a Finnish funding agency for its Finland subsidiary. The
modification of terms included 1) a forgiveness of debt of €477,000 ($669,000)
on one note payable, and 2) extending the due dates of the remaining payments
for two years on all three notes payable. The following table summarizes the
changes in the payment terms and the forgiveness of debt (amounts in US Dollars
using a conversion rate of 1.4048 at June 30, 2009):
|
|
|
|
|
|
|
|
|
|
Note
Payable 1
|
|
Note
Payable 2
|
|
Note
Payable 3
|
|
|
|
|
|
|
|
|
|
Original
Balance:
|
|
$123,000
|
|
$281,000
|
|
$2,025,000
|
|
|
|
|
|
|
|
|
|
Original
payment terms:
|
|
$123,000
due 7/3/09
|
|
$140,500
due 9/6/09
|
|
$675,000
due 12/27/09
|
|
|
|
|
|
$140,500
due 9/6/10
|
|
$675,000
due 12/27/10
|
|
|
|
|
|
|
|
$675,000
due 12/27/11
|
|
|
|
|
|
|
|
|
|
Forgiveness
of debt:
|
|
—
|
|
—
|
|
$669,000
|
|
|
|
|
|
|
|
|
|
New
Balance:
|
|
$123,000
|
|
$281,000
|
|
$1,356,000
|
|
|
|
|
|
|
|
|
|
New
Payment terms:
|
|
$123,000
due 7/3/11
|
|
$140,500
due 9/6/11
|
|
$452,000
due 12/27/11
|
|
|
|
|
|
$140,500
due 9/6/12
|
|
$452,000
due 12/27/12
|
|
|
|
|
|
|
|
$452,000
due 12/27/13
|
|
At
June 30, 2009, long-term debt consisted of the following:
Unsecured
notes payable to a Finnish funding agency of $1,808,000, including interest at
2.00%, due at dates ranging from July 2011 to December 2013; $200,000 to a
Finnish bank, including interest at the 3-month EURIBOR plus 1.1% (total of
2.33% at June 30, 2009), due March 2011, secured by guarantees by the Company,
and by the Finnish Government Organization, which also requires additional
interest at 2.65% of the loan principal; and an unsecured note payable to a
Finnish financing company of $140,000, including interest at the 6 month EURIBOR
plus .5% (total of 1.94% at June 30, 2009), due March 2011.
Future
maturities of long-term debt are as follows as of June 30, 2009 (in
thousands):
|
|
|
|
|
|
|
For
the Year Ending June 30,
|
|
|
|
|
2010
|
|
|
$
|
171
|
|
|
2011
|
|
|
|
218
|
|
|
2012
|
|
|
|
716
|
|
|
2013
|
|
|
|
593
|
|
|
2014
|
|
|
|
452
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
$
|
2,150
|
|
(9)
Warrant Derivative
Liability
In
June 2008, the Emerging Issues Task Force (“EITF”) reached a consensus in
Issue No. 07-5,
Determining
Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own
Stock
(“EITF 07-5”). This Issue addresses the determination of whether an
instrument (or an embedded feature) is indexed to an entity’s own stock, which
is the first part of the scope exception in paragraph 11(a) of SFAS 133. EITF
07-5 is effective for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. Early application is not permitted.
Th
e
Company has adopted EITF 07-05 and has made a cumulative adjustment as of
January 1, 2009. As of March 31, 2009 the Company had 1.6 million warrants to
purchase common stock outstanding at exercise prices ranging from $0.57 to
$0.75. The existence of a “subsequent equity sales (anti-dilution)” provision in
the warrants prevented the warrants from being considered to be indexed to the
Company’s own stock, which is the first part of the scope exception in paragraph
11(a) of SFAS 133. Accordingly, pursuant to SFAS 133, the Company was required
to record a cumulative adjustment to increase retained earnings as of January 1,
2009 of $803,000, a decrease to additional paid-in capital of $924,000, and an
increase to warrant derivative liability of $121,000 to account for the impact
of EITF 07-5. During the three and six months ended June 30, 2009 the Company
recorded a charge of $18,000 to reflect the change in the fair value of the
warrant derivative liability. The fair value was calculated using the
Black-Scholes pricing model.
(10) Common
Stock
During
the six months ended June 30, 2009, the Company issued 3,831,000 restricted
common stock grants. During this period, the Company cancelled 89,000 shares of
restricted common stock grants from 2008 formerly held by terminated employees.
The Company cancelled 7,000 shares of common stock resulting from the retirement
of Treasury Stock, as outlined in Note 11 below.
(11) Treasury
Stock
In
April 2007, the Company’s Board of Directors authorized that all the shares
recorded as treasury stock be cancelled and that all subsequent shares received
from cashless exercises be cancelled immediately after receipt. The Company
allowed its employees to relinquish shares from the vesting of a portion of
restricted stock grants for payment of taxes. During the six months ended June
30, 2009, the Company received a total of 7,000 shares at a value of $4,000 for
payment of taxes. During the six months ended June 30, 2008, the Company
received a total of 53,000 shares at a value of $52,000 for payment of
taxes.
(12) Geographical
Reporting and Customer Concentration
The
components of the Company’s revenue for the three and six months ended June 30,
2009 and 2008 are summarized as follows (in thousands):
|
|
|
|
|
|
|
|
|
For
the three months ended June 30
|
|
|
|
2009
|
|
|
2008
|
|
License
software revenue
|
|
$
|
3,198
|
|
|
$
|
2,087
|
|
Engineering
services and support
|
|
|
598
|
|
|
|
482
|
|
Royalties
|
|
|
1,181
|
|
|
|
677
|
|
Other
|
|
|
19
|
|
|
|
19
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
4,996
|
|
|
$
|
3,265
|
|
|
|
For
the six months ended June 30
|
|
|
|
2009
|
|
|
2008
|
|
License
software revenue
|
|
$
|
5,402
|
|
|
$
|
5,002
|
|
Engineering
services and support
|
|
|
1,264
|
|
|
|
1,062
|
|
Royalties
|
|
|
2,308
|
|
|
|
1,615
|
|
Other
|
|
|
38
|
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
9,012
|
|
|
$
|
7,717
|
|
For the
three and six months ended June 30, 2009 foreign customers accounted for
approximately 72% and 63%, respectively of the Company’s total revenue. For the
three and six months ended June 30, 2008 foreign customers accounted for
approximately 62% and 46%, respectively of the Company’s total revenue. These
customers are primarily located in Europe and Middle East, and
Asia.
Selected
information by geographic location is as follows (in thousands):
|
|
For
the three months ended June 30
|
|
|
|
2009
|
|
|
2008
|
|
Revenue
from unaffiliated customers:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United
States Operations
|
|
$
|
1,703
|
|
|
$
|
1,952
|
|
Finland
Operations
|
|
|
3,293
|
|
|
|
1,313
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
4,996
|
|
|
$
|
3,265
|
|
|
|
|
|
|
|
|
|
|
Net
Loss:
|
|
|
|
|
|
|
|
|
United
States Operations
|
|
$
|
(2,106
|
)
|
|
$
|
(4,069
|
)
|
Finland
Operations
|
|
|
1,882
|
|
|
|
(3,106
|
)
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
(224
|
)
|
|
$
|
(7,175
|
)
|
|
|
|
|
|
|
|
|
|
|
|
For
the six months ended June 30
|
|
|
|
2009
|
|
|
2008
|
|
Revenue
from unaffiliated customers:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United
States Operations
|
|
$
|
4,227
|
|
|
$
|
4,857
|
|
Finland
Operations
|
|
|
4,785
|
|
|
|
2,860
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
9,012
|
|
|
$
|
7,717
|
|
|
|
|
|
|
|
|
|
|
Net
Loss:
|
|
|
|
|
|
|
|
|
United
States Operations
|
|
$
|
(3,153
|
)
|
|
$
|
(5,018
|
)
|
Finland
Operations
|
|
|
(59
|
)
|
|
|
(6,896
|
)
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
(3,212
|
)
|
|
$
|
(11,914
|
)
|
|
|
June
30,
2009
|
|
|
December
31,
2008
|
|
Identifiable
assets:
|
|
|
|
|
|
|
United
States Operations
|
|
$
|
4,863
|
|
|
$
|
6,287
|
|
Finland
Operations
|
|
|
17,769
|
|
|
|
19,589
|
|
Total
|
|
$
|
22,632
|
|
|
$
|
25,876
|
|
For
the three months ended June 30, 2009, there was one customer that accounted for
15% and one customer that accounted for 13% of the Company’s revenue. For the
six months ended June 30, 2009, there was one customer that accounted for 10% of
the Company’s revenue. For the three and six months ended June 30, 2008, there
was one customer that accounted for 23% and 10%, respectively of the Company’s
revenue.
Financial
instruments that subject the Company to concentrations of credit risk consist
primarily of cash and cash equivalents. The Company maintains cash and cash
equivalents in two financial institutions in the US and in two financial
institutions in foreign countries. The Company performs periodic evaluations of
the relative credit standing of the institutions. The cash balances are insured
by the FDIC. The Company has cash balances in a money market fund and a checking
account at June 30, 2009 that exceeds the FDIC insured amount. Additionally, the
Company has a balance in an investment account at June 30, 2009. The investment
account is insured by the Securities Investor Protection Corporation up to a
value of $500,000 per depositor. The Company did not have investments in excess
of $500,000 at June 30, 2009.
(13)
Net Loss Per Share
Basic
net loss per share is computed by dividing the net loss applicable to common
shares by the weighted average number of common shares outstanding during the
period. Diluted loss attributable to common shares adjusts basic loss per share
for the effects of convertible securities, warrants, stock options and other
potentially dilutive financial instruments, only in the periods in which such
effect is dilutive. The shares issuable upon the exercise of stock options and
warrants are excluded from the calculation of net loss per share as their effect
would be anti-dilutive.
Securities
that could potentially dilute earnings per share in the future, that had
exercise prices below the market price at June, 2009 and 2008, were not included
in the computation of diluted loss per share and consist of the following as of
June 30:
|
|
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
Warrants
to purchase common stock
|
|
|
—
|
|
|
|
123,000
|
|
Options
to purchase common stock
|
|
|
302,500
|
|
|
|
1,649,000
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
302,500
|
|
|
|
1,772,000
|
|
(14)
Related Party Transactions
During
the six months ended June 30, 2008, the Company retained McGuireWoods LLP to
perform certain legal services on our behalf and incurred approximately $148,000
and $169,000 for the three and six months ended June 30, 2008, respectively, for
such legal services. William A. Newman, a director of the Company during that
period, was a partner of McGuireWoods LLP until May 2008. In May 2008, Mr.
Newman became a partner at Sullivan & Worcester LLP which continues to
represent the Company. Mr. Newman resigned as a Director in November
2008.
(15)
Restructuring
During
the first quarter of fiscal 2009, the Company recorded a pre-tax restructuring
and impairment charge of $1.032 million, or $0.01 per share, in connection with
a number of cost reduction initiatives at its Finnish subsidiary, On2 Finland.
These initiatives through June 2009 have resulted in a reduction of workforce
that has currently reduced headcount, through resignation and furlough, by 31
On2 Finland employees. In accordance with Finnish law, the Company had
negotiated in the first quarter of fiscal 2009 with the representative of the
On2 Finland employees and On2 Finland’s management team in order to obtain
consensus on the reduction in workforce plan. The Company announced
implementation of the final plan to On2 Finland employees on March 18, 2009 and
will execute it primarily through a furlough process that began in April 2009
and is anticipated to be fully implemented within fiscal 2009.
The
charges consisted primarily of four items: (1) severance and benefits costs for
the minimum future post-termination cash payments to be made to employees as
required by Finnish law and the collective bargaining agreement covering most
On2 Finland employees; (2) lease payments related to office and property no
longer required for operations; (3) related legal and other administrative
costs; and (4) non-cash write-offs for impairment from discontinued use of
excess capital leased equipment. The future post-termination cash payments are
triggered if the Company terminates some or all of the furloughed employees or
if employees who are furloughed for longer than 200 days elect to terminate
their own employment. The total charges incurred will depend on a number of
factors, including the duration of the furloughs, the number of employees, if
any, that are recalled from furlough or terminated and, for employees that are
furloughed for longer than 200 days, the number of such employees that have not
obtained other employment. We have currently estimated the cash and non-cash
restructuring and impairment charges to be $1.032 million, however, based on the
factors noted, this may increase by an additional $0.2 million during 2009 once
the 200 day furlough period has concluded.
Restructuring
and Impairment charges and liability consist of the following (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance
&
Benefits
|
|
|
Office
&
Property
|
|
|
Legal
&
Other
|
|
|
Asset
Impairment
|
|
|
Total
|
|
Balance
at March 18, 2009
|
|
$
|
262
|
|
|
$
|
583
|
|
|
$
|
12
|
|
|
$
|
175
|
|
|
$
|
1,032
|
|
Amount
Paid
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Adjustment
to Expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Decrease
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Effect
of exchange rate
|
|
|
3
|
|
|
|
8
|
|
|
|
—
|
|
|
|
—
|
|
|
|
11
|
|
Balance
at March 31, 2009
|
|
$
|
265
|
|
|
$
|
591
|
|
|
$
|
12
|
|
|
$
|
175
|
|
|
$
|
1,043
|
|
Amount
Paid
|
|
|
(58
|
)
|
|
|
(58
|
)
|
|
|
(23
|
)
|
|
|
—
|
|
|
|
(139
|
)
|
Adjustment
to Expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
|
|
|
241
|
|
|
|
—
|
|
|
|
17
|
|
|
|
—
|
|
|
|
258
|
|
Decrease
|
|
|
—
|
|
|
|
(258
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(258
|
)
|
Effect
of exchange rate
|
|
|
17
|
|
|
|
38
|
|
|
|
1
|
|
|
|
—
|
|
|
|
56
|
|
Balance
at June 30, 2009
|
|
$
|
465
|
|
|
$
|
313
|
|
|
$
|
7
|
|
|
$
|
175
|
|
|
$
|
960
|
|
The
Company has recorded and classified the liability at June 30, 2009 of $785,000
for the restructuring as Accrued Restructuring Expenses, and the charges for
Asset Impairment has resulted in a $175,000 reduction of the Company’s assets,
Capital Leases-Net, on the Company’s condensed consolidated balance sheet at
June 30, 2009. The restructuring and impairment charges of $-0- and $1,032,000
for the three and six months ended June 30, 2009, respectively, are classified
as Restructuring Expense on the Company’s condensed consolidated statements of
operations.
(16)
Litigation
Islandia
On
August 14, 2008, Islandia, L.P. filed a complaint against On2 in the Supreme
Court of the State of New York, New York County. Islandia was an investor in the
Company’s October 2004 issuance of Series D Convertible Preferred Stock pursuant
to which On2 sold to Islandia 1,500 shares of Series D Convertible Preferred
Stock, raising gross proceeds for the Company from Islandia of $1,500,000.
Islandia’s Series D Convertible Preferred Stock was convertible into On2 common
stock at an effective conversion price of $0.70 per share of common stock.
Pursuant to this transaction, Islandia also received two warrants to purchase an
aggregate of 1,122,754 shares of On2 common stock.
The
complaint asserted that, at various times in 2007, On2 failed to make monthly
redemptions of the Series D Preferred Stock in a timely manner and that On2
failed to deliver timely notice of its intention to make such redemptions using
shares of On2’s common stock. The complaint also asserted that Islandia timely
exercised its right to convert the Series D Preferred Stock into shares of On2
common stock and that On2 failed to credit to Islandia such allegedly converted
shares. The complaint further asserted that On2 failed to pay to Islandia
certain Series D dividends to which it was entitled. The complaint sought a
total of $4,645,193 in damages plus interest and reasonable attorneys’
fees.
On
October 8, 2008, On2 filed an answer in which it denied the material assertions
of the complaint and asserted various affirmative defenses, including that (i)
On2 made the required Series D redemptions in full and on the dates agreed upon
by the parties, (ii) On2 provided timely notice that it would pay redemptions in
On2 common stock and that Islandia accepted all of the redemption payments on
the dates made without protest, (iii) Islandia failed to timely assert its
conversion rights under the terms of the Series D agreements and (iv) On2 duly
paid the dividends owed to Islandia under the terms of the Agreement and
Islandia accepted all dividend payments without protest.
On
July 23, 2009, On2 and Islandia entered into a Release and Settlement Agreement
(the “Settlement Agreement”) to settle the litigation without admitting any of
the allegations in the complaint. The Settlement Agreement provides for the
issuance by On2 of a convertible note to Islandia in the principal amount of
$500,000 which bears an interest rate equal to eight percent (8%) per annum paid
semiannually in arrears (the “Note”). The Note may be redeemed by On2 at any
time and will become due and payable on July 23, 2010 or earlier upon a change
of control. At the time of payment, the Note shall be payable in cash or shares
of On2 at the sole discretion of On2, subject to certain conditions. The
Settlement Agreement provides that Islandia will file a stipulation to
discontinue the lawsuit without prejudice within two business days of the
issuance of the Note. The Settlement Agreement also provides that Islandia may
recommence the original lawsuit if On2 defaults on its obligations to pay
principal and interest on the Note, and if such original lawsuit is recommenced
and On2 ultimately is held liable to Islandia, On2 shall receive full credit for
any and all amounts already paid on the Note. On July 28, 2009, On2 and Islandia
executed and filed with New York State Supreme Court a stipulation of
discontinuance of the litigation without prejudice.
Litigation
settlement costs for the three and six months ended June 30, 2009 were $523,000
of which $500,000 is the settlement cost of the lawsuit and $23,000 is for
related legal fees.
(17)
Subsequent Event.
On
August 4, 2009, the Company entered into an Agreement and Plan of Merger (the
“Merger Agreement”) by and among the Company, Google Inc., a Delaware
corporation (“Google”), and Oxide Inc., a Delaware corporation and a wholly
owned subsidiary of Google (“Merger Sub”) pursuant to which Merger Sub will be
merged with and into the Company, and as a result the Company will continue as
the surviving corporation and a wholly owned subsidiary of Google (the
“Merger”). The directors and officers of Merger Sub immediately prior to the
Merger shall be the directors and officers of the surviving corporation after
the Merger. Under the terms of the Merger Agreement, which was approved by both
companies’ boards of directors, for each share of the Company’s common stock
owned, the Company’s stockholders will be entitled to receive the number of
shares of Google’s Class A common stock equal to $0.60 divided by the
volume weighted average trading price of a share of Google’s Class A common
stock for the 20 trading day period ending on the second trading day prior to
the date of the Company’s stockholders meeting to consider and approve the
Merger Agreement. The merger is conditioned upon, among other things, the
approval of the Company’s stockholders, and the receipt of regulatory approvals
and other closing conditions. Assuming the satisfaction of these conditions, the
transaction is expected to close during the fourth quarter of
2009.
On
August 4, 2009, the Compensation Committee of the Company’s board of directors
adopted the On2 Technologies, Inc. Retention and Severance Plan in connection
with the proposed Merger.
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
|
Forward-Looking
Statements
This
document contains forward-looking statements concerning our expectations, plans,
objectives, future financial performance and other statements that are not
historical facts. These statements are “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995. In most cases,
you can identify forward-looking statements by terminology such as “may,”
“might,” “will,” “would,” “could,” “should,” “expect,” “plan,” “anticipate,”
“believe,” “estimate,” “predict,” “potential,” “objective,” “forecast,” “goal”
or “continue,” the negative of such terms, their cognates, or other comparable
terminology. Forward-looking statements include statements with respect
to:
|
|
|
|
●
|
the
impact of the current global recession on our business and operations,
including the markets for our products and services and the availability
of credit and/or investment financing which we may need to fund our
operations;
|
|
|
|
|
●
|
the
impact of volatile securities markets on our access to capital markets and
on our share price and the impact of volatile foreign exchange rates on
our business;
|
|
|
|
|
●
|
future
revenues, income taxes, net loss per share, acquisition costs and related
amortization, and other measures of results of
operations;
|
|
|
|
|
●
|
the
effects of acquiring On2 Finland, including possible future impairments of
goodwill associated with that acquisition;
|
|
|
|
|
●
|
difficulties
in controlling expenses, legal compliance matters or internal control over
financial reporting review, improvement and
remediation;
|
|
|
|
|
●
|
risks
associated with the previously reported ineffectiveness of the Company’s
internal control over financial reporting and our ability to remediate
material weaknesses, if any;
|
|
|
|
|
●
|
the
financial performance and growth of our business, including future
international growth;
|
|
|
|
|
●
|
our
financial position and the availability of resources;
|
|
|
|
|
●
|
the
availability of credit and future debt and/or equity investment
capital;
|
|
|
|
|
●
|
the
effects of our furlough and other cost-containment measures undertaken at
On2 Finland, including the effectiveness of those measures, the
anticipated cost savings associated with those measures and any future
restructuring and/or impairment charges arising in connection with current
and future cost-containment measures;
|
|
|
|
|
●
|
risks
associated with the proposed merger between the Company and a subsidiary
of Google Inc.;
|
|
|
|
|
●
|
future
competition; and
|
|
|
|
|
●
|
the
degree of seasonality in our
revenue.
|
These
forward-looking statements are only predictions, and actual events or results
may differ materially. The statements are based on management’s beliefs and
assumption using information available at the time the statements were made. We
cannot guarantee future results, levels of activity, performance or
achievements. Factors that may cause actual results to differ are often
presented with the forward-looking statements themselves. Additionally, other
risks that may cause actual results to differ from predicted results are set
forth in “
Risk
Factors That May Affect Future Operating Results
” in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008.
Many
of the forward-looking statements are subject to additional risks related to our
need to either secure additional financing or to increase revenues to support
our operations or business or technological factors. We believe that between the
funds we have on hand and the funds we expect to generate, we have sufficient
funds to finance our operations for the next 12 months. We have based our
forecasts on assumptions we have made relating to, among other things, the
market for our products and services, economic conditions and the availability
of credit to us and our customers. If these assumptions are incorrect, we may
not have sufficient resources to fund our operations for this entire period,
however. Additional funds may also be required in order to pursue strategic
opportunities or for capital expenditures. Because of the recent tightening in
global credit markets, we may not be able to obtain financing on favorable
terms, or at all. In this regard, the business and operations of the Company are
subject to substantial risks that increase the uncertainty inherent in the
forward-looking statements contained in this Form 10-Q. In evaluating our
business, you should give careful consideration to the information set forth
under the caption “
Risk
Factors That May Affect Future Operating Results
” in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008, in addition to the
other information set forth herein.
We
undertake no duty to update any of the forward-looking statements except as
required by applicable law, whether as a result of new information, future
events or otherwise. In light of the foregoing, readers are cautioned not to
place undue reliance on the forward-looking statements contained in this
report.
Subsequent
Event.
On
August 4, 2009, the Company entered into an Agreement and Plan of Merger (the
“Merger Agreement”) by and among the Company, Google Inc., a Delaware
corporation (“Google”), and Oxide Inc., a Delaware corporation and a wholly
owned subsidiary of Google (“Merger Sub”) pursuant to which Merger Sub will be
merged with and into the Company, and as a result the Company will continue as
the surviving corporation and a wholly owned subsidiary of Google (the
“Merger”). The directors and officers of Merger Sub immediately prior to the
Merger shall be the directors and officers of the surviving corporation after
the Merger. Under the terms of the Merger Agreement, which was approved by both
companies’ boards of directors, for each share of the Company’s common stock
owned, the Company’s stockholders will be entitled to receive the number of
shares of Google’s Class A common stock equal to $0.60 divided by the
volume weighted average trading price of a share of Google’s Class A common
stock for the 20 trading day period ending on the second trading day prior to
the date of the Company’s stockholders meeting to consider and approve the
Merger Agreement. The merger is conditioned upon, among other things, the
approval of the Company’s stockholders, and the receipt of regulatory approvals
and other closing conditions. Assuming the satisfaction of these conditions, the
transaction is expected to close during the fourth quarter of
2009.
On
August 4, 2009, the Compensation Committee of the Company’s board of directors
adopted the On2 Technologies, Inc. Retention and Severance Plan in connection
with the proposed Merger.
Overview
On2
Technologies is a developer of video compression technology and technology that
enables the creation, transmission, and playback of multimedia in
resource-limited environments, such as cellular networks transmitting to battery
operated mobile handsets or High Definition (HD) video transmitted over the
Internet. We have developed a proprietary technology platform and the On2® Video
VPx family (e.g., VP6, VP7, and VP8) of video compression/decompression
(“codec”) software to deliver high-quality video at the lowest possible data
rates over proprietary networks and the Internet to personal computers, wireless
devices, set-top boxes and other devices. Unlike many other video codecs that
are based on standard compression specifications set by industry groups (e.g.,
MPEG-2 and H.264), our video compression/decompression technology is based
solely on intellectual property that we developed and own ourselves. In
addition, through our wholly-owned subsidiary, On2 Technologies Finland Oy, we
license to chip and mobile handset manufacturers, and other developers of
multimedia consumer products the hardware and software designs that make the
encoding or decoding of video possible on mobile handsets, set top boxes,
portable media players, cameras and other devices. We also provide integration,
customization and support services to enable high quality video on, and faster
interoperability between devices.
In
2004, we licensed our video compression technology to Macromedia, Inc. (now
Adobe Systems Incorporated) for use in the Adobe® Flash® multimedia player. In
anticipation of Adobe using our codec in the Flash platform, we launched our
business of developing and marketing video encoding software for the Flash
platform. Flash encoding has become an increasingly important part of our
business. In May 2008, we entered into a license agreement with Sun Microsystems
for the use of our video compression technology in the JavaFX® platform and
anticipate further growth for our encoding and transcoding businesses as a
result of this transaction.
In
addition, we have also dedicated significant resources to marketing customized
software to device manufacturers that enable their devices to decode Flash and
JavaFx content.
We
offer the following suite of products that incorporate our proprietary
compression technology:
|
|
|
|
●
|
Video
codecs, including On2 VP6®, VP7™ and VP8™;
|
|
|
|
|
●
|
Flix®
Pro – an application targeted at web developers for encoding and
transcoding video for delivery over the Internet to either Flash or JavaFX
players;
|
|
|
|
|
●
|
Flix
Publisher – a set of web browser plug-ins that enable live capture,
encoding, and transcoding of video along with posting on web sites or live
streaming via the Adobe Flash Media Server;
|
|
|
|
|
●
|
Flix
Engine – a backend server side transcoding platform used by a large number
of video sites to repurpose their video for playback over the Internet and
devices; and
|
|
|
|
|
●
|
Flix
DirectShow SDK – a set of libraries that enable software vendors to
create, edit, and deliver video content for Flash or
JavaFX;
|
We
also offer the following suite of hardware and software products that
incorporate our video technology for mobile and embedded platforms:
|
|
|
|
●
|
On2
VP6, VP7 and VP8 software video codec designs;
|
|
|
|
|
●
|
MPEG-4,
H.263, H.264 / AVC and VC-1 hardware and software video codec
designs;
|
|
|
|
|
●
|
Hardware
and software JPEG codecs;
|
|
|
|
|
●
|
AMR-NB
and Enhanced aacPlus™ audio codecs;
|
|
|
|
|
●
|
Pre-
and post-processing technologies (such as cropping, rotation, scaling)
implemented in both software and hardware;
|
|
|
|
|
●
|
File
format and streaming components; and
|
|
|
|
|
●
|
Recorder
and player application logic.
|
In
addition, we offer the following services in connection with both our
proprietary video compression technology and our mobile video
technology:
|
●
|
Customized
engineering and consulting services;
|
|
|
|
|
●
|
On2
Flix Cloud, our pay-as-you go encoding service; and
|
|
|
|
|
●
|
Technical
support.
|
Many
of our customers are hardware and software developers who use our products and
services chiefly to provide the following video-related products and services to
end users:
|
|
TYPE
OF CUSTOMER
APPLICATION
|
EXAMPLES
|
Video
and Audio Distribution over Proprietary Networks
|
● Providing
video-on-demand services to residents in multi-dwelling units
(MDUs)
● Video
surveillance
|
|
|
Video
and Audio Distribution over IP-based Networks (Internet)
|
● Video-on-demand
● Teleconferencing
services
● Video
instant messaging
● Video
for Voice-over-IP (VOIP) services
|
|
|
Consumer
Electronic Devices
|
● Digital
video players
● Digital
video recorders
● Mobile
TV
● Video
camera recorder
● Mobile
video player
|
|
|
Wireless
Applications
|
● Delivering
video via wireless networks, e.g., satellite, WLAN, WIMAX, and
cellular
● Providing
video record and playback capability to battery-operated handsets such as
mobile phones, MIDs, PDAs, and PMPs
|
|
|
User-Generated
Content (“UGC”) Sites
|
● Providing
video encoding software for use on UGC site operators’
servers
● Providing
encoding software for users who are creating UGC
● Providing
transcoding software to allow UGC site operators to convert video from one
format to
another
|
Our
goal is to be a premier provider of video compression software and hardware
technology and compression tools. We are striving to achieve that goal and the
goal of building a stable base of quarterly revenues by implementing the
following key strategies:
|
|
|
|
●
|
Using
the success of current customer implementations of our On2 Video
technology (e.g., Adobe Flash, Skype, Move Networks) and other
high-profile customers (e.g., Sun Microsystems) to increase our brand
recognition, promote new business and encourage proliferation across
platforms;
|
|
●
|
Continuing
our research and development efforts to improve our current codecs and
developing new technologies that increase the quality of video technology
and improve the experience of end users;
|
|
|
|
|
●
|
Continuing
our research and development efforts to design hardware decoders and
encoders that minimize the space used on a chip and to continue to improve
the quality of those products;
|
|
|
|
|
●
|
Updating
and enhancing our existing consumer products, such as the Flix line and
embedded technologies;
|
|
|
|
|
●
|
Providing
pay-as-you-go encoding in our Flix Cloud software-as-a-service offering
using the Amazon EC2® cloud computing environment;
|
|
|
|
|
●
|
Employing
flexible licensing strategies to offer customers more attractive business
terms than those available for competing technologies;
|
|
|
|
|
●
|
Attempting
to negotiate licensing arrangements with customers that provide for
receipt of recurring revenue and/or that offer us the opportunity to
market products that complement our customers’ implementations of our
software; and
|
|
|
|
|
●
|
Using
the expertise of On2 Finland to develop hardware designs of our
proprietary codecs and optimizations for embedded processors that will
allow those products to be easily implemented on
devices.
|
We
earn revenue chiefly through licensing our software technology and hardware
designs and providing specialized software engineering and consulting services
to customers. In addition to up-front license fees, we often require that
customers pay us royalties in connection with their use of our software and
hardware products. The royalties may come in the form of either a fee for each
unit of the customer’s products containing our software products or hardware
designs that are sold or distributed or payments based on a percentage of the
revenues that the customer earns from any of its products or services that use
our software. Royalties may be subject to guaranteed minimum amounts (e.g.,
minimum annual royalties) and/or maximum amounts (e.g., annual caps) that may
vary substantially from deal to deal.
We
also sell additional products and services that relate to our existing
relationships with licensees of our video codec products. For instance, if a
customer has licensed our software to develop its own proprietary video format
and video players, we may sell encoding software to users who want to encode
video for playback on that customer’s players, or we may provide engineering
services to companies that want to modify our customer’s software for use on a
specific platform, such as a cell phone. As with royalties or revenue share
arrangements, complementary sales of encoding software or engineering services
should allow us to participate in the success of our customers’ products. For
instance, if a customer’s video platform does well commercially, we would expect
there to be a market for encoding software and/or engineering services in
support of that platform.
We
recognize the strategic importance of implementing our proprietary VPx video
codecs in hardware and developing highly optimized software libraries for
operation on processors used in embedded devices. Prior to the acquisition of
our On2 Finland subsidiary, we had a limited selection of off-the-shelf
optimized software that we could license to customers who were interested in
implementing our codecs on devices. We therefore regularly required customers to
pay us to customize our software, or to perform the customizations themselves,
or to hire third-party consultants to perform the customizations. The On2
Finland acquisition has given us access to additional experienced internal
resources to help us to develop hardware and software implementations that will
allow customers to implement our codecs quickly and efficiently on embedded
devices.
As
part of our strategy to develop complementary products that could allow us to
capitalize on our customers’ success, in 2005 we completed the acquisition from
Wildform, Inc., of its Flix line of encoding software. The Flix software allows
users to prepare video and other multimedia content for playback on the Adobe
Flash player, which is one of the most widely distributed multimedia players.
Adobe is currently using our VP6 software as the video engine for Flash 8 video,
which is used in the Flash 8 player and all of the subsequent Flash players that
have been released to date. We believed that there was an opportunity for us to
sell Flash encoding software to end users, such as video professionals and web
designers, and to software development companies that wish to add Flash encoding
functionality to their software. We concluded that we could best take advantage
of the anticipated success of Flash by taking the most up-to-date Flash encoding
software straight from the company that developed VP6 video and combining it
with the already well-known Flix brand, which has existed since the advent of
Flash video and has a loyal following among users. Following Adobe’s
announcement in late 2007 of support for the H.264 codec in its Flash 9 player,
we announced support for H.264 in our Flix products and have been adding support
for additional codecs. These additional features have helped to make the Flix
product line a more complete encoding solution for users.
A
primary factor that will be critical to our success is our ability to improve
continually on our current proprietary video compression technology, so that it
streams the highest-quality video at the lowest transmission rates (bit rate).
We believe that our video compression software is highly efficient, allowing
customers to stream good quality video (as compared with that of our
competitors) at low bit rates (i.e., over slow connections) and unsurpassed
high-resolution video at higher bit rates (i.e., over broadband
connections).
Another
factor that may affect our success is the relative complexity of our proprietary
video compression software compared with other compression software producing
comparable compression rates and image quality. Software with lower complexity
can run on a computer chip that is less powerful, and therefore generally less
expensive, than would be required to run software that is comparatively more
complex. In addition, the process of getting software to operate on a chip is
easier if the software is less complex. Increased compression rates frequently
result in increased complexity. While potential customers desire software that
produces the highest possible compression rates while producing the best
possible decompressed image, they also want to keep production costs low by
using the lowest-powered and accordingly least expensive chips that will still
allow them to perform the processing they require. We believe that the encoding
and decoding functions of our video compression software are less complex than
those offered by our competitors. In addition, in some applications, such as
mobile devices, constraints such as size and battery life rather than price
issues limit the power of the chips embedded in such devices. Of course, in
devices where a great deal of processing power can be devoted to video
compression and decompression, the issue of software complexity is less
important. In addition, in certain applications, savings in chip costs related
to the use of low complexity software may be offset by increased costs (or
reduced revenue) stemming from less efficient compression (e.g., increased
bandwidth costs).
One
of the most significant recent trends in our business is our increasing reliance
on the success of the product deployments of our customers. As referenced above,
our license agreements with customers increasingly provide for the payment of
license fees that are dependent on the number of units of a customer’s product
incorporating our software that are sold or the amount of revenue generated by a
customer from the sale of products or services that incorporate our software. We
have chosen this royalty-dependent licensing model because, as a small company
competing in a market that offers a vast range of video-enabled devices, we do
not have the product development or marketing resources to develop and market
end-to-end video solutions. Instead, our codec software is primarily intended to
be used as a building block for companies that are developing end-to-end video
products and/or services.
Under
our agreements with certain customers, we have retained the right to market
products that complement those customers’ applications. These arrangements allow
us to take advantage of our customers’ superior ability to produce and market
end-to-end video products, while offering those customers the benefit of having
us produce technologically-advanced products that should contribute to the
success of their applications. As with arrangements in which we receive
royalties, the ability to market complementary products can yield revenues in
excess of any initial, one-time license fee. In instances where we have licensed
our products to well-known customers, our right to sell complementary products
may be very valuable. But unlike royalties, which we receive automatically
without any additional effort on our part, the successful sale of complementary
products requires that we effectively execute an end-user product development
and marketing program.
We
believe that we have adopted the licensing model most appropriate for a business
of our size and expertise. However, a natural result of this licensing model is
that the amount of revenue we generate is highly dependent on the speed with
which our customers deploy products containing our technology and the success of
those deployments. In certain circumstances, we may decide to reduce the amount
of up-front license fees and charge a higher per-unit royalty. If the products
of customers with whom we have established per unit royalty or revenue sharing
relationships or for which we expect to market complementary products do not
generate significant sales, these revenues may not attain significant levels.
Conversely, if one or more of such customers’ products are widely adopted, our
revenues will likely be enhanced.
We
are continuing to participate in the trend towards the proliferation of user
generated video content on the web. As Internet use has grown worldwide and
Internet connection speeds have increased, sites such as MySpace, Facebook, and
YouTube, which allow visitors to create and view user generated content (“UGC”),
have sprung up and seen their popularity soar. Although initially consumer
generated content consisted primarily of text content and still photographs, the
availability of relatively inexpensive digital video cameras and video-enabled
mobile phones, the growth in the number of users with access to broadband
Internet connections, and improvements in video compression technology have
contributed to a rapid rise in consumer-created video content. Weblogs (blogs)
and podcasts (broadcasts of audio content to iPod® and MP3 devices) have evolved
to include video content. The continued proliferation of UGC video on the
Internet and the popularity of Adobe Flash video on the web have had a positive
effect on our business and have given us the opportunity to license Flash
encoding tools for use in video blogs, video podcasts, and to UGC sites or to
individual users of those services.
We
continue to experience an increased interest by UGC site operators and device
manufacturers to allow users to access UGC content by means of mobile handsets,
set-top boxes, and other devices. Many of the UGC sites use Flash VP6 video, and
while VP6 video is available on a vast number of PCs, it is still only available
on a limited number of chip-based devices, such as mobile devices and set top
boxes. We are therefore witnessing demand on two fronts: (1) demand to integrate
Flash 8 video onto non-PC platforms, and (2) until most devices can play Flash 8
content, demand to provide transcoding software that allows Flash 8 content to
be decoded and re-encoded into a format (such as the 3GPP standard) that is
supported on devices. We are actively working to provide solutions for both of
these demands and plan to continue to respond as necessary to the evolution and
migration of Flash video.
H.264
continues to rise as a competitor with the Company’s VPx products in the video
compression field. H.264 is a standards-based codec that is the successor to
MPEG-4. We believe that our technology is superior to H.264, and that we can
offer significantly more flexibility in licensing terms than customers get when
licensing H.264. H.264 has nevertheless gained significant adoption by potential
customers because, as a standards-based codec, it has the advantage of having
numerous developers who are programming to the H.264 standard and developing
products based on that standard. In addition, many manufacturers of multimedia
processors have done the work necessary to have H.264 operate on their chips,
which makes H.264 attractive to potential customers who would like to enable
video on devices. For example, Apple Inc. uses H.264 in its QuickTime® player
and has thus chosen H.264 for the current generation of video iPods. Finally,
there is already a significant amount of professional content that has been
encoded in H.264. These advantages may make H.264 attractive to potential
customers and allow them to implement a solution based on H.264 with less
initial development time and expense than a solution using On2’s proprietary
video codecs might require. In addition, there are certain customers that prefer
to license standards-based codecs. We continue to believe that VP6 will be an
important part of the Flash video ecosystem for three reasons: (1) Adobe has in
the past provided backwards compatibility with all generations of Flash video
codecs; (2) VP6 has certain performance advantages over H.264 (e.g., HD VP6
content may be played back on a lower-powered processor than HD H.264 content);
and (3) there is a vast amount of existing VP6 content that consumers want on
portable and mobile devices.
The
market for digital media creation and delivery technology is constantly changing
and becoming more competitive. Our strategy includes focusing on providing our
customers with video compression/decompression technology that delivers the
highest possible video quality at the lowest possible data rates. To do this, we
devote a significant portion of our engineering capacity to research and
development. We also are devoting significant attention to enabling our codecs
to operate on a wide array of chips, both in software and in hardware. We
continue to cultivate relationships with chip companies to enable those
companies to integrate our codecs on chips. By increasing support for our
technology on the chips that power embedded devices, we hope to encourage use by
customers who want to develop video-enabled consumer products in a short
timeframe.
A
continuing trend in our business is the growing presence of Microsoft
Corporation as a significant competitor in the market for digital media creation
and distribution technology. In 2007, Microsoft released Silverlight™, a rich
Internet application that allows users to integrate multimedia features, such as
vector graphics, audio and video, into web applications. Silverlight may compete
directly with Flash. If Silverlight gains market share at the expense of Flash,
it could have a negative impact on our Flix business. In addition, Microsoft VC1
format also competes in the marketplace with H.264 and our VPx technologies. We
believe that our VPx technologies have the same advantages over VC1 as they do
over H.264.
Although
we expect that competition from Microsoft, H.264 developers, and others will
continue to intensify, we expect that our video compression technology will
remain competitive and that our relatively small size will allow us to innovate
in the video compression field and respond to emerging trends more quickly than
monolithic organizations like Microsoft and the MPEG consortium. We focus on
developing relationships with customers who find it appealing to work with a
smaller company that is not bound by complex and rigid standards-based licenses
and fee structures and that is able to offer sophisticated custom engineering
services. Moreover, as broadcast networks, web portal operators and others
distribute ever-increasing amounts of high-resolution video over the Internet,
the cost savings arising from the use of our high quality video should offer an
increasing advantage over lower quality competitive technology.
Another
one of our primary businesses is the development and marketing of digital
electronic hardware designs (known as register transfer level designs or RTL) of
video and audio codecs to manufacturers of computer chips and multimedia
devices. A licensee of our RTL design might use that product to implement a
video decoder on the licensee’s chip, and the decoder would be built into the
circuitry of the licensee’s chip. One of the factors affecting our hardware
business is our ability to develop efficient RTL designs that minimize the
physical area of a chip devoted to our designs. Increasing the surface area of a
chip increases the manufacturer’s production costs. Our ability to produce RTL
designs that require less surface area than our competitors’ designs results in
lower production costs for our licensees and gives us a competitive
advantage.
Another
factor affecting our hardware business is our reputation for producing reliable
products that have been thoroughly tested, are accompanied by good
documentation, and are supported by a strong technical support team. Chip and
device manufacturers that are potential customers for our hardware products
develop the products with which they will integrate our RTL designs. Our
technology is hard-wired into chip circuitry rather than loaded as software. In
connection with high volume chip production, the per-unit price of a specialized
chip that has had multimedia support built into the chip can be substantially
less than the costs of using a more powerful software-upgradable digital signal
processor (DSP). However, any errors in the software operating on a DSP can be
relatively easily corrected through a software upgrade or patch, while errors
that have been hardwired into a circuit are more difficult, and may be
impossible, to correct. Because customers for our RTL designs will invest a
great deal of time and money into the designs, our reputation as a
well-established provider of reliable, well-supported RTL designs is an
important factor in our continuing success.
As
multimedia content has proliferated on the Internet, manufacturers of mobile
devices such as cell phones and personal media players (PMPs) have expanded
their product lines to support playback and creation of that content. As noted
above, in general, manufacturers have two options to add multimedia support to
their devices. They can use either a specialized chip that has multimedia
support hard-wired into it (RTL) or a more powerful DSP that can run software to
provide the necessary multimedia functions. Hardware implementations that
require RTL designs such as ours offer a number of advantages over DSPs with
software layers:
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They
are cheaper to produce in high volumes;
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They
use less energy, which prolongs battery life of mobile
devices;
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They
produce less heat, which has important implications for, among other
things, circuit design; and
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They
allow for simultaneous encoding and decoding of HD video
content.
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But there
are also disadvantages to hardware implementations of multimedia
tools:
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Initial
implementation costs are high; and
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Hardware
implementations are generally not
upgradeable.
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Similarly,
software-upgradable DSPs offer certain advantages:
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Modifying
software to operate on a DSP is easier and less expensive then
implementing the software in hardware, reducing initial project costs and
speeding deployment;
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DSPs
do not require costly re-designs and re-tooling to operate new software;
and
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They
are more easily upgradeable.
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But they
also have certain disadvantages:
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Per-chip
costs are higher than pure hardware solutions as volumes increase;
and
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The
increased processor power required to operate diverse software increases
heat and power
consumption.
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Manufacturers
that want to maintain the ability to upgrade mobile devices and PMPs to support
new multimedia software may opt for DSPs rather than hardware solutions, which
could impact our business of licensing hardware codecs. Nevertheless, we believe
that even if manufacturers do choose to use DSPs in their devices, it is likely
that many will continue to implement hardware codecs alongside the DSPs to take
advantage of the efficiency of those hardware implementations. In addition,
support for DSPs on multimedia devices would have the benefit of making those
devices more easily upgraded to new generations of our proprietary codecs. We
are continuing to monitor this trend and make the adjustments to our business
model necessary to address changing markets.
Critical
Accounting Policies and Estimates
This
discussion and analysis of our financial condition and results of operations are
based on our condensed consolidated financial statements that have been prepared
under accounting principles generally accepted in the United States. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires our management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could materially differ from those
estimates. We have disclosed all significant accounting policies in Note 1 to
the consolidated financial statements included in our Form 10-K for the
fiscal year ended December 31, 2008. The consolidated financial statements and
the related notes thereto should be read in conjunction with the following
discussion of our critical accounting policies. Our critical accounting policies
and estimates are:
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Revenue
recognition;
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Accounts
receivable allowance;
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Equity-based
compensation; and
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Impairment
of goodwill and other intangible
assets.
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Revenue
Recognition.
We currently recognize revenue from professional services
and the sale of software licenses. As described below, significant management
judgments and estimates must be made and used in determining the amount of
revenue recognized in any given accounting period. Material differences may
result in the amount and timing of our revenue for any given accounting period
depending upon judgments made by or estimates utilized by
management.
We
recognize revenue in accordance with SOP 97-2,
Software
Revenue Recognition
(“SOP 97-2”), as amended by SOP 98-4,
Deferral
of the Effective Date of Sop 97-2, Software Revenue Recognition
and SOP
98-9,
Modification
of Sop 97-2 With Respect To Certain Transactions
(“SOP 98-9”) and Staff
Accounting Bulletin No. 104 (“SAB 104”). Under each arrangement, revenues are
recognized when a non-cancelable agreement has been signed and the customer
acknowledges an unconditional obligation to pay, the products or applications
have been delivered, there are no uncertainties surrounding customer acceptance,
the fees are fixed and determinable, and collection is reasonably assured.
Revenues recognized from multiple-element software arrangements are allocated to
each element of the arrangement based on the fair values of the elements, such
as product licenses, post-contract customer support or training. The
determination of the fair value is based on the vendor specific objective
evidence available to us. If such evidence of the fair value of each element of
the arrangement does not exist, we defer all revenue from the arrangement until
such time that evidence of the fair value does exist or until all elements of
the arrangement are delivered.
Our
software licensing arrangements typically consist of two elements: a software
license and post-contract customer support (“PCS”). We recognize license
revenues based on the residual method after all elements other than PCS have
been delivered as prescribed by SOP 98-9. We recognize PCS revenues over the
term of the maintenance contract or on a “per usage” basis, whichever is stated
in the contract. Vendor specific objective evidence of the fair value of PCS is
determined by reference to the price the customer will have to pay for PCS when
it is sold separately (i.e. the renewal rate). Most of our license agreements
offer additional PCS at a stated price. Revenue is recognized on a per copy
basis for licensed software when each copy of the licensed software purchased by
the customer or reseller is delivered. We do not allow returns, exchanges or
price protection for sales of software licenses to our customers or resellers,
and we do not allow our resellers to purchase software licenses under
consignment arrangements.
When
we sell engineering and consulting services together with a software license,
the arrangement typically requires customization and integration of the software
into a third party hardware platform. In these arrangements, we require the
customer to pay a fixed fee for the engineering and consulting services and a
licensing fee in the form of a per-unit royalty. We account for engineering and
consulting arrangements in accordance with SOP 81-1,
Accounting
for Performance of Construction Type and Certain Production Type
Contracts
, (“SOP 81-1”). When reliable estimates are available for the
costs and efforts necessary to complete the engineering or consulting services
and those services do not include contractual milestones or other acceptance
criteria, we recognize revenue under the percentage of completion contract
method based upon input measures, such as hours. When such estimates are not
available, we defer all revenue recognition until we have completed the contract
and have no further obligations to the customer.
Accounts
Receivable Allowance
. We perform ongoing credit evaluations of our
customers and adjust credit limits, as determined by our review of current
credit information. We continuously monitor collections and payments from our
customers and maintain an allowance for doubtful accounts based upon our
historical experience, our anticipation of uncollectible accounts receivable and
any specific customer collection issues that we have identified. While our
credit losses have historically been low and within our expectations, we may not
continue to experience the same credit loss rates that we have in the
past.
Equity-Based
Compensation
. In December 2004, the Financial Accounting Standards Board
(“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R
Share-Based
Payment
(“SFAS 123R”), which requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
statement of operations as an operating expense, based on their fair values on
grant date. Prior to the adoption of SFAS 123R, we accounted for stock based
compensation using the intrinsic value method. We adopted the provisions of SFAS
No. 123R effective January 1, 2006, using the modified prospective transition
method. Under the modified prospective method, non-cash compensation expense is
recognized under the fair value method for the portion of outstanding share
based awards granted prior to the adoption of SFAS 123R for which service has
not been rendered, and for any future share based awards granted or modified
after adoption. Accordingly, periods prior to adoption have not been restated.
We recognize share-based compensation cost associated with awards subject to
graded vesting in accordance with the accelerated method specified in FASB
Interpretation No. 28 pursuant to which each vesting tranche is treated as a
separate award. The compensation cost associated with each vesting tranche is
recognized as expense evenly over the vesting period of that
tranche.
Critical
estimates in valuing certain of the intangible assets include, but are not
limited to, future expected cash flows from customer contracts, customer lists,
distribution agreements and acquired developed technologies and patents; the
acquired company’s brand awareness and market position as well as assumptions
about the period of time the brand will continue to be used in the combined
company’s product portfolio; and discount rates. We derive our discount rates
from our internal rate of return based on our internal forecasts and we may
adjust the discount rate giving consideration to specific risk factors of each
asset. Management’s estimates of fair value are based upon assumptions believed
to be reasonable but which are inherently uncertain and unpredictable.
Assumptions may be incomplete or inaccurate, and unanticipated events and
circumstances may occur.
Impairment
of Goodwill and Other Intangible Assets
. We assess goodwill for
impairment in accordance with SFAS 142, Goodwill and Other Intangible Assets,
which requires that goodwill be tested for impairment on a periodic basis. The
process of evaluating the potential impairment of goodwill is highly subjective
and requires significant management judgment to forecast future operating
results, projected cash flows and current period market capitalization levels.
In estimating the fair value of the business, we make estimates and judgments
about the future cash flows. Although our cash flow forecasts are based on
assumptions that are consistent with the plans and estimates we are using to
manage our business, there is significant judgment in determining such future
cash flows. We also consider market capitalization on the date we perform the
analysis.
Long-lived
assets and identifiable intangibles with finite lives are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future undiscounted net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment recognized is measured
by the amount by which the carrying amount of the assets exceeds the fair value
of the assets. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell.
Results
of Operations
Revenue.
Revenue for the three months ended June 30, 2009 was $4,996,000, as compared to
$3,265,000 for the three months ended June 30, 2008. Revenue for the six months
ended June 30, 2009 was $9,012,000, as compared to $7,717,000 for the six months
ended June 30, 2008. Revenue for the three and six months ended June 30, 2009
and 2008 was derived primarily from the sale of software licenses and RTL
licenses, royalties, and engineering and consulting services. The increase in
revenue for both the three and six months ended June 30, 2009 is primarily
attributable to an increase in license and royalty revenue from our Finland
subsidiary, partially offset by decreases in US license and royalty
revenue.
Operating
Expenses.
The Company’s operating expenses consist of costs of revenue,
research and development, sales and marketing, general and administrative
expenses, litigation settlement costs, costs associated with proposed merger,
and equity based compensation. Operating expenses for the three months ended
June 30, 2009 were $6,020,000 as compared to $10,441,000 for the three months
ended June 30, 2008. Operating expenses were $13,258,000 for the six months
ended June 30, 2009 as compared to $19,706,000 for the six months ended June 30,
2008.
Costs
of Revenue.
Costs of revenue includes personnel and related overhead
expenses, royalties paid for software that is incorporated into the Company’s
software, consulting compensation costs, operating lease costs and depreciation
and amortization costs. Costs of revenue for the three months ended June 30,
2009 was $445,000 as compared to $1,194,000 for the three months ended June 30,
2008. Costs of revenues for the six months ended June 30, 2009 was $1,018,000 as
compared to $2,624,000 for the six months ended June 30, 2008. The decrease of
$749,000 for the three months ended June 30, 2009 as compared to the three
months ended June 30, 2008 is primarily attributable to a $390,000 decrease in
the amortization of purchased technology and customer relationships as a result
of the asset impairments in 2008 associated with On2 Finland, and a $359,000
decrease in production and engineering costs, technical support and fewer hours
allocated by our engineering staff, and a reduction in the foreign currency
exchange rate. The decrease of $1,606,000 for the six months ended June 30, 2009
as compared to the six months ended June 30, 2008 is primarily attributable to a
$901,000 decrease in the amortization of purchased technology and customer
relationships as a result of the asset impairments in 2008 associated with On2
Finland, and a $705,000 decrease in production and engineering costs, technical
support and fewer hours allocated by our engineering staff, as well as a
reduction in the foreign currency exchange rate.
Research
and Development.
Research and development expenses, excluding
equity-based compensation, consist primarily of salaries and related expenses
and consulting fees associated with the development and production of our
products and services, operating lease costs and depreciation costs. Research
and development expenses for the three months ended June 30, 2009 were
$1,721,000 as compared to $3,009,000 for the three months ended June 30, 2008.
Research and development expenses for the six months ended June 30, 2009 were
$3,885,000 as compared to $5,817,000 for the six months ended June 30, 2008. The
decrease of $1,288,000 and $1,932,000 for the three and six months ended June
30, 2009, respectively, is primarily the result a Company-wide cost savings plan
implemented during the second half of 2008, a workforce reduction (furlough)
process implemented during the first quarter of 2009 and a reduction in the
foreign currency exchange rate.
Sales
and Marketing.
Sales and marketing expenses, excluding equity-based
compensation, consist primarily of salaries and related costs, commissions,
business development costs, tradeshow costs, marketing and promotional costs
incurred to create brand awareness and public relations expenses. Sales and
marketing expenses for the three months ended June 30, 2009 were $926,000 as
compared to $1,875,000 for the three months ended June 30, 2008. Sales and
marketing expenses for the six months ended June 30, 2009 were $1,902,000 as
compared to $3,764,000 for the six months ended June 30, 2008. The decrease of
$949,000 and $1,862,000 for the three and six months ended June 30, 2009,
respectively, is primarily a decrease in sales and marketing personnel and
related travel and overhead costs that is a result of a company-wide cost
savings plan implemented during the second half of 2008, a workforce reduction
(furlough) process implemented during the first quarter of 2009, and a reduction
in the foreign currency exchange rate.
General
and Administrative
. General and administrative expenses, excluding
equity-based compensation, consist primarily of salaries and related costs for
general corporate functions including finance, human resources, management
information systems, legal, facilities, outside legal and other professional
fees and insurance. General and administrative expenses for the three months
ended June 30, 2009 were $1,548,000, as compared to $3,926,000 for the three
months ended June 30, 2009. General and administrative expenses for the six
months ended June 30, 2009 were $3,622,000 as compared to $6,694,000 for the six
months ended June 30, 2008. The decrease of $2,378,000 and $3,072,000 for the
three and six months ended June 30, 2009, respectively, is primarily due to a
decrease in legal and accounting fees incurred during 2008 related to the Audit
Committee’s review of certain 2007 sales contracts in connection with the
restatement, a decrease in consulting fees related to the implementation of
Sarbanes Oxley Section 404 and other consulting and professional services, a
company-wide cost savings plan implemented during the second half of 2008, a
workforce reduction (furlough) process implemented during the first quarter of
2009 and a reduction in the foreign currency exchange rate.
Restructuring
Expense.
Restructuring expenses consist primarily of severance and
benefits, unused office and property leases, legal and other administrative
costs, and asset impairment related to unused capital leases.
Restructuring
expenses for the three and six months ended June 30, 2009 were $1,032,000, as
compared with $-0- for the three and six months ended June 30, 2008. The
increase is due to a restructuring plan implemented during the first quarter of
fiscal 2009 for the On2 Finland subsidiary.
Costs
Associated with Proposed Merger.
Costs associated with proposed merger
consist primarily of professional fees related to the proposed merger with a
subsidiary of Google. Costs associated with proposed merger for the three and
six months ended June 30, 2009 were $420,000.
Litigation
Settlement Costs.
Litigation settlement costs are the costs of the
settlement of the Islandia lawsuit and related legal costs. Litigation
settlement costs for the three and six months ended June 30, 2009 were $523,000
of which $500,000 is the settlement cost of the lawsuit and $23,000 is for
related legal fees.
Equity-Based
Compensation.
Equity based compensation, which is presented separately,
was $496,000 and $986,000 for the three and six months ended June 30, 2009,
respectively. Equity-based compensation of $59,000 and $130,000 is included in
cost of revenue for the three and six months ended June 30, 2009, respectively.
Equity-based compensation was $516,000 and $969,000 for the three and six months
ended June 30, 2008, respectively. Equity-based compensation of $79,000 and
$162,000 is included in cost of revenue for the three and six months ended June
30, 2008, respectively. The increase for the six months ended June 30, 2009 is
primarily due to the issuance of restricted stock grants during the first
quarter of 2009.
Other
Income (Expense), Net
Interest
income (expense), net primarily consists of interest incurred for capital lease
obligations and long-term debt, offset by interest earned on the Company’s
invested cash balances. Interest income (expense), net was $(33,000) and
$(70,000) for the three and six months ended June 30, 2009, respectively, as
compared to $(14,000) and $61,000 for the three and six months ended June 30,
2008, respectively. The decrease of $19,000 and 131,000 for the three and six
months ended June 30, 2009, respectively, is primarily related to lower cash
balances and additional capital leases during the second half of
2008.
Other
income (expense), net primarily consists of government grants related to our
Finland subsidiary and changes in the fair value of the warrant derivative
liability. The increase in income of $149,000 and $421,000 for the three and six
months ended June 30, 2009, respectively, is primarily the result of government
grants received by the Company’s Finland subsidiary, offset by the change in the
warrant derivative liability.
Gain
from forgiveness of debt
Gain
from forgiveness of debt is a result of modifications to our notes payable to a
Finnish Funding Agency for the Company’s Finland subsidiary during the second
quarter of 2009. Gain from forgiveness of debt for the three and six months
ended June 30, 2009 was $669,000.
Liquidity
and Capital Resources
At
June 30, 2009, the Company had cash and cash equivalents and short-term
investments of $2,797,000, as compared to $4,289,000 at December 31, 2008. At
June 30, 2009 the Company had negative working capital of $3,124,000 (without
the restructuring accrual, negative working capital would have been $2,339,000
at June 30, 2009), as compared with negative working capital of $1,866,000 at
December 31, 2008.
Net
cash used in operating activities was $1,105,000 and $4,407,000 for the six
months ended June 30, 2009 and 2008, respectively. The decrease in net cash used
in operating activities is primarily related to a net loss of $3,212,000, a
decrease in deferred revenue of $617,000, a decrease in accounts payable and
accrued expenses of $126,000, a reduction for bad debt expense of $226,000, a
gain from forgiveness of debt income of $669,000, partially offset by a decrease
in accounts receivable of $725,000, a decrease in prepaid expenses and other
current assets of $82,000, an increase in depreciation and amortization of
$926,000, an asset impairment from restructuring of $175,000, an increase in
accrued restructuring expenses of $746,000, and an increase in equity-based
compensation of $986,000.
Net
cash (used in) provided by investing activities was $(167,000) and $5,186,000
for the six months ended June 30, 2009 and 2008, respectively. The decrease in
net cash provided by investing activities is primarily a result of the maturing
of a majority of the short term investments during the second quarter of
2008.
Net
cash used in financing activities was $112,000 and $2,562,000 for the six months
ended June 30, 2009 and 2008, respectively. The decrease in net cash used in
financing activities is primarily attributable to a decrease in payments on
short-term debt for our Finland subsidiary, due to the non-renewal of certain
lines of credit.
We
currently have material commitments for the next 12 months under our operating
lease arrangements and borrowings. These arrangements consist primarily of lease
arrangements for our office space in Clifton Park, and Manhattan, New York,
Cambridge UK, Oulu, Finland, Beijing, China and Tokyo. The aggregate required
payments for the next 12 months under these arrangements are $857,000.
Notwithstanding the above, our most significant non-contractual operating costs
for the next 12 months are compensation and benefit costs, insurance costs and
general overhead costs such as telephone and utilities.
At
June 30, 2009, short-term borrowings consisted of the following:
A
line of credit with a Finnish bank for $632,000 (€450,000 at June 30, 2009). The
line of credit has no expiration date. Borrowings under the line of credit bear
interest at one month EURIBOR plus 1.25% (total of 2.163% at June 30, 2009). The
bank also requires a commission payable at .45% of the loan principal.
Borrowings are collateralized by substantially all assets of On2 Finland and a
guarantee by the Company. The outstanding balance on the line of credit was
$190,000 at June 30, 2009. On July 30, 2009 the limit on the line of credit was
reduced to €300,000.
A
term loan. During July 2008, the Company renewed its Directors and Officers
Liability Insurance and financed the premium with a $140,000, nine-month
term-loan that carries an effective annual interest rate of 4.75%. The balance
at June 30, 2009 was $-0-.
At
June 30, 2009, long-term debt consisted of the following:
Unsecured
notes payable to a Finnish funding agency of $1,808,000, including interest at
2.00%, due at dates ranging from July 2011 to December 2013; $200,000 to a
Finnish bank, including interest at the 3-month EURIBOR plus 1.1% (total of
2.33% at June 30, 2009), due March 2011, secured by guarantees by the Company,
and by the Finnish Government Organization, which also requires additional
interest at 2.65% of the loan principal; and an unsecured note payable to a
Finnish financing company of $140,000, including interest at the 6 month EURIBOR
plus .5% (total of 1.94% at June 30, 2009), due March 2011.
We
have experienced significant operating losses and negative operating cash flows
to date. We plan to increase cash flows from operations principally from
increases in revenue and from cost reduction and restructuring initiatives that
we implemented during 2008 and the first quarter of 2009.
During
2008 and the first quarter of 2009, the Company implemented a restructuring
program, including a reduction of its workforce, a reduction in overhead costs,
and the identification of one time charges for professional fees. On March 18,
2009 the Company began implementing a number of cost reduction initiatives at
its Finnish subsidiary, On2 Finland, including a reduction in workforce that is
expected to reduce headcount by approximately 31 On2 Finland employees. The
Company implemented these cost reduction initiatives in order to align spending
with demand that has weakened as a result of the current global economic
conditions and uncertainties, particularly in the semiconductor industry in
which On2 Finland operates. In accordance with Finnish law, the Company
negotiated with the representative of the On2 Finland employees and On2
Finland’s management team in order to obtain consensus on the reduction in
workforce plan. The Company implemented the plan primarily through a furlough
process that took effect in April 2009 and is expected to be fully implemented
within fiscal 2009.
As
a result of the cost reduction initiatives at On2 Finland, the Company incurred
initial restructuring and impairment charges of approximately $1.032 million the
first quarter of 2009. These estimated charges consist primarily of one-time
employee reduction costs, the majority of which are related to post-termination
employee payments required by Finnish law and the collective bargaining
agreement covering most On2 Finland employees, and other related restructuring
costs. The post-termination payments are triggered if the Company terminates
some or all of the furloughed employees or if employees who are furloughed for
longer than 200 days elect to terminate their own employment. The total costs
incurred will depend on a number of factors, including the duration of the
furloughs, the number of employees, if any, that are recalled from furlough or
terminated and, for employees that are furloughed for longer than 200 days, the
number of such employees that have not obtained other employment.
Additionally,
On2 Finland may borrow funds up to a maximum of €450,000 ($632,000 based on
exchange rates as of June 30, 2009) under a line of credit. As of June 30,
2009
the
balance on this line of credit was $190,000. On July 30, 2009, the limit on the
line of credit was reduced to €300,000. Given our cash and short-term
investments of $2,797,000 at June 30, 2009, and the Company’s forecasted cash
requirements, the Company’s management anticipates that the Company’s existing
capital resources will be sufficient to satisfy our cash flow requirements for
the next 12 months.
We
have based our forecasts on assumptions we have made relating to, among other
things, the market for our products and services, economic conditions and the
availability of credit to us and our customers. If these assumptions are
incorrect, or if our sales are less than forecasted and/or expenses higher than
expected, we may not have sufficient resources to fund our operations for this
entire period. In that event, the Company may need to seek other sources of
funds by issuing equity or incurring debt, or may need to implement further
reductions of operating expenses, or some combination of these measures, in
order for the Company to generate positive cash flows to sustain the operations
of the Company. However, because of the recent tightening in global credit
markets, we may not be able to obtain financing on favorable terms, or at all.
See “
Management’s
Discussion and Analysis of Financial Condition and Results of Operations – Risk
Factors That May Affect Future Operating Results
” in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008.
Off-Balance
Sheet Arrangements
The
Company has no off-balance sheet arrangements that have or are reasonably likely
to have a current or future effect on the Company’s financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to
investors.
Impact
of Recently-Issued Accounting Pronouncements
In
June 2009 the Financial Accounting Standards Board (FASB) has issued Statement
of Financial Accounting Standards (SFAS) 168, The
“FASB
Accounting Standards Codification” and the Hierarchy of Generally Accepted
Accounting Principles.
SFAS 168 establishes the
FASB
Accounting Standards Codification
(Codification)
as the single source of authoritative U.S. generally accepted accounting
principles (U.S. GAAP) recognized by the FASB to be applied by nongovernmental
entities. Rules and interpretive releases of the SEC under authority of federal
securities laws are also sources of authoritative U.S. GAAP for SEC registrants.
SFAS 168 and the Codification are effective for financial statements issued for
interim and annual periods ending after September 15, 2009. There will be no
change to the Company’s condensed consolidated financial position and results of
operations due to the implementation of this Statement.
When
effective, the Codification will supersede all existing non-SEC accounting and
reporting standards. All other non-grandfathered non-SEC accounting literature
not included in the Codification will become non-authoritative. Following SFAS
168, the FASB will not issue new standards in the form of Statements, FASB Staff
Positions, or Emerging Issues Task Force Abstracts. Instead, the FASB will issue
Accounting Standards Updates, which will serve only to: (
a
)
update the Codification; (
b
)
provide background information about the guidance; and (
c
)
provide the bases for conclusions on the change(s) in the
Codification.
In
June 2009 the FASB has issued the following two standards which change the way
entities account for securitizations and special-purpose entities:
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SFAS 166,
Accounting
for Transfers of Financial Assets;
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SFAS 167,
Amendments
to FASB Interpretation No.
46(R).
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SFAS 166
is a revision to FASB SFAS. 140,
Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities,
and will require more information about transfers of
financial assets, including securitization transactions, and where entities have
continuing exposure to the risks related to transferred financial assets. It
eliminates the concept of a “qualifying special-purpose entity,” changes the
requirements for derecognizing financial assets, and requires additional
disclosures. SFAS 167 is a revision to FASB Interpretation No. 46 (Revised
December 2003),
Consolidation
of Variable Interest Entities,
and changes how a reporting entity
determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. The
determination of whether a reporting entity is required to consolidate another
entity is based on, among other things, the other entity’s purpose and design
and the reporting entity’s ability to direct the activities of the other entity
that most significantly impact the other entity’s economic performance. The new
standards will require a number of new disclosures. Statement 167 will require a
reporting entity to provide additional disclosures about its involvement with
variable interest entities and any significant changes in risk exposure due to
that involvement. A reporting entity will be required to disclose how its
involvement with a variable interest entity affects the reporting entity’s
financial statements. Statement 166 enhances information reported to users of
financial statements by providing greater transparency about transfers of
financial assets and an entity’s continuing involvement in transferred financial
assets. SFAS 166 and 167 will be effective at the start of a reporting entity’s
first fiscal year beginning after November 15, 2009, or January 1, 2010, for a
calendar year-end entity. Early application is not permitted. The Company is
currently evaluating the impact of adopting SFAS 166 and SFAS 167 on its
condensed consolidated financial position and results of
operations.
In
May 2009 the FASB has issued SFAS 165,
Subsequent
Events.
SFAS 165 establishes general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. Specifically,
SFAS 165 provides:
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The
period after the balance sheet date during which management of a reporting
entity should evaluate events or transactions that may occur for potential
recognition or disclosure in the financial statements;
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The
circumstances under which an entity should recognize events or
transactions occurring after the balance sheet date in its financial
statements; and
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The
disclosures that an entity should make about events or transactions that
occurred after the balance sheet
date.
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SFAS 165
is effective for interim or annual financial periods ending after June 15, 2009,
and shall be applied prospectively. The Company adopted this statement as of
June 30, 2009. This Statement did not impact the condensed consolidated
financial results. Management has evaluated subsequent events through August 7,
2009, the date the condensed consolidated financial statements were
issued.
During
the second quarter of 2009 the FASB has issued FASB Staff Position (FSP) FAS
157-4,
Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not
Orderly.
This FSP:
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Affirms
that the objective of fair value when the market for an asset is not
active is the price that would be received to sell the asset in an orderly
transaction.
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Clarifies
and includes additional factors for determining whether there has been a
significant decrease in market activity for an asset when the market for
that asset is not active.
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Eliminates
the proposed presumption that all transactions are distressed (not
orderly) unless proven otherwise. The FSP instead requires an entity to
base its conclusion about whether a transaction was not orderly on the
weight of the evidence.
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Includes
an example that provides additional explanation on estimating fair value
when the market activity for an asset has declined
significantly.
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Requires
an entity to disclose a change in valuation technique (and the related
inputs) resulting from the application of the FSP and to quantify its
effects, if practicable.
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Applies
to all fair value measurements when
appropriate.
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FSP
FAS 157-4 must be applied prospectively and retrospective application is not
permitted. FSP FAS 157-4 is effective for interim and annual periods ending
after June 15, 2009, with early adoption permitted for periods ending after
March 15, 2009. An entity early adopting FSP FAS 157-4 must also early adopt FSP
FAS 115-2 and FAS 124-2,
Recognition
and Presentation of Other-Than-Temporary Impairments.
The Company has
complied with the requirements FSP FAS 157-4.
During
the second quarter of 2009 the FASB has issued FSP FAS 115-2 and FAS 124-2,
Recognition
and Presentation of Other-Than-Temporary Impairments.
This
FSP:
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Changes
existing guidance for determining whether an impairment is other than
temporary to debt securities;
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Replaces
the existing requirement that the entity’s management assert it has both
the intent and ability to hold an impaired security until recovery with a
requirement that management assert: (
a
)
it does not have the intent to sell the security; and (
b
)
it is more likely than not it will not have to sell the security before
recovery of its cost
basis;
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Incorporates
examples of factors from existing literature that should be considered in
determining whether a debt security is other-than-temporarily
impaired;
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Requires
that an entity recognize noncredit losses on held-to-maturity debt
securities in other comprehensive income and amortize that amount over the
remaining life of the security in a prospective manner by offsetting the
recorded value of the asset unless the security is subsequently sold or
there are additional credit losses;
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Requires
an entity to present the total other-than-temporary impairment in the
statement of earnings with an offset for the amount recognized in other
comprehensive income; and
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When
adopting FSP FAS 115-2 and FAS 124-2, an entity is required to record a
cumulative-effect adjustment as of the beginning of the period of adoption
to reclassify the noncredit component of a previously recognized
other-temporary impairment from retained earnings to accumulated other
comprehensive income if the entity does not intend to sell the security
and it is not more likely than not that the entity will be required to
sell the security before
recovery.
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FSP
FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending after
June 15, 2009, with early adoption permitted for periods ending after March 15,
2009. An entity may early adopt this FSP only if it also elects to early adopt
FSP FAS 157-4. The company adopted this FSP for the quarter ended June 30, 2009,
and there was no material impact on the Company’s condensed consolidated results
of operations or financial position.
During
the second quarter of 2009 the FASB has issued FSP FAS 107-1 and APB 28-1,
Interim
Disclosures about Fair Value of Financial Instruments.
This FSP amends
FASB Statement No. 107,
Disclosures
about Fair Value of Financial Instruments,
to require an entity to
provide disclosures about fair value of financial instruments in interim
financial information. This FSP also amends APB Opinion No. 28,
Interim
Financial Reporting,
to require those disclosures in summarized financial
information at interim reporting periods. Under this FSP, a publicly traded
company shall include disclosures about the fair value of its financial
instruments whenever it issues summarized financial information for interim
reporting periods. In addition, an entity shall disclose in the body or in the
accompanying notes of its summarized financial information for interim reporting
periods and in its financial statements for annual reporting periods the fair
value of all financial instruments for which it is practicable to estimate that
value, whether recognized or not recognized in the statement of financial
position, as required by Statement 107.
FSP
107-1 and APB 28-1 is effective for interim periods ending after June 15, 2009,
with early adoption permitted for periods ending after March 15, 2009. However,
an entity may early adopt these interim fair value disclosure requirements only
if it also elects to early adopt FSP FAS 157-4 and FSP FAS 115-2 and FAS 124-2.
The company adopted this FSP in the quarter ended June 30, 2009. There was no
impact on the condensed consolidated financial position and results of
operations as it relates only to additional disclosures. The Company has
complied with the disclosure requirements of FSP FAS 107-1 and APB
28-1.
On
April 1, 2009 the FASB issued FSP FAS 141(R)-1,
Accounting
for Assets Acquired and Liabilities Assumed in a Business Combination That Arise
from Contingencies.
This FSP amends the guidance in FASB Statement No.
141 (Revised December 2007),
Business
Combinations,
to:
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Require that assets
acquired and liabilities assumed in a business combination that arise from
contingencies be recognized at fair value if fair value can be reasonably
estimated. If fair value of such an asset or liability cannot be
reasonably estimated, the asset or liability would generally be recognized
in accordance with FASB Statement No. 5,
Accounting
for Contingencies,
and FASB Interpretation (FIN) No. 14,
Reasonable
Estimation of the Amount of a Loss.
Further, the FASB decided to
remove the subsequent accounting guidance for assets and liabilities
arising from contingencies from Statement 141R, and carry forward without
significant revision the guidance in FASB Statement No. 141,
Business
Combinations.
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Eliminate
the requirement to disclose an estimate of the range of outcomes of
recognized contingencies at the acquisition date. For unrecognized
contingencies, the FASB decided to require that entities include only the
disclosures required by Statement 5 and that those disclosures be included
in the business combination footnote.
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Require
that contingent consideration arrangements of an acquiree assumed by the
acquirer in a business combination be treated as contingent consideration
of the acquirer and should be initially and subsequently measured at fair
value in accordance with Statement
141R.
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This
FSP is effective for assets or liabilities arising from contingencies in
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008 (i.e., January 1, 2009 for a calendar year-end company). This FSP was
adopted effective January 1, 2009. There was no material impact upon adoption,
and its effects on future periods will depend on the nature and significance of
business combinations subject to this statement.
In
June 2008, the EITF reached a consensus in Issue No. 07-5,
Determining
Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own
Stock
(“EITF 07-5”). This Issue addresses the determination of whether an
instrument (or an embedded feature) is indexed to an entity’s own stock, which
is the first part of the scope exception in paragraph 11(a) of SFAS 133. EITF
07-5 is effective for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. Early application is not permitted.
Th
e
Company has adopted EITF 07-05 and has made a cumulative adjustment to
increase retained earnings by $803,000 as of January 1, 2009. The Company also
recorded an increase to the warrant derivative liability of $121,000, and a
decrease to additional paid-in capital of $924,000.
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141R,
Business
Combinations
(“SFAS 141R”), which replaces SFAS No. 141,
Business
Combinations
. SFAS 141R establishes principles and requirements for
determining how an enterprise recognizes and measures the fair value of certain
assets and liabilities acquired in a business combination, including
non-controlling interests, contingent consideration, and certain acquired
contingencies. SFAS 141R also requires acquisition-related transaction expenses
and restructuring costs be expensed as incurred rather than capitalized as a
component of the business combination. SFAS 141R will be applicable
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. The implementation of SFAS 141R did not have a material
effect on the Company’s condensed consolidated financial position and results of
operations and its effects on future periods will depend on the nature and
significance of business combinations subject to this statement.
In
April 2009, the FASB issued FASB Staff Position (FSP) Financial Accounting
Standard (FAS) 157-4, “Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly.” Based on the guidance, if an entity
determines that the level of activity for an asset or liability has
significantly decreased and that a transaction is not orderly, further analysis
of transactions or quoted prices is needed, and a significant adjustment to the
transaction or quoted prices may be necessary to estimate fair value in
accordance with SFAS No. 157, “Fair Value Measurements.” This FSP is to be
applied prospectively and is effective for interim and annual periods ending
after June 15, 2009 with early adoption permitted for periods ending after March
15, 2009. The company adopted this FSP in the quarter ended June 30, 2009, and
there was no material impact on the Company’s condensed consolidated financial
position and results of operations.
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Item
3.
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Quantitative
and Qualitative Disclosures About
Risk
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We
do not currently have any material exposure to foreign currency risk, exchange
rate risk, commodity price risk or other relevant market rate or price risks.
However, we do have some exposure to fluctuations in interest rates due to our
variable rate debt and to currency rate fluctuations arising from our operations
in Finland, and to a lesser extent in other parts of Europe and Asia. Our
operations in Finland transact business both in the local functional
currency and in U.S. Dollar. To date, we have not entered into any derivative
financial instrument to manage foreign currency risk, and we are not currently
evaluating the future use of any such financial instruments.
Item
4.
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Controls
and
Procedures
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(a)
Evaluation of Disclosure Controls and Procedures:
The
term “disclosure controls and procedures,” as defined in Rule 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, or Exchange Act, means
controls and other procedures of a company that are designed to ensure that
information required to be disclosed in the reports that an issuer files or
submits under the Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the SEC’s rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by a company in the
reports that it files or submits under the Exchange Act is accumulated and
communicated to the issuer’s management, including its principal financial
officers, as appropriate, to allow timely decisions regarding required
disclosure. There are inherent limitations to the effectiveness of any system of
disclosure controls and procedures, including the possibility of human error and
the circumvention or overriding of the controls and procedures. Accordingly,
even effective disclosure controls and procedures can only provide reasonable
assurance of achieving their control objectives and management necessarily
applies its judgment in evaluating the cost-benefit relationship of possible
controls and procedures.
As
of June 30, 2009, we carried out an evaluation, under the supervision and with
the participation of our principal executive officer and our principal financial
officer of the effectiveness of the design and operation of our disclosure
controls and procedures. Based on this evaluation, our principal executive
officer and our principal financial officer concluded that our disclosure
controls and procedures were effective as of the end of the period covered by
this report.
(b)
Changes in Internal Controls over Financial Reporting:
There
were no changes in our internal control over financial reporting identified in
connection with the evaluation required by Rules 13a-15 and 15d-15 that occurred
during the quarter ended June 30, 2009 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
PART
II — OTHER INFORMATION
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Item
1.
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Legal
Proceedings
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Islandia
On
August 14, 2008, Islandia, L.P. filed a complaint against On2 in the Supreme
Court of the State of New York, New York County. Islandia was an investor in the
Company’s October 2004 issuance of Series D Convertible Preferred Stock pursuant
to which On2 sold to Islandia 1,500 shares of Series D Convertible Preferred
Stock, raising gross proceeds for the Company from Islandia of $1,500,000.
Islandia’s Series D Convertible Preferred Stock was convertible into On2 common
stock at an effective conversion price of $0.70 per share of common stock.
Pursuant to this transaction, Islandia also received two warrants to purchase an
aggregate of 1,122,754 shares of On2 common stock.
The
complaint asserted that, at various times in 2007, On2 failed to make monthly
redemptions of the Series D Preferred Stock in a timely manner and that On2
failed to deliver timely notice of its intention to make such redemptions using
shares of On2’s common stock. The complaint also asserted that Islandia timely
exercised its right to convert the Series D Preferred Stock into shares of On2
common stock and that On2 failed to credit to Islandia such allegedly converted
shares. The complaint further asserted that On2 failed to pay to Islandia
certain Series D dividends to which it was entitled. The complaint sought a
total of $4,645,193 in damages plus interest and reasonable attorneys’
fees.
On
October 8, 2008, On2 filed an answer in which it denied the material assertions
of the complaint and asserted various affirmative defenses, including that (i)
On2 made the required Series D redemptions in full and on the dates agreed upon
by the parties, (ii) On2 provided timely notice that it would pay redemptions in
On2 common stock and that Islandia accepted all of the redemption payments on
the dates made without protest, (iii) Islandia failed to timely assert its
conversion rights under the terms of the Series D agreements and (iv) On2 duly
paid the dividends owed to Islandia under the terms of the Agreement and
Islandia accepted all dividend payments without protest.
On
July 23, 2009, On2 and Islandia entered into a Release and Settlement Agreement
(the “Settlement Agreement”) to settle the litigation without admitting any of
the allegations in the complaint. The Settlement Agreement provides for the
issuance by On2 of a convertible note to Islandia in the principal amount of
$500,000 which bears an interest rate equal to eight percent (8%) per annum paid
semiannually in arrears (the “Note”). The Note may be redeemed by On2 at any
time and will become due and payable on July 23, 2010 or earlier upon a change
of control. At the time of payment, the Note shall be payable in cash or shares
of On2 at the sole discretion of On2, subject to certain conditions. The
Settlement Agreement provides that Islandia will file a stipulation to
discontinue the lawsuit without prejudice within two business days of the
issuance of the Note. The Settlement Agreement also provides that Islandia may
recommence the original lawsuit if On2 defaults on its obligations to pay
principal and interest on the Note, and if such original lawsuit is recommenced
and On2 ultimately is held liable to Islandia, On2 shall receive full credit for
any and all amounts already paid on the Note. On July 28, 2009, On2 and Islandia
executed and filed with New York State Supreme Court a stipulation of
discontinuance of the litigation without prejudice.
With
the exception of the following risk factor, there have been no other material
changes in our risk factors from those disclosed in Part I, Item 1A of the
Company’s Annual Report on Form 10-K for the year ended December 31,
2008.
Merger
Agreement with Google
There
are a number of risks and uncertainties relating to the proposed merger between
the Company and a subsidiary of Google. The risks and uncertainties include the
possibility that the transaction may be delayed or may not be completed as a
result of failure to obtain necessary approval of the Company’s stockholders,
the failure to obtain or any delay in obtaining necessary regulatory clearances
or satisfying other closing conditions. Any delay in completing, or failure to
complete, the merger could have a negative impact on the Company’s business, its
stock price, and its relationships with customers or employees. In addition,
under certain circumstances, if the transaction is terminated, the Company may
be required to pay a significant termination fee to Google.
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Item
2.
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Unregistered
Sales of Equity Securities and Use of
Proceeds
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On
July 23, 2009, On2 issued a convertible note to Islandia, L.P. in the principal
amount of $500,000 which bears an interest rate equal to eight percent (8%) per
annum (the “Note”). The Note was issued in connection with the execution of a
Release and Settlement Agreement (the “Settlement Agreement”) by and between On2
and Islandia to settle ongoing litigation between the parties. The Note may be
redeemed by On2 at anytime and will become due and payable on July 23, 2010 or
earlier upon a change of control. At the time of payment, the Note shall be
payable in cash or shares of On2 at the sole discretion of On2, subject to
certain conditions. If On2 opts to pay the Note in shares of On2 common stock,
the conversion price will be calculated by dividing (i) the principal amount
plus accrued and unpaid interest outstanding under the Note by (ii) a price per
share equal to 85% of the average of the 20 trading day daily volume weighted
average price of a share of On2 common stock at the time of conversion ending
one trading day prior to the date of payment. On2 issued the Note in a private
placement transaction made in reliance upon the exemption from securities
registration afforded by Section 4(2) under the Securities Act of 1933, as
amended and Regulation D thereunder.
Item
4.
|
Submission
of Matters to a Vote of Security
Holders
|
On
May 20, 2009, we held our annual stockholders meeting at the Company’s
headquarters in Clifton Park, New York. Our stockholders re-elected our board of
directors and approved all proposals presented at the annual meeting. The items
considered and approved at the annual meeting are described in the proxy
statement dated April 6, 2009. The record date for the annual meeting was March
31, 2009. The meeting was called for the purpose of considering the following
proposals:
|
|
|
|
1.
|
to
elect six (6) directors to serve on our Board of Directors for the term
commencing immediately following the Annual Meeting;
|
|
|
|
|
2.
|
To
ratify the selection of Marcum & Kliegman LLP as the independent
registered public accounting firm of the Company for the fiscal year
ending December 31, 2009; and
|
|
|
|
|
3.
|
to
transact any business as may properly come before the meeting and any
adjournments
thereof.
|
J.
Allen Kosowsky, Mike Alfant, Mike Kopetski, James Meyer, Afsaneh Naimollah, and
Thomas Weigman were nominated by the Board of Directors for election to the
Board of Directors at the annual meeting. All of the nominees were current
directors and were elected at the last annual meeting of
stockholders.
The
votes received on the above proposals, including a separate tabulation with
respect to each director nominee, were as follows:
|
|
|
|
|
|
|
|
|
|
Proposal
1: Election of Directors
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Director
|
|
For
|
|
%
For*
|
|
Withheld
|
|
%
Withheld*
|
|
J.
Allen Kosowsky
|
|
114,413,058
|
|
80.25%
|
|
28,173,798
|
|
19.75%
|
|
Mike
Alfant
|
|
114,795,297
|
|
80.51%
|
|
27,791,559
|
|
19.49%
|
|
Mike
Kopetski
|
|
114,132,839
|
|
80.05%
|
|
28,454,017
|
|
19.95%
|
|
James
Meyer
|
|
112,450,227
|
|
78.87%
|
|
30,136,628
|
|
21.13%
|
|
Afsaneh
Naimollah
|
|
112,331,476
|
|
78.79%
|
|
30,255,380
|
|
21.21%
|
|
Thomas
Weigman
|
|
113,623,661
|
|
79.69%
|
|
28,963,195
|
|
20.31%
|
|
Proposal
2: Ratification of the Selection of Marcum & Kliegman as the Company’s
Independent Registered Public Accounting Firm
|
|
For
|
%
For**
|
Against
|
%
Against**
|
Witheld
|
%
Witheld**
|
134,693,820
|
77.47%
|
3,042,269
|
1.73%
|
3,561,387
|
2.02
|
|
|
|
|
|
|
* -
% of shares voted
|
|
|
|
**
- % of shares outstanding
|
|
|
|
31.1 Certification
by the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
31.2 Certification
by the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
32.1 Certification
of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification
of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In
accordance with the requirements of the Exchange Act, the registrant has caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
|
|
|
|
|
On2
Technologies, Inc.
|
|
|
(Registrant)
|
|
|
|
August
7, 2009
|
|
/s/
MATTHEW FROST
|
(Date)
|
|
(Signature)
|
|
|
Matthew
Frost
|
|
|
Interim
Chief Executive Officer
|
|
|
|
|
|
On2
Technologies, Inc.
|
|
|
(Registrant)
|
|
|
|
August
7, 2009
|
|
/s/
WAYNE BOOMER
|
(Date)
|
|
(Signature)
|
|
|
Wayne
Boomer
|
|
|
Senior
Vice President and Chief Financial Officer
|
|
|
(Principal
Financial
Officer)
|
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