Innovaro, Inc. 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Form 10-Q. This Form 10-Q contains forward-looking statements regarding the plans and objectives of management for future operations. These forward-looking statements may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by any forward-looking statements. Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words "may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend" or "project" or the negative of these words or other variations on these words or comparable terminology. These forward-looking statements are based on assumptions that may be incorrect, and we cannot assure you that the projections included in these forward-looking statements will come to pass. Our actual results could differ materially from those expressed or implied by the forward-looking statements as a result of various factors. Business Overview We provide services that help clients become stronger innovators, develop compelling strategies to drive and catalyze growth, rapidly source externally developed technologies, create value from their intellectual property and gain foresight into marketplace and technology developments that affect their business. These services are provided internationally from our offices in the United States and the United Kingdom. We have two business segments: Strategic Services and Technology Services. Our clients require strategies to help them embrace improved innovation capabilities. We apply innovation insights; build those strategies with supporting infrastructure, processes and mechanisms; and create a culture primed for repeatable innovation success. We help organizations create and realize new, breakthrough growth strategies, create and execute non-incremental new growth platforms and opportunities, and develop the capability for ongoing creation and execution of those growth platforms and concepts. We provide strategic services to enable our clients to become more efficient by finding new avenues to grow, fighting commoditization, improving return on investment, transforming the organization, and removing barriers to innovation. Business value is delivered to clients through working with a team of seasoned and experienced professionals capable of unlocking an organization's capacity by: · Identifying and developing new segments and markets; · Creating and acting on game-changing strategies; · Building an enterprise-wide capability for innovation; · Accelerating and improving new product development processes; and · Assessing a company’s innovation capability. Our technology services segment offers expansive networks, experts in scouting, partner sourcing and licensing expertise, and world leading online marketplaces. We also provide an important foundation to successful licensing - understanding the true potential value of our clients’ intellectual property “IP” and IP portfolio. We access that value and build a roadmap for our clients’ use, and uncover opportunities and options to realize any latent value. We have an online information service, purpose-built for those who need it most-technology transfer, business development, intellectual property, competitive intelligence, and marketing professionals across the physical and life sciences. We also provide the insight and intelligence our clients require, applied to their markets today and into the future. From current market research to predictive intelligence, we help our clients find insights at the intersections affecting their business. Our research identifies and explains key consumer trends—including emerging trends not covered by other sources—and delivers insights about how these trends will shape the future operating environment. These services include: · Futures scenario development and planning · Custom and syndicated research · Online information services · IP consulting · IP and market landscape analysis · Technology search · In- and out-licensing · Online marketplaces · Partner search and profiling 13 Innovaro LaunchPad We are continuing the development of our innovation management software platform, Innovaro LaunchPad, which is designed to enhance and complement our innovation service offerings to clients. We have completed an external review by user clients of version one of the software, which is evolving based on their feedback, and are moving toward the launch of Innovaro LaunchPad in the marketplace. Recent Developments On April 18, 2011, our Board of the Directors increased its size from four to five directors and, upon the recommendation of the Nominating and Corporate Governance Committee, elected Asa Lanum as a new director of the Company. In addition, our Board of Directors appointed Mr. Lanum, who has served as our interim Chief Executive Officer since August 2010, as our permanent Chief Executive Officer. Financial Condition Our total assets were $24.7 million as of March 31, 2011 and December 31, 2010. As of March 31, 2011, we had $635,000 in cash and cash equivalents, $2.1 million in accounts receivable and contracts in process, $1.7 million in accounts payable and accrued expenses and $5.5 million in total debt outstanding. As of December 31, 2010, we had $263,000 in cash and cash equivalents, $2.0 million in accounts receivable and contracts in process, $1.5 million in accounts payable and accrued expenses and $5.8 million in total debt outstanding. As of March 31, 2011, we had working capital of $536,000 and positive cash flows from operating activities of $692,000. Current Market Conditions Although the global economic environment has improved somewhat over the last several months, our financial results for the first quarter of 2011 continued to be negatively impacted by the weakened state of the global economy. To the extent that the global economic recovery stalls or worsens, our financial condition and operating results could be materially adversely affected. Results of Operations Revenue Three Months Ended March 31, Percentage Change (in thousands, except percentages) 2011 2010 Strategic services $ 3,028 $ 1,430 112 % Technology services 575 840 (32 )% Total revenue $ 3,603 $ 2,270 59 % Strategic Services Our strategic services revenue is derived from consulting services we provide to our clients. Our strategic services revenue increased by $1.6 million for the three months ended March 31, 2011 in comparison to the three months ended March 31, 2010. This increase is the result of the Company having a significant number of new contracts with a higher average value in the first quarter of 2011 than we had in the first quarter of 2010. We attribute the increased contract level in 2011 to a renewed interest in innovation efficiency and new product development in the U.S. and abroad. Our strategic services revenue in recent years has largely been dependent on the efforts of certain key consulting professionals whose employment contracts with us expired in April 2011. We were able to retain the majority of these consulting professionals under new employment contracts or consulting contracts in order to maintain the level of strategic services revenue we have generated in recent years. We expect that our strategic services revenue will continue to increase over 2010 levels for the remainder of 2011. Technology Services Our technology services revenue is derived from a combination of global technology partnering search retainer fees, online subscription fees, online information services revenue, foresight and trend research revenue and IP consulting revenue. Our technology services revenue decreased by $265,000 for the three months ended March 31, 2011 in comparison to the three months ended March 31, 2010. The decreased revenue is primarily a result of a reduction of $39,000 in monthly fees for our global technology partnering services, a reduction of $90,000 in online marketplace fees and a reduction in foresight and trend research revenue of $128,000. The decreased revenue results from a reduction in the number of personnel selling and fulfilling projects, which has had a direct impact on new sales for this business. Consequently, we have not been able to replace prior year contracts with new contracts as they come up for renewal. 14 We expect that our technology services revenue will remain consistent with the first quarter of 2011 for the remainder of 2011. Direct Costs of Revenue (in thousands, except percentages) Three Months Ended March 31, 2011 Gross Profit Margin Three Months Ended March 31, 2010 Gross Profit Margin Direct costs of revenue - strategic services $ 1,682 44 % $ 1,004 30 % Direct costs of revenue - technology services 333 42 % 444 47 % Total direct costs of revenue $ 2,015 $ 1,448 Direct costs of strategic services revenue are comprised of salaries and related taxes, bonuses, certain outside services and other business development costs related to our strategic services business. The most significant portion of direct costs of strategic services revenue is comprised of consulting personnel compensation, which includes bonuses. Direct costs of strategic services revenue increased by $678,000 for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. The increase is related to an increase in outside consultants needed to complete the higher number of jobs in process during the first quarter of 2011. We expect that our direct costs of strategic services revenue will increase over the first quarter of 2011 for the remainder of 2011 as a result of bonuses being earned by consulting professionals. The gross profit margin for the strategic services business increased to 44% for the three months ended March 31, 2011 as compared to 30% for the three months ended March 31, 2010. The increase is related to improved utilization of our strategic services employees during the first quarter of 2011. Direct costs of technology services revenue are comprised of certain salaries and related taxes, commissions, certain outside services and other direct costs related to technology services. Direct costs of technology services revenue decreased by $111,000 for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. The majority of the decrease relates to a reduction in sales and project management personnel. We expect that our direct costs of technology services revenue will remain consistent with the first quarter of 2011 for the remainder of 2011. The gross profit margin for the technology services business decreased to 42% for the three months ended March 31, 2011 as compared to 47% for the three months ended March 31, 2010. The decrease is related to the aforementioned reduction in sales personnel having had a negative impact on new sales for this business. Salaries and Wages Three Months Ended March 31, Percentage (in thousands, except percentages) 2011 2010 Change Salaries and wages $ 325 $ 680 (52) % As a percent of revenue 9 % 30 % (21) ppt * The abbreviation “ppt” denotes percentage points. Salaries and wages include non-sales employee and officer salaries and related benefits, including bonuses and stock-based compensation, that are not otherwise allocated to direct costs of revenue,. Salaries and wages decreased by $355,000 for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. $78,000 of the decrease related to the resignation of our former CEO in August 2010, $213,000 related to reduction in administrative staff, and $65,000 related to reduced stock compensation expense as a result of a change in estimate in conjunction with the valuation of our stock option issuances. We expect that our salaries and wages will increase over the first quarter of 2011 for the remainder of 2011 as a result of the permanent hire of our interim CEO in April 2011. 15 Professional Fees Three Months Ended March 31, Percentage Change (in thousands, except percentages) 2011 2010 Professional fees $ 88 $ 201 (56 )% As a percent of revenue 2 % 9 % (7) ppt Professional fees include accounting fees, legal fees and valuation expenses for our investments. Professional fees decreased by $113,000 for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. Valuation expenses were reduced by $27,000 because our investments no longer require valuations on a quarterly basis. Accounting fees were reduced by $22,000 as a result of our having become a smaller reporting company during 2010. As a smaller reporting company, we have fewer reporting requirements than that of an accelerated filer. Legal fees were reduced by $63,000 because of costs incurred in the first quarter of 2010 related to the preparation of our restricted stock plan and the settlement of a severance liability related to our former CEO that were not repeated or replaced in the first quarter of 2011. We expect that our professional fees will remain consistent with the first quarter of 2011 for the remainder of 2011. Research and Development Three Months Ended March 31, Percentage Change (in thousands, except percentages) 2011 2010 Research and development $ 304 $ 199 52 % As a percent of revenue 8 % 9 % (1) ppt Research and development costs include salaries, outside services, travel and other costs related to the development of our innovation management software platform, which is designed to enhance and complement our innovation services offerings to clients. Research and development costs increased by $105,000 for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. The increase relates to the fact that the software development did not start until mid-first quarter 2010 and we currently have more contractors involved with the development. We expect that our research and development costs will remain consistent with the first quarter of 2011 for the remainder of 2011. Sales and Marketing Three Months Ended March 31, Percentage Change (in thousands, except percentages) 2011 2010 Sales and marketing $ 61 $ 246 (75 )% As a percent of revenue 2 % 11 % (9) ppt Sales and marketing expenses include advertising, marketing, commissions paid to outside service providers, certain travel and other business development expenses. Sales and marketing expenses decreased by $185,000 for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. The decrease relates primarily to a decrease in marketing costs undertaken in the first quarter of 2010, including $46,000 in rebranding costs and $75,000 for partnering with external search partners, that were not repeated in 2011. We also participated in and sponsored conferences during the first quarter of 2010 that we did not participate in or sponsor during the first quarter of 2011. We expect that our sales and marketing costs will remain consistent with the first quarter of 2011 for the remainder of 2011. General and Administrative Three Months Ended March 31, Percentage Change (in thousands, except percentages) 2011 2010 General and administrative $ 505 $ 595 (15) % As a percent of revenue 14 % 26 % (12) ppt 16 General and administrative expenses decreased by $90,000 for the three months ended March 31, 2011 compared to the three months ended M arch 31, 2010. The decrease relates to an $80,000 reduction in insurance and other employee related costs due to having fewer employees; a $12,000 reduction in investor relations related fees as a result of reducing all outside investor relations programs; and a continued overall company plan to reduce all aspects of overhead. We expect that our general and administrative costs will remain consistent with the first quarter of 2011 for the remainder of 2011. Depreciation and Amortization Three Months Ended March 31, Percentage Change (in thousands, except percentages) 2011 2010 Depreciation and amortization $ 341 $ 400 (15) % As a percent of revenue 9 % 18 % (9) ppt Depreciation and amortization decreased by $59,000 for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. Amortization expense decreased by $50,000 as a result of the impairment charges related to our intangible assets that were incurred in 2010. Depreciation expense decreased by $9,000 as a result of the impairment charges related to our fixed assets that were incurred in 2010. We expect that our depreciation and amortization will remain consistent with the first quarter of 2011 for the remainder of 2011. Other (Income) Expense Other (income) expense includes rental income, gains and losses related to adjusting our derivative liabilities to fair value, capital gains and losses and other miscellaneous income (losses). Other (income) expense increased by $1.7 million for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. The net other expense of $1.7 million for the three months ended March 31, 2011 is comprised primarily of a loss of $1.8 million related to adjusting our derivative liabilities to fair value, partially offset by rental income of $71,000. For additional detail on our derivative liabilities, see Note 6 to the Consolidated Financial Statements contained elsewhere in this Quarterly Report on Form 10-Q. The net other income of $2,074 for the three months ended March 31, 2010 is comprised of a gain of $54,000 related to adjusting our derivative liabilities to fair value; rental income of $61,000; and miscellaneous income of $21,000; partially offset by capital losses of $135,000. Interest Expense, Net Interest expense, net increased by $6,000 for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. The net interest expense of $142,000 for the three months ended March 31, 2011 is primarily comprised of interest expense on long-term debt of $109,000 and amortization of our debt discount of $33,000. The net interest expense of $135,000 for the three months ended March 31, 2010 is primarily comprised of interest expense on long-term debt of $119,000 and amortization of our debt discount of $46,000, partially offset by interest income on our note receivable of $29,000. Liquidity and Capital Resources Cash Flows Cash flows from operating activities of $692,000 for the three months ended March 31, 2011 increased $1,535,000 from $(842,000) for the three months ended March 31, 2010. Total cash flows from operations of $692,000 in the current period is primarily attributable to: · $1.8 million loss on derivative liabilities; · $374,000 in non-cash depreciation and amortization; · $83,000 in non-cash stock-based compensation expense related to vesting options; and · $289,000 increase in accounts payable and deferred revenue. 17 Partially offset by: · $1.9 million net operating loss. Cash flows from investing activities of $(23,000) for the three months ended March 31, 2011 decreased $28,000 from $5,000 for the three months ended March 31, 2010. There were no significant investing transactions during the period. Cash flows from financing activities of $(292,000) for the three months ended March 31, 2011 decreased $191,000 from $(101,000) for the three months ended March 31, 2010. Total cash flows from financing of $(292,000) is related to principal payments on long-term debt. Research and Development Expenditures We are developing an innovation management software platform designed to enhance and complement our innovation services deliverable to clients. As of March 31, 2011, we have invested $1.5 million in this software platform. The Company anticipates a working model of the software platform in the latter part of the second quarter of 2011 and expects to incur approximately $300,000 in additional research and development expenses during the second quarter of 2011. Liquidity Our primary cash requirements include working capital, research and development expenditures, principal and interest payments on indebtedness, and employee bonuses. Our primary sources of funds are cash received from customers in connection with operations and proceeds from the sale of our investments. At March 31, 2011, we had cash and cash equivalents of $635,000, accounts receivable and contracts in process of $2.1 million and working capital of $536,000. We currently intend to fund our research and development expenditures and liquidity needs with existing cash and cash equivalent balances, cash generated from operations, collections of our existing receivables and the potential sales of our investments. We expect that our recent reductions in costs, coupled with the expected revenue for the remainder of 2011, will be sufficient to fund our scheduled debt service and fund our working capital for the next twelve months. Should we face a restricted cash flow scenario during 2011, we have the capability to delay all cash intensive activities, including our research and development expenditures, and will look to reduce costs further. Critical Accounting Estimates The preparation of financial statements in conformity with GAAP requires management to make assessments, estimates and assumptions that affect the amounts reported in the financial statements. We evaluate the accounting policies and estimates used to prepare the financial statements on an ongoing basis. Critical accounting estimates are those that require management’s most difficult, complex, or subjective judgments and have the most potential to impact our financial position and operating results. For a detailed discussion of our critical accounting estimates, see our Annual Report on Form 10-K for the year ended December 31, 2010. There have been no material changes to our critical accounting estimates during the three months ended March 31, 2011. ITEM 3. Quantitative and Qualitative Disclosures about Market Risks Not applicable.