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[March 31, 2014]
ASPECT SOFTWARE GROUP HOLDINGS LTD. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion summarizes the significant factors affecting our consolidated operating results, financial condition, liquidity and cash flows as of and for the periods presented below. The following discussion and analysis should be read in conjunction with the financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Item 1A. "Risk Factors." Overview We are a global provider of customer contact and workforce optimization solutions. We help our customers build, enhance and sustain stronger relationships with their customers by uniting enterprise technologies with customer contact solutions. Through seamless, two-way communications across phone, chat, email, IVR, IM, SMS and social channels, we equip companies with the tools and technologies needed to serve today's demanding customers. Aspect solutions enable organizations to integrate customer contact and workforce optimization solutions into existing enterprise technology investments for companies looking to ensure a consistent and integrated multi-channel customer support experience while creating more productive business -------------------------------------------------------------------------------- Table of Contents processes. We believe that this integrated multi-channel solution approach drives enhanced business efficiencies, fosters loyalty and grows customer value.
Our customer contact and workforce optimization software can enhance business processes throughout the organization by incorporating interaction management, collaboration and other enterprise technologies. Our interaction management applications for customer contact are built on feature-rich, high-availability, next-generation platforms that fully leverage real-time communications and intelligent workflows, enabling organizations to maintain best practices while engaging consumers through the channels and devices they expect, including social media and mobile services.
Acquisitions On October 4, 2013, we acquired a 51% interest in Bright Pattern, a leading provider of next generation cloud-based contact center and customer experience management solutions for $6.7 million. We concurrently entered into a reseller agreement which grants us the right to market and distribute Bright Pattern's products and services. Our investment in Bright Pattern led to the November 2013 announcement of our cloud-based contact center offering, Zipwire, which provides the right blend of enterprise-grade functionality, reliability, and scalability not otherwise available in the industry. Bright Pattern had 34 employees and a negligible amount of annual revenue in 2012.
On July 25, 2013, we acquired Voxeo, a leading provider of hosted and on-premise IVR solutions and a leading platform provider for Communications Enabled Business Processes. The Voxeo acquisition significantly enhanced our ability to support cloud, hybrid and premise-based deployments while adding a market-leading IVR and multi-channel self-service capability to our solution portfolio. The purchase price was $145.0 million, subject to customary adjustments for items such as working capital, cash, and certain specified payments. We funded the acquisition purchase price by drawing $85.0 million of additional term loans and issuing an additional $25.0 million of second lien notes with the residual amount addressed from our cash on hand. Voxeo had 145 employees and annual revenue of approximately $44 million in 2012.
On February 4, 2013, we acquired a 10% interest in eg solutions plc. ("eg"), a back office optimization software company in the United Kingdom for $1.9 million. We concurrently entered into a reseller agreement which grants us the right to market and distribute eg's products and services in all territories with exclusivity rights in all territories other than Europe, Middle East and Africa. We must achieve minimum annual revenue targets to maintain the exclusivity rights and we were issued a conditional warrant to purchase up to 400,000 eg shares,which is approximately 2% of its current outstanding equity, at a price of 79 pence per share based upon annual revenue levels within the first two years of the agreement.
Results and Trends in 2013 Our orders increased more than 65% in 2013 compared to 2012, as we added 112 new logos in 2013. Orders for our off-premise (i.e. cloud-based and managed service deployments) continued to increase as a percent of total orders from a negligible percentage in 2012 to more than 40% in 2013. As cloud-based orders increase as a percentage of total orders, an increasing percentage of revenue is deferred from current revenue to hosted and managed services, resulting in lower revenues recognized for the current period and lower operating margins.
A key element of our 2013 strategy was expanding our product portfolio, primarily in relation to cloud-based offerings, through strategic investments and nearly $10 million of additional investment in research and development efforts. Since a larger portion of the orders received in 2013 were cloud-based and not recognized immediately, the combination of deferred recognition of a larger percent of orders and increasing operating expenses resulted in a decrease in our operating margin in 2013.
Outlook for 2014 During 2014 we expect total hosted and managed services revenue to increase by more than 3x. Additionally, we expect product revenues to continue to increase and we are focused on operational efficiencies to grow our services revenue and improve these margins in 2014. If the dollar amount and mix between on-premise and off-premise orders occur as forecasted, we expect total 2014 revenues to be significantly higher than 2013. The continued shift to cloud-based orders will result in orders received in the current period that will be recognized in future periods. We have announced the release of Zipwire, a new version of our cloud-based solution that is targeted to smaller contact centers with less complex implementations, and we are creating an inside sales organization to market to small contact centers. During 2014 we will invest in targeted operational efforts to migrate our existing customers, expand our cloud offerings, grow our managed services business and increase awareness and adoption of our fraud detection applications available through Qivox, which was acquired as part of our investment in Voxeo.
We have identified certain items that management uses as performance indicators to manage our business, including revenue and Adjusted EBITDA, and we describe these items further below.
25-------------------------------------------------------------------------------- Table of Contents Financial Summary The following table sets forth, for the periods presented, our results of operations expressed in dollars and as a percentage of net revenue. In the table below and throughout this "Management's Discussion and Analysis of Financial Condition and Results of Operations," consolidated statements of income data for the years ended December 31 2013, 2012 and 2011 have been derived from our audited consolidated financial statements which are included elsewhere in this annual report. The information contained in the table below should be read in conjunction with our consolidated financial statements and the related notes.
(Dollars in millions) Years Ended December 31, Years Ended December 31 2013 2012 2011 2013 2012 2011 Net revenues $ 436.8 $ 442.7 $ 515.6 100 % 100 % 100 % Total cost of revenues 174.7 175.7 206.4 40 % 40 % 40 % Gross profit 262.1 267.0 309.2 60 % 60 % 60 % Operating expenses 205.4 202.6 199.7 47 % 46 % 39 % Income from operations 56.7 64.5 109.5 13 % 15 % 21 % Interest and other expense, net (70.4 ) (67.7 ) (66.1 ) (16 )% (15 )% (13 )% (Loss) income before income taxes (13.7 ) (3.2 ) 43.4 (3 )% (1 )% 8 % (Benefit from) provision for income taxes (19.2 ) (1.6 ) 4.3 (4 )% - % 1 % Net income (loss) 5.5 (1.6 ) 39.1 1 % (1 )% 7 % Less: Net loss attributable to noncontrolling interest (0.4 ) - - - % - % - % Net income (loss) attributable to Aspect Software Group Holdings Ltd. $ 5.9 $ (1.6 ) $ 39.1 1 % (1 )% 7 % Adjusted EBITDA Earnings before interest, taxes, depreciation and amortization, as adjusted ("Adjusted EBITDA") is used in our debt agreements to determine compliance with financial covenants and our ability to engage in certain activities, such as making certain payments. In addition to covenant compliance, our management also uses Adjusted EBITDA to assess our operating performance and to calculate performance-based cash bonuses which are tied to Adjusted EBITDA targets.
Adjusted EBITDA contains other charges and gains, for which we believe adjustment is permitted under our senior secured credit agreement. Adjusted EBITDA is not a measure of our liquidity or financial performance under GAAP and should not be considered as an alternative to net income, income from operations or any other performance measures derived in accordance with GAAP, or as an alternative to cash flow from operating activities as a measure of our liquidity. The use of Adjusted EBITDA instead of income from operations has limitations as an analytical tool, including the failure to reflect changes in cash requirements, including cash requirements necessary to service principal or interest payments on our debt, or changes in our working capital needs.
Management compensates for these limitations by relying primarily on our GAAP results and by using Adjusted EBITDA on a supplemental basis. Other companies in our industry may calculate this measure differently than we do, limiting its usefulness as a comparative measure.
The following is a reconciliation of income from operations to Adjusted EBITDA: (In millions) Years Ended December 31, 2013 Change ($) 2012 Change ($) 2011 Income from operations $ 56.7 $ (7.8 ) $ 64.5 $ (45.0 ) $ 109.5 Depreciation and amortization 37.3 (6.0 ) 43.3 (7.9 ) 51.2 Stock based compensation 0.5 - 0.5 (0.3 ) 0.8 Sponsor management fees 2.0 - 2.0 - 2.0 Other (1) 21.2 9.5 11.7 3.0 8.7 Adjusted EBITDA $ 117.7 $ (4.3 ) $ 122.0 $ (50.2 ) $ 172.2 (1) These costs represent amounts that are allowed to be added back for calculation of compliance with our debt agreement covenants, including; acquisition related adjustments to revenue, strategic investment costs, legal entity rationalization, IRS audit, debt issuance, Sarbanes-Oxley compliance, foreign withholding taxes, and non-recurring charges.
26-------------------------------------------------------------------------------- Table of Contents Net Revenues The following table presents the breakdown of net revenues between product, maintenance, services and hosting and managed services revenue: (In millions) Years Ended December 31, 2013 Change ($) 2012 Change ($) 2011 Product revenue $ 76.8 $ 6.1 $ 70.7 $ (48.1 ) $ 118.8 Maintenance revenue 262.0 (22.0 ) 284.0 (18.0 ) 302.0 Services revenue 79.4 (8.6 ) 88.0 (6.8 ) 94.8 Hosting & managed services revenue 18.6 18.6 - - - Total revenue $ 436.8 $ (5.9 ) $ 442.7 $ (72.9 ) $ 515.6 The increase in product revenue in 2013 when compared to the prior year is primarily related to a solid fourth quarter where our strategy to offset the decline in demand for our legacy Signature product sales with growth in Unified IP, new logos and Workforce Optimization up-sell opportunities materialized.
Product revenue in the fourth quarter of 2013 was 50% higher than the prior year quarter. During 2013, our product revenue was negatively impacted by our customers shifting away from on-premise deployment to either hosted or managed services deployment models. For example, during 2013 we had two significant customers opt for multi-year hosting and managed services agreements with aggregate contract values of more than $15 million each. Hosted offerings allow capital investment cautious customers the opportunity to delay cash outflow by switching from up front license fees to a recurring service. We expect this trend to continue and we will continue to invest in these alternative deployment methods across our broad scale customer base.
The decline in product revenue in 2012, when compared to the prior year is primarily related to several significant expansion orders and extraordinarily large one time dialer migrations that occurred in 2011. With the majority of migrations of our Dialer customer base to Unified IP completed, we are in the process of migrating our ACD customers, but we continued to experience lengthening decision and approval cycles as economic uncertainty had resulted in customers remaining cautious with capital investments.
We have experienced reductions in our maintenance revenue during 2013 and 2012 as our customers consolidated due to license decommissioning resulting from agent downsizing and we have also experienced competitive displacements. In some cases our customers began migrating to the competitive platform in previous years and completed the migration during 2013.
Hosting and managed services revenue during 2013 represents the acquired Voxeo business as well as recurring revenue from customers that outsource management of their call center hardware and software to us and Aspect's hosted business.
Our acquisition of Voxeo significantly enhanced our ability to support cloud, hybrid and premise-based deployments while adding a market-leading IVR and multi-channel self-service capability to our solution portfolio. We expect this revenue stream to become a more significant component of our total revenue as both prospective customers and existing customers opt for solutions requiring lower start up costs and predictable ongoing operating expenses.
The decline in services revenue in 2013 is primarily the result of the timing of our product revenue volume closing late in 2013 as our revenue from customers purchasing installation services lags their product order. The decline in services revenue in 2012 is primarily the result of reduced product volume as a majority of our customers also purchase installation services with their product order.
For information regarding net revenue by geographic region see Note 26 of Item 8 of this Annual Report on Form 10-K.
27-------------------------------------------------------------------------------- Table of Contents Cost of Revenues The following table presents the breakdown of cost of revenues between product, maintenance and services revenue and amortization expense for acquired intangible assets: (In millions) Years Ended December 31, 2013 Change ($) 2012 Change ($) 2011 Cost of product revenue $ 20.5 $ (2.8 ) $ 23.3 $ (8.6 ) $ 31.9 Cost of maintenance revenue 69.6 (4.2 ) 73.8 (11.4 ) 85.2 Cost of services revenue 70.4 (2.6 ) 73.0 (4.1 ) 77.1 Cost of hosting & managed services revenue 8.1 8.1 - - - Amortization expense for acquired intangible assets 6.1 0.5 5.6 (6.6 ) 12.2 Total cost of revenues $ 174.7 $ (1.0 ) $ 175.7 $ (30.7 ) $ 206.4 The following table presents gross profit as a percentage of related revenue: Years Ended December 31, 2013 Change (pts) 2012 Change (pts) 2011 Product gross margin 73.0 % 6.0 67.0 % (6.1 ) 73.1 % Maintenance gross margin 73.5 % (0.6 ) 74.1 % 2.3 71.8 % Services gross margin 10.4 % (6.1 ) 16.5 % (2.2 ) 18.7 % Hosting & managed services margin 56.4 % N/A - % - - % Product gross margin in 2012 were unfavorably impacted by approximately $2.3 million of additional excess and obsolete inventory reserves recorded during 2012. The increase in inventory reserves related to excess Signature inventory on hand based upon the significant decrease in anticipated future sales of our Signature product. In addition, product gross margin improved in 2013 when compared to the prior year resulting from a slight shift in the composition of our product revenue mix. Our Unified IP and Workforce Optimization products have considerably less hardware costs than our legacy Signature products, which results in more favorable gross margins for these product offerings.
Maintenance and services gross margins were unfavorably impacted by lower volume in 2013 when compared to the prior year. As many of our costs are fixed, volume declines affect our ability to leverage these costs. During the first quarter of 2012 we redesigned the structure of our support and professional services organizations to realign, invest and hire the skill sets necessary to better meet customer experience expectations. These actions had a favorable impact on our maintenance and services gross margins in 2012 as they reduced our total headcount in these organizations by approximately 10% year over year. These cost saving initiatives were more than offset by the reduced volume of services revenue which did not allow us to leverage our fixed costs.
Cost of hosting and managed services during 2013 represents costs related to the acquired Voxeo business as well as Aspect on Demand. These costs primarily include recurring telecommunications costs, royalties, labor and overhead costs to manage our customers' call center hardware and software.
During 2013, amortization expense for acquired intangible assets increased as compared to the prior year as the result of the Voxeo acquisition. Amortization expense for acquired intangible assets in 2012 decreased as compared to the same period in the prior year as the result of certain assets becoming fully amortized.
Operating Expenses (In millions) Years Ended December 31, 2013 Change ($) 2012 Change ($) 2011 Research and development $ 50.2 $ 9.6 $ 40.6 $ 2.1 $ 38.5 Selling, general and administrative 131.8 2.9 128.9 0.8 128.1 Amortization expense for acquired intangible assets 23.4 (7.3 ) 30.7 0.2 30.5 Restructuring charges - (2.3 ) 2.3 (0.3 ) 2.6 Total $ 205.4 $ 2.9 $ 202.5 $ 2.8 $ 199.7 The increase in research and development expenses for 2013 and 2012, is primarily related to an increase in headcount of approximately 10% in 2013 and 15% in 2012 year over year. We increased our research and development spend in 2013 and 28-------------------------------------------------------------------------------- Table of Contents 2012 as we sought to expand our product development portfolio with next generation customer contact solutions. Customer contact solutions are evolving with consumers to provide multichannel interactions utilizing unified communications and collaboration platforms to improve agent productivity and customer satisfaction. These additional investments during 2012 were partially offset by lower employee incentive plan expenses, which are driven by our actual financial results relative to established targets.
The increase in selling, general and administrative expenses and amortization expense for acquired intangibles in 2013 as compared to 2012 is primarily related to third party costs related to our Voxeo acquisition.
Amortization expense for acquired intangible assets in 2013 decreased as compared to the same period in the prior year as certain assets became fully amortized.
Restructuring charges during 2012 consisted of the aforementioned realignment of our support organization as well as a workforce reduction in response to a decline in revenue volume. In addition, we incurred restructuring charges relating to reducing our office space in the United Kingdom during 2012.
Interest and Other Expense, Net The components of interest and other expense, net, were as follows: (In millions) Years Ended December 31, 2013 Change ($) 2012 Change ($) 2011 Interest expense, net $ 71.6 $ 5.9 $ 65.7 $ (2.2 ) $ 67.9 Exchange rate (gain) loss (0.6 ) (3.5 ) 2.9 4.1 (1.2 ) Other (income) expense, net (0.6 ) 0.3 (0.9 ) (0.3 ) (0.6 ) Total interest and other expense, net $ 70.4 $ 2.7 $ 67.7 $ 1.6 $ 66.1 Interest expense for 2013 increased as compared to the prior year period due to increased debt levels resulting from $85.0 million of incremental delayed draw term loan and $25.0 million of issued second lien notes to partially fund the Voxeo acquisition. Interest expense for 2012 decreased as compared to the prior year periods due to lower debt levels resulting from $78.3 million of principal payments made during 2012.
We experienced an exchange rate gain in the years ended December 31, 2013 and 2011 compared to losses in 2012 , as the United States dollar strengthened against foreign currencies in 2012.
Income Taxes The following table presents (benefit from) provision for income taxes and the effective tax rate: (Dollars in millions) Years Ended December 31, 2013 Change 2012 Change 2011 (Benefit from) provision for income taxes $ (19.2 ) $ (17.6 ) $ (1.6 ) $ (5.9 ) $ 4.3 Effective tax rate 140.3 % 89.1 pts 51.2 % 41.3 pts 9.9 % The increase in benefit from income taxes for the year ended December 31, 2013 as compared to the year ended December 31, 2012 is primarily due to a significant release of a portion of the valuation allowance on our United States deferred tax assets as the result of our Voxeo acquisition as we determined these deferred tax assets are more likely than not realizable.
The decrease in provision for income taxes for the year ended December 31, 2012 as compared to the year ended December 31, 2011 is primarily due to the benefit of U.S. losses in 2012, as well as the release of $4.8 million of ASC 740-10 reserves and foreign tax credits of $3.3 million. These benefits were offset by the establishment of a valuation allowance in the United States to offset deferred tax assets we determined are not more likely than not realizable. Based upon consideration of a number of factors, including a determination of the recoverability of these deferred tax assets weighing all evidence available as of December 31, 2012, it was determined that it was more likely than not that these deferred tax assets were not realizable and required a valuation allowance.
29-------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES Our existing cash balance generated by operations and borrowings available under our credit facilities are our primary sources of short-term liquidity. Based on our current level of operations, we believe these sources will be adequate to meet our liquidity needs for at least the next 12 months.
A condensed statement of cash flows for the years ended December 31, 2013, 2012 and 2011 follows: (In millions) Years Ended December 31, 2013 2012 2011 Net cash provided by: Net income (loss) $ 5.5 $ (1.6 ) $ 39.1 Adjustments to net income (loss) for non-cash items 16.8 51.1 45.4 Changes in operating assets and liabilities (9.9 ) (24.9 ) 3.0 Operating activities 12.4 24.7 87.5 Investing activities (158.2 ) (5.1 ) (17.2 ) Financing activities 92.3 (80.4 ) (11.4 ) Effect of exchange rate changes (0.6 ) 1.8 (4.0 ) Net change in cash and cash equivalents (54.1 ) (59.0 ) 54.9 Cash and cash equivalents at beginning of period 82.4 141.3 86.4 Cash and cash equivalents at end of period $ 28.2 $ 82.4 $ 141.3 Net Cash Provided by Operating Activities The decrease in net cash provided by operating activities for the year ended December 31, 2013 as compared to December 31, 2012 was primarily due to increased interest payments and acquisition related expenses during 2013.
Net cash provided by operating activities for the year ended December 31, 2012 decreased as compared to December 31, 2011 primarily due to lower net income for the year ended December 31, 2012. Additionally, negative cash flows from our working capital accounts contributed to lower net cash provided by operating activities in 2012 as accounts payable and accrued liability balances have been reduced versus prior year as a result of lower accrued tax and compensation balances.
Net Cash Used In Investing Activities Net cash used in investing activities for the year ended December 31, 2013 primarily consisted of our $142.1 million acquisition of Voxeo, $6.7 million investment in Bright Pattern and $1.9 million investment in eg. Net cash used in investing activities for the year ended December 31, 2013 also included $11.1 million of capital expenditures compared to $5.1 million in the prior year. This additional investment in 2013 is primarily related to the establishment of our corporate headquarters in Phoenix, Arizona as well as an initiative to revitalize each of our existing office spaces.
Net cash used in investing activities for the year ended December 31, 2011 primarily consisted of $12.9 million of cash paid for the Corsidian acquisition, net of cash acquired.
Net Cash Used In Financing Activities Net cash used in financing activities for the year ended December 31, 2013 represented $110.0 million of additional debt to fund a portion of our Voxeo acquisition partially offset by scheduled principal payments under our debt facilities and debt issuance fees.
Net cash used in financing activities for the year ended December 31, 2012 increased $69.0 million as compared to the year ended December 31, 2011 primarily due to increased principal payments under our debt facilities as the result of a mandatory prepayment for excess cash flow which was remitted in April 2012 and a $50 million voluntary prepayment that was remitted in November 2012.
30-------------------------------------------------------------------------------- Table of Contents Existing Credit Facilities Senior Secured Credit Facility On May 7, 2010, we entered into a senior secured credit facility with JPMorgan Chase Bank, N.A., as administrative agent and issuing bank, and JPMorgan Chase Bank, N.A. and Bank of America, N.A., as co-syndication agents. Our subsidiary, Aspect Software, Inc., is the borrower under the facility. The facility is guaranteed by certain of our direct and indirect parents and all of our domestic subsidiaries. The facility is secured by a first-priority lien on substantially all of our assets and substantially all of the assets of the guarantors.
The facility consists of a $500.0 million term loan facility maturing on May 7, 2016 and a $30.0 million revolving credit facility maturing on May 7, 2014. On July 2, 2013, we amended our term loan facility to provide an $85.0 million incremental delayed draw senior secured term loan facility ("Delayed Draw Facility"). On July 25, 2013, we utilized the Delayed Draw Facility to fund a portion of the Voxeo acquisition All borrowings under the facilities are subject to the accuracy of representations and warranties in all material respects and the absence of default or event of default. As of December 31, 2013 we had a principal amount of $475.1 million, outstanding under the term loan facility and $20.0 million available under the revolving credit facility. As of December 31, 2012 we had a principal amount of $413.0 million outstanding under the term loan facility and $30.0 million available under the revolving credit facility.
Loans under our term loan facility and our revolving credit facility bear interest, at a rate equal to the adjusted LIBOR plus a margin of 5.25%. The interest rate margin on these facilities is reduced if we meet specified leverage ratios. In addition, loans under our term loan facility are subject to a LIBOR floor of 1.75%. Interest on base rate loans is required to be paid on the last day of each March, June, September and December. Interest on LIBOR loans is required to be paid on the last day of the interest periods we elect of one, two, three or six months (or, if allowed by all lenders, nine or twelve months) in duration, provided the payments are due not less than every three months for interest periods of greater than three months.
In addition to paying interest on outstanding principal under the facility, we are required to pay a fee on unutilized commitments under our revolving credit facility. The rate for this commitment fee is 0.75% if our total leverage ratio is greater than or equal to 3.75:1.00, 0.625% if our total leverage ratio is less than 3.75:1.00 but greater than or equal to 2.50:1.00, and 0.50% if our total leverage ratio is less than 2.50:1.00. We are also required to pay customary letter of credit and issuance and administration fees, as necessary.
We are required to make quarterly principal payments on our term loan facility in the amounts of $6.1 million through December 31, 2015, $1.525 million through March 31, 2016, with the remaining amount due at maturity. In the event of a prepayment of principal, the required quarterly principal payments for the year following the payment are not required to the extent that the prepayment offsets such required payments. To the extent that the prepayment exceeds the following year's required principal payments, the residual amount is ratably allotted to subsequent scheduled principal payments. The revolving facility matures and is required to be repaid in full on May 7, 2014.
Mandatory prepayments of the term loans are required upon the occurrence of certain events, as defined in the credit facility agreement. In addition we must use a percentage of our annual excess cash flow, as defined. The percentage is determined based on our leverage ratio as of 10 business days after the end of each fiscal year commencing with fiscal 2011 and ranges from 0% to 50%. As of December 31, 2013 and 2012, this calculation did not result in a mandatory prepayment.
The credit facility agreements include customary representations, covenants, and warranties. The financial covenants include minimum interest coverage ratios, leverage ratio maximums, and a maximum capital expenditures test to be reviewed on a quarterly basis. We were in compliance with these covenant requirements as of December 31, 2013. Based on our annual operating plan for 2014, we believe we will be in compliance with the financial covenants during 2014. If the Company is unable to maintain compliance with such covenants and the lenders do not waive the event of non-compliance, the lenders may accelerate payment of the debt.
The facility also limits our ability to make capital expenditures in excess of $15.0 million in any fiscal year, provided however, that we may carry forward unused amounts of our capital expenditures allowance to the next succeeding fiscal year.
Our senior secured credit facility also contains a number of covenants that, among other things, restrict our ability to incur additional debt, pay dividends and make distributions, make certain investments and acquisitions, repurchase stock and prepay certain indebtedness, create liens, enter into agreements with affiliates, modify the nature of the business, transfer and sell material assets and merge or consolidate.
31-------------------------------------------------------------------------------- Table of Contents Senior Notes We have $320.0 million in aggregate principal amount of senior secured notes outstanding as of December 31, 2013. We pay interest on the notes semi-annually at an annual interest rate of 10 5/8 %. The senior secured notes are due in full at maturity on May 15, 2017.
Our obligations under the notes are fully and unconditionally guaranteed, jointly and severally, on a senior secured basis by Aspect Software Parent, Inc.
and each of our direct and indirect domestic subsidiaries that guarantee our senior secured credit facility and on a senior unsecured basis by Holdings. The notes and the related note guarantees are secured by a second lien on substantially all of our and each guarantor's assets, other than certain excluded assets. The indenture governing the notes contains covenants that, among other things, limit our ability and the ability of our restricted subsidiaries to: incur additional indebtedness; pay dividends on or make distributions in respect of capital stock or make certain other restricted payments or investments; enter into agreements that restrict distributions from restricted subsidiaries; sell or otherwise dispose of assets, including capital stock of restricted subsidiaries; enter into transactions with affiliates; create or incur liens and merge, consolidate or sell substantially all of our assets. These covenants are subject to important exceptions and qualifications.
Other Long-Term Debt In connection with our acquisition of Quilogy in January 2010, we assumed an existing promissory note with Microsoft with a face value of approximately $6.5 million. No interest is payable on the note unless an event of default occurs, at which point the note will bear interest at 12% per annum. In addition to certain customary terms of default, we will be in default if we terminate our Technical & Business Collaboration Agreement with Microsoft for any reason other than certain reasons specified in the agreement. This promissory note was amended in February 2010 whereby Microsoft forgave $1.5 million of the note upon its acceptance of a plan by us to spend $1.5 million for the purpose of advancing our partnership with Microsoft and deploying Microsoft products. A principal payment of $1.5 million was made in April 2011, leaving the remaining $3.5 million of principal due on April 1, 2014.
Contractual Cash Obligations and Commitments We enter into long-term contractual obligations and commitments in the normal course of business, primarily debt obligations and non-cancelable operating leases. Other than operating leases that are detailed below, we do not utilize variable interest entity financing or any other form of off-balance sheet financing. As of December 31, 2013, our contractual cash obligations and commercial commitments over the next several periods are set forth below.
Payments Due by Period (in thousands) Total < 1 Year 1 - 3 Years 3 - 5 Years > 5 Years Debt(1) $ 809,300 $ 37,900 $ 451,400 $ 320,000 $ - Operating leases(2) 34,804 8,816 14,147 8,252 3,589 Total $ 844,104 $ 46,716 $ 465,547 $ 328,252 $ 3,589 (1) Amounts shown in the table above exclude interest in an aggregate amount of approximately $192.1 million that will become due over the expected term of our existing credit facilities based on interest rates in effect at December 31, 2013.
(2) We enter into operating leases in the normal course of business. Most lease arrangements provide us with the option to renew the leases at defined terms. The future operating lease obligations would change if we were to exercise these options, or if we were to enter into additional new operating leases. As of December 31, 2013, we had 51 operating leases, which expire from 2014 to 2021.
In addition to the amounts set forth in the table above, we have contractual obligations to pay royalties to certain third-party technology companies based upon our future licensing of their products and patented technologies. We cannot estimate what these future amounts will be; however, we expect them to increase as our product revenues continue to grow.
Off-Balance Sheet Arrangements Except as set forth above in the contractual obligations table, we have no off-balance sheet arrangements that have or are reasonably likely to have a material current or future impact on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources as of December 31, 2013.
We provide indemnification provisions in certain of our agreements with customers and our leases of real estate in the ordinary course of our business.
With respect to customer agreements, these provisions may obligate us to indemnify and hold harmless the customer against losses, expenses, liabilities and damages that are awarded against the customer in the event our products or services infringe upon a patent or other intellectual property right of a third party, in the event the customer's confidential 32-------------------------------------------------------------------------------- Table of Contents information is misused, or in other circumstances. The customer agreements may limit the scope of and remedies for such indemnification obligations in certain respects, including, but not limited to, geographical limitations and the right to replace or modify an infringing product or service. We believe our internal development processes and other policies and practices limit our exposure related to the indemnification provisions of these agreements. We generally warrant our products against certain manufacturing and other defects. These product warranties are provided for specific periods of time depending on the nature of the product, geographic location of its sale and other factors. We accrue for estimated product warranty claims for certain customers based primarily on historical experience of actual warranty claims, as well as current information on repair costs. To date, we have not incurred any material costs associated with these product warranties, and as such, we have not reserved for any such warranty liabilities in our operating results.
Critical Accounting Policies Our financial statements are prepared in accordance with Generally Accepted Accounting Principles ("GAAP") in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities. Management evaluates its estimates on an on-going basis. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable under the circumstances. Actual results may differ from the estimates used. Our actual results have generally not differed materially from our estimates. However, we monitor such differences and, in the event that actual results are significantly different from those estimated, we disclose any related impact on our results of operations, financial position and cash flows.
The notes to our consolidated financial statements provide a description of significant accounting policies. We believe that of these significant accounting policies, the following involve a higher degree of judgment or complexity: Long-Lived Assets, including Goodwill and Other Acquired Intangible Assets We review property, plant, and equipment and certain identifiable intangible assets with finite lives, excluding goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amounts to the future undiscounted cash flows the assets are expected to generate. If property, plant, and equipment and certain identifiable intangible assets with finite lives are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the asset exceeds its estimated fair value.
We estimated the fair value of our single reporting unit using both an income approach and a market approach. The discounted cash flow model used in our income approach relies on assumptions regarding revenue growth rates, gross margin, projected working capital needs, selling, general and administrative expenses, research and development expenses, capital expenditures, income tax rates, discount rates and exit multiples. To estimate fair value, we discount the expected cash flows of our single reporting unit. The discount rate used represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk involved and the rate of return an outside investor would expect to earn. To estimate cash flows beyond the final year of our model, we use a terminal value approach. Under this approach, we use the estimated cash flows in the final year of our model and apply an exit multiple assumption. We incorporate the present value of the resulting terminal value into our estimate of fair value. We forecasted cash flows for our single reporting unit and took into consideration current economic conditions and trends, estimated future operating results, our view of growth rates and anticipated future economic conditions. Revenue growth rates inherent in this forecast are based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional trends in the industry and product evolution from a technological segment basis. Macro-economic factors such as changes in economies, product evolutions, industry consolidations and other changes beyond our control could have a positive or negative impact on achieving our targets. We forecasted a return to revenue growth in 2014 in our discounted cash flow model. If actual results differ materially and adversely from the forecast used in the valuation, our determination of fair value and conclusions on goodwill impairment could be negatively affected. More specifically, the following factors could have a negative impact on our estimated fair value; we are not successful in migrating our Automatic Call Distributor customers to Unified IP, we are not successful against competitors in attaining our targeted new customers, maintenance retention rates deteriorate, research and development investments do not materialize, amongst a more comprehensive list of risks and uncertainties which are discussed further in Item 1A. Risk Factors.
Revenue Recognition We derive our revenue from (i) product revenues, which typically include perpetual software licenses and hardware, (ii) service revenues, which include software license updates and product support, installation, consulting and education and (iii) hosting and managed services revenues, which include subscription fees for access to and use of our on-demand applications.
33-------------------------------------------------------------------------------- Table of Contents Revenues from products and services have been derived from sales to end users through our direct sales force, distributors and resellers.
We recognize revenue from the sale of software licenses and hardware (the "Product") when persuasive evidence of an arrangement exists, the Product has been delivered, the fee is fixed or determinable and collection of the resulting receivable is probable. Revenue recognition for software licenses with multiple-element arrangements generally requires recognition of revenue using the residual method. Under the residual method, the portion of the total arrangement fee attributable to undelivered elements is deferred based upon its vendor-specific objective evidence ("VSOE") of fair value, or the stated amount if higher, and subsequently recognized as the service is delivered. The difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements, which is generally Product.
Certain of our multiple-element arrangements include software and hardware components that function together to deliver the product's essential functionality. When these software and non-software elements are sold together, we believe the arrangements meet the scope exception in Accounting Standards Codification 985-605, Software Revenue Recognition, ("ASC 985-605") because of (i) the infrequency of the tangible product's sale without a software element, (ii) the degree of integration between the tangible product and the software element, which is considered significant and (iii) the non-software element of the tangible product's substantive contributions to the tangible product's essential functionality. For these multiple-element arrangements, we allocate the total arrangement fee to all deliverables based on a selling price hierarchy. The selling price for a deliverable is based on VSOE, if available, third party evidence ("TPE"), if VSOE is not available, or estimated selling price ("ESP"), if neither VSOE nor TPE is available. We generally expect that we will not be able to establish TPE due to the nature of the products sold and the markets in which we competes, and therefore rely upon VSOE or ESP in allocating the arrangement's arrangement fee. Once the arrangement fee has been allocated to each deliverable, revenue is recognized as each item is delivered.
VSOE generally exists only when we sell the deliverable separately and is the price actually charged by us for that deliverable. We have established VSOE for support and maintenance services, certain professional services, and education services.
ESP reflects our best estimate of what the selling prices of elements would be if they were sold regularly on a standalone basis. ESP is based upon all reasonably available information including both market data and conditions and entity-specific factors. These factors include market trends and competitive conditions, product maturity, differences related to geography, distribution channel, deal size, and cumulative customer purchases. We have established ESP for software licenses, hardware and subscriptions and review them annually or more frequently when a significant change in our business or selling practices occurs.
Delivery generally occurs when the Product is delivered to a common carrier at our loading dock unless title and risk of loss transfers upon delivery to the customer. In sales transactions through a distributor or reseller, we generally recognize revenues upon shipment to the distributor, reseller or identified end user, as applicable.
At the time of the Product sale, we assess whether the fee associated with the revenue transaction is fixed or determinable and whether collection is probable.
The assessment of whether the fee is fixed or determinable is based in part on the payment terms associated with the transaction. If any portion of a fee is due beyond our normal payment terms, we evaluate the specific facts and circumstances to determine if the fee is fixed or determinable. If it is determined that the fee is not fixed or determinable, we recognize revenue as the fees become due. If we determine that collection of a fee is not probable, then we will defer the entire fee and recognize revenue upon receipt of cash.
Product revenue for software licenses sold on a perpetual basis, along with hardware, is recognized at the inception of the arrangement, presuming all other relevant revenue recognition criteria are met. Product revenue for software sold on a non-perpetual basis (Rental or Term) is recognized ratably over the license term.
In connection with the sale of our software licenses, we sell support and maintenance services, which are recognized ratably over the term of the arrangement, typically one year. Under support and maintenance services, customers receive unspecified software product upgrades, maintenance and patch releases during the term, as well as internet and telephone access to technical support personnel.
Many of our software arrangements also include professional services for consulting and implementation sold under separate agreements. Professional services revenue from these arrangements is generally accounted for separately from the software license because the services qualify as a separate element under ASC 985-605. The more significant factors considered in determining whether professional services revenue should be accounted for separately include (i) the nature of the services and whether they are essential to the functionality of the licensed product, (ii) the degree of risk, (iii) the availability of services 34-------------------------------------------------------------------------------- Table of Contents from other vendors, (iv) the timing of payments and (v) the impact of milestones or acceptance criteria on the realizability of the software license fee.
Professional services revenue under these arrangements, as well as when sold on a standalone basis, is generally recognized as the services are performed.
We recognize revenue associated with education as these services are performed.
Hosting and managed services revenue reflects subscription and other recurring revenues which includes fees for access rights to software solutions offered under a subscription-based delivery model where the users do not take possession of the software. Under this model, the software applications are hosted by us or by a third party and the customer accesses and uses the software on an as-needed basis over the internet or via a dedicated line. The underlying arrangements typically (i) include a single fee for the service that is billed monthly, quarterly or annually, (ii) cover a period from 12 to 36 months and (iii) do not provide the customer with an option to take delivery of the software at any time during or after the subscription term. Hosting revenues are recognized ratably over the subscription term beginning on the commencement dates of each contract.
Professional services revenue for consulting or training services, when sold with hosted offerings, are accounted for separately if they have standalone value to the customer. We believe our professional services have standalone value because those services are sold separately by us and similar services are sold by other vendors. In addition, our hosted offerings have standalone value as such offerings are often sold separately.
Deferred revenues primarily represent payments received from customers for software licenses and updates, hardware, product support, installation services, educational services and hosting prior to satisfying the revenue recognition criteria related to those payments.The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable hosting and managed services agreements. Deferred revenue that will be recognized during the succeeding twelve month period is recorded as current deferred revenue and the remaining portion is recorded as noncurrent.
We record our estimate for customer returns or other customer allowances as a reduction in revenues. In determining our revenue reserve estimate, and in accordance with internal policy, we rely on historical data and known returned goods in transit. These factors, and unanticipated changes in the economic and industry environment, could cause our return estimates to differ from actual results.
Business Combinations We apply the provisions of ASC 805, Business Combinations, in the accounting for our acquisitions. It requires us to recognize separately from goodwill the assets acquired and the liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations.
Accounting for business combinations requires our management to make significant estimates and assumptions, especially at the acquisition date including our estimates for intangible assets, contractual obligations assumed, restructuring liabilities, pre-acquisition contingencies and contingent consideration, where applicable. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain.
Examples of critical estimates in valuing certain of the intangible assets we have acquired include but are not limited to: • future expected cash flows from software license sales, cloud software subscriptions contracts, hardware systems product sales, support agreements, consulting contracts, other customer contracts, acquired developed technologies and patents; • expected costs to develop the in-process research and development into commercially viable products and estimated cash flows from the projects when completed; • the acquired company's brand and competitive position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined company's product portfolio; and • discount rates.
Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results.
35-------------------------------------------------------------------------------- Table of Contents We estimate the fair values of cloud software subscriptions, software license updates and product support and hardware systems support obligations assumed.
The estimated fair values of these performance obligations are determined utilizing a cost build-up approach. The cost build-up approach determines fair value by estimating the costs related to fulfilling the obligations plus a normal profit margin. The estimated costs to fulfill the obligations are based on the historical direct costs related to providing the services including the correction of any errors in the products acquired. The sum of these costs and operating profit approximates, in theory, the amount that we would be required to pay a third party to assume the performance obligations. We do not include any costs associated with selling efforts or research and development or the related fulfillment margins on these costs. Profit associated with any selling efforts is excluded because the acquired entities would have concluded those selling efforts on the performance obligations prior to the acquisition date. We also do not include the estimated research and development costs in our fair value determinations, as these costs are not deemed to represent a legal obligation at the time of acquisition. Historically, substantially all of our customers, including customers from acquired companies, renew their software license updates and product support contracts when the contracts are eligible for renewal and we strive to renew cloud software subscriptions and hardware systems support contracts. To the extent cloud software subscriptions, software support or hardware systems support contracts are renewed, we will recognize the revenues for the full values of the contracts over the contracts' periods, which are generally one year in duration.
For a given acquisition, we may identify certain pre-acquisition contingencies as of the acquisition date and may extend our review and evaluation of these pre-acquisition contingencies throughout the measurement period in order to obtain sufficient information to assess whether we include these contingencies as a part of the fair value estimates of assets acquired and liabilities assumed and, if so, to determine their estimated amounts.
If we cannot reasonably determine the fair value of a pre-acquisition contingency (non-income tax related) by the end of the measurement period, which is generally the case given the nature of such matters, we will recognize an asset or a liability for such pre-acquisition contingency if: (i) it is probable that an asset existed or a liability had been incurred at the acquisition date and (ii) the amount of the asset or liability can be reasonably estimated.
Subsequent to the measurement period, changes in our estimates of such contingencies will affect earnings and could have a material effect on our results of operations and financial position.
In addition, uncertain tax positions and tax related valuation allowances assumed in connection with a business combination are initially estimated as of the acquisition date. We reevaluate these items quarterly based upon facts and circumstances that existed as of the acquisition date with any adjustments to our preliminary estimates being recorded to goodwill if identified within the measurement period. Subsequent to the measurement period or our final determination of the tax allowance's or contingency's estimated value, whichever comes first, changes to these uncertain tax positions and tax related valuation allowances will affect our provision for income taxes in our consolidated statement of operations and could have a material impact on our results of operations and financial position.
Stock-Based Compensation At December 31, 2013 we had two stock-based employee compensation plans. The fair value of ordinary shares is determined by our management and approved by the board of directors. In the absence of a public trading market for our stock, our management and board of directors consider objective and subjective factors in determining the fair value of ordinary shares, including a fair value analysis prepared by an independent third-party valuation firm, dividend rights and voting control attributable to then-outstanding stock and, primarily, the likelihood of achieving a liquidity event such as an initial public offering or sale of our company.
We generally use the Black-Scholes option pricing model to determine the fair value of stock options granted. We recognize the compensation cost of stock-based awards on a straight-line basis over the vesting period of the award. As there is no public market for our ordinary shares, we determined the volatility for options granted based on an analysis of reported data for a peer group of companies that issued options with substantially similar terms. The expected volatility of options granted has been determined using an average of the historical volatility measures of this peer group of companies. The expected life of options has been determined utilizing the "Simplified" method as there is not sufficient historical data of exercises to develop the expected term assumption. The risk-free interest rate is based on a treasury instrument whose term is consistent with the expected life of the stock options. We do not anticipate paying cash dividends in the future on our ordinary shares; therefore, the expected dividend yield is assumed to be zero. We applied an estimated annual forfeiture rate of 23%, 24% and 13% for the years ended December 31, 2013, 2012 and 2011, respectively in determining the expense recorded in our consolidated statements of operations relating to our 2003 Share Purchase and Option Plan ("2003 Option Plan"). For options granted under the Second Amended and restated 2004 Option Plan ("2004 Option Plan"), we have deferred recognition of compensation expense until a liquidity event occurs, causing the options to become exercisable. The weighted-average assumptions utilized to determine the values of stock options granted using the Black-Scholes option pricing model are presented in the following table: 36-------------------------------------------------------------------------------- Table of Contents Years Ended December 31, 2013 2012 2011 Risk-free interest rate 1.29 % 0.77 % 1.40 % Expected volatility 37.00 % 49.00 % 48.80 % Expected life (in years) 4.58 4.58 4.58 Dividend yield - - -Weighted average fair value per share $ 0.33 $ 0.80 $ 0.98 As of December 31, 2013, there was $0.5 million of unrecognized compensation expense related to non-vested stock option awards granted under the 2003 Option Plan that is expected to be recognized over a weighted-average period of 3.17 years. In addition, as of December 31, 2013, there was $10.6 million of unrecognized compensation expense related to contingently exercisable stock options granted under the 2004 Option Plan, which is being deferred until a contingent liquidity event occurs, as defined in the 2004 Option Plan.
Claims and Contingencies We are subject to various claims and contingencies related to legal, regulatory, and other matters arising out of the normal course of business. Our determination of the treatment of claims and contingencies in the consolidated financial statements is based on management's view of the expected outcome of the applicable claim or contingency. Management may also use outside legal advice on matters related to litigation to assist in the estimating process. We accrue a liability if the likelihood of an adverse outcome is probable and the amount is estimable. If the likelihood of an adverse outcome is only reasonably possible, or if an estimate is not determinable, disclosure of a material claim or contingency is disclosed in the Notes to the consolidated financial statements. We re-evaluate these assessments on a quarterly basis or as new and significant information becomes available to determine whether a liability should be established or if any existing liability should be adjusted. However, the ultimate outcome of various legal issues could be different than management's estimates and, as a result, adjustments may be required.
Allowances for Accounts Receivable Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We specifically analyze historical bad debts, the aging of the accounts receivable, customer concentrations and credit worthiness, potential disagreements with customers, current economic trends and changes in customer payment terms to evaluate the allowance for doubtful accounts. We review our allowance for doubtful accounts quarterly. Past due balances are reviewed individually for collectability.
Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
We also record a provision for estimated sales returns and allowances on product- and service-related revenues in the same period as the related revenues are recorded. These estimates are based on the specific facts and circumstances of a particular order, analysis of credit memo data, and other known factors. If the data we use to calculate these estimates does not properly reflect reserve requirements, then a change in the allowances would be made in the period in which such a determination is made and revenues in that period could be affected.
Income Taxes We account for income taxes in accordance with ASC 740, Accounting for Income Taxes. Under ASC 740, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statement of income in the period that includes the enactment date.
Under ASC 740, we can only recognize a deferred tax asset for the future benefit of its tax loss, tax credit carryforwards and cumulative temporary differences to the extent that it is more likely than not that these assets will be realized. In determining the realizability of these assets, we considered numerous factors, including historical profitability, estimated future taxable income and the industry in which it operates.
ASC 740-10 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements and provides a model for recognizing and measuring, in the financial statements, positions taken or expected to be taken in a tax return. We may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position 37-------------------------------------------------------------------------------- Table of Contents will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.
We recognize interest and penalties related to uncertain tax positions in income tax expense.
Recent Accounting Pronouncements In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"). ASU 2013-11 clarifies guidance and eliminates diversity in practice on the presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. This new guidance is effective on a prospective basis for fiscal years and interim reporting periods within those years, beginning after December 15, 2013. The adoption of ASU 2013-11 in the first quarter of 2014 is not anticipated to have a material impact on our financial position or results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk Our exposure to interest rate risk primarily relates to our senior secured credit facility. Interest to be paid on our first lien debt is at a floor of 1.75% or USD LIBOR, plus 5.25%. We are able to select the USD LIBOR rate based upon a 1 month, 3 month or 6 month interval, at our option. Our next date to elect our USD LIBOR rate is May 7, 2014. The published USD LIBOR rate is subject to change on a periodic basis. Recently, interest rates have trended downwards in major global financial markets, stabilizing at relatively low levels over the past year. If these interest rate trends were to reverse, this would result in increased interest expense as a result of higher LIBOR rates. We currently estimate that our annual interest expense on our floating rate indebtedness under our senior secured credit facility would increase by approximately $5.0 million for each increase in interest rates of 1%, however this estimate does not give effect to the fact that until interest rates rise above our 1.75% floor there will be no impact on our interest expense.
Foreign Exchange We conduct business globally in numerous currencies. Our sales are primarily denominated in U.S. dollars, however we do face exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as our business practices evolve and could have a material adverse impact on our financial results. Our primary exposures to fluctuations in foreign currency exchange rates relate to sales and operating expenses denominated in currencies other than the US dollar. The majority of our sales are denominated in US dollars, however when we do invoice customers in a non U.S. dollar currency, we are exposed to foreign exchange fluctuations from the time of invoice until collection occurs. In Europe and Asia Pacific, where we sometimes invoice our customers in U.S. dollars, we pay our operating expenses in local currencies.
Accordingly, fluctuations in the local currencies relative to the U.S. dollar are reflected directly in our consolidated statement of operations. We are also exposed to foreign currency rate fluctuations between the time we collect in U.S. dollars and the time we pay our operating expenses in local currency.
Fluctuations in foreign currency exchange rates could affect the profitability and cash flows in U.S. dollars of our products and services sold in international markets.
Market Risk Financial instruments which potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable.
Cash and cash equivalents are held primarily with three financial institutions and consist primarily of money market funds and cash on deposit with banks. We sell our products primarily to large organizations in diversified industries worldwide. We perform ongoing credit evaluations of our customers' financial condition and generally do not require our customers to provide collateral or other security to support accounts receivable. Due to these factors, no additional credit risk beyond amounts provided for collection losses is believed by management to be probable in our accounts receivable. No single customer accounted for 10% or more of accounts receivable as December 31, 2013 and 2012 or net revenues during the years ended December 31, 2013, 2012 and 2011.
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