ITEM 1. BUSINESS
Overview
Sizmek Inc. ("Sizmek," the "Company," "we," "us," and "our"), a Delaware corporation formed in 2013, is a leading open ad management company that empowers marketers, agencies, and publishers to (i) create inspiring and omni-channel advertising, (ii) drive better performance, and (iii) cultivate deeper relationships with customers around the world. Our revenues are principally derived from services related to online advertising. We help advertisers, agencies and publishers engage with consumers across multiple online media channels (mobile, display, rich media, video and social). We connect 17,000 advertisers and 3,500 agencies to audiences in about 60 countries, serving more than 1.4 trillion impressions a year. See Note 14 of our consolidated and combined financial statements for a summary of revenues by geographical area.
Prior to February 7, 2014, we operated as the online segment of Digital Generation, Inc. ("DG"), a leading global television and online advertising management and distribution business. On February 7, 2014, pursuant to the terms of the Agreement and Plan of Merger, dated as of August 12, 2013 (the "Merger Agreement"), by and among Extreme Reach, Inc. ("Extreme Reach"), Dawn Blackhawk Acquisition Corp., a wholly-owned subsidiary of Extreme Reach ("Acquisition Sub"), and DG, all of our issued and outstanding shares of common stock, par value $0.001 per share ("Sizmek Common Stock") were distributed by DG pro rata to its stockholders (the "Spin-Off") with the DG stockholders receiving one share of Sizmek Common Stock for each share of DG common stock they held ("DG Common Stock"). Immediately after the distribution of the Sizmek Common Stock, pursuant to the Merger Agreement, Acquisition Sub merged with and into DG with DG as the surviving corporation (the "Merger") and all of the outstanding shares of DG Common Stock was converted into the right to receive $3.00 per share, and DG became a wholly-owned subsidiary of Extreme Reach. Prior to the Spin-Off, DG contributed to us all of the business and operations of its online advertising segment, all of DG's cash, most of the working capital from its television segment, and certain other corporate assets pursuant to the Separation and Redemption Agreement and related documents, and we agreed to indemnify DG and affiliates of DG (including Extreme Reach) for all pre-closing liabilities of DG, including stockholder litigation, tax obligations, and employee liabilities. Sizmek now operates as a separate, stand-alone publicly-traded company in the online advertising services business segment.
Background and Business Model
Sizmek works directly and indirectly with media agencies, advertisers, creative agencies, and publishers. Our primary customers are media agencies, such as Mediacom or Mindshare, who are paid by advertisers to develop their media plan and then execute their advertising campaigns. Advertisers such as Unilever or Nike may also work directly with Sizmek or through publishers. Creative agencies utilize Sizmek's authoring tools to develop and tailor advertising for a digital environment. Finally, publishers such as MSN or Yahoo that own online media content (for example a web page or a mobile app) attract end users to interact with their content (most typically for free) and are paid by advertisers to reach those end users through advertising that is placed within or next to the content. The standard advertising unit sold to an advertiser is known as an advertising impression. A single advertising impression represents a single advertisement that is served on a webpage or in an app.
The ability to execute advertising campaigns in a timely and scalable manner is a crucial requirement for our customers. Our technology empowers advertisers and agencies to deliver their creative assets to broad audiences, ensure consistent quality of the consumer experience, and utilize our
data for rigorous analysis and optimization. We focus on online media advertising, including display, video, mobile, social and connected TV channels.
Our online campaign management platform, Sizmek MDX (formerly known as the MediaMind platform), helps advertisers, agencies and publishers simplify the complexities of managing their advertising budgets across multiple online media channels and formats, such as desktop, mobile, rich media, social media, in-stream video, interactive video, display and search. The Sizmek MDX platform provides our customers with an easy-to-use, end-to-end solution to enhance planning, creative, delivery, measurement and optimization of online media campaigns. Our solutions are delivered through a scalable technology platform that allows delivery of sophisticated, global online media advertising campaigns, as well as smaller, more targeted campaigns.
We generally do not enter into long term contracts with our customers. We provide customers with a rate card, which is a menu of the services we provide through our platform in connection with the delivery of ads for their campaign. The variety of services we offer are available to all customers; however, an individual customer's rate can vary based on a number of factors. The rates for our services will also vary based on the ad format.
All revenue transactions are supported by an insertion order, which includes the customer's rate per impression served, the start and end date of the campaign, and usually the maximum number of impressions to be served. We generate revenue based on the number of times we serve the customer's ad during the campaign.
We generally remain free to change our rate card for particular customers at any time, but any change to our pricing applies to future campaigns and orders after we have advised the customer of the changes. We tend to review our pricing annually, and sometimes more frequently, depending upon a customer's usage and other circumstances. A customer's campaign typically runs three to six weeks for a particular ad. Customers are generally not obligated to run a particular number of campaigns or volume of deliveries through our platform, but we remain in touch with customers on a regular basis to encourage them to choose our platform and the delivery services we offer each time they develop new ads and commence new campaigns. We have no further service obligations to the customer after the campaign has ended.
Our customers rely on us to accurately count the number of advertising impressions delivered and the engagement or interaction with those ads including click-throughs. While we are typically paid on the number of advertisements served, rather than the click-throughs on those advertisements, fraudulent clicks caused by bots and other non-human activity can cause an artificial increase in the performance of the advertisements we serve which would be misleading to our customers and ultimately harm our reputation as a platform that accurately measures campaign delivery and performance. Accordingly, we employ sophisticated detection mechanisms to weed out fraud.
Measured by the number of advertising impressions served and the number of countries in which we serve customers, we are the largest provider of integrated campaign management solutions not owned by, or affiliated with, a particular publisher, agency or agency group, or advertising network. Our focus is connecting advertisers to audiences across the full spectrum of available online media channels and formats, therefore optimizing the audience for a specific campaign rather than a particular media or channel. We believe our data-neutral position is a key strategic differentiator for our customers. Our positioning eliminates potential conflicts with advertisers since we do not own any advertising inventory, allowing us to provide unbiased insight and analysis into our customers' campaigns and strategies and ensuring our customers' proprietary data remains protected.
Industry Background and Strategy
Online advertisers are often challenged by fragmentation in audience base, creative formats, and media channels. The growing availability of media online and the proliferation of emerging online media formats and channels, such as mobile devices, tablets, social networks and other forms of user-generated media, has led to an increasingly fragmented audience base. The diversity of online media options available to consumers often results in advertising inventory with multiple formats, a range of delivery specifications, metrics and targeting capabilities. Advertisers must also navigate through decentralized workflow processes involving numerous constituencies to deliver an effective campaign.
Our focus on open ad management means guiding advertisers and publishers through this complex and fragmented online landscape by providing products and services to help advertisers reach, engage and optimize their desired audience for each particular campaign. Open ad management means:
• end-to-end-bringing together all of the technology, intelligence and strategic guidance that a client needs to execute the most effective, global campaign; and
• choice-providing an open, flexible framework that allows each client to choose what's best for their particular needs.
Reach. Our integrated platform simplifies the complexities of managing online media advertising campaigns across multiple websites, advertising formats and channels and allows customers to manage varying publisher-imposed creative content restrictions. Our open architecture technology enables advertisers to reach audiences on many device types through the placement of ads in multiple formats on numerous channels including desktop, mobile, tablet and social, and is also designed to accommodate new and emerging online media channels such as connected TVs.
Engage. Since our incorporation, our Flash and now HTML5 based authoring environments have helped advertisers and publishers create innovative and scalable formats for rich media, in-stream video, standard banners and emerging media capabilities. These capabilities include interactive video and synced media that enable advertisers to interact with their target audience more effectively and yield higher engagement, performance and recall rates among consumers.
Optimize. Our platform and services are designed to help our customers deliver the most effective campaigns through data driven real-time targeting and creative optimization. This allows advertisers to reach specific consumer segments by assigning the best performing and most relevant creative advertisements throughout the campaign. Through our analytics capabilities, we offer advertisers the ability to target specific content categories through real-time exchange and/or programmatic bought inventory, offering cookie-less contextual targeting for greater efficiency and protection from unsafe content.
The future of online advertising and our business is data driven. In order to enhance the overall effectiveness of their online campaigns and determine the optimal allocation of their advertising budgets, advertisers need to integrate, compare and analyze campaign performance data from multiple sources. The Sizmek MDX platform provides actionable, comprehensive advertising performance statistics with numerous metrics, such as reach, frequency, dwell rate, interaction time, and ad viewability, as well as key metrics that verify whether the ads were delivered to the appropriate audience, devices and geographies. As the industry continues to adopt programmatic buying, and as users connect with brands using more than one device, our ability to collect and process multi-channel data and seamlessly execute on that data is critical to our strategy. Today we rely upon 3rd party cookies to measure ad delivery. However cookies are increasingly being blocked by certain browsers and browser plug-ins as well as being poorly accepted on mobile devices which create limitations for measuring ad delivery. We are well positioned in data mining and data matching (both online and
offline) which are both key to next generation solutions for statistical user identification which will increasingly be used to power our targeting infrastructure and measurement capabilities and replace cookies.
Moving forward, our key strategic initiatives include:
• enhancing our HTML5 and cross device capabilities to ensure our formats work and we can measure delivery across all devices (including devices that don't support cookies) and channels (including programmatic bought inventory and exchange bought inventory);
• developing our data collection and processing infrastructure for targeting and multi-touch attribution;
• increasing the compatibility between the Sizmek MDX platform and other companies in the advertising ecosystem to improve workflows and syndicate more data; and
• extending our global platform and service capabilities into emerging markets.
Service Offerings
Online ad serving technologies can be broken into three categories: distribution technologies that deliver the creative content to the user, analysis technologies that provide reports to advertisers and agencies about their campaigns, and logic technologies that bring all of these functions together and control the process.
Distribution technologies are outsourced to Content Distribution Networks (CDN). These are third party service providers who operate large numbers of servers that are deployed around the world and are collocated on many different middle mile and last mile networks to provide low latency connections with fast response times for end users. The first step in the distribution flow is determining which server or collection of servers should be used to serve the ad for each individual request. This function is also provided by the third party CDNs by means of global load balancers or other routing mechanisms developed by each CDN and sometimes proprietary to that CDN. Once this decision is made, the user's request is routed to the specific server and that server responds by delivering the ad, including the creative and interactive elements. We have contracts with multiple CDNs to provide high performance service in multiple regions globally.
Analysis technologies are built and operated by us or by selected partners. Analysis starts with data gathering followed by processing that data into many different types of reports. Data can be gathered by collecting logs from logic servers and by automated browsing of large numbers of websites. Logs collected from logic servers include information about the specific ad served, the user's environment, and any interactions that may have happened during the ad impression. Automated browsing involves sending massive numbers of queries to websites and capturing the information, textual content, and meta data that comprise that site. All of these data points are collected in central data centers and processed together to produce reports and actionable data feeds. Reports include campaign metrics like reach and frequency, user metrics like tracking and conversion rates, and ad metrics like performance and impact of specific creative. Actionable data feeds include contextual website classifications, cookie level data, and impression data that can be used by advertisers and agencies to tune their campaigns and verify their media purchases. These central data centers are large scale data processing facilities that can handle billions and tens of billions of data points each day. They include licensed and internally developed proprietary software running on hundreds of servers racked into processing nodes. Reports and data feeds are the end result of the ad serving process and are critical in linking our services to third party services also contracted by the client, and to the client's own internal systems used for campaign planning and execution.
Logic technologies are the heart of the ad serving process. They start with content management including ingestion and layout of the actual creative and end with the serving of the impression including the tracking mechanisms for interactions and conversions. Many different servers and software modules including licensed and internally developed proprietary modules are involved in the process. These modules allow the customers and campaign managers to upload the ads, create specific layouts for static or dynamic visual presentation, set up the campaigns which include the windows of time during which the ads will be shown and the sites on which the ads will be shown or bidding platforms on which the site inventory will be purchased, the trafficking of the ads to the sites, the specific tags which will be delivered with the ads and enable the collection of data by us, the client, or third parties, and the serving of that logic to the end user which begins the process of delivering the actual ad. The largest physical component of this system is the logic servers, which are comprised of over a hundred servers distributed in multiple data centers globally. The logic servers also coordinate the integration of the client's technical systems or third party technical systems which the client has contracted. This is accomplished through the integration of third party tags which cause the user's browser to report directly to a third party system and through the coordination and synchronization of unique data elements like 3rd party browser cookies.
Our online campaign management product and service offerings span the lifecycle of an advertising campaign, including:
Creative Authoring. We provide creative designers and producers with the tools and services to manage a campaign's creative development lifecycle, from initial design, to inclusion of interactive features, to adaptation for analytics and ad insertion, and finally, to integration with campaign management and ad serving processes. Our authoring environments include Flash and HTML5 based capabilities that support devices and permit custom designs as well as ready-made templates.
The formats, channels and advertising functionalities supported by our online campaign management platform, include:
• Rich Media Advertising. Rich media advertising typically includes more extensive graphics, animation and interactivity, and in some cases, audio and video within the advertisement.
• Video Advertising. Video advertising includes in-stream video formats displayed within or alongside video content on a publisher website, as well as in-banner video formats displayed within rich media banners.
• Standard Display Advertising. A low-cost, high-volume marketing tool, standard display represents the majority of banners viewed online.
• Social. Our social rich media posts are fully shareable in their interactive form across Facebook, Twitter and other social networks-directly connecting brands with users via rich media formats that perform and engage across all screens.
• Search Engine Advertising. Our search engine advertising product analyzes the performance of search engine marketing campaigns along with display campaigns by the same advertisers and enables cross-channel measurement and attribution.
• Mobile Advertising. Our mobile advertising product provides our customers with the ability to manage mobile ad campaigns with all the benefits of third-party ad serving through the Sizmek MDX platform.
Campaign Management. Our customizable and integrated global campaign management platform enables seamless delivery of advertisements to the target audience through one end to end platform:
• Ad serving. Our platform transmits ad content into ad insertions on publisher websites, offering one workflow for all channels and formats.
• Targeting. Our tools enable our customers to deliver tailored messages to a specific consumer segment. Targeting options include device type, device brand, geography, weather, domain, day and/or hour, keywords, content context and behavior.
• Optimization. We offer several tools that enable our customers to test ad performance on defined groups of consumers and adjust campaigns to show the audience the best performing ad variation in real-time. We offer optimization capabilities for improving ad relevancy by dynamically changing ad messaging in real-time. Our dynamic creative optimization solution automates ad personalization and dynamic updating of advertisement messaging.
Analytics and Monitoring. Our campaign management platform enables clear and comprehensive monitoring and reporting of campaign execution, delivery and performance in multi-channel campaigns for our customers to achieve campaign optimization and insights through attribution. For example, our verification suite verifies the brand safety, content and viewability attributes of campaigns. Data is made available to our customers in a wide variety of analytical tools and data delivery methods, including near real-time dashboards, robust reporting interfaces and granular data feeds.
Peer 39 Data. Peer 39 is a provider of data based on the content and structure of web pages for the purpose of improving the relevance and effectiveness of online display advertising. Peer 39's data attributes are critical to Real Time Bidding (RTB). Peer 39 analyzes pages across multiple supply sources and surfaces page level attributes across four channels: Quality, Safety, Category, and any format, with a focus on display and video. This enables buyers to make bidding and buying decisions based on Peer 39 page level attributes, aligning page environment with the brand, product or creative message defined by the advertisers.
Programmatic Managed Services. We offer a service of assisting our customers in their online advertising in an effort to maximize their campaign results. In general, we manage the process of our customers' online advertising which includes (i) selecting vendors and purchasing online advertising inventory through multiple ad exchanges, (ii) selecting or advising on campaign parameters, monitoring campaign results, and adjusting parameters and modifying publishers throughout the campaign to optimize results, and (iii) establishing the selling price. This is the only part of our business where we buy advertising impressions and resell them to our customers.
Customized Services. We offer our customers a range of optional customized professional services based on their specific needs. These services include:
• Trafficking. We provide access to a team of client service managers to oversee the set-up of the individual placements within a media plan such as which creative assets will be delivered to each website.
• Creative production. We provide access to a team of designers, creative developers and producers to build Flash and HTML5 mocks/ads.
• Quality assurance. We provide access to a team of software engineers to develop test plans and manage the quality assurance process for campaign executions.
• Research, analysis and custom reporting. We provide access to research analysts to produce custom reports, analysis and recommendations.
• Data integration. We provide access to sales engineers and developers to integrate data through custom data feeds and application programming interfaces.
Customer Support. Our customer support program assists our customers in the use of our services and identifies, analyzes and solves problems with our products and solutions. Our customer support group is available to customers by telephone, e-mail or through our website 24 hours per day, seven days per week. We offer specialized support for our different customer types-media, creative and
publisher. Our support organization combines customer-facing local account managers with a global support desk that handles all technical service aspects.
Markets and Customers
Our largest customer group consists of advertisers and their agency partners seeking to enhance planning, delivery, measurement and optimization of their online media campaigns who need an integrated campaign management platform with robust functionality and scalability. Advertisers benefit from improved advertising returns due to increased reach, impact, relevancy and measurement of their online campaigns across a variety of channels and formats; advertising agencies benefit from an integrated campaign management platform that simplifies the complexity of online media advertising and enables them to focus on delivering data driven insights.
We also work with some of the world's leading publishers seeking to provide advertisers with innovative opportunities to reach audiences at scale. Publishers benefit from our multi-channel campaign management capabilities, creative support, our data driven products for targeting, analytics and dynamic creative optimization and our service layer for quality assurance and ad operations support.
We are typically hired and paid by a media agency to manage the online campaign and coordinate with the media agency, the creative agency and the publishers to deliver the ad. In some situations, publishers, advertisers, or other constituents decide to retain us. For instance, publishers may opt to pay our fees and bundle them with the media fees that they charge to the agency and advertiser.
We provide services to a diversified base of customers consisting of a great majority of the online advertising industry in all key markets. In 2014, we served:
• approximately 3,500 media agencies and creative agencies worldwide, including Mediacom, Mindshare, Universal McCann, ZenithOptimedia, OMD, Zed Media, MEC and Media Contacts;
• over 22,000 global web publishers who are Sizmek MDX-enabled, including Yahoo!, MSN, Google, AOL, Facebook and ESPN; and
• over 17,000 brand advertisers in every major product vertical, including Nike, Sony, Toyota, Volkswagen, H&M, McDonalds, Vodafone, Reckitt Benckiser and MasterCard.
Our business is seasonal. Revenues tend to be the highest in the fourth quarter as a large portion of our revenues follow the advertising patterns of our customers.
Sales, Marketing, Customer Service and R&D
We aim to grow our market share by expanding existing relationships with advertisers, advertising agencies and publishers. We further aim to access additional advertising budgets by establishing new agency relationships and creating partnerships with global advertising agency holding companies, leading online media publishers and technology companies, and increasing our global footprint by expanding into new geographic markets.
Sales. We sell our offerings primarily through a direct sales force or through third-party selling agents that employ a direct sales force. Our sales organization consists of local sales teams, including sales managers and sales engineers, who cover agencies and advertisers in an effort to increase their awareness and utilization of our solutions and services.
In 2014, we delivered campaigns in about 60 countries. Our sales and services organization is globally organized and our offices and partners are coordinated and supported through four regional offices covering North America, EMEA, Asia Pacific, and Latin America. We believe this is an important advantage that allows us to offer global advertisers a consistent pan-regional service.
We sell directly in countries including Argentina, Australia, Austria, Brazil, Canada, China, France, Germany, Japan, Mexico, New Zealand, Norway, Portugal, Spain, Sweden, Taiwan, the United Kingdom, and the United States.
We sell through local third-party selling agents in countries and regions that include Belgium, Dubai, Greece, Hong Kong, India, Indonesia, Israel, Malaysia, the Netherlands, Pakistan, the Philippines, Poland, Romania, Russia, Singapore, South Africa, Thailand and Turkey. We typically maintain a long-term, strategic relationship with our local selling agents. Our agreements are typically at least one year in term, with automatic renewals in most cases, unless one party provides the other with prior written notice or if we and the local selling agent are unable to agree upon sales targets. The agreements generally provide our agents with the exclusive right to promote us in a certain region and are generally terminable only for cause or if the local selling agent does not meet the agreed upon sales targets. These agreements also include provisions regarding non-competition, non-disclosure and the protection of our intellectual property.
Marketing. Our marketing efforts are focused on enhancing the corporate brand, thought leadership research, lead generation, sales support and product marketing. We support these objectives through public relations, industry events, road shows, conferences, advertising, social media, web sites, blogs and research publications.
Business Development. Our business development team supports our sales efforts by developing strategic relationships with agency holding groups, key publishers and media companies, as well as technology partners.
Customer Service. Our client services organization assumes responsibility and account management for active relationships with clients and handles management of campaigns and the ongoing adoption of our solutions. The client services organization includes specialist representatives for our different categories of clients, including media agencies, creative agencies and publishers.
Research & Development. Our R&D team is responsible for the underlying architecture of the Sizmek MDX platform ensuring we provide market leading scale and the ability to integrate in an open manner with many of our partners. In addition, they are responsible for building out the products and service offerings that form the full extent of the Sizmek MDX campaign management platform. As part of a thorough innovation exercise, they also test and evaluate new technologies that could speed up and strengthen our overall platform offering. Presently, our R&D team is designing and developing a new ad management platform which will be a single, end-to-end, integrated platform encompassing all channels and formats. We anticipate the new platform will be operational by the end of 2015 and we expect to retire the old platform by mid-2016.
Competition
The online markets in which we operate are rapidly evolving, highly fragmented and highly competitive. We expect this competitive environment to continue. We believe that the principal competitive factors affecting the market for online advertising services and tools are existing strategic relationships with customers and vendors globally, ease-of-use, integration and customization, innovation, technology, quality and breadth of service, including local language support, data analysis, price and independence. We believe that no other company in the digital advertising market can claim to be a complete, end-to-end solution provider that is also open and flexible:
• Where point solutions provide only single functions, we integrate all of the necessary technology and data (both our own and that of our best-in-class partners) that our clients need, making advertising easier and driving exponential performance.
• Where other comprehensive solutions are tied to their own media businesses and often force clients to use only their solutions, we give clients the choice to use whatever technology suits their needs the best. Our technology is open by design and we are continually integrating new partner solutions to our platform to ensure the widest choice possible.
With respect to these significant competitive factors, we believe that our solutions and services are one of the best in the areas of ease-of-use, integration and customization, innovation, technology, quality and breadth of service (including local support), data analysis and independence. For example, we offer near real-time monitoring capabilities and additional unique custom analytics tools that allow us to measure various levels of users' engagement and brand awareness. We have an advantage that many of our competitors lack because our technology platform is accepted and supported by thousands of publishers worldwide.
Our main competitors in the ad management and ad serving category are DoubleClick (which was acquired by Google in March 2008), Atlas (which was acquired by Facebook in April 2013), and MediaPlex, a division of ValueClick. Our main competitors for stand-alone video ad serving are Vindico and Innovid. Our main competitors in the stand-alone rich media category are niche players, such as PointRoll (which is owned by Gannett) and FlashTalking. Our main competitors in data and analytics include Integral Ad Sciences and DoubleVerify for verification.
Intellectual Property and Proprietary Rights
Our intellectual property rights are important to our business. We believe that the complexity of our products and the know-how incorporated in them make it difficult to copy them or replicate their features. We rely on a combination of confidentiality clauses, copyrights, patents and trademarks to protect our intellectual property and know-how.
To protect our know-how and trade secrets, we customarily require our employees, customers and third-party collaborators to execute confidentiality agreements or otherwise agree to keep our proprietary information confidential when their relationship with us begins. Typically, our employment contracts also include clauses requiring our employees to assign to us all inventions and intellectual property rights they develop in the course of their employment and agree not to disclose our confidential information. Because software is stored electronically and thus is highly portable, we attempt to reduce the portability of our software by physically protecting our servers through the use of closed networks and physical security systems that prevent external access. We also seek to minimize disclosure of our source code to customers or other third parties.
The online advertising industry is characterized by ongoing product changes resulting from new technological developments, performance improvements and decreasing costs. We believe that our future growth depends, to a large extent, on our ability to profoundly understand our clients and their needs and to be an innovator in the development and application of technology. As we develop next generation products, we intend to continue to pursue patent and other intellectual property rights protection, when practical, for our core technologies. As we continue to move into new markets, we will evaluate how best to protect our technologies in those markets.
As of December 31, 2014, we had 44 issued U.S. patents with expiration dates ranging from March 2016 to May 2032 and 23 pending U.S. patent applications. We also had ten registered international patents and four pending international patent applications. We cannot be certain that patents will be issued as a result of the patent applications we have filed. We also had 18 U.S. and 20 international trademark registrations and two U.S. and ten international trademark applications.
Available Information
We file quarterly and annual reports, proxy statements and other documents with the SEC under the Securities Exchange Act of 1934 (the "Exchange Act").
The public may read and copy any materials that we file with the SEC at the SEC's Public Reference Room at 100 F Street N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with the SEC. The public can obtain any documents that we file with the SEC at http://www.sec.gov.
We also make available free of charge through our website (www.sizmek.com) our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Employees
As of December 31, 2014 we had a total of 906 employees, including 236 in research and development, 183 in sales and marketing, 379 in operations, and 108 in headquarters, finance and administration; 306 of these employees are located in the United States, 252 are located in Israel, and 348 are located in other countries. Our employees are not represented by a collective bargaining agreement and we have not experienced a work stoppage. We believe we have good relations with our employees.
ITEM 1A.
ITEM 1A. RISK FACTORS
You should carefully consider the following risks and other information in this Annual Report on Form 10-K when considering an investment in our common stock. Any of the following risks could materially and adversely affect our business, financial condition, results of operations and cash flows. The risk factors generally have been separated into the following groups:
•risks related to our industry and the markets we serve,
•risks related specifically to our business and operations,
•risks related to our capital structure,
•risks concerning law, regulation and policy that affect our business,
•risks related to our spin-off from DG, and
•risks concerning our common stock.
Risks Related to Our Industry and the Markets We Serve
The industry is in a state of rapid technological change and we may not be able to keep up with that pace.
The advertisement distribution and management industry is characterized by extremely rapid technological change, frequent new products and service introductions and evolving industry standards. The introduction of products with new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. Our future success will depend upon our ability to enhance our existing products and services, develop and introduce new products and services that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of our customers. We may not succeed in developing and marketing product enhancements or new products and services that respond to technological change or emerging industry standards. We may experience difficulties that could delay or prevent the successful development, introduction and marketing of these products and services. Our products and services may not adequately meet the requirements of the marketplace and achieve market acceptance. If we cannot, for technological or other reasons, develop and introduce products and services in a timely manner in response to changing market conditions, industry standards or other customer requirements, particularly if we have pre-announced the product and service releases, our business, financial condition, results of operations and cash flows will be harmed.
The online advertising industry has undergone rapid and dramatic changes in its short history. You must consider our business and prospects in light of the risks and difficulties we will encounter in a new and rapidly evolving market. We may not be able to successfully address new risks and difficulties as they arise, which could have a material adverse effect on our business, financial condition and results of operations.
Our industry has been adversely affected by continued economic challenges and uncertainty in the United States, Europe and throughout the world.
Demand for online campaign management solutions and services to advertising agencies and advertisers tends to be tied to economic cycles, reflecting overall economic conditions as well as budgeting and buying patterns. Following the recent negative developments in the world economy, spending on traditional broadcast advertising has been adversely affected and growth in online advertising may be slower than previously expected. We cannot assure you that advertising budgets and expenditures by advertising agencies and advertisers will not decline in any given period or that advertising spending will not be diverted to more traditional media or other online marketing products and services, which would lead to a decline in the demand for our campaign management solutions and
services. A decline in the economic prospects of advertisers or the economy in general could alter current or prospective customers' spending priorities. As a result, our revenues may not increase or may decline significantly in any given quarterly or annual period.
Seasonality makes forecasting difficult and can result in widely fluctuating quarterly results.
Historically, the industry has experienced the lowest sales in the first quarter and the highest sales in the fourth quarter, with the second quarter being slightly stronger than the third quarter. Fourth quarter sales tend to be the highest due to increased customer advertising volumes for the holiday selling season. In addition, product and service revenues are influenced by political advertising, which generally occurs every two years. Nevertheless, in any single period, product and service revenues and delivery costs are subject to significant variation based on changes in the volume and mix of deliveries performed during such period. In addition, we have historically operated with little or no backlog. The absence of backlog and fluctuations in revenues and costs due to seasonality increases the difficulty of predicting our operating results.
The markets in which we operate are highly competitive and competition may increase further as new participants enter the market and more established companies with greater resources seek to expand their market share.
Competition within the markets for media distribution is intense. We face formidable competition from other companies that provide solutions and services similar to ours. Currently, our primary competitors are DoubleClick (a subsidiary of Google) and Atlas (a subsidiary of Facebook). Atlas offers solutions and services similar to ours and competes directly with us. We expect that Atlas will have the benefit of substantial financial resources, though it is unclear whether such resources will be focused on agency side campaign management products and capabilities to support the needs of advertisers wanting to advertise across multiple publishers and, thus, increase its ability to compete with us.
There are other platform companies and demand side platform companies that offer advertisement services that could potentially expand their capabilities to include rich media, online video, verification and viewability in competition with us. Other competitors exist in niches in which we operate, such as rich media, online video, verification, viewability and social media.
We believe that our ability to compete successfully with all of our service offerings depends on a number of factors, both within and outside of our control, including: (i) the price, quality and performance of our products and those of our competitors; (ii) the timing and success of new product introductions; (iii) the emergence of new technologies; (iv) the number and nature of our competitors in a given market; (v) the protection of our intellectual property rights; and (vi) general market and economic conditions. In addition, the assertion of intellectual property rights by others factor into the ability to compete successfully. The competitive environment could result in price reductions that could result in lower profits and loss of our market share.
The unilateral actions of certain browser companies that are owned by media companies combined with growing usage of mobile devices is likely to put more pressure on the relevance of the kind of 3rd party cookies that we currently use for targeting and measurement. Consumer technology companies like Google, Amazon, Facebook, Microsoft and Yahoo on the other hand with direct relationships with consumers have access to user log-in data that will allow them to target audiences and measure campaigns, which may provide them with a competitive advantage. We see data mining and data matching (both online and offline) as two keys to the next generation solutions for statistical user identification which will be used to augment 3rd party cookies, and we are well positioned to establish solutions of these types given our strengths in large scale data management and our global scale. In addition we are currently engaged in certain collaborative industry initiatives with the goal of providing a cookie alternative as well as testing certain third party technologies with whom we might partner.
In addition, many of our current and potential competitors have established or may establish cooperative relationships among themselves or with third parties, and several of our competitors have combined or may combine in the future with larger companies with greater resources than ours. Through our open approach to technology partnerships, we have created cooperative relationships with a number of players in the market such as demand side platforms and search engine management. In addition, we have also integrated with businesses (e.g., MediaOcean) involved in planning and buying tools. Our integration allows a user to create a media plan in a different platform and push the plan into the Sizmek MDX platform. Our strategy is to offer our customers differentiated and valued added workflows while offering choice through an openness to connecting to other technologies. Notwithstanding our own efforts, this growing trend of cooperative relationships and consolidation within our industry may create a great number of powerful and aggressive competitors that may engage in more extensive research and development, undertake more far- reaching marketing campaigns and/or make more attractive offers to existing and potential employees and customers than we are able to. They may also adopt more aggressive pricing policies and may even provide services similar to ours at no additional cost by bundling them with their other product and service offerings. Any increase in the level of competition from these, or any other competitors, is likely to result in price reductions, reduced margins, loss of market share and a potential decline in our revenues. We cannot assure you that we will be able to compete successfully with our existing or future competitors. If we fail to withstand competitive pressures and compete successfully, our business, financial condition and results of operations could be materially adversely affected.
Consolidation in the industry in which we operate could lead to increased competition and loss of customers.
The Internet industry (and online advertising in particular) has experienced substantial consolidation. We expect this consolidation to continue. This consolidation could adversely affect our business and results of operations in a number of ways, including the following:
• our customers could acquire or be acquired by our competitors and terminate their relationship with us;
• our customers could merge with each other, which could reduce our ability to negotiate favorable terms; and
• competitors could improve their competitive position through strategic acquisitions.
Consolidation of Internet advertising networks, web portals, Internet search engine sites and web publishers may impair our ability to serve advertisements and to collect campaign data and could lead to a loss of significant online customers.
The growing trend of consolidation of Internet advertising networks, web portals, Internet search engine sites and web publishers, and increasing industry presence of a small number of large companies, such as Google, Facebook and, most recently, Apple, with the announcement of its iAd platform for placing ads on Apple's applications, could harm our business. We are currently able to serve, track and manage advertisements for our customers in a variety of networks and websites, which is a major benefit to our customers' overall campaign management. Concentration of advertising networks could substantially impair our ability to serve advertisements if these networks or websites decide not to permit us to serve, track or manage advertisements on their websites, if they develop ad placement systems that are incompatible with our ad serving systems or if they use their market power to force their customers to use certain vendors on their networks or websites. These networks or websites could also prohibit or limit our aggregation of advertising campaign data if they use technology that is not compatible with our technology. In addition, concentration of desirable advertising space in a small number of networks and websites could result in competitive pricing pressures and diminish the value of our advertising campaign databases, as the value of these databases
depends to some degree on the continuous aggregation of data from advertising campaigns on a variety of different advertising networks and websites. Additionally, major publishers can terminate our ability to serve advertisements on their properties on short notice. If we are no longer able to serve, track and manage advertisements on a variety of networks and websites, our ability to service campaigns effectively and aggregate useful campaign data for our customers will be limited.
The Internet advertising or marketing market may deteriorate, or develop more slowly than expected, which could have a material adverse effect on our business, financial condition or results of operations.
The Internet advertising and marketing market is rapidly evolving. As a result, demand and market acceptance for Internet advertising solutions and services is uncertain. If the market for Internet advertising or marketing deteriorates, or develops more slowly than we expect, our business could suffer. The future success of our business is dependent on an increase in the use of the Internet, the commitment of advertisers and advertising agencies to the Internet as an advertising and marketing medium, the advertisers' implementation of advertising campaigns and the willingness of current or potential customers to outsource their Internet advertising and marketing needs. If our products do not achieve the anticipated level of market acceptance, our future growth could be jeopardized. Broad adoption of our products and services will require us to overcome significant market development hurdles, many of which we cannot predict.
Internet security poses risks to our entire business.
The process of e-commerce aggregation by means of our hardware and software infrastructure involves the transmission and analysis of confidential and proprietary information of the advertiser, as well as our own confidential and proprietary information. The compromise of our security or misappropriation of proprietary information could have a material adverse effect on our business, prospects, financial condition and results of operations. We rely on encryption and authentication technology licensed from other companies to provide the security and authentication necessary to effect secure Internet transmission of confidential information, such as credit and other proprietary information. Advances in computer capabilities, new discoveries in the field of cryptography, or other events or developments may result in a compromise or breach of the technology used by us to protect client transaction data. Anyone who is able to circumvent our security measures could misappropriate proprietary information or cause material interruptions in our operations. We may be required to expend significant capital and other resources to protect against security breaches or to minimize problems caused by security breaches. To the extent that our activities or the activities of others involve the storage and transmission of proprietary information, security breaches could damage our reputation and expose us to a risk of loss or litigation and possible liability. Our security measures may not prevent security breaches. Our failure to prevent these security breaches may have a material adverse effect on our business, prospects, financial condition and results of operations.
Risks Related to Our Business and Operations
Our business may be harmed if we are not able to protect our intellectual property rights from third-party challenges or if the intellectual property we use or business operations in which we engage infringes upon the proprietary rights of third parties.
The steps taken to protect our proprietary information may not prevent misappropriation of such information, and such protection may not preclude competitors from developing confusingly similar brand names or promotional materials or developing products and services similar to ours. We consider our trademarks, copyrights, advertising and promotion design and artwork to be of value and important to our business. We rely on a combination of trade secret, copyright and trademark laws and nondisclosure and other arrangements to protect our proprietary rights. We generally enter into confidentiality or license agreements with our distributors and customers and limit access to and
distribution of our software, documentation and other proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries where our products are utilized do not protect our proprietary rights to the same extent as do the laws of the United States.
The technology services sector within advertising and marketing contains a large and ever growing number of new and existing technology providers with potentially overlapping intellectual property claims. We cannot assure you that our intellectual property or business operations do not infringe on the proprietary rights of third parties. While we believe that our trademarks, copyrights, advertising and promotion design and artwork do not infringe upon the proprietary rights of third parties, we may still receive future communications from third parties asserting that we are infringing, or may be infringing, on the proprietary rights of third parties. Any such claims, with or without merit, could be time-consuming, require us to enter into royalty arrangements or result in costly litigation and diversion of management attention. If such claims are successful, we may not be able to obtain licenses necessary for the operation of our business, or, if obtainable, such licenses may not be available on commercially reasonable terms, either of which could prevent our ability to operate our business.
If we fail to manage our growth effectively, our business, financial condition and results of operations could be materially adversely affected.
We have experienced, and continue to experience, growth in our operations and headcount, which has placed, and will continue to place, significant demands on our management, operational and financial infrastructure. If we do not effectively manage our growth, the quality of our solutions and services could suffer, which could negatively affect our brand and operating results. To effectively manage this growth, we will need to continue to improve, among other things:
• our information and communication systems, to ensure that our offices around the world are well coordinated and that we can effectively communicate with our growing base of customers;
• our systems of internal controls, to ensure timely and accurate reporting of all of our operations;
• our documentation of our information technology systems and our business processes for our advertising and billing systems; and
• our information technology infrastructure, to maintain the effectiveness of our systems.
In order to enhance and improve these systems, we will be required to make significant capital expenditures and allocate valuable management resources. If the improvements are not implemented successfully, our ability to manage our growth will be impaired and we may have to make additional expenditures to address these issues, which could materially adversely affect our business, financial condition and results of operations.
We depend on key personnel to manage the business effectively, and if we are unable to retain our key employees or hire additional qualified personnel, our ability to compete could be harmed.
Our future success will depend, to a significant extent, upon the services of our executive team. Uncontrollable circumstances, such as the death or incapacity of any key executive officer, could have a serious impact on our business.
Our future success will also depend upon our ability to attract and retain highly qualified management, sales, operations, information technology and marketing personnel. There is, and will continue to be, intense competition for personnel with experience in the markets applicable to our products and services. Because of this intense competition, we may not be able to retain key personnel or attract, assimilate or retain other highly qualified technical and management personnel in the future.
The inability to retain or to attract additional qualified personnel as needed could have a material adverse effect on our business.
System disruptions and security threats to our computer networks or phone systems could have a material adverse effect on our business.
The performance and reliability of our computer network and phone systems infrastructure is critical to our operations. Any computer system error or failure, regardless of cause, could result in a substantial outage that materially disrupts our operations. In addition, we face the threat to our computer systems of unauthorized access, computer hackers, computer viruses, malicious code, organized cyber-attacks and other security problems and system disruptions. We devote significant resources to the security of our computer systems, but our computer systems may still be vulnerable to these threats. A user who circumvents security measures could misappropriate proprietary information or cause interruptions or malfunctions in our operations. As a result, we may be required to expend significant resources to protect against the threat of these system disruptions and security breaches or to alleviate problems caused by these disruptions and breaches. Any of these events could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our use of "open source" software could subject our technology to general release or require us to re-engineer our solutions, or subject us to litigation, which could harm our business.
Our technology incorporates or is distributed with software or data licensed from third parties, including some software that incorporates so-called "open source" software, and we may incorporate open source software in the future. Open source software is generally licensed by its authors or other third parties under open source licenses. Some of these licenses contain requirements that we make available source code for modifications or derivative works we create based upon, incorporating or using the open source software, that we license such modifications or derivative works under the terms of a particular open source license or other license granting third parties certain rights of further use, and that we offer our services that incorporate the open source software for no cost. By the terms of certain open source licenses, we could be required to release the source code of our proprietary software, and to make our proprietary software available under open source licenses, if we combine our proprietary software with open source software in certain manners. While we carefully monitor the use of all open source software and try to ensure that no open source software is used in such a way as to require us to disclose the source code to our software, such use could inadvertently occur. Additionally, the terms of many open source licenses to which we are subject have not been interpreted by U.S. or foreign courts. There is a risk that open source licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to provide our solutions. In the future, we could be required to seek licenses from third parties in order to continue offering some of our solutions, and these licenses may not be available on favorable terms, or at all. Alternatively, we may be forced to re-engineer some of our solutions or discontinue use of portions of the functionality provided by our solutions. In addition, the terms of open source licenses may require us to provide our solutions that use open source software to others on unfavorable terms. If a third party that distributes open source software were to allege that we had not complied with the conditions of one or more of these licenses, we could be required to incur significant legal expenses defending against such allegations and could be subject to significant damages, enjoined from the sale of our solutions that contain the open source software and required to comply with the foregoing conditions, which could disrupt the distribution and sale of some of our services. Any of these events could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Defects or errors in our solutions or failure to detect click-through fraud or other invalid clicks may impair our customers' ability to deliver against their advertising campaign goals, which could damage our reputation and have a material adverse effect on our business.
The technology underlying our solutions, including our own proprietary technology and third-party technology provided by our vendors, may contain material defects or errors that could adversely affect our ability to operate our business and cause significant harm to our reputation. These defects or errors, or other disruptions in service or other performance problems in our solutions, could result in the incomplete or inaccurate delivery of advertisements, including the inability of an advertisement format to render within a specific placement, in the wrong geographical location or in a context that the advertiser finds inappropriate or otherwise undesirable for its brand. In addition, we are exposed to the risk of fraudulent clicks and other invalid clicks on advertisements delivered by us from a variety of potential sources. Invalid clicks are clicks that are not intended by the user to link to the underlying content, or when a software program, known as a bot, spider, or crawler, intentionally simulates user activity causing impressions, ad engagements or clicks to be counted as real users. Such malicious software programs can run on single machines or on tens of thousands of machines, making them difficult to detect and filter.
If we experience any of the defects, errors or other problems described above, our business, brand and reputation could suffer and our ability to retain existing customers and attract new business could be harmed. If fraudulent clicks are not detected, the data that our solutions provide to our customers will be inaccurate and the affected advertisers may lose confidence in our solutions to deliver a return on their investment. In addition, customers whose advertisements were placed in an incomplete or inaccurate manner or undesirable context could refuse to pay for such advertisements, demand refunds or future credits or initiate litigation against us. Our advertisers could become dissatisfied with our solutions and may choose to do business with our competitors or reduce their spending on Internet advertising. Any of the consequences described above could have a material adverse effect on our business, financial condition and results of operations.
If we do not continue to innovate and provide high quality solutions and services, as well as increase our revenues from more traditional solutions and services, we may not remain competitive, and our business, financial condition or results of operations could be materially adversely affected.
Our success depends on providing high quality solutions and services that make online campaign management easier and more efficient for our customers. Our competitors are constantly developing innovations in online advertising and campaign management, and therefore the prices that we charge for existing services and solutions generally decline over time. As a result, we must continue to invest significant resources in research and development in order to enhance our technology and our existing solutions and services and introduce new high-quality solutions and services. If we are unable to predict user preferences or industry changes, or if we are unable to modify our solutions and services on a timely basis, and as a result are unable to provide quality solutions and services that run without complication or service interruptions, our customers may become dissatisfied and we may lose customers to our competitors and our reputation in the industry may suffer, making it difficult to attract new customers. Our operating results will also suffer if our innovations are not responsive to the needs of our customers, are not appropriately timed with market opportunity or are not effectively brought to market. As online advertising and campaign management technologies continue to develop, our competitors may be able to offer solutions that are, or that are perceived to be, substantially similar or better than those offered by us. Customers will not continue to do business with us if our solutions do not deliver advertisements in an appropriate and effective manner, if the advertiser's investment in advertising does not generate the desired results, or if our campaign management tools do not provide our customers with the help they need to manage their campaigns. If we are unable to meet these challenges or if we over-expend our resources in our research and development of new
solutions and services, our business, financial condition and results of operations could be materially adversely affected. If we are unable to grow our market share in this area significantly, our revenue could decrease.
Our business depends on a strong brand reputation, and if we are not able to maintain and enhance our brand, our business, financial condition and results of operations could be materially adversely affected.
We believe that maintaining and enhancing our brand is critical to expanding our base of customers and maintaining brand loyalty among customers, particularly in North America where brand perception can impact the competitive position in other markets worldwide, and that the importance of brand recognition will increase due to the growing number of competitors providing similar services and solutions. Maintaining and enhancing our brand may require us to make substantial investments in research and development and in the marketing of our solutions and services, and these investments may not be successful. If we fail to promote and maintain our brand, or if we incur excessive expenses in this effort, our business, financial condition and results of operations could be materially adversely affected. We anticipate that, as our market becomes increasingly competitive, maintaining and enhancing our brand may become increasingly difficult and expensive. Maintaining and enhancing our brand will depend largely on our ability to be a technology leader and to continue to provide high quality solutions and services, which we may not do successfully.
New advertisement blocking technologies could limit or block the delivery or display of advertisements by our solutions, which could undermine the viability of our business.
Advertisement blocking technologies, such as "filter" software programs, that can limit or block the delivery or display of advertisements delivered through our solutions are currently available for Internet users and are continuing to be developed. If these technologies become widespread, the commercial viability of the current Internet advertisement model may be undermined. As a result, ad-blocking technology could, in the future, have a material adverse effect on our business, financial condition and results of operations.
More individuals are using non-personal computer devices to access the Internet, and browser companies may change some of their underlying functionality. Our solutions developed for these devices and browsers may not be widely deployed.
The number of people who access the Internet through devices other than personal computers ("PCs"), including mobile devices, game consoles and television set-top devices, has increased dramatically in the past few years. Many of these devices do not accept the cookies we currently use to target audiences and measure campaign performance and require a new approach. If we are unable to deliver our solutions and services to a substantial number of alternative device users or if we are slow to develop solutions and technologies that are more compatible with non-PC communications devices, we will fail to capture a significant share of an increasingly important portion of the market. Our failure to deliver our solutions and services to a substantial number of alternative device users, or failure to develop in a timely manner solutions and technologies that are more compatible with non-PC communications devices, could have a material adverse effect on our business, financial condition and results of operations.
In addition, some of the more popular browsers in use today have indicated that in the future, they may not accept or support the cookies we currently use to target audiences and measure campaign performance. Furthermore, the ability to provide attribution, tracking a user's activity through multiple ad, search, or site interactions across multiple devices requires the development of a single Cross Device ID. If we are unable to develop or license this type of technology, our services may be insufficient to meet the needs of our customers in the future.
We may have difficulty scaling and adapting our existing network infrastructure to accommodate increased systems traffic and technology advances or changing business or regional privacy requirements.
For our business to be successful, our network infrastructure must perform well and be reliable. We will need significantly more computing power as traffic within our systems increases and our solutions and services become more complex. As advertisers use more video, rich media and interactive ads, ad unit sizes increase substantially, causing greater load on our servers and increasing the cost of delivery. We expect to continue spending significant amounts to lease data centers and to purchase or lease equipment, and to upgrade our technology and network infrastructure to handle increased Internet traffic and roll-out new solutions and services, many of which internal improvements were delayed during the recent financial crisis. This expansion will be expensive and complex and could result in inefficiencies or operational failures. The costs associated with these necessary adjustments to our network infrastructure could harm our operating results. In addition, cost increases, loss of traffic or failure to accommodate new technologies or changing business or regional privacy requirements associated with our network infrastructure could also have a material adverse effect on our business, financial condition and results of operations.
Problems with content delivery services, bandwidth providers, data centers or other third parties could harm our business, financial condition or results of operations.
Our business relies significantly on third-party vendors, such as content delivery services, bandwidth providers and data centers. For example, we have entered into an agreement (as amended) to use a third-party, Akamai Technologies, Inc. ("Akamai"), to provide content delivery services to assist us in serving advertisements. We have committed to a minimum revenue amount to Akamai during the term, provided Akamai meets our service requirements. The term of our agreement with Akamai is until January 31, 2016. Akamai may terminate this agreement if we materially breach the agreement and such breach continues uncured for 30 days following Akamai's notice to us. If Akamai or other third-party vendors fail to provide their services or if their services are no longer available to us for any reason and we are not immediately able to find replacement providers, our business, financial conditions or results of operations could be materially adversely affected.
Additionally, any disruption in network access or co-location services provided by these third-party providers or any failure of these third-party providers to handle current or higher volumes of use could significantly harm our business operations. If our service is disrupted, we may lose revenues directly related to the impression that we fail to serve and we may be obligated to compensate clients for their loss. Our reputation may also suffer in the event of a disruption. Any financial or other difficulties our providers face may negatively impact our business and we are unable to predict the nature and extent of any such impact. We exercise very little control over these third- party vendors, which increases our vulnerability to problems with the services they provide. We license technologies from third-parties to facilitate aspects of our data center and connectivity operations including, among others, Internet traffic management services. We have experienced and expect to continue to experience interruptions and delays in service and availability for such elements. Any errors, failures, interruptions or delays experienced in connection with these third-party technologies and information services could negatively impact our customer relationships and materially adversely affect our brand reputation and our business, financial condition or results of operations and expose us to liabilities to third parties.
Our data centers are vulnerable to natural disasters, terrorism and system failures that could significantly harm our business operations and lead to client dissatisfaction.
In delivering our solutions, we are dependent on the operation of our data centers, which are vulnerable to damage or interruption from earthquakes, terrorist attacks, war, floods, fires, power loss, telecommunications failures, computer viruses, computer denial of service attacks or other attempts to harm our system, and similar events. In particular, two of our data centers, in Tokyo, Japan and Los
Angeles, California, are located in areas with a high risk of major earthquakes and others are located in areas with a high risk of terrorist attacks, such as New York, New York. Our insurance policies have limited coverage in such cases and may not fully compensate us for any loss. Some of our systems are not fully redundant, and our disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, a terrorist attack, a provider's decision to close a facility we are using without adequate notice or other unanticipated problems at our data centers could result in lengthy interruptions in our service. Any damage to or failure of our systems could result in interruptions in our service. Interruptions in our service could reduce our revenues and profits, and our brand reputation could be damaged if customers believe our system is unreliable, which could have a material adverse effect on our business, financial condition and results of operations.
Acquisitions may expose us to significant unanticipated liabilities that could adversely affect our business and results of operations.
Our acquired businesses may expose us to significant unanticipated liabilities. These liabilities could include employment, retirement or severance-related obligations under applicable law or other benefits arrangements, legal claims, technology and intellectual property issues, including claims of infringement, warranty or similar liabilities to customers, and claims by or amounts owed to vendors. The incurrence of such unforeseen or unanticipated liabilities, should they be significant, could have a material adverse effect on our business, results of operations and financial condition.
We may enter into, or seek to enter into, business combinations and acquisitions that may be difficult to integrate, disrupt our business, dilute stockholder value or divert management attention.
Our business strategy may include the acquisition of complementary businesses and product lines. Any such acquisitions would be accompanied by the risks commonly encountered in such acquisitions, including:
• the difficulty of assimilating the operations and personnel of the acquired companies;
• the potential disruption of our business;
• the inability of our management to maximize our financial and strategic position by the successful incorporation of acquired technology and rights into our product and service offerings;
• difficulty maintaining uniform standards, controls, procedures and policies, with respect to accounting matters and otherwise;
• the potential loss of key employees of acquired companies; and
• the impairment of relationships with employees and customers as a result of changes in management and operational structure.
Any acquired businesses and product lines may not be successfully integrated with our operations, personnel or technologies. Any inability to successfully integrate the operations, personnel and technologies associated with an acquired business and/or product line may negatively affect our business and results of operation. We may dispose of any of our businesses or product lines in the event that we are unable to successfully integrate them, or in the event that management determines that any such business or product line is no longer in our strategic interests.
We are exposed to the risks of operating internationally.
International operations are important to our future operations, growth and prospects. We have operations in numerous foreign countries and may continue to expand our operations internationally. Our international operations are subject to varying degrees of regulation in each of the jurisdictions in which services are provided. Local laws and regulations, and their interpretation and enforcement,
differ significantly among those jurisdictions, and can change significantly over time. Future regulatory, judicial and legislative changes or interpretations may have a material adverse effect on our ability to deliver services within various jurisdictions. Moreover, in order to effectively compete in certain foreign jurisdictions, it is frequently necessary or required to establish joint ventures, strategic alliances or marketing arrangements with local operators, partners or agents. Reliance on local operators, partners or agents could expose us to the risk of being unable to control the scope or quality of our overseas services or products. In addition, expansion into new international markets requires additional management attention and resources in order to tailor our products, services and solutions to the unique aspects of each country.
Some of the risks inherent in conducting business internationally include:
• challenges caused by distance, language and cultural differences;
• longer payment cycles in some countries;
• legal and regulatory restrictions;
• currency exchange rate fluctuations;
• challenges to our transfer pricing arrangements;
• foreign exchange controls that might prevent us from repatriating cash earned in countries outside the United States;
• political and economic instability and export restrictions;
• potentially adverse tax consequences; and
• higher costs associated with doing business internationally.
Any one or more of these factors could adversely affect our international operations.
We are exposed to risks relating to our location in Israel and conditions in Israel could adversely affect our business.
Our business is subject to a number of risks and challenges that specifically relate to our Israeli operations. The majority of our research and development activities and a large portion of our accounting functions are performed in Herzliya, Israel. In total, about 28% of our workforce is located in Israel. Accordingly, political, economic and military conditions in Israel could directly affect our business. Since the State of Israel was established in 1948, a number of armed conflicts have occurred between Israel and its Arab neighbors. Several countries, principally in the Middle East, restrict doing business with Israel and Israeli companies. These restrictions may limit materially our ability to sell our products to companies in these countries. Any hostilities involving Israel, acts of terrorism, or the interruption or curtailment of trade between Israel and its present trading partners, or significant downturn in the economic or financial condition of Israel, could adversely affect our operations, accounting and research and development and cause our revenues to decrease.
In addition, our business insurance may not cover losses that may occur as a result of events associated with the security situation in the Middle East. Although the Israeli government currently covers the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, we cannot assure you that this government coverage will be maintained. Any losses or damages incurred by us could have a material adverse effect on our business and financial condition.
Our Israeli operations may be disrupted by the obligations of personnel to perform military service.
As of December 31, 2014, we had 252 employees based in Israel. Our employees in Israel may be called upon to perform up to 36 days (and in some cases more) of annual military reserve duty until
they reach the age of 45 (and in some cases, up to 49), and in emergency circumstances, could be called to active duty. In response to increased tension and hostilities, since September 2000 there have been occasional call-ups of military reservists, and it is possible that there will be additional call-ups in the future. Our operations could be disrupted by the absence of a significant number of our employees related to military service or the absence for extended periods of one or more of our key employees for military service. Such disruption could materially adversely affect our operations, business and results of operations.
Market conditions or weak financial performance in our operations may make it difficult to obtain financing needed to make acquisitions necessary to grow our business or protect our existing lines of business.
We have grown primarily through acquisition over the past several years. If we are unable to find sources of capital on favorable terms due to market conditions or weak financial performance in our operations, we may lose opportunities to expand our business through additional acquisitions, or to protect against erosion of revenue and margins in our existing businesses. If our stock price becomes weak or depressed, we could have difficulty using our stock as currency in acquisitions, or be forced to enter into dilutive transactions using our stock to consummate acquisitions necessary to our business strategy.
Risks Related to our Capital Structure
A portion of our assets is reflected as goodwill and intangible assets on our balance sheet, which may be subject to further impairment should our market capitalization fall substantially below the book value of our shareholders' equity or our actual or expected future cash flows fall sufficiently below our forecasts.
A portion of our assets is reflected as goodwill and intangible assets on our balance sheet, which may be subject to further impairment should our market capitalization fall substantially below the book value of our shareholders' equity or our actual or expected future cash flows fall sufficiently below our forecasts.
Our goodwill was created in the acquisitions we completed over the past several years. If we are unable to generate sufficient cash flows in future periods from the businesses that we have acquired, and/or our market capitalization declines relative to our book value, we may be required to take an impairment charge against the balances reflected on our balance sheet that would result in a reduction to our operating results in the period in which we take the charge.
Further, our market capitalization plus a reasonable control premium is an indicator of the total value of our company. If our market capitalization should fall substantially below the book value of our shareholders' equity or our actual or expected future cash flows fall sufficiently below our forecasts, it may result in us recording an impairment charge in the future.
Our board of directors may issue, without stockholder approval, preferred stock with rights and preferences superior to those applicable to the common stock.
Our Certificate of Incorporation includes a provision for the issuance of "blank check" preferred stock. This preferred stock may be issued in one or more series, with each series containing such rights and preferences as the board of directors may determine from time to time, without prior notice to, or approval of, stockholders. Among others, such rights and preferences might include the rights to dividends, superior voting rights, liquidation preferences and rights to convert into common stock. The rights and preferences of any such series of preferred stock, if issued, may be superior to the rights and preferences applicable to our common stock and might result in a decrease in the price of our common stock.
Risks Related to Law, Regulation and Policy Affecting our Business
Uncertainty regarding a variety of United States and foreign laws may expose us to liability and adversely affect our ability to offer our solutions and services.
The laws relating to the liability of providers of online services for activities of their customers and users are currently unsettled both within the United States and abroad. Claims have been threatened and filed under both United States and foreign law for defamation, libel, invasion of privacy and other claims, including for data protection violations, tort, unlawful activity, copyright or trademark infringement or other theories based on the nature and content of the advertisements posted or the content generated by our customers. From time to time, we have received notices from individuals who do not want to be exposed to advertisements delivered by us on behalf of our customers. If one of these complaints results in liability to us, it could be costly, encourage similar lawsuits, distract management and harm our reputation and possibly our business. In addition, increased attention focused on these issues and legislative proposals could harm our reputation or otherwise negatively affect the growth of our business.
There is also uncertainty regarding the application to us of existing laws regulating or requiring licenses for certain advertisers' businesses, including, for example, distribution of pharmaceuticals, adult content, financial services, alcohol, marijuana or firearms. Existing or new legislation could expose us to substantial liability, restrict our ability to deliver services to our customers and post ads for various industries, limit our ability to grow and cause us to incur significant expenses in order to comply with such laws and regulations.
Several other federal laws could also expose us to liability and impose significant additional costs on us. For example, the Digital Millennium Copyright Act has provisions that limit, but do not eliminate, our liability for listing or linking to third-party web sites that include materials that infringe copyrights or other rights, so long as we comply with the statutory requirements of the Act. In addition, the Children's Online Privacy Protection Act restricts the ability of online services to collect information from minors and the Protection of Children from Sexual Predators Act of 1998 requires online service providers to report evidence of violations of federal child pornography laws under certain circumstances. Compliance with these laws and regulations is complex and any failure on our part to comply with these regulations may subject us to additional liabilities.
We must comply with complex foreign and U.S. laws and regulations, such as the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, and other local laws prohibiting corrupt payments to governmental officials. Violations of these laws and regulations could result in fines and penalties, criminal sanctions, restrictions on our business and on our ability to offer our services or products in one or more countries, and could also materially affect our ability to attract and retain employees, our international operations, our business and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these laws and regulations, there can be no assurance that our employees, local operators, partners or agents will not violate our policies.
Furthermore, it has been reported in the press that both the United States and some regional regulatory bodies, including in the EU and Brazil, are considering material and far reaching changes to regulations governing user tracking, measurement and profiling, as well as the definitions of Personally Identifiable Information. Such regulatory changes could have the effect of causing us to spend significantly more money to segregate data elements, to exit the measurement, tracking, and optimization business in specific regions, or even block us entirely from providing services in specific regions.
Privacy concerns could lead to legislative and other limitations on our ability to collect or process user level data from Internet users, including limitations on our use of various tracking technologies such as cookies or conversion tags and user profiling, which are crucial to our ability to provide our solutions and services to our customers.
Our ability to conduct targeted advertising campaigns and compile data that we use to execute campaign strategies for our customers depends, in part, on the use of "cookies," "conversion tags" and other tracking technologies to track users, their devices and their online behavior, which allows us to create user profiles to deliver more relevant advertisements to users and to measure an advertising campaign's effectiveness. A cookie is a small file of information stored on a user's computer that allows us to recognize that user's browser when we serve advertisements. Our conversion tags are pieces of code placed on specific pages of websites that record a specific action such as the completion of an online form or the check out on an ecommerce website. As a general matter we do not collect personally identifiable information on users other than cookie IDs and IP addresses, which we use anonymously and do not associate with other personally identifiable information. Occasionally at the request and on behalf of a customer, Sizmek may collect personal information supplied voluntarily by consumers through their interaction with data collection fields in the body of advertisements or on websites (such as name, email, etc.). This personal information is provided directly to the customer on whose behalf the information was collected, or the customer's service providers, and is processed by Sizmek only to the extent and as long as is necessary to provide the advertising services for which the personal information was collected. In certain services requested by our clients, the Sizmek MDX platform may utilize IP addresses for geo-targeting, click-fraud detection and for use in analytics. In terms of data retention, logs with raw user data are saved for 13 months as required by Interactive Advertising Bureau policy.
We fully support industry and regulatory privacy initiatives that encourage transparency and choice for users in the Internet community. We voluntarily participate in several industry self-regulatory groups that promote best practices or codes of conduct related to interest-based advertising, including the Network Advertising Initiative, Digital Advertising Alliance and European Interactive Digital Advertising Alliance.
Our privacy program is built upon the fair information privacy principles that form the basis for applicable laws and industry self-regulatory initiatives in the regions where we operate. Our program is managed by a multi- disciplinary team comprised of an executive sponsor that reports to the CEO along with representatives from across the business, including legal, product marketing and R&D. This team monitors global privacy developments and creates organizational accountability for meeting our privacy commitments.
Notwithstanding the foregoing initiatives, government authorities inside the United States concerned with the privacy of Internet users have suggested limiting or eliminating the use of tracking technologies, such as cookies, conversion tags or user profiling. Bills aimed at regulating the collection and use of personal data from Internet users are currently pending in U.S. Congress and many state legislatures. Attempts to regulate spyware may be drafted in such a way as to include technology, like cookies and conversion tags, in the definition of spyware, thereby creating restrictions on our ability to use them. In addition, the Federal Trade Commission and the Department of Commerce have conducted hearings regarding user profiling, the collection of non-personally identifiable information and online privacy.
Our foreign operations may also be adversely affected by regulatory action outside the United States. For example, the European Union has adopted a directive addressing data privacy that limits the collection, disclosure and use of information regarding European Internet users. In addition, the European Union has enacted an electronic communications directive that imposes certain restrictions on the use of cookies and conversion tags and also places restrictions on the sending of unsolicited
communications. Each European Union member country was required to enact legislation to comply with the provisions of the electronic communications directive by October 31, 2003 (though not all have done so). Germany has also enacted additional laws limiting the use of user profiling, and other countries, both in and out of the European Union, may impose similar limitations. EU legislators are currently considering amendments to these EU laws that, if passed as expected, will increase the limitations imposed by existing laws.
Internet users may also directly limit or eliminate the placement of cookies on their computers by using third party software that blocks cookies, or by disabling or restricting the cookie functions of their Internet browser software. Internet browser software upgrades may also result in limitations on the use of cookies or conversion tags. Microsoft's Internet Explorer 10 browser has the Do Not Track signal turned on by default and Firefox has publicly talked about turning on the 3rd party cookie blocking feature by default, in both cases impacting our ability to deliver and measure more targeted advertising. Technologies like the Platform for Privacy Preferences (P3P) Project may limit collection of cookie and conversion tag information. The owners of mobile device operating systems place significant restrictions on the use of tracking technologies as well as privacy-enabling technologies, such as our opt-out cookie. Controls by the mobile device operating system owners could limit or eliminate our ability to collect Internet user information. Individuals have also brought class action suits against companies related to the use of cookies and several companies, including companies in the Internet advertising industry, have had claims brought against them before the Federal Trade Commission regarding the collection and use of Internet user information. We may be subject to such suits in the future, which could limit or eliminate our ability to collect such information.
If our ability to use tracking technologies such as cookies or conversion tags or to build user profiles is substantially restricted due to the foregoing, or for any other reason, we would have to generate and use other technology or methods that allow the gathering of user profile data in order to provide our services to our customers.
This change in technology or methods could require significant reengineering time and resources, and may not be complete in time to avoid negative consequences to our business. In addition, alternative technology or methods might not be available on commercially reasonable terms, if at all. If the use of tracking technologies such as cookies and conversion tags are prohibited and we are not able to efficiently and cost effectively create new technology, our business, financial condition and results of operations could be materially adversely affected.
In addition, any compromise of our security that results in the release of Internet users' and/or our customers' data could seriously limit the adoption of our solutions and services, as well as harm our reputation and brand, expose us to liability and subject us to reporting obligations under various federal and state laws, which could have an adverse effect on our business. The risk that these types of events could seriously harm our business is likely to increase, as the amount of data we store for our customers on our servers (including personal information) and the number of countries where we operate has increased, and we may need to expend significant resources to protect against security breaches, which could have an adverse effect on our business, financial condition or results of operations.
Any perception of our practices or products as an invasion of privacy, whether or not such practices or products are consistent with current or future regulations and industry practices, may subject us to public criticism, private class actions, reputational harm or claims by regulators, which could disrupt our business and expose us to increased liability.
To the extent that we collect and store information derived from the activities of website visitors and their devices on behalf of particular clients, our compliance with privacy laws, regulations and industry codes and our reputation among the public body of website visitors depend in part on our clients' adherence to privacy laws and regulations and their use of our services in ways consistent with
visitors' expectations. We contractually require our website publisher clients to notify visitors to their websites about our services (i.e., that we place cookies and collect and share certain non-identifying data for purposes of targeting advertisements), and further require that they link to pages where visitors can opt-out of the collection or targeting. We rely on representations made to us by clients that they will comply with all applicable laws including all relevant privacy and data protection regulations. We make reasonable efforts to enforce contractual notice requirements but do not fully audit our clients' compliance with our recommended disclosures or their adherence to privacy laws and regulations, nor do we contractually require them to seek explicit consent to the placement of cookies which may be required in certain countries. If our clients fail to adhere to our contracts in this regard, or a court or governmental agency determines that we have not adequately, accurately or completely contractually required our clients to do so, our business, financial condition and results of operations could be materially adversely affected.
We may be required to collect sales and use taxes on the services we sell in additional jurisdictions in the future, which may decrease sales, and we may be subject to liability for sales and use taxes and related interest and penalties on prior sales.
A successful assertion by one or more states that we should collect sales or other taxes on the sale of our services, or that we have failed to do so where required in the past, could result in substantial tax liabilities for past sales and decrease our ability to compete for future sales. Each state has different rules and regulations governing sales and use taxes and these rules and regulations are subject to varying interpretations that may change over time. We review these rules and regulations periodically and, when we believe our services are subject to sales and use taxes in a particular state, voluntarily engage state tax authorities in order to determine how to comply with their rules and regulations. We cannot assure you that we will not be subject to sales and use taxes or related penalties for past sales in states where we presently believe sales and use taxes are not due. We reserve estimated sales and use taxes in our financial statements but we cannot be certain that we have made sufficient reserves to cover all taxes that might be assessed.
Many states are also pursuing legislative expansion of the scope of goods and services that are subject to sales and similar taxes as well as the circumstances in which a vendor of goods and services must collect such taxes. Furthermore, legislative proposals have been introduced in Congress that would provide states with additional authority to impose such taxes. Accordingly, it is possible that either federal or state legislative changes may require us to collect additional sales and similar taxes from our clients in the future.
Risks Related to the Spin-Off
Sizmek has limited history operating as an independent publicly- traded company, and Sizmek's historical financial information is not necessarily representative of the results that it would have achieved as a separate, publicly-traded company and therefore may not be a reliable indicator of its future results.
On February 7, 2014, Sizmek was spun-off from DG, its former parent company. Prior to the Spin-Off, Sizmek had no operating history as a separate publicly-traded company. The historical financial information in this Form 10-K about Sizmek prior to the Spin-Off refers to Sizmek's business as part of DG and is derived from the consolidated financial statements and accounting records of DG. Accordingly, such historical financial information included herein does not necessarily reflect the financial condition, results of operations or cash flows that Sizmek would have achieved as a separate, publicly-traded company during such periods presented or those that Sizmek will achieve in the future primarily as a result of the factors described below:
• Sizmek is in the process of making investments to replicate or outsource certain systems, infrastructure, and functional expertise since the Spin-Off. These initiatives may prove costly to
implement. It is expected Sizmek's administrative costs will increase from the historical amounts allocated to it in its pre Spin-Off financial statements and, as a result, its future profitability may decline; and
• Generally, prior to the Spin-Off, Sizmek had relied on DG for working capital requirements and other cash requirements, including in connection with Sizmek's previous acquisitions. Now that the Spin-Off has been completed, Sizmek's access to and cost of debt financing may be different from the historical access to and cost of debt financing under DG. Differences in access to and cost of debt financing may result in differences in the interest rate charged to Sizmek on financings, as well as the amounts of indebtedness, types of financing structures and debt markets that may be available to Sizmek, which could have an adverse effect on Sizmek's business, financial condition and results of operations and cash flows.
For additional information about the past financial performance of Sizmek's business and the basis of presentation of the historical combined financial statements, see the sections entitled "Selected Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and accompanying notes included elsewhere in this Form 10-K.
DG may fail to perform under various transaction agreements that were executed as part of the Spin-Off or we may fail to have necessary systems and services in place when certain of the transaction agreements expire.
We and DG have entered into certain agreements, such as the Separation and Redemption Agreement, a Transition Services Agreement and certain other agreements that provide for the performance of services by each company for the benefit of the other for a period of time after the Spin-Off. We are relying on DG to satisfy its performance and payment obligations under these agreements. If DG is unable to satisfy its obligations under these agreements, we could incur operational difficulties or losses.
If we do not have our own systems and services in place, or we do not have agreements with other providers of these services when the transitional or long-term agreements terminate, or if we do not implement the new systems or replace DG's services successfully, we may not be able to operate our business effectively, which could disrupt our business and have a material adverse effect on our business, financial condition and results of operations. These systems and services may also be more expensive to install, implement and operate, or less efficient than the systems and services DG is currently providing.
We are responsible for all pre-closing liabilities and contingencies of DG.
Because DG has contributed all of its cash and substantially all of its working capital to Sizmek as part of the Spin-Off, we have assumed and are responsible for all pre-closing liabilities and any loss contingencies of DG and its television business prior to the Merger of DG with a wholly-owned subsidiary of Extreme Reach. Under the terms of the separation and distribution agreement and other agreements entered into in connection with the Spin-Off, we have agreed to indemnify DG and its affiliates (including Extreme Reach following the Merger) from all such liabilities and loss contingencies.
Risks Related to Our Stock
We have a very limited trading history in our common stock, which could subject our shareholders to wide fluctuations in market price and trading volumes and could result in substantial losses for our stockholders.
Shares of our common stock are listed on the NASDAQ Global Select Market. The market price of our common stock may be highly volatile and could be subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur, which may limit or prevent investors from readily selling their common stock and may otherwise negatively affect the liquidity of our common stock. We cannot provide any assurance that the market price of our common stock will not fluctuate or decline significantly in the future.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our principal executive offices are at 401 Park Avenue South, 5th Floor, New York City, New York. Our properties are listed below:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
For further information on legal proceedings, see Note 12 "Litigation and Commitments-Litigation" to the consolidated and combined financial statements, which is included in Part II, Item 8 of this Report and is incorporated herein by reference. Except as discussed in Note 12, we are not party to any other material pending legal proceedings.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock began trading on the NASDAQ Global Select Market on February 10, 2014 under the symbol "SZMK". Prior to this, there was no public market for our common stock. The following table sets forth the high and low closing sales prices of our common stock from February 10, 2014 to December 31, 2014.
As of March 18, 2015, we had 29,542,529 shares of our common stock outstanding. As of March 18, 2015, our common stock was held by approximately 117 stockholders of record. We estimate that there are approximately 7,250 beneficial stockholders.
We have never declared or paid cash dividends on our capital stock. We currently expect to retain any future earnings for use in the operation and expansion of our business and do not anticipate paying cash dividends in the foreseeable future.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
In August 2014, our Board of Directors approved a $15 million share repurchase program. In March 2015, our Board of Directors increased the share repurchase program to $30 million. The program allows us to repurchase shares of our common stock through open market purchases, privately negotiated transactions or otherwise, subject to certain conditions. The share repurchase program does not have an expiration date. Through December 31, 2014, we made share repurchases totaling $2.0 million. Depending on market conditions and other factors, these repurchases may be commenced or suspended from time to time without notice. We have no obligation to repurchase shares under the share repurchase program. The following table sets forth information with respect to purchases of shares of our common stock during the periods indicated:
Issuer Purchases of Equity Securities
Stock Performance Table
This performance graph is furnished and shall not be deemed "filed" with the SEC or subject to Section 18 of the Exchange Act, nor shall it be deemed incorporated by reference in any of our filings under the Securities Act of 1933, as amended.
The following graph compares the cumulative total stockholders return on our common stock from February 10, 2014, when trading in our common stock began on the NASDAQ Global Select Market, through December 31, 2014, with the comparable cumulative return of (i) the NASDAQ Composite Index and (ii) the S&P Information Technology Sector Index. The graph assumes that $100 was invested in our common stock and each index on February 10, 2014 and the reinvestment of any dividends paid. The stock price performance on the following graph is not necessarily indicative of future stock price performance. Information used in the graph was obtained from information published by NASDAQ and Research Data Group, Inc., sources believed to be reliable, but we are not responsible for any errors or omissions in such information.
The following table shows total indexed return of stock price plus reinvestments of dividends, assuming an initial investment of $100 at February 10, 2014, for the indicated periods.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents our selected historical consolidated and combined financial data. We derived the selected historical consolidated and combined financial data as of December 31, 2014, 2013 and 2012 and for the years ended December 31, 2014, 2013, 2012 and 2011 from our audited consolidated and combined financial statements. We derived the selected historical combined financial data as of December 31, 2011 and 2010 and for the year ended December 31, 2010 from our historical books and records. In the opinion of management, the unaudited combined financial statements as of December 31, 2011 and 2010 and for the year ended December 31, 2010 have been prepared on the same basis as the audited combined financial statements and include all adjustments, consisting only of ordinary recurring adjustments, necessary for a fair statement of the information for the periods presented. This section should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the audited consolidated and combined financial statements and corresponding notes included elsewhere in this Form 10-K.
The data below includes the results of acquired operations from the respective dates of closing as detailed below:
Statement of Operations Data:
*Excludes depreciation and amortization
Balance Sheet Data:
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following management's discussion and analysis of financial condition and results of operations ("MD&A") should be read in conjunction with our consolidated and combined financial statements and notes thereto contained elsewhere in this Annual Report on Form 10-K.
The following discussion contains forward-looking statements. The matters discussed in these forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those made, projected or implied in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Form 10-K, particularly in "Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements."
Introduction
MD&A is provided as a supplement to the accompanying consolidated and combined financial statements and notes to help provide an understanding of Sizmek's financial condition, changes in financial condition and results of operations. MD&A is organized as follows:
• Overview. This section provides a general description of our business, as well as recent developments that we believe are important to understanding our results of operations and financial condition or in understanding anticipated future trends. In addition, significant transactions that impact the comparability of the results being analyzed are summarized.
• Results of Operations. This section provides an analysis of our results of operations for the three years in the period ended December 31, 2014.
• Financial Condition. This section provides a summary of certain major balance sheet accounts and a discussion of the factors that tend to cause these accounts to change, or the reasons for the change.
• Liquidity and Capital Resources. This section provides a summary of our cash flows for the three years in the period ended December 31, 2014, as well as a discussion of those cash flows. Also included is a discussion of our sources of liquidity and cash requirements.
• Critical Accounting Policies. This section discusses accounting policies that are considered important to our results of operations and financial condition, require significant judgment and require estimates on the part of management. Our significant accounting policies, including those considered to be critical accounting policies, are summarized in Note 2 to the accompanying consolidated and combined financial statements.
• Recently Adopted and Recently Issued Accounting Guidance. This section provides a discussion of recently issued accounting guidance that has been adopted or will be adopted in the near future, including a discussion of the impact or potential impact of such guidance on our consolidated and combined financial statements when applicable.
• Contractual Payment Obligations. This section provides a summary of our contractual payment obligations by major category and in total, and a breakdown by period.
Overview
We operate a leading open ad management and distribution platform. In 2014, we helped 17,000 advertisers and 3,500 agencies engage with consumers in about 60 countries across multiple online media channels (mobile, display, rich media, video and social). Our revenues are principally derived from services related to online advertising. Our technology and service help advertisers overcome the
fragmentation in the online advertising market and achieve optimal results from their advertising campaigns.
Our business can be impacted by several factors, including general economic conditions, the overall advertising market, new emerging digital technologies, and the continued growth of online and other alternative advertising.
Our Business Strategy
Our goal is to operate the leading independent ad management platform worldwide, and become the platform of choice among advertisers, agencies and publishers. We are in the process of completing the development of a single, end-to-end, integrated ad management platform across all channels and formats. In order to achieve our objective, we need to:
(i)continue to expand the products available on our platform,
(ii)increase our partnership program inviting the latest technology and features, and
(iii)control our costs.
In 2015, we are focusing on four key growth areas:
(i)Programmatic Decisioning-Our Peer 39 unit is the largest provider of data for ad buying (and selling) decisions. Our solutions provide page and event based data enabling advertisers to access safer, appropriate and relevant web page environments for their ads.
(ii)Mobile-With our 2014 acquisition of Aerify, we now have a robust mobile offering across the mobile web and in-app technology.
(iii)Video-Our roots and heritage, video is an area of the market also experiencing heavy growth, and is the vehicle of choice for branding advertisers as they move to digital and programmatic.
(iv)Data-We intend to enable our clients to centralize, manage and activate their data and leverage deeper data sets within our Sizmek MDX platform for dynamic, creative targeting and frequency capping.
Completion of Merger and Spin-Off
Prior to February 7, 2014, we operated as the online segment of DG. On February 7, 2014 the Merger between DG, Extreme Reach and Acquisition Sub was completed. Immediately prior to the Merger, DG contributed its cash and most of its other working capital to us, and the shares of our common stock were distributed to DG's shareholders (the "Spin-Off") resulting in Sizmek becoming a new publicly-held company with its shares traded on the NASDAQ Global Select Market under the symbol SZMK. See Notes 1 and 11 of our consolidated and combined financial statements contained elsewhere herein.
Comparability of Operating Results before and after the Spin-Off
Prior to the Spin-Off, our combined financial statements were derived from the consolidated financial statements and accounting records of DG, which includes an allocation of DG's corporate costs. To a degree, prior to the Spin-Off we benefited from sharing the corporate cost structure of DG rather than incurring such costs ourselves on a stand-alone basis. Since the Spin-Off, we have been able to control our corporate overhead expenses to a level reasonably consistent with the pre Spin-Off periods. However, our operating results before and after the Spin-Off are not entirely comparable.
Acquisitions
We have a history of acquisitions. DG entered the online advertising arena in October 2008 with the acquisition of Enliven, which included Unicast, its principal operating unit. In 2011, we acquired MediaMind and EyeWonder. In April 2012, we acquired Peer 39. In October 2013, we acquired Republic Project, and in August and September 2014, we acquired Aerify Media and Pixel, respectively. As a result of these acquisitions, our operating results from period to period are not entirely comparable. Each of the acquisitions has been included in our results of operations since their respective dates of closing.
Consolidation to a Single Platform
Prior to 2013, we operated three separate online advertising platforms (the MediaMind, EyeWonder and Unicast platforms). Beginning in 2012 and continuing until September 2013, we transitioned all of our online advertising business over to a single distribution platform, the Sizmek MDX platform (formerly known as the MediaMind platform). Since completing the consolidation, we are able to operate more efficiently.
Goodwill Impairment Charges
In 2012 and 2014, we recorded goodwill impairment charges of $220 million and $98 million, respectively. The impairment charges primarily relate to our acquisitions of MediaMind and EyeWonder in 2011. Prior to these acquisitions, MediaMind enjoyed several years of revenue growth at or in excess of 20% per year. We expected this trend would continue. Although much smaller, the EyeWonder acquisition was intended to enhance the online customer base and solidify our revenue growth strategies. Following these acquisitions, we embarked on an integration effort to consolidate all customers onto a single platform. This involved consolidating and reducing the size of our sales, marketing, and operations workforces. Unfortunately, weaker than expected market conditions combined with our internal difficulty in effectively integrating the businesses resulted in an overall pro forma revenue decline of 7% in 2012, which was far below our original forecast. Given our weaker than expected operating results, in 2012 we reduced our future forecast which resulted in the 2012 impairment charges.
In 2013, we completed the integration of our online businesses and our operating results were substantially in line with the revised 2012 forecast. In 2014, our revenues and operating results fell below our earlier forecast. Further, our market capitalization plus a reasonable control premium was well below the book value of our total stockholders' equity. As a result, in 2014, we again revised our future forecast which resulted in us recording an impairment charge in 2014.
At December 31, 2014, the fair value of our Company was slightly in excess of its carrying value. We could experience another goodwill impairment charge if our actual or expected future operating results fall sufficiently below our current forecast, or if the market value of our common stock should fall sufficiently below the current level for an extended period. See Note 5 to the accompanying consolidated and combined financial statements.
Results of Operations
2014 vs. 2013
The following table sets forth certain historical financial data (dollars in thousands):
(a)Excludes depreciation and amortization.
NMNot meaningful.
Revenues. For 2014, revenues increased $9.7 million, or 6%, as compared to 2013. The increase was due to growth in our (i) premium and other services revenue ($11.7 million) and (ii) programmatic managed services revenue ($6.2 million), partially offset by a decline in our basic services revenue ($8.2 million). Our premium and other services revenue grew primarily due to greater usage of our (i) analytics capabilities, (ii) services revenue which includes flat fee billing arrangements and (iii) viewability and verification services. Our programmatic managed services revenue, consisting primarily of display media which we buy on behalf of our customers from multiple ad exchanges, grew to $16.7 million in 2014 as compared to $10.5 million in 2013, an increase of 59%. Our basic services revenue declined due to a reduction in rich media services ($19.4 million), partially offset by increases in in-stream ($9.3 million) and mobile services ($2.5 million).
Cost of Revenues. For 2014, cost of revenues increased $6.2 million, or 11%, as compared to 2013. As a percentage of revenues, cost of revenues increased to 35.2% in 2014, as compared to 33.5% in 2013. Cost of revenues increased primarily due to an increase in programmatic managed services costs of $3.9 million, which is proportional to the increase in our programmatic managed services revenues, delivery costs ($1.9 million) and costs associated with our new Aerify revenue stream ($0.6 million). The increase in delivery costs is due to higher content delivery network and data center costs.
Sales and Marketing. For 2014, sales and marketing expense increased $2.2 million, or 4%, as compared to 2013. The increase relates to higher (i) marketing costs ($0.6 million), (ii) facilities costs ($0.5 million), (iii) reseller costs ($0.4 million), and (iv) recruiting costs ($0.4 million). Reseller costs
involve paying a commission or fee to the party responsible for causing the customer to use our platform in their online advertising. As a percentage of revenues, sales and marketing expense decreased to 33.9% in 2014 as compared to 34.6% in 2013.
Research and Development. For 2014, research and development expense increased $3.0 million, or 29%, as compared to 2013. The increase principally relates to higher compensation ($2.2 million), facilities ($0.3 million) and recruiting costs ($0.2 million). The increase in compensation costs relates to higher compensation levels per research and development employee (including share-based compensation), partially offset by an increase in capitalized salaries.
General and Administrative. For 2014, general and administrative expense increased $4.5 million, or 25%, as compared to 2013. As a percentage of revenues, general and administrative expense increased to 13.4% in 2014, as compared to 11.4% in 2013. Substantially all of the increase was the result of accelerating the vesting of share-based payment awards in connection with consummating the Merger and Spin-Off. In addition, for each of the twelve months in 2013, a portion of the expenses were allocated to DG's other business unit versus only a little more than one month in 2014.
Merger, Integration and Other. For 2014, merger, integration and other costs increased $0.4 million, or 7%, as compared to 2013. The increase relates principally to (i) costs incurred in connection with completing the Merger and Spin-off transactions in February 2014 and (ii) higher integration, severance and employee relocation costs subsequent to the Merger and Spin-off, partially offset by (iii) recognizing a credit of $3.1 million for collecting DG television receivables in excess of the bad debt reserve. These receivables were contributed to us by DG in connection with the Merger and Spin-Off. The 2014 amount excludes incremental costs associated with the accelerated vesting of all share-based awards in connection with the Merger and Spin-Off.
Depreciation and Amortization. For 2014, depreciation and amortization increased $2.6 million, or 11%, as compared to 2013. The increase was primarily attributable to greater depreciation of capitalized software ($2.4 million). The increase in depreciation of capitalized software relates to (i) an increase in capitalized software, which is attributable to working on more software development projects that qualify for capitalization and (ii) shortening the estimated remaining useful life of our Sizmek MDX platform from 46 months to 20 months effective November 1, 2014 in anticipation of retiring the MDX platform in June 2016 ($0.6 million). See Use of Estimates in Note 2 to our consolidated and combined financial statements.
Goodwill Impairment. For 2014, we recognized a goodwill impairment charge of $98.2 million. See Note 5 to the accompanying consolidated and combined financial statements.
Other expense, net. For 2014, other expense, net was $1.1 million as compared to a nominal expense (less than $0.1 million) for 2013. The 2014 expense primarily relates to foreign exchange losses, which resulted from the strengthening of the U.S. dollar in comparison with other currencies in which we conduct business.
Benefit for Income Taxes. For 2014, our effective tax rate was 0.9% compared to 31.6% for 2013. The effective tax rate for each period differs from the expected federal statutory rate of 35% as a result of non-deductible expenses, a change in our valuation allowance and state and foreign income taxes. For 2014, the vast majority of the goodwill impairment charge is not deductible for income tax purposes. Presently, our operations in the U.S. are in a net operating loss position and we have not recognized a tax benefit for those losses as realization of the tax benefit has not been determined to be likely.
Results of Operations
2013 vs. 2012
The following table sets forth certain historical financial data (dollars in thousands):
(a)Excludes depreciation and amortization.
Revenues. For 2013, revenues increased $20.5 million, or 15%, as compared to 2012. The increase was due to growth in our (i) premium and other services revenue ($15.8 million) and (ii) programmatic managed services revenue ($5.8 million), partially offset by a slight decline in our basic services revenue ($1.1 million). Our premium and other services revenue grew due to greater usage of our smart versioning, data and analytics campaign management capabilities. Our programmatic managed services revenue, which consists primarily of display media which we buy on behalf of our customers from multiple ad exchanges, grew to $10.5 million in 2013 as compared to $4.7 million in 2012, an increase of 124%. Our basic services revenue, which is based on the number of impressions served, declined slightly in 2013 due to a decrease in the average selling price per impression served; partially offset by an increase in the number of impressions served. The increase in the number of impressions served was due to enhanced capabilities and stabilization of our platform resulting from customer migration and platform integration activities.
Cost of Revenues. For 2013, cost of revenues increased $3.2 million, or 6%, as compared to 2012. As a percentage of revenues, cost of revenues decreased to 33.5% in 2013, as compared to 36.1% in 2012. Cost of revenues increased due to an increase in programmatic managed services costs of $4.0 million, which is proportional to the increase in our online programmatic managed services revenues. This increase in cost of revenue was somewhat offset by reductions in headcount and other costs due to transitioning the majority of our customers' online advertising over to a single advertising platform in 2013 from the three separate advertising platforms we operated in 2012. The decrease as a percentage of revenue is due to efficiencies gained by completing the integration of our ad serving platforms.
Sales and Marketing. For 2013, sales and marketing expense increased $5.1 million, or 10%, as compared to 2012. The increase in costs relates to higher incentive compensation paid to our sales team as a result of our increase in revenue, and greater spending on business partnerships. Business partnerships involve paying a commission or fee to the party responsible for causing the customer to use our platform in their online advertising. As a percentage of revenues, sales and marketing expense decreased slightly to 34.6% in 2013 from 36.0% in 2012. The percentage decrease was the result of revenues growing faster than sales and marketing spending.
Research and Development. For 2013, research and development costs decreased $2.4 million, or 19%, as compared to 2012. The decrease was entirely due to higher capitalized wages of $2.6 million. The increase in capitalized wages was due to working on more software development projects that qualify for capitalization.
General and Administrative. For 2013, general and administrative expense decreased $3.4 million, or 16%, as compared to 2012. As a percentage of revenues, general and administrative expense decreased to 11.4% in 2013, as compared to 15.4% in 2012. The decrease was primarily due to lower (i) personnel costs ($4.0 million), (ii) professional fees ($1.0 million), and (iii) travel and entertainment costs ($0.4 million), partially offset by a higher allocation of overhead costs from DG ($2.8 million). The decrease in personnel costs was attributable to a reduction in the average compensation cost per employee and the number of employees. The decrease in professional fees was due to lower (i) consulting, (ii) audit and tax fees and (iii) legal fees. In 2013, the online business received a higher allocation of DG's corporate overhead costs partially due to the growth in our online revenues as compared to DG's consolidated revenues. The majority of corporate overhead costs are allocated based upon revenues.
Included in total operating expenses are amounts associated with corporate overhead which historically have not been allocated to DG's TV segment or its online segment (which represents Sizmek). Corporate overhead historically included the cost of the executive management team, costs of being a public company (including accounting, audit and legal fees), as well as other general corporate human resources, treasury, tax, information technology, and risk management costs. For 2013, DG reported corporate overhead associated with both segments of $24.2 million. The amount of such corporate overhead that was allocated to us in these carve out financial statements was $9.1 million, in accordance with the allocation principles for preparing carve out financial statements. As a result, these carve out financial statements include corporate overhead expenses which represent approximately 37% of DG's total corporate overhead for 2013. After the Spin-Off, we expect a higher percentage of DG's total corporate overhead will shift to us, rather than the 37% that has been allocated to us in these financial statements.
Merger, Integration and Other. For 2013, merger, integration and other expenses were substantially consistent with 2012. In 2013, a reduction in severance costs was offset by an increase in costs associated with the Merger with Extreme Reach and the Spin-Off of the online business. In 2012, severance costs were higher as we were in the process of transitioning our three previously separate online businesses into a single operation.
Depreciation and Amortization. For 2013, depreciation and amortization expense decreased $1.3 million, or 5%, as compared to 2012. The decrease was partially attributable to retiring certain assets in 2012 that were no longer deemed to be useful. In addition, certain other capital assets became fully depreciated in 2012 and early 2013.
Goodwill Impairment. For 2012, we recorded $219.6 million of goodwill impairment charges. See Note 5 to the accompanying consolidated and combined financial statements. We did not record a similar impairment charge in 2013.
Other expense, net. For 2013, other expense, net decreased $2.8 million. The decrease principally relates to writing-down the carrying value of two investments in 2012 that we determined were impaired. We had no similar write-downs in 2013.
Benefit for Income Taxes. For 2013, our effective tax rate was 31.6% compared to 4.2% for 2012. The effective tax rate for each year differs from the expected federal statutory rate of 35% as a result of state and foreign income taxes, a change in our valuation allowance, non-deductible expenses and adjustments for uncertain tax positions. For 2012, the vast majority of the goodwill impairment charge was not deductible for income tax purposes.
Financial Condition
The following table sets forth certain major balance sheet accounts as of December 31, 2014 and 2013 (in thousands):
Cash and cash equivalents fluctuate with changes in operating, investing and financing activities. In particular, cash and cash equivalents fluctuate with (i) operating results, (ii) the timing of payments, (iii) capital expenditures, (iv) acquisition and investment activity, and (v) capital activity. The increase in cash and cash equivalents during 2014 primarily relates to cash contributed by DG prior to the Merger and Spin-Off ($44.8 million), and other working capital contributed by DG that has been converted into cash since the Merger and Spin-Off ($38.3 million).
Accounts receivable generally fluctuate with revenues. As revenues increase or decrease, accounts receivable tend to increase or decrease, correspondingly. The number of days of revenue included in accounts receivable was 96 days and 92 days at December 31, 2014 and 2013, respectively.
Assets of TV business relate to assets contributed by DG immediately prior to the Merger. The majority of these assets consists of income tax receivables, but also includes DG's trade receivables from its television customers.
Property and equipment tends to increase when we make significant improvements to our equipment or properties, expand our platform or capitalize software development initiatives. It also can increase as a result of acquisition activity. Further, the balance of property and equipment is decreased by recording depreciation expense. For 2014 and 2013, purchases of property and equipment used to power our ad serving platform were $5.0 million and $6.3 million, respectively. For 2014 and 2013, capitalized costs of developing software were $14.0 million and $9.6 million, respectively.
Intangible assets decreased during 2014 as a result of amortization, partially offset by intangible assets obtained in the acquisition of Aerify. Goodwill decreased as a result of the $98.2 million impairment charge, partially offset by goodwill recorded in the acquisitions of Aerify and Pixel.
Accounts payable and accrued liabilities increased $1.5 million to $23.1 million at December 31, 2014 as compared to $21.6 million at December 31, 2013. The decrease primarily relates to the timing of payments.
Stockholders' equity decreased by $26.7 million to $266.4 million at December 31, 2014 compared to $293.1 million at December 31, 2013, principally as a result of our $114.3 million net loss (which includes a $98.2 million goodwill impairment charge), partially offset by capital contributions made by DG ($88.9 million).
Liquidity and Capital Resources
The following table sets forth a summary of our statements of cash flows (in thousands):
We generate cash from operating activities principally from net loss adjusted for certain non-cash expenses such as (i) goodwill impairment, (ii) depreciation and amortization and (iii) share-based
compensation. In 2014, we generated $13.8 million in cash from operating activities, as compared to $18.7 million in 2013 and a use of cash of $8.7 million in 2012. In 2014, the reduction in cash generated from operating activities ($4.9 million) was primarily due to our operating expenses increasing at a faster rate than our revenues. A portion of our expense growth was due to Sizmek becoming a separate, stand-alone publically-traded company in 2014, as compared to being part of DG and only receiving an allocation of DG's corporate overhead in 2013. In 2013, the increase in cash generated from operating activities ($27.4 million) primarily resulted from (i) improved operating results and (ii) liquidating a portion of our operating assets and liabilities. The improved operating results was largely due to transitioning our former EyeWonder and Unicast customers over to the Sizmek MDX platform in 2013 (formerly the MediaMind platform) from the three separate advertising platforms we operated in 2012.
Historically, we have invested our cash in (i) property and equipment, (ii) the development of software, (iii) strategic investments and (iv) the acquisition of complementary businesses. In 2014, we purchased Aerify Media and Pixel. We also purchased a $1.0 million convertible promissory note from a small private company that has developed a digital attribution software solution (see "Abakus Convertible Notes" in Note 7 to the accompanying consolidated and combined financial statements). In 2013 we purchased Republic Project, and in 2012 we purchased Peer 39.
Prior to our Spin-Off, we obtained cash from financing activities principally as a result of capital contributions from DG, our former parent. Subsequent to our Spin-Off, we obtain cash from financing activities as a result of collecting DG's television receivables that were contributed to us.
Sources of Liquidity
Our sources of liquidity include:
• cash and cash equivalents on hand (including $9.5 million held outside the United States at December 31, 2014, all of which can be repatriated into the United States with little or no adverse tax consequences);
• cash generated from operating activities;
• borrowings from a credit facility we may enter into; and
• the issuance of equity securities.
As of December 31, 2014, we had $90.7 million of cash and cash equivalents on hand. Prior to 2013, we did not generate significant amounts of cash from operating activities. This trend began to reverse in the 2013 fiscal year when we generated $18.7 million of cash from operating activities.
We believe our sources of liquidity, including (i) cash and cash equivalents on hand and (ii) cash generated from operating and financing activities, will satisfy our capital needs for the next twelve months.
Cash Requirements
We expect to use cash in connection with:
• the purchase of capital assets (including the development of capitalized software projects);
• the organic growth of our business;
• the strategic acquisition of related businesses, with cash requirements varying depending on if our common stock is used to fund all or part of any acquisition; and
• repurchases of our common stock.
In August 2014, our Board of Directors approved a $15 million share repurchase program. In March 2015, our Board of Directors increased the share repurchase program to $30 million. The program allows us to repurchase shares of our common stock through open market purchases, privately negotiated transactions or otherwise, subject to certain conditions. The share repurchase program does not have an expiration date. Through December 31, 2014, we made share repurchases totaling $2.0 million. Depending on market conditions and other factors, these repurchases may be commenced or suspended from time to time without notice. We have no obligation to repurchase shares under the share repurchase program.
During 2015, we expect we will purchase property and equipment and incur capitalized software development costs of approximately $18 million to $20 million. We expect to use cash to further expand and develop our business.
Off-Balance Sheet Arrangements
We have entered into operating leases for all of our office facilities and certain equipment rentals. Generally these leases are for periods of three to ten years and usually contain one or more renewal options. We use leasing arrangements to preserve capital. We expect to continue to lease the majority of our office facilities under arrangements substantially consistent with the past. See "Leases" in Note 12 in the accompanying consolidated and combined financial statements for a summary of our future lease commitments. Rent expense totaled $6.0 million, $5.3 million and $6.8 million in 2014, 2013 and 2012, respectively.
Other than our operating leases, we are not a party to any off-balance sheet arrangement that we believe is likely to have a material impact on our current or future financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies
The preparation of financial statements, in conformity with generally accepted accounting principles in the United States, requires us to make estimates and assumptions in determining the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from our estimates. Our significant accounting policies and methods used in the preparation of our consolidated and combined financial statements are discussed in Note 2 to the accompanying consolidated and combined financial statements. Following is a discussion of our critical accounting policies.
Goodwill
We are required to test our goodwill for potential impairment on an annual basis, or more frequently upon the occurrence of certain events, at the reporting unit level. We operate as a single reporting unit, online advertising services. The accounting guidance allows us to assess qualitatively whether it is necessary to perform step one of the prescribed two-step annual goodwill impairment test. If we believe, as a result of our qualitative assessment, that it is more likely than not that the fair value of our reporting unit exceeds its carrying amount, the two-step goodwill impairment test is not required. If we elect not to perform the qualitative assessment, or the qualitative assessment indicates it is more likely than not an impairment exists; then we would be required to conduct the two-step impairment test.
The first step in the two-step impairment test is to compare the fair value of a reporting unit with its carrying amount. The fair value of a reporting unit is determined based on a discounted cash flow analysis or other methods of valuation including the guideline public company method. A discounted cash flow analysis requires us to make various assumptions about future cash flows, growth rates and a
discount rate. The assumptions about future cash flows and growth rates are based on our long-term projections. The discount rate used reflects the risk inherent in the projected cash flows. If the fair value of a reporting unit exceeds its carrying amount, there is no impairment. If not, the second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with its carrying amount. To the extent the carrying amount of the reporting unit's goodwill exceeds its implied fair value, a write-down of the reporting unit's goodwill would be necessary.
During 2014, we revised our future forecast which resulted in us recording a goodwill impairment charge of $98.2 million.
The impairment charge was the result of (i) our weaker than expected operating results which prompted us to revise our future forecast, (ii) a decline in our market capitalization, (iii) a decreasing trend in our revenue growth rate and (iv) turnover within the sales executive team. See Note 5 to the accompanying consolidated and combined financial statements. At December 31, 2014 we had $40.2 million of goodwill and the fair value of our online advertising services reporting unit was slightly in excess of its carrying value. If our actual or expected future cash flows should fall sufficiently below our current forecast, we may be required to record another goodwill impairment charge. Future net cash flows are impacted by a variety of factors including revenues, operating margins, capital expenditures, income tax rates, and a discount rate.
Income Taxes
Deferred income taxes arise as a result of temporary differences between amounts recognized in accordance with generally accepted accounting principles and amounts recognized for federal, foreign and state income tax purposes. We have both deferred tax assets and deferred tax liabilities. Deferred tax assets relate primarily to NOL carryforwards. Deferred tax liabilities relate primarily to (i) intangible assets, such as customer relationships and trade names, some of which have little or no tax basis and (ii) property and equipment where previous tax depreciation exceeded book depreciation.
We provide a valuation allowance for deferred tax assets when we do not have sufficient positive evidence to conclude that it is more likely than not that some portion, or all, of our deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon future taxable income during the periods in which those temporary differences become deductible. In assessing the need for a valuation allowance for our deferred tax assets, we considered all available positive and negative evidence, including our ability to carry back operating losses to prior periods, the reversal of deferred tax liabilities, tax planning strategies and projected future taxable income. For 2014, 2013 and 2012, we do not believe we have sufficient positive evidence to conclude that future realization of all of our federal net deferred tax assets is more likely than not. As such, we established a valuation allowance of approximately $10.2 million at December 31, 2014. We will reassess the valuation allowance quarterly, and if future events or sufficient evidence exists to suggest such amounts are more likely than not to be realized, a tax benefit will be recorded to adjust the valuation allowance.
Impairment of Long-Lived Assets
Long-lived assets principally relate to acquired identifiable intangible assets, such as customer relationships and trade names, and property and equipment, including capitalized internally developed software and network equipment. In determining whether long-lived assets are impaired, the accounting rules do not provide for an annual impairment test. Instead they require that a triggering event occur before testing an asset for impairment. Triggering events include poor operating performance, significant negative trends, and significant changes in the use of such assets. Once a triggering event has occurred, an impairment test is employed based on whether the intent is to hold the asset for continued use or hold the asset for sale. If the intent is to hold the asset for continued use, first a comparison of projected undiscounted future cash flows against the carrying value of the asset is
performed. If the carrying value exceeds the undiscounted future cash flows, the asset would be written down to its fair value. Fair value is determined using a discounted cash flow model. If the intent is to hold the asset for sale, then to the extent the asset's carrying value is greater than its fair value less selling costs, an impairment loss is recognized for the difference. The most significant assumption relates to the projection of future cash flows. We also evaluate the estimated remaining useful life of long-lived assets that have been reviewed for impairment. For the three years ended December 31, 2014, we did not recognize an impairment loss related to long-lived assets.
Business Combinations
We account for business combinations under the acquisition method of accounting. Under the acquisition method, the assets acquired and liabilities assumed are recorded at their estimated fair values at the acquisition date. The excess of consideration transferred over the fair value of assets acquired and liabilities assumed, if any, is recorded as goodwill. Determining the nature of identifiable intangible assets and the fair value of assets acquired and liabilities assumed requires management's judgment and often involves the use of significant estimates and assumptions regarding expected future cash flows of the acquired entity. The value assigned to a specific asset or liability, and the period over which an asset is depreciated or amortized can impact future earnings. Some of the more significant estimates made in business combinations relate to the values assigned to identifiable intangible assets, such as customer relationships and trade names, and the period over which these assets are amortized. Further, we sometimes agree to contingent consideration arrangements based on the acquired entity's future operating results. Valuing contingent consideration obligations requires us to make significant estimates about future results.
Revenue Recognition
We derive revenue primarily from volume-based fees for using our online ad serving platform. We recognize revenue only when all of the following criteria have been met:
• Persuasive evidence of an arrangement exists,
• Delivery has occurred or services have been rendered,
• Our price to the customer is fixed or determinable, and
• Collectability is reasonably assured.
For the majority of our revenue, we charge our customers on a cost per thousand ("CPM") impressions basis, and recognize revenue when the impressions are served. CPM volumes are independently verifiable, and the price per CPM is based on our arrangement with the customer. In some instances, we charge a flat fee for a campaign and recognize revenue ratably over the period of the campaign.
We also offer programmatic managed services. In providing these services, we enter into arrangements with third parties to facilitate our customer's online advertising. The determination of whether we should recognize revenue on a gross or net basis is based on an assessment of whether we are acting as the principal, or an agent, in the transaction. In determining whether we are acting as the principal or an agent, we follow the accounting guidance for principal-agent considerations. While none of the factors identified in this guidance is individually considered presumptive or determinative, because we are the primary obligor in the arrangement and we are responsible for (i) selecting and contracting with third party suppliers for the purchase of inventory, (ii) managing the advertising process including selecting or advising on campaign parameters, monitoring campaign results, and adjusting parameters and modifying publishers throughout the campaign to optimize results, (iii) establishing the selling price, and (iv) assuming credit risk in the transaction, we act as the
principal in these arrangements and therefore we report revenues earned and costs incurred on a gross basis.
Recently Adopted and Recently Issued Accounting Standards
See Note 2 to the accompanying consolidated and combined financial statements.
Contractual Payment Obligations
The table below summarizes our contractual obligations at December 31, 2014 (in thousands):
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the potential loss arising from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates and changes in the market value of financial instruments.
Foreign Currency Exchange Risk
We are exposed to foreign currency exchange rate risk resulting from our international operations. In each of the foreign countries where we operate, we generally only enter into agreements that are denominated in that country's currency. However, in one country, we have employees and a real estate lease which is denominated in a foreign currency, which exposes us to ongoing foreign currency transaction gains and losses. We do not comprehensively hedge the exposure to currency rate changes, but we do enter into foreign currency forward contracts and options to hedge a portion of our exposure. At December 31, 2014 and 2013, we had $14.3 million and $5.2 million notional amount of foreign currency forward contracts and options outstanding that had a net fair value of $0.1 million liability and $0.1 million asset, respectively. As a result of our hedging activities, in the years ended December 31, 2014 and 2013 we incurred a gain of $0.1 million and $0.9 million, respectively, which is included in various operating expenses.
For additional information about our use of foreign currency forward contracts and options, see Note 2 and Note 7 to the accompanying consolidated and combined financial statements contained herein.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is set forth in our consolidated and combined financial statements and the notes thereto beginning at Page of this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
In accordance with Rule 13a-15(b) of the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K, we have evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based on their evaluation of these disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective as of the date of such evaluation.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management, with the participation of our principal executive officer and principal financial officer, uses the framework set forth in the report entitled "Internal Control-Integrated Framework" published by the Committee of Sponsoring Organizations of the Treadway Commission (referred to as "COSO") (2013 framework), to evaluate the effectiveness of our internal control over financial reporting. Based on its assessment, our management concluded our internal control over financial reporting was effective as of December 31, 2014.
Our internal control over financial reporting as of December 31, 2014 has been audited by Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, an independent registered public accounting firm. Kost Forer Gabbay & Kasierer's report on our internal control over financial reporting appears on page.
Changes in Internal Control over Financial Reporting
During the three months ended December 31, 2014, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning this item is incorporated herein by reference to the information under the headings "Corporate Governance," "Board of Directors and Committees," "Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement or amendment to this Form 10-K to be filed within 120 days of year end as required.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning this item is incorporated by reference to the information under the headings "Management Compensation," "Compensation of Directors," and "Corporate Governance," in the Company's Proxy Statement or amendment to this Form 10-K to be filed within 120 days of year end as required.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information concerning this item is incorporated by reference to the information under the heading "Principal Stockholders and Management Ownership" and "Equity Compensation Plan Information," in the Company's Proxy Statement or amendment to this Form 10-K to be filed within 120 days of year end as required.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information concerning this item is incorporated by reference to the information under the heading "Certain Transactions," in the Company's Proxy Statement or amendment to this Form 10-K to be filed within 120 days of year end as required.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information concerning this item is incorporated by reference to the information under the heading "Independent Registered Public Accounting Firm Fees," in the Company's Proxy Statement or amendment to this Form 10-K to be filed within 120 days of year end as required.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) See Index to Financial Statements on page for a list of financial statements filed herewith.
(a)(2) The information required under this item is included under Item 8 at Note 16 of the Notes to Consolidated and Combined Financial Statements.
(a)(3) See Exhibit Index on page for a list of exhibits filed as part of this Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Neil H. Nguyen and Kenneth Saunders, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him in his name, place and stead, in any and all capacities, to sign any or all amendments to this Form 10-K and to file the same, with all exhibits thereto, and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or its or his substitute or substitutes, may lawfully do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Report of Independent Registered Public Accounting Firm
The Board of Directors
Sizmek Inc.:
We have audited the accompanying consolidated balance sheet of Sizmek Inc. as of December 31, 2014, and the related consolidated and combined statements of operations, comprehensive loss, cash flows and stockholders' equity or changes in business capital for the year then ended. These financial statements are the responsibility of Sizmek Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sizmek Inc. as of December 31, 2014, and the consolidated and combined results of its operations and its cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Sizmek Inc.'s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 26, 2015 expressed an unqualified opinion thereon.
Tel-Aviv, Israel
KOST FORER GABBAY & KASIERER
March 26, 2015
A Member of Ernst & Young Global
Report of Independent Registered Public Accounting Firm
The Board of Directors
Sizmek Inc.:
We have audited the accompanying combined balance sheet of Sizmek Inc. (formerly known as The New Online Company, a carve-out of Digital Generation, Inc.) as of December 31, 2013, and the related combined statements of operations, comprehensive loss, cash flows and changes in business capital for the two years ended December 31, 2013. These financial statements are the responsibility of Sizmek Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Sizmek Inc. as of December 31, 2013, and the combined results of its operations and its cash flows for each of the two years ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
Dallas, Texas
March 14, 2014
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Sizmek Inc.:
We have audited Sizmek Inc. and subsidiaries' (the Company) internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying "Management's Report on Internal Control over Financial Reporting." Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based upon the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Sizmek Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Sizmek Inc. as of December 31, 2014 and the related consolidated statements of operations, stockholders' equity and cash flows for the year ended December 31, 2014 and our report dated March 26, 2015 expressed an unqualified opinion thereon.
Tel-Aviv, Israel
KOST FORER GABBAY & KASIERER
March 26, 2015
A Member of Ernst & Young Global
SIZMEK INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED BALANCE SHEETS
(In thousands, except par value amounts)
The accompanying notes are an integral part of these financial statements.
SIZMEK INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
The accompanying notes are an integral part of these financial statements.
SIZMEK INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
The accompanying notes are an integral part of these financial statements.
SIZMEK INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED STATEMENT OF STOCKHOLDERS' EQUITY OR CHANGES
IN BUSINESS CAPITAL
(In thousands)
The accompanying notes are an integral part of these financial statements.
SIZMEK INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
(In thousands)
The accompanying notes are an integral part of these financial statements.
SIZMEK INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
1. Basis of Presentation
The Company
Sizmek Inc. ("Sizmek," the "Company," "we," "us," and "our"), a Delaware corporation formed in 2013, operates a leading independent global online ad campaign management and distribution platform as measured by the number of advertising impressions served and the number of countries in which we serve customers. Our revenues are principally derived from services related to online advertising. We help advertisers, agencies and publishers engage with consumers across multiple online media channels (mobile, display, rich media, video and social) while delivering efficient, impactful and measurable ad campaigns. We connect 17,000 advertisers and 3,500 agencies to audiences in about 60 countries, serving more than 1.4 trillion impressions a year.
Separation from Digital Generation, Inc.
Prior to February 7, 2014, we operated as the online segment of Digital Generation, Inc. ("DG"), a leading global television and online advertising management and distribution business. On February 7, 2014, pursuant to the terms of the Agreement and Plan of Merger, dated as of August 12, 2013 (the "Merger Agreement"), by and among Extreme Reach, Inc. ("Extreme Reach"), Dawn Blackhawk Acquisition Corp., a wholly-owned subsidiary of Extreme Reach ("Acquisition Sub"), and DG, all of our issued and outstanding shares of common stock, par value $0.001 per share ("Sizmek Common Stock") were distributed by DG pro rata to its stockholders (the "Spin-Off") with the DG stockholders receiving one share of Sizmek Common Stock for each share of DG common stock ("DG Common Stock") they held. Immediately after the distribution of the Sizmek Common Stock, pursuant to the Merger Agreement, Acquisition Sub merged with and into DG with DG as the surviving corporation (the "Merger") and all of the outstanding shares of DG Common Stock was converted into the right to receive $3.00 per share, and DG became a wholly-owned subsidiary of Extreme Reach. Prior to the Spin-Off, pursuant to the Separation and Redemption Agreement and related documents, DG contributed to us all of the business and operations of its online advertising segment, all of DG's cash, most of the working capital from its television segment, and certain other corporate assets; and we agreed to indemnify DG and affiliates of DG (including Extreme Reach) for all pre-closing liabilities of DG, including stockholder litigation, tax obligations, and employee liabilities. Sizmek now operates as a separate, stand-alone publicly-traded company in the online advertising services business segment.
Carve-out Financial Statements Prior to Spin-Off
Prior to our Spin-Off from DG on February 7, 2014, our combined financial statements were derived from the consolidated financial statements and accounting records of DG. These statements reflected the combined historical results of operations, financial position and cash flows of DG's online business primarily conducted through MediaMind Technologies Inc., EyeWonder, LLC, Peer39, Inc., and Unicast EMEA, Ltd., and an allocable portion of DG's corporate costs. Prior to the Spin-Off, our financial statements are presented as if such businesses had been combined for all periods presented.
All intercompany transactions have been eliminated. All intercompany transactions between us and DG have been included in these combined financial statements and are considered to be effectively settled for cash in the combined financial statements at the time the transaction is recorded. The total net effect of the settlement of these intercompany transactions is reflected in the combined statements of cash flows as a financing activity and in the combined balance sheet as "Parent company investment."
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
1. Basis of Presentation (Continued)
For periods prior to our Spin-Off on February 7, 2014, the combined financial statements include expense allocations for (1) certain corporate functions historically provided by DG, including, but not limited to, finance, audit, legal, information technology, human resources, communications, compliance, and shared services; (2) employee benefits and incentives; and (3) share-based compensation. These expenses have been allocated to us on the basis of direct usage when identifiable, with the remainder allocated on a pro-rata basis of combined revenues, headcount or other measures of the Company and DG. We consider the basis on which the expenses have been allocated to be a reasonable reflection of the utilization of services provided to, or the benefit received by, us during the periods presented. The allocations may not, however, reflect the expense we would have incurred as an independent, publicly-traded company for the periods presented. We benefited from sharing the corporate cost structure of DG rather than incurring such costs ourselves on a stand-alone basis. For 2013, DG reported corporate overhead (excluding share-based compensation) of $24.2 million. The amount of DG's corporate overhead that was allocated to us for 2013 in these carve-out financial statements was $9.1 million, in accordance with the allocation principles for preparing carve-out financial statements (see Note 11 for a summary of DG's expense allocations to us for 2014, 2013 and 2012). As a result, the 2013 carve-out financial statements include corporate overhead expenses which represent about 37% of DG's 2013 total corporate overhead. The majority of the pre Spin-Off expense allocations were charged to general and administrative expense. For the period subsequent to the Spin-Off, general and administrative expense as a percentage of revenues has been comparable to the corresponding period of the prior year. Accordingly, while we benefited from sharing DG's cost structure prior to the Spin-Off, since the Spin-Off we have been able to control our corporate overhead expenses to a level reasonably consistent with the pre Spin-Off periods.
Historically, DG used a centralized approach to cash management and the financing of its operations. Prior to the Spin-Off, the majority of our cash was transferred to DG on a daily basis, and DG funded our operating and investing activities as needed. Cash transfers to and from DG's cash management accounts are reflected in "Parent company investment."
Prior to the Spin-Off, the combined financial statements included certain assets and liabilities that were held at the DG corporate level but were specifically identifiable or otherwise allocable to us. The cash and cash equivalents held by DG at the corporate level were not specifically identifiable to us and therefore were not allocated to us for any of the periods presented prior to the Spin-Off; however, at the Spin-Off date, cash and working capital associated with DG's TV business were contributed to us. Cash and cash equivalents in our combined balance sheet prior to the Spin-Off primarily represents cash held locally by entities included in our combined financial statements. DG's third-party debt and the related interest expense have not been allocated to us for any period as we were not the legal obligor and those amounts were paid off on or about February 7, 2014 as part of DG's Merger with Extreme Reach.
2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated and combined financial statements have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP") and include the accounts of our wholly-owned, and majority-owned and controlled subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. For the periods prior to the Spin-Off,
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
2. Summary of Significant Accounting Policies (Continued)
the carve-out financial statements have been prepared on a basis that management believes to be reasonable to reflect the financial position, results of operations and cash flows of the Company's operations, including portions of DG's corporate costs and administrative shared services.
Revenue Recognition
We derive revenue primarily from volume-based fees for using our online ad serving platform. We recognize revenue only when all of the following criteria have been met:
• Persuasive evidence of an arrangement exists,
• Delivery has occurred or services have been rendered,
• Our price to the customer is fixed or determinable, and
• Collectability is reasonably assured.
We offer online advertising campaign management and deployment products. These products allow publishers, advertisers, and their agencies to manage the process of deploying online advertising campaigns. We charge our customers on a cost per thousand ("CPM") impressions basis, and recognize revenue when the impressions are served. In some instances, we charge a flat fee for a campaign and recognize revenue ratably over the period of the campaign.
We also offer programmatic managed services. In providing these services, we enter into arrangements with third parties to facilitate our customer's online advertising. The determination of whether we should recognize revenue on a gross or net basis is based on an assessment of whether we are acting as the principal, or an agent, in the transaction. In determining whether we are acting as the principal or an agent, we follow the accounting guidance for principal-agent considerations. While none of the factors identified in this guidance is individually considered presumptive or determinative, because we are the primary obligor in the arrangement and we are responsible for (i) selecting and contracting with third party suppliers for the purchase of inventory, (ii) managing the advertising process including selecting or advising on campaign parameters, monitoring campaign results, and adjusting parameters and modifying publishers throughout the campaign to optimize results, (iii) establishing the selling price, and (iv) assuming credit risk in the transaction, we act as the principal in these arrangements and therefore we report revenues earned and costs incurred on a gross basis.
For 2014, 2013 and 2012, we reported revenues and cost of revenues from programmatic managed services as follows (dollars in thousands):
(1)Includes the cost of purchasing media, but does not include personnel and other overhead related costs that are recorded in cost of revenues.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
2. Summary of Significant Accounting Policies (Continued)
Seasonality
Our business is seasonal. Revenues tend to be the highest in the fourth quarter as a large portion of our revenues follow the advertising patterns of our customers.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to the recoverability and useful lives of long-lived assets, the adequacy of our allowance for doubtful accounts and credit memo reserves, contingent consideration and income taxes. We base our estimates on historical experience, future expectations and other relevant assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.
In 2014 and 2012, we recorded goodwill impairment charges of $98.2 million and $219.6 million, respectively. See Note 5 for a discussion of the risk of a future impairment of our goodwill.
Effective November 1, 2014, we shortened the estimated remaining useful life of our Sizmek MDX platform assets from an average of 46 months to 20 months in anticipation of our new platform (which is currently in development). We anticipate the new platform will be operational by the end of 2015 and we expect to retire our existing platform by mid-2016. As a result, we recorded additional depreciation expense of $0.6 million during 2014, which increased our net loss and loss per share by $0.5 million and $0.02, respectively.
Cash and Cash Equivalents
Cash equivalents consist of liquid investments with original maturities of three months or less at the date of acquisition. We maintain substantially all of our cash and cash equivalents with a few major financial institutions in the United States and Israel.
Restricted Cash
Restricted cash principally relates to (i) funding of Israeli statutory employee compensation, (ii) required cash balances for foreign currency forward contracts and options, and (iii) security deposits on office leases.
Accounts Receivable and Allowances
Accounts receivable are recorded at the amount invoiced, provided the revenue recognition criteria have been met, less allowances for doubtful accounts and credit memos. We maintain allowances for doubtful accounts and credit memos on an aggregate basis, at a level we consider sufficient to cover estimated losses in the collection of our accounts receivable and credit memos expected to be issued. The allowance is based primarily on known troubled accounts, the collectability of specific customer accounts and customer concentrations, with consideration given to current economic conditions and trends. We charge off accounts that remain uncollected after reasonable collection efforts are made.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
2. Summary of Significant Accounting Policies (Continued)
Property and Equipment, Net
Property and equipment are stated at cost. Depreciation is computed over the estimated useful lives of the assets using the straight-line method. Leasehold improvements are amortized on a straight-line basis over the shorter of the remaining lease term plus expected renewals or the estimated useful life of the asset. The estimated useful lives of our property and equipment (excluding property and equipment acquired in a business combination) are principally as follows:
Long-Term Investments
We acquired available for sale equity securities with an original cost of $1.2 million. During 2012, these securities declined in value to about $0.3 million. We determined the decline in value was other than temporary and, as a result, recorded an impairment charge of $0.9 million (cost basis of $1.2 million less fair value of $0.3 million). Also during 2012, we made a $1.5 million equity investment in a company that was developing a web-based audience and content measurement platform. Later in 2012, we determined that our investment was impaired and wrote-off the investment. These two charges are recorded in "other (income) and expense, net" in the accompanying statements of operations.
Leases
We lease certain properties under operating leases, generally for periods of 3 to 10 years. Some of our leases contain renewal options and escalating rent provisions. For leases that provide for escalating rent payments or free-rent occupancy periods, we recognize rent expense on a straight-line basis over the non-cancelable lease term plus option renewal periods where failure to exercise an option appears, at the inception of the lease, to be reasonably assured. Deferred rent is included in both accrued liabilities and other non-current liabilities in the accompanying balance sheets. See "Leases" under Note 12 for additional information regarding our lease commitments.
Software Development Costs
Costs incurred to create software for internal use are expensed during the preliminary project stage and only costs incurred during the application development stage are capitalized. Upon placing the completed project in service, capitalized software development costs are amortized over the estimated useful life, which generally ranges from two to five years.
Depreciation of capitalized software development costs for the years ended December 31, 2014, 2013 and 2012 was $4.3 million, $1.9 million and $2.9 million, respectively. The net book value of
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
2. Summary of Significant Accounting Policies (Continued)
capitalized software development costs was $23.0 million and $13.3 million as of December 31, 2014 and 2013, respectively.
Assets and Liabilities of DG's TV Business
Pursuant to the Separation and Redemption Agreement (see Note 1), DG contributed to us substantially all of its television business current assets and certain other assets existing on February 7, 2014, and we agreed to assume substantially all of DG's television business liabilities that existed on February 7, 2014 or were attributable to periods up to and including February 7, 2014. The net assets contributed were recorded at $78.5 million. The details of these assets and liabilities outstanding as of December 31, 2014 were as follows (in thousands):
Derivative Instruments
We enter into foreign currency forward contracts and options to hedge a portion of the exposure to the variability in expected future cash flows resulting from changes in related foreign currency exchange rates between the New Israeli Shekel ("NIS") and the U.S. Dollar. These transactions are designated as cash flow hedges, as defined by Accounting Standards Codification ("ASC") Topic 815, "Derivatives and Hedging."
ASC Topic 815 requires that we recognize derivative instruments as either assets or liabilities in our balance sheet at fair value. These contracts are Level 2 fair value measurements in accordance with ASC Topic 820, "Fair Value Measurements and Disclosures." For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income (loss), net of taxes, and reclassified into earnings (various operating expenses) in the same period or periods during which the hedged transaction affects earnings.
Our cash flow hedging strategy is to hedge against the risk of overall changes in cash flows resulting from certain forecasted foreign currency rent and salary payments during the next twelve months. We hedge portions of our forecasted expenses denominated in the NIS with a single
SIZMEK INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
2. Summary of Significant Accounting Policies (Continued)
counterparty using foreign currency forward contracts and options. At December 31, 2014, we had $14.3 million notional amount of foreign currency forward contracts and options outstanding that had a net fair value liability balance of $0.1 million ($0.2 million liability, net of a $0.1 million asset). The net liability is included in "accrued liabilities" and is expected to be recognized in our results of operations in the next twelve months. At December 31, 2013, we had $5.2 million notional amount of foreign currency forward contracts and options outstanding that had a net fair value asset balance of $0.1 million ($0.1 million asset, net of a $0.0 million liability). The vast majority of any gain or loss from hedging activities is included in our various operating expenses. As a result of our hedging activities, we incurred the following gains and losses in our results of operations (in thousands):
It is our policy to offset fair value amounts recognized for derivative instruments executed with the same counterparty. In connection with our foreign currency forward contracts and options and other banking arrangements, we have agreed to maintain $1.5 million of cash in bank accounts with our counterparty, which we classify as restricted cash on our balance sheet.
Accumulated Other Comprehensive Income (Loss)
Components of accumulated other comprehensive income (loss), net of tax, during the years ended December 31, 2014, 2013 and 2012, were as follows (in thousands):
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
2. Summary of Significant Accounting Policies (Continued)
The following table summarizes the reclassifications from accumulated other comprehensive income (loss) to the consolidated and combined statements of operations for the years ended December 31, 2014 and 2013 (in thousands):
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net identifiable assets acquired. We test goodwill for potential impairment at the reporting unit level on an annual basis, or more frequently if an event occurs or circumstances exist indicating goodwill may not be recoverable. Such events or circumstances may include operating results lower than previously forecasted or declines in future expectations of our operating results, or other significant negative industry trends. In evaluating goodwill for potential impairment, we perform a two-step process that begins with an estimate of the fair value of each reporting unit that contains goodwill (presently, we operate as a single reporting unit). We use a variety of methods, including discounted cash flow models, to determine fair value. In the event a reporting unit's carrying value exceeds its estimated fair value, evidence of a potential impairment exists. In such a case, the second step of the impairment test is required, which involves allocating the fair value of the reporting unit to its assets and liabilities, with the excess of fair value over allocated net assets representing the implied fair value of its goodwill. An impairment loss is measured as the amount, if any, by which the carrying value of a reporting unit's goodwill exceeds its implied fair value. During 2014 and 2012 we recorded goodwill impairment losses of $98.2 million and $219.6 million, respectively. See Note 5 for a discussion of the risk of a future impairment of our goodwill.
Long-Lived Assets
We assess our long-lived assets (other than goodwill), including acquired identifiable intangibles, for potential impairment whenever certain triggering events occur. Events that may trigger an impairment review include the following:
• significant underperformance relative to historical or projected future operating results;
• significant changes in the use of our assets or the strategy for our overall business; and
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2. Summary of Significant Accounting Policies (Continued)
• significant negative industry or economic trends.
If we determine the carrying value of our long-lived or intangible assets may not be recoverable based upon the occurrence of a triggering event, we assess the recoverability of these assets by determining whether amortization of the asset balance over its remaining life can be recovered through undiscounted future operating cash flows. Any impairment is determined based on a projected discounted cash flow model using a discount rate reflecting the risk inherent in the projected cash flows.
We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each asset. Factors considered when determining useful lives include the contractual term of any agreement, the history of the asset, our long-term strategy for using the asset, any laws or other local regulations that could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have finite lives are generally amortized on a straight-line basis over their useful lives which generally range from 3 to 12 years. See "Intangible Assets" under Note 5 for additional information.
Foreign Currency Translation and Measurement
We translate the assets and liabilities of our non-U.S. dollar functional currency subsidiaries into U.S. dollars using exchange rates in effect at the end of each period. Revenue and expenses for these subsidiaries are translated using the average exchange rates that were in effect during the period. Gains and losses from these translations are recognized in foreign currency translation, a component of accumulated other comprehensive income (loss) and part of stockholders' equity (business capital prior to the Spin-Off). Gains or losses from measuring foreign currency transactions into the functional currency are included in our statements of operations. For 2014, 2013 and 2012, we recognized foreign currency transaction gains and (losses) of ($1.2) million, $0.1 million and ($0.4) million, respectively.
Research and Development Expenses
Research and development expenses mainly include costs associated with maintaining our technology platform and are expensed as incurred.
Merger, Integration and Other Expenses
Merger, integration and other expenses reflect the expenses incurred in (i) DG's Merger with Extreme Reach and our Spin-Off from DG, (ii) acquiring or disposing of a business, (iii) integrating an acquired operation (e.g., severance pay, office closure costs) into the Company and (iv) certain other
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2. Summary of Significant Accounting Policies (Continued)
items of income or expense not deemed to be part of our core operations. A summary of our merger, integration and other expenses is as follows (in thousands):
(1)Merger and Spin-Off includes costs incurred prior to the transactions while DG was evaluating strategic alternatives. See discussion of Merger and Spin-Off under "Separation from Digital Generation, Inc." in Note 1.
(2)Represents a reduction in expense due to realizing more TV net assets than originally estimated at the time of the Spin-Off.
Severance costs primarily relate to consolidating the workforces of MediaMind, EyeWonder, and Unicast and eliminating redundancy. All costs shown above were paid in the period the expense was recognized, or shortly thereafter. As of December 31, 2014, our integration efforts were substantially complete.
Share-Based Payments
Subsequent to the Spin-Off, the compensation committee of our board of directors authorizes the issuance of stock options, time-based restricted stock units ("RSUs") and performance-based RSUs to our employees, directors and consultants. The committee approves grants only out of shares previously authorized by our stockholders.
We recognize compensation expense based on the estimated fair value of the share-based payments. The fair value of our RSUs is based on the closing price of our common stock the day prior to the date of grant. The fair value of our stock options is calculated using the Black-Scholes option pricing model. Share-based awards that do not require future service are expensed immediately. Share-based awards that only require future service are amortized over the relevant service period on a straight-line basis. Share-based awards that require satisfaction of performance conditions, such as performance-based RSUs, are amortized over the performance period provided it is probable that the performance conditions will be satisfied. Subsequently, if the performance conditions are no longer probable of achievement, then all previously recognized compensation expense for that award will be reversed.
Prior to the Spin-Off, we participated in DG's compensation programs that included equity-based incentive awards. Those equity-based awards related to shares of DG's common stock, not to our equity. For DG equity awards, we recognized an allocated cost equal to the cost recognized by DG. Allocations of share-based payments also arose from acquisitions when DG agreed to assume the
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
2. Summary of Significant Accounting Policies (Continued)
share-based obligations of the acquired company on our behalf; such as the case in our acquisition of MediaMind. In connection with completing the Merger and Spin-Off, all of DG's outstanding equity awards became fully vested and, to the extent the award had an intrinsic value, were converted into shares of DG stock. Equity awards with no intrinsic value were cancelled. Following the Spin-Off, we did not assume any equity award previously issued by DG.
We recognized $9.4 million, $6.4 million and $8.9 million in share-based compensation expense related to stock options, restricted stock and RSUs during the years ended December 31, 2014, 2013 and 2012, respectively. For 2014, $2.9 million relates to our equity awards and $6.5 million relates to the allocated cost of DG's equity awards. See Note 10.
Income Taxes
Subsequent to the Spin-Off, we file our income tax returns on a stand-alone basis. Prior to the Spin-Off, our results of operations were included in the combined federal and state income tax returns of DG. For those periods, the income tax amounts reflected in the accompanying financial statements have been allocated to us based on taxable income (loss) directly attributable to us on a stand-alone basis. Management believes that the assumptions underlying the allocation of income taxes are reasonable. However, the amounts allocated for income taxes in the accompanying financial statements are not necessarily indicative of the amount of income taxes that would have been recorded had we operated as a separate, stand-alone entity during those periods. Prior to the Spin-Off, the U.S. federal and state tax losses generated by us were utilized by DG in its consolidated U.S. tax return. We are reflecting these U.S. federal and state tax losses as a distribution to DG for the year they were included in DG's U.S. tax returns.
We establish deferred income tax assets and liabilities for temporary differences between the tax and financial accounting bases of our assets and liabilities. The tax effects of such differences are recorded in the balance sheet at the enacted tax rates expected to be in effect when the differences reverse. A valuation allowance is recorded to reduce the carrying amount of deferred tax assets if it is more likely than not that all or a portion of the asset will not be realized. The ultimate realization of our deferred tax assets is primarily dependent upon generating taxable income during the periods in which those temporary differences become deductible. The need for a valuation allowance is assessed each year. We forecast the reversal of our deferred tax assets and liabilities in determining the need for a valuation allowance. For 2014, 2013 and 2012, we recorded a valuation allowance.
The tax balances and income tax expense recognized by us are based on our interpretation of the tax statutes of multiple jurisdictions and judgment. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated results of operations, financial position and cash flows.
We account for uncertain tax positions in accordance with ASC 740, which contains a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining whether the weight of available evidence indicates that it is more likely than not that, on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. We reevaluate our income tax positions periodically to consider factors such as changes in facts or circumstances, changes in or interpretations of tax law, effectively
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2. Summary of Significant Accounting Policies (Continued)
settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in recognition of a tax benefit or an additional charge to the tax provision.
We include interest related to tax issues as part of income tax expense in our consolidated or combined financial statements. We record any applicable penalties related to tax issues within the income tax provision. See Note 8.
Business Combinations
Business combinations are accounted for using the acquisition method. The purchase price is allocated to the assets acquired and liabilities assumed based on their estimated fair values. Any excess purchase price over the fair value of the net identifiable assets acquired is recorded as goodwill. Operating results of an acquired business are included in our results of operations from the date of acquisition. See Note 3.
Financial Instruments and Concentration of Credit Risk
Financial instruments that subject us to significant concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. The vast majority of our cash and cash equivalents is held at large financial institutions in the United States and Israel that management believes to be of high credit quality. At certain financial institutions, our cash and cash equivalents regularly exceeds the federally insured limit. We have not experienced any losses on our cash and cash equivalents to date. We perform ongoing credit evaluations of our customers, generally do not require collateral and maintain a reserve for potential credit losses. We only recognize revenue when collection is reasonably assured. Our receivables are principally from advertising agencies and direct advertisers. Our receivables and the related revenues are not contingent on our customers' sales or collections. We believe the fair value of our accounts receivable approximate their carrying value. For the years ended December 31, 2014, 2013 and 2012, there was no single customer that accounted for more than 10% of our revenue. At December 31, 2014 and 2013, there was no single customer that accounted for more than 10% of our accounts receivables.
Israel Operations
The majority of our research and development activities and a large portion of our accounting functions are performed in Herzliya, Israel. In total, about 28% of our workforce is located in Israel. As a result, we are subject to risks associated with operating in the Middle East.
Recently Adopted and Recently Issued Accounting Guidance
Adopted
Effective January 1, 2014, we adopted ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" on a prospective basis. ASU 2013-11 amends the accounting guidance related to the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. The guidance requires an unrecognized tax benefit to be presented as a decrease in a deferred tax asset where a net operating loss, a similar tax loss, or a tax credit
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2. Summary of Significant Accounting Policies (Continued)
carryforward exists and certain criteria are met. The adoption of ASU 2013-11 did not have a material impact on our financial statements.
Issued
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)." ASU 2014-09 modifies revenue recognition guidance for GAAP. Previous revenue recognition guidance in GAAP comprised broad revenue recognition concepts together with numerous revenue requirements for particular industries or transactions, which sometimes resulted in different accounting for economically similar transactions. In contrast, International Accounting Standards Board ("IASB") provided limited guidance on revenue recognition. Accordingly, the FASB and IASB initiated a joint project to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP and International Financial Reporting Standards ("IFRS"). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps:
Step 1: Identify the contract(s) with a customer.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations in the contract.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
For Sizmek, the amendments in ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. An entity shall adopt the amendments in ASU 2014-09 by either (i) retrospectively adjusting each prior reporting period presented or (ii) retrospectively adjusting for the cumulative effect of initially applying ASU 2014-09 at the date of initial adoption. We have not as yet determined (i) the extent to which we expect ASU 2014-09 will impact our reported revenues or (ii) the manner in which it will be adopted.
3. Acquisitions
Over the last three years, we acquired four businesses in the media services industry. The objective of each transaction was to expand our product offerings, customer base, and global digital distribution network, and/or to better serve the advertising community. We expect to realize operating synergies from each of the transactions, or the acquired operation has created, or will create, opportunities for
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3. Acquisitions (Continued)
the acquired entity to sell its services to our customers. Both of these factors resulted in a purchase price that contributed to the recognition of goodwill. The acquisitions are summarized as follows:
Each of the acquired businesses has been included in our results of operations since the date of closing. Accordingly, the operating results for the periods presented are not entirely comparable due to these acquisitions and related costs. In each acquisition, the excess of the purchase price over the fair value of the net identifiable assets acquired has been allocated to goodwill. A brief description of each acquisition is as follows:
Pixel
On September 4, 2014, we acquired all of the outstanding shares of Zestraco Investments Limited including its wholly-owned subsidiary PixelCo. D.O.O. ("Pixel") for $0.45 million in cash and a deferred payment obligation of $0.05 million which was paid in December 2014. Pixel performed advertising service operations principally for us prior to our purchase and had virtually no assets.
The objective of the transaction was to bring in-house the group of technology service personnel that had been providing advertising operations service to us through a contract. We expect to realize operating synergies from this transaction. Pixel has been included in our results of operations since the date of closing. The $0.5 million purchase price was allocated to goodwill and is not deductible for income tax purposes. The purchase price allocation is final.
Aerify Media
On August 11, 2014, we acquired substantially all the assets and operations of privately-held Aerify Media LLC ("Aerify"), a firm specializing in mobile tracking and retargeting, for $5.625 million in cash and a $0.625 million deferred payment obligation due in one-year. Aerify's mobile in-app and web tracking technology expands our capabilities in the fast-growing mobile segment, adding both talent and technology to our platform.
The objective of the transaction was to accelerate the development of our mobile technology in order to better serve the advertising community. We expect to realize operating synergies from this transaction. Aerify has been included in our results of operations since the date of closing.
The $6.25 million purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values. We allocated $2.05 million to developed technology, $0.4 million to customer relationships and $3.8 million to goodwill. The developed technology and customer relationships acquired in the transaction are being amortized on a straight-line basis over 4 years and 5 years, respectively. The weighted average amortization period is 4.2 years. The goodwill and other intangible assets created in the acquisition are deductible for income tax purposes. For 2013, prior to our purchase, Aerify reported revenues of $3.1 million and a loss before income taxes of $0.6 million.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
3. Acquisitions (Continued)
For the period from the acquisition date through December 31, 2014, we recognized $0.9 million of revenues and a $0.4 million loss before income taxes from Aerify in our results of operations. The purchase price allocation is final.
Purchase of Republic Project
On October 4, 2013, we acquired the assets and operations of privately-held Republic Project, a cloud-based ad platform that enables agencies and brands to create, deliver and measure social and mobile rich media campaigns, for $1.1 million in cash, a $0.3 million deferred payment obligation and contingent consideration we valued at zero. The contingent consideration payment ranges from zero to $13.1 million based on reaching revenue and adjusted EBITDA performance targets in 2014 and 2015. For 2014, the performance targets were not reached.
The purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values. We allocated $0.3 million to customer relationships, $0.6 million to developed technology and $0.4 million to noncompetition agreements. The customer relationships, developed technology and noncompetition agreements acquired in the transaction are being amortized on a straight-line basis over 5 years, 4 years and 4 years, respectively. The weighted average amortization period is 4.2 years. The intangible assets created in the acquisition are deductible for income tax purposes. For the period from the acquisition date through December 31, 2013, we recognized $0.1 million of revenue and a $0.3 million loss before income taxes from Republic Project in our results of operations. The Republic Project purchase price allocation is final.
Purchase of Peer39
On April 30, 2012, we acquired Peer39, Inc. ("Peer39"), a provider of webpage level data for approximately $15.7 million in cash, shares of DG's common stock and an installment payment. Peer39 is the leading provider of data based on the content and structure of web pages for the purpose of improving the relevance and effectiveness of online display advertising. Peer39 analyzes web pages in terms of quality, safety and brand category which allows advertisers to make better buying decisions.
In connection with the transaction, (i) we paid $10.1 million in cash, (ii) DG issued 357,143 shares of its common stock and (iii) we agreed to pay up to $2.3 million in an installment payment within one year of the acquisition. The installment payment represented amounts we withheld to address any unrecorded liabilities or other unreported claims that may have existed on the purchase date.
The purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values. In 2012, we finalized the Peer39 purchase price allocation. The customer relationships, trade name, developed technology and noncompetition agreements acquired in the transaction are being amortized on a straight-line basis over 10 years, 10 years, 6 years and 4 years, respectively. The weighted average amortization period is 7.1 years. The goodwill and intangible assets created in the acquisition are not deductible for income tax purposes. The acquired assets include $0.8 million of gross receivables which we recognized at their estimated fair value of $0.8 million. For the eight months ended December 31, 2012, we recognized $4.4 million of revenue and a $1.4 million loss before income taxes from Peer39 in our results of operations.
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3. Acquisitions (Continued)
Transfer Majority of Chors
In September 2011, we acquired EyeWonder LLC ("EyeWonder") and chors GmbH (a German limited liability company "Chors"). On April 2, 2012, in consideration of $0.1 million, we transferred the majority of the assets, agreements and employees of Chors to 24/7 Real Media Deutschland GmbH ("24/7 Germany"), a German limited liability company, and an affiliate of WPP plc, an international advertising and media investment management firm. For the three months ended March 31, 2012, we reported $1.3 million of revenue and $0.3 million of income before income taxes from Chors. We did not report a significant gain or loss in connection with the transfer.
Purchase Price Allocations
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the respective dates of acquisition for the above referenced transactions (in millions).
Pro Forma Information
The following pro forma information presents our results of operations for the years ended December 31, 2014 and 2013 as if the acquisitions of Pixel, Aerify and Republic Project had occurred on January 1, 2013 (in thousands). A table of actual amounts is provided for reference.
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4. Property and Equipment, Net
Property and equipment were as follows (in thousands):
5. Goodwill and Intangible Assets, net
Goodwill
We operate as a single reporting unit. Changes in the carrying value of our goodwill for the years ended December 31, 2014 and 2013 are as follows (in thousands):
We evaluate goodwill for possible impairment each year on December 31st and whenever events or changes in circumstances indicate the carrying value of our goodwill may not be recoverable. Generally, the goodwill impairment test involves a two-step process. In the first step, we compare the fair value of the Company to its carrying value. If the fair value of the Company exceeds its carrying value, goodwill is not impaired and no further testing is required. If the fair value of the Company is less than its carrying value, we must perform the second step of the impairment test to measure the amount of the impairment loss. In the second step, the Company's fair value is allocated to its assets and liabilities, including any unrecognized intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the Company was being acquired in a business combination. If the implied fair value of the Company's goodwill is less than the carrying value, the difference is recorded as an impairment loss.
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5. Goodwill and Intangible Assets, net (Continued)
ASC 350-20-35 allows an entity to assess qualitatively whether it is necessary to perform step one of the prescribed two-step annual goodwill impairment test. If an entity believes, as a result of its qualitative assessment, that it is more likely than not that the fair value of a reporting unit exceeds its carrying amount, the two-step goodwill impairment test is not required. At December 31, 2014, we performed a qualitative assessment of our goodwill and determined that the two-step process was not necessary. We considered that as of September 30, 2014 we had adjusted our goodwill to its fair value (see below), and since then (i) our operating results were in line with our September 2014 forecast, (ii) our December 2014 forecast reflects a slightly improved outlook and (iii) our market capitalization (an indicator of the fair value of the Company) has improved from the level used in our third quarter impairment analysis.
2014 Goodwill Impairment Loss
At December 31, 2013, based on a variety of methods including a discounted cash flow model (a Level 3 fair value measurement) that used our internal forecast, we determined the fair value of the Company was only 5% in excess of its carrying value. In preparing our discounted cash flow model, we made assumptions about future revenues and expenses to determine the cash flows that would result from our operations.
We noted at the time, and at each of the next two quarters, there was substantial risk our forecasted cash flows may fall short of our expectations. We noted that if actual or expected future cash flows should fall sufficiently below our forecast, it would likely require us to record another goodwill impairment charge (in addition to the impairment charge taken in 2012). We noted future net cash flows are impacted by a variety of factors including revenues, operating margins, capital expenditures, income tax rates, and a discount rate.
We also noted the market value of our common stock plus a reasonable control premium is an indicator of the fair value of our Company. We noted that if the market value of our common stock should decline sufficiently below its initial trading value (initial trading began in February 2014) for an extended period of time, it would likely cause us to conclude that our goodwill was impaired and we would be required to record another goodwill impairment charge. At each of March 31, 2014 and June 30, 2014, we continued to monitor our goodwill and determined an interim goodwill impairment test was not required.
During the third quarter of 2014, we determined that indicators of potential impairment existed requiring us to perform an interim goodwill impairment test. These indicators included (i) revenues and operating results sufficiently below our earlier forecast which prompted us to revise our future forecast, (ii) our market capitalization continuing to decline throughout 2014 such that our market capitalization plus a reasonable control premium was well below the book value of our total stockholders' equity, (iii) a decreasing trend in our revenue growth, and (iv) turnover within the sales executive team.
In performing our interim goodwill impairment test, we estimated the fair value of the Company using an income approach, specifically a discounted cash flow model (a Level 3 fair value measurement). Under the income approach, we calculated the fair value of the Company based on the present value of its estimated future cash flows. Cash flow projections are based on a variety of estimates including revenue growth rates, operating margins, tax rates, capital expenditures and a discount rate. The discount rate used was based on our weighted average cost of capital adjusted for the risks associated with the Company's projected cash flows.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
5. Goodwill and Intangible Assets, net (Continued)
Upon estimating the fair value of our goodwill, we determined it was less than its carrying value. As a result, we performed the second step of the impairment analysis and allocated the fair value of the Company to each of its assets and liabilities (including identifiable intangible assets) with the excess fair value being the implied goodwill. Estimating the fair value of certain assets and liabilities requires significant judgment about future cash flows. The implied fair value of the Company's goodwill was $98.2 million less than its carrying value, which we recorded as a goodwill impairment loss during the third quarter of 2014.
To verify the reasonableness of the fair value of the Company, we compared the Company's adjusted carrying value to its market capitalization plus a reasonable control premium. We determined the implied control premium of about 42% was reasonable based upon a review of historical control premiums of comparable companies. In accordance with our policy, at December 31, 2014 we performed our annual goodwill impairment test and determined no additional impairment was required.
Risk of Future Impairment
At December 31, 2014, based on our discounted cash flow model that uses our internal forecast, we determined the fair value of the Company was only slightly in excess of its carrying value. In preparing our discounted cash flow model, we made assumptions about future revenues and expenses for several periods to determine the cash flows that will result.
As with any forecast, there is substantial risk our forecasted cash flows may fall short of our current expectations. If actual or expected future cash flows should fall sufficiently below our current forecast, it is likely we would be required to record another goodwill impairment charge. Future net cash flows are impacted by a variety of factors including revenues, operating margins, capital expenditures, income tax rates, and a discount rate.
Further, the market value of our common stock plus a reasonable control premium is an indicator of the fair value of our Company. If the market value of our common stock should fall sufficiently below the current level for an extended period of time, it would likely cause us to conclude that our goodwill is impaired and we would be required to record another goodwill impairment charge.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
5. Goodwill and Intangible Assets, net (Continued)
Intangible Assets
Intangible assets were as follows at December 31, 2014 and 2013 (dollars in thousands):
Intangible assets are initially stated at their estimated fair value at the date of acquisition. Subsequently, intangible assets are adjusted for amortization expense and any impairment losses recognized. Net intangible assets decreased during the year ended December 31, 2014 as a result of amortization expense, partially offset by our acquisition of Aerify Media (see Note 3). Amortization expense related to intangible assets totaled $15.6 million, $15.8 million and $15.4 million for the years ended December 31, 2014, 2013 and 2012, respectively. The estimated future amortization of our intangible assets as of December 31, 2014 is as follows (in thousands):
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
6. Other Assets and Liabilities
Other current assets consist of the following (in thousands):
Accrued liabilities consist of the following (in thousands):
Other non-current liabilities consist of the following (in thousands):
7. Fair Value Measurements
ASC 820, Fair Value Measurements, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date.
ASC 820 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
• Level 1-Quoted prices in active markets for identical assets or liabilities.
• Level 2-Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
7. Fair Value Measurements (Continued)
• Level 3-Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
Financial Assets and Liabilities Measured on a Recurring Basis
We have classified our assets and liabilities that are measured at fair value on a recurring basis (at least annually) into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date.
The tables below set forth by level assets and liabilities that were accounted for at fair value as of December 31, 2014 and 2013. The carrying values of our accounts receivable and accounts payable approximate their respective fair values due to the short-term nature of these financial instruments. The tables do not include cash on hand or assets and liabilities that are measured at historical cost or any basis other than fair value (in thousands).
(a)Included in cash and cash equivalents.
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7. Fair Value Measurements (Continued)
(b)Included in other current assets.
(c)Included in current assets of TV business.
(d)Included in other non-current assets.
(e)Included in accrued liabilities.
(f)See contingency related to Republic Project acquisition at Note 3.
The fair value of our money market funds was determined based upon quoted market prices. The currency forward derivatives/options are derivative instruments whose value is based upon quoted market prices from various market participants. We have a zero cost basis in these derivative instruments. Our marketable equity securities relate to a single issuer that has a cost basis of $0.3 million.
In connection with our Spin-Off from DG, DG contributed a revenue sharing asset to us that resulted from DG's sale of its Springbox unit. We are entitled to a percentage of the revenues collected by the business for three years after the closing date (June 1, 2012). Revenue sharing payments are generally made once a year. We have estimated the future revenues of Springbox based on the historical revenues and certain other factors, discounted to their present value. The following table provides a reconciliation of changes in the fair values of our Level 3 assets (in thousands):
Also, in connection with our Spin-Off from DG, we assumed a portion of a revenue earnout arrangement that DG had agreed to in its purchase of North Country. Further, in connection with an acquisition of a business, we sometimes include a contingent consideration component of the purchase price based on (i) future revenues or (ii) future revenues and operating results (e.g., adjusted EBITDA), that require minimum thresholds be met before any earnout payment becomes due. Accordingly, there can be significant volatility in the earnout liability. Each reporting period, we review our estimates of the performance indicators (e.g., revenue, adjusted EBITDA) and the corresponding earnout levels achieved, discounted to their present values. The change in fair value is recorded in cost of revenues in the accompanying statements of operations.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
7. Fair Value Measurements (Continued)
The following table provides a reconciliation of changes in the fair value of our Level 3 liabilities (in thousands):
In connection with our acquisition of Republic Project, we agreed to make additional payments to the sellers if Republic's 2014 or 2015 revenues and adjusted EBITDA exceed certain levels. As of December 31, 2014, we do not expect to make any payments with respect to the Republic Project contingent consideration arrangement. See Note 3-Purchase of Republic Project.
Abakus Convertible Notes
In May 2014, we purchased $1.0 million of Abakus convertible promissory notes ("Convertible Notes") for $1.0 million. The Convertible Notes are due 90 days after written notice after the earlier of (i) May 30, 2016 or (ii) an occurrence of an Event of Default (as defined in the Convertible Notes). Abakus is a small private company that has developed a digital attribution software solution. The Convertible Notes bear interest at 5% per annum payable at maturity. The Convertible Notes are convertible into Abakus Series A Preferred Stock ("Series A Preferred") as follows:
a)Automatic conversion if Abakus sells $2.0 million of Series A Preferred ("Qualified Financing"), whereupon the Convertible Notes shall be converted, at Sizmek's option, at either (i) 75% of the share price in the Qualified Financing, or (ii) the quotient of $7.0 million divided by the number of shares outstanding upon exercise of all dilutive securities, and
b)Optional conversion at Sizmek's election if Abakus completes an Equity Financing (as defined in the Convertible Notes) that is not a Qualified Financing, whereupon the Convertible Notes shall be converted at 75% of the share price in the Equity Financing.
In addition, upon a Change in Control, as defined in the Convertible Notes, the Convertible Notes shall be paid off at the greater of (i) the outstanding balance, or (ii) the amount the holder would have received upon conversion of the Convertible Notes. The Convertible Notes are considered held-to-maturity securities and are carried at amortized cost. The fair value of the Convertible Notes is not readily determinable. We are not aware of a market for the Convertible Notes. The Convertible Notes are included in other non-current assets.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
7. Fair Value Measurements (Continued)
Financial Assets and Liabilities Measured on a Nonrecurring Basis
Except for the impairments of our goodwill during 2014 and 2012, we did not record any material other-than-temporary impairments on financial assets required to be measured at fair value on a nonrecurring basis. See Note 5.
8. Income Taxes
The components of our loss before income taxes were as follows (in thousands):
The components of our benefit for income taxes were as follows (in thousands):
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
8. Income Taxes (Continued)
The components of our net deferred tax liabilities were as follows (in thousands):
A reconciliation of our net deferred tax liabilities to our balance sheets is as follows (in thousands):
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
8. Income Taxes (Continued)
Income tax expense differs from the amounts that would result from applying the federal statutory rate to our income (loss) before income taxes as follows (dollars in thousands):
For periods subsequent to our Spin-Off, we file separate tax returns on a stand-alone basis.
For periods prior to our Spin-Off, we calculated the benefit for income taxes as if we were a stand-alone entity and filed separate tax returns. For periods prior to the Spin-Off, if we had filed separate tax returns we would have generated U.S. federal and state NOLs. Those hypothetical NOLs and the corresponding tax benefits were fully utilized by DG, our former parent, in the same period. For the losses incurred in the financial statement periods, we evaluated whether or not such losses could be realized if we did not have the benefit of filing a consolidated income tax return with DG. For the period of January 1 to February 7, 2014 we determined under ASC 740 that generated losses were not realizable and therefore the tax benefits for the losses generated and contributed to DG were not provided. These unbenefited losses did not result in additional valuation allowance on the balance sheet, as they were contributed through net parent funding/equity. Any U.S. tax benefit utilized by the parent is reclassified to net parent funding in the same period. Any valuation allowance and corresponding tax expense relate to separate company deferred tax assets, mainly acquired NOLs that will be carried forward into 2015.
For periods prior to our Spin-Off, any tax attributes utilized by the parent were reclassified to business capital in the same period. As of December 31, 2014, we had NOL carryforwards with a tax-effected carrying value of approximately $4.4 million for federal purposes. Our federal NOLs will expire in 2030. Utilization of these carryforwards will be limited on an annual basis as a result of previous business combinations pursuant to Section 382 of the Internal Revenue Code. Expected future limitations are as follows (in millions, amounts shown are not tax effected):
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
8. Income Taxes (Continued)
We provide a valuation allowance for deferred tax assets when we do not have sufficient positive evidence to conclude that it is more likely than not that some portion, or all, of our deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon future taxable income during the periods in which those temporary differences become deductible. In assessing the need for a valuation allowance for our deferred tax assets, we considered all available positive and negative evidence, including our ability to carry back operating losses to prior periods, the reversal of deferred tax liabilities, tax planning strategies and projected future taxable income. Given our history of losses, we do not believe we have sufficient positive evidence to conclude that future realization of all of our federal net deferred tax assets is more likely than not. As such, we have maintained a valuation allowance on deferred tax assets to the extent they exceed our deferred tax liabilities in the same jurisdiction. We will continue to reassess the valuation allowance quarterly, and if future events or sufficient evidence exists to suggest such amounts are more likely than not to be realized, a tax benefit will be recorded to adjust the valuation allowance.
We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. Interest and penalties related to uncertain tax positions are recognized in income tax expense. For the year ended December 31, 2014, we recognized $0.7 million of interest or penalties related to uncertain tax positions in our consolidated financial statements. For the year ended December 31, 2013, we recognized $0.2 million of interest or penalties related to uncertain tax positions in our combined financial statements. For the year ended December 31, 2012, we did not recognize any interest or penalties related to uncertain tax positions in our combined financial statements. At December 31, 2014 and 2013, $0.7 million and $0.2 million of interest and penalties were included in our balance sheets, respectively.
The change in unrecognized tax benefits for the years ended December 31, 2014, 2013, and 2012, was as follows (in thousands):
If we reduced our reserve for uncertain tax positions, it would result in us recognizing a tax benefit. Upon the taxing authority accepting those tax returns, we expect substantially all of the uncertain tax positions to be effectively settled within 12 months.
As of December 31, 2014, we provided a valuation allowance against substantially all of our U.S. and state NOL carryforwards as ultimate realization of these NOLs was not determined to be more likely than not. Accordingly, we have NOL carryforwards available to us (should we have sufficient
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
8. Income Taxes (Continued)
future taxable income to utilize them) that are not reflected in our consolidated and combined balance sheets at December 31, 2014 and 2013, respectively.
We are subject to U.S. federal income tax, income tax from multiple foreign jurisdictions including Israel and the United Kingdom, and income taxes of multiple state jurisdictions. U.S. federal, state and local income tax returns for 2011 through February 7, 2014 remain open to examination. Israeli and United Kingdom income tax returns remain open to examination for 2008 through 2014 and 2009 through 2014, respectively. Prior to our Spin-Off, our operating results had been included in DG's U.S. federal and state tax returns or tax returns of non-U.S. jurisdictions. Subsequent to our Spin-Off, we will file stand-alone income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and various foreign jurisdictions. Prior to our Spin-Off, we entered into a tax matters agreement with DG that governs the parties' respective rights, responsibilities and obligations with respect to taxes. The tax matters agreement generally provides that the filing of tax returns, the control of audit proceedings, and the payment of any additional tax liability relative to periods prior to February 8, 2014 is our responsibility.
We do not provide deferred taxes on the undistributed earnings of our non-U.S. subsidiaries in situations where our intention is to reinvest such earnings indefinitely. Furthermore, all of our U.S. and non-U.S. subsidiaries have significant net assets, liquidity, and other financial resources available to meet their operational and capital investment requirements. As of December 31, 2014, we recorded a deferred tax liability for undistributed earnings, including applicable withholding taxes, in the amount of $0.3 million that are expected to be remitted in the foreseeable future. This deferred tax liability is a result of dissolving, merging, or liquidating purchased legal entities according to management's stated plan of integration. As of December 31, 2014, the aggregate undistributed earnings of our non-U.S. subsidiaries subject to indefinite reinvestment totaled $6.8 million. Should we make a distribution in the form of dividends or otherwise, we may be subject to additional income taxes. The unrecognized deferred tax liability related to the undistributed earnings of our non-U.S. subsidiaries is estimated to be $2.5 million as of December 31, 2014. This assumes we will not be able to recognize the benefits of a foreign tax credit upon remittance of the foreign earnings due to expected losses in the United States.
9. Employee Benefit Plan
We have a 401(k) retirement plan for our employees based in the United States. Employees may contribute a portion of their earnings up to a yearly maximum (in 2014, $17,500 for employees under age 50, $23,000 for employees over age 49). We match 25% of the amount contributed by employees, up to a maximum employee contribution of 6% of gross earnings. Prior to the Spin-Off, our U.S. based employees participated in DG's 401(k) retirement plan. During 2014, 2013 and 2012, we made matching contributions on behalf of our employees of approximately $303,000, $252,000 and $261,000, respectively.
10. Stock Plan and Stock Repurchase Program
Since the Spin-Off on February 7, 2014, all share-based compensation expense relates to the Sizmek 2014 Incentive Award Plan (the "2014 Plan"). All share-based compensation recognized prior to the Spin-Off relates to DG's equity-based incentive programs. Prior to the Spin-Off, certain of our employees participated in DG's equity incentive programs. Immediately prior to completing the
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10. Stock Plan and Stock Repurchase Program (Continued)
Spin-Off, all of DG's outstanding equity awards became fully vested and, to the extent the award had an intrinsic value, were converted into shares of DG common stock. Equity awards with no intrinsic value were cancelled. DG's equity incentive plans were terminated in connection with the Merger Agreement (see Note 1). Below is a summary of our share-based compensation expense (in thousands):
Shares in the Plan, Terms and Vesting
Under the 2014 Plan, the compensation committee of our Board of Directors (the "Committee") is authorized to grant awards to our employees, non-employee directors and consultants. Awards can take the form of (i) stock options, (ii) restricted stock, (iii) restricted stock units ("RSUs"), (iv) performance awards, (v) dividend equivalents, (vi) stock payments and (vii) stock appreciation rights. The 2014 Plan provides that the maximum number of shares of common stock with respect to which awards may be granted shall not exceed 4,500,000, plus
(i)any shares tendered or withheld to satisfy the exercise price of an option or any tax withholding obligation pursuant to any award under the 2014 Plan,
(ii)any shares subject to a stock appreciation right that are not issued in connection with the stock settlement of the stock appreciation right on its exercise, and
(iii)any shares purchased on the open market with the cash proceeds from the exercise of options.
In addition, to the extent all or a portion of an award is forfeited, expires or is settled for cash, the shares subject to the award shall, to the extent of such forfeiture, expiration or cash settlement, again be available for future grants. Further, any shares of restricted stock repurchased by us or surrendered to us shall again be available for future grant. Further, awards granted under the 2014 Plan upon the assumption of, or in substitution for, outstanding equity awards of an entity we acquire (substitute awards), will not reduce the shares authorized for grant under the 2014 Plan. Further, in the event that a company acquired by us has shares available under a pre-existing plan approved by stockholders and not adopted in contemplation of such acquisition or combination, the shares available for grant may be used for awards under the 2014 Plan and will not reduce the shares authorized for grant under the 2014 Plan, but such awards will only be made to individuals who were not employed by or providing services to us immediately prior to such acquisition or combination.
Generally, the granting of share-based awards including the terms and vesting schedules thereof is authorized by the Committee. The exercise price of stock options shall not be less than the fair value of our common stock on the date of grant. Stock option grants typically have terms of ten years, vest over three years, and are recognized on a straight-line basis over the vesting term. At December 31,
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
10. Stock Plan and Stock Repurchase Program (Continued)
2014, there were a total of 3,389,471 shares of common stock available for future grant under the 2014 Plan.
Stock Options
A summary of 2014 stock option activity pursuant to the 2014 Plan is presented below:
The following table summarizes information about stock options outstanding at December 31, 2014:
Options granted in 2014 had a weighted average grant-date fair value of $5.65 per share. The weighted average remaining contractual life of vested stock options at December 31, 2014 was 0.2 years. At December 31, 2014, the intrinsic value of options outstanding and options exercisable was less than $0.1 million and $0.0 million, respectively. The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the option exercise price.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
10. Stock Plan and Stock Repurchase Program (Continued)
Unrecognized compensation costs related to our stock options was $2.2 million at December 31, 2014. These costs are expected to be recognized over the weighted average remaining vesting period of 2.0 years. The fair value of each option was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:
(1)Since our common stock has a limited trading history (trading began in February 2014), we based our expected volatility on the historical volatility of DG's common stock over a preceding period commensurate with the expected term of the option.
(2)The risk free rate is based on the U.S. Treasury yield curve at the time of grant for periods consistent with the expected term of the option.
(3)The expected term was calculated as the average between the vesting term and the contractual term, weighted by tranche. We used the simplified method discussed in ASC 718-10-S99-1 as we do not have sufficient historical data in order to calculate a more appropriate estimate.
RSUs-Time Based
In 2014, subsequent to the Spin-Off, the Committee awarded 410,332 time-based RSUs to our employees and non employee directors. The total grant date fair value of the time-based RSUs was $4.2 million. As of December 31, 2014, the total fair value of outstanding time-based RSUs that have vested or we expect to vest was $2.4 million. The awards (i) vest over periods ranging from nine months to three years and (ii) are subject to the awardees' continued employment with us or continuing to provide services to us.
In 2014, we recognized $1.4 million in share-based compensation expense related to time-based RSUs. At December 31, 2014, the unrecognized compensation costs related to time-based RSUs was $2.5 million. The amount of share-based compensation expense we ultimately recognize will depend on the degree to which the time-based service conditions are satisfied. The grant date fair value of the time-based RSUs that vested during 2014 was less than $0.1 million. At December 31, 2014, the nonvested time-based RSUs had a weighted average remaining vesting period of 1.8 years and an intrinsic value of $2.4 million.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
10. Stock Plan and Stock Repurchase Program (Continued)
A summary of our time-based RSU activity for 2014 is presented below:
RSUs-Performance Based
In 2014, subsequent to the Spin-Off, the Committee awarded 204,280 performance-based RSUs to certain of our employees. The total grant date fair value of the performance-based RSUs was $2.2 million. As of December 31, 2014, the total fair value of outstanding performance-based RSUs that have vested or we expect to vest was $1.2 million.
The awards (i) vest over periods ranging from seven months to 34 months, (ii) are subject to the awardees' continued employment with us and (iii) are subject to reaching certain (a) revenue, (b) adjusted EBITDA and (c) free cash flow growth targets (i.e., performance conditions). The amount of share-based compensation expense we ultimately recognize will depend on the degree to which the performance conditions are satisfied. As a result, there can be significant volatility in the amount of share-based compensation expense we recognize from period to period due to differences between actual and expected results, and changes in our estimates of future results.
In 2014, we recognized $0.7 million in share-based compensation expense related to performance-based RSUs. At December 31, 2014, the unrecognized compensation costs related to performance-based RSUs was $0.2 million. The unrecognized compensation costs is based on our current estimate of future operating results and could change significantly in the future. At December 31, 2014, the nonvested performance-based RSUs had a weighted average remaining vesting period of 1.2 years and an intrinsic value of $1.2 million.
According to the terms of the performance-based RSU agreements, after the performance period has ended, the RSUs do not vest until the performance results are certified by the Committee. The first performance period ended on December 31, 2014 and, once the performance results are certified, we expect to issue 52,407 shares of common stock with a weighted average grant-date fair value $10.79 per share.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
10. Stock Plan and Stock Repurchase Program (Continued)
A summary of our performance-based RSU activity for 2014 is presented below:
Pre Spin-Off-Participation in DG's Stock Plans
Prior to the Spin-Off, certain of our employees participated in DG's equity-based incentive programs. DG allocated the cost of our employees' participation in those plans to us. Prior to the Spin-Off, we did not have any equity-based incentive plans ourselves. In addition, DG allocated a portion of the cost of share-based awards for their corporate services personnel to us. As discussed above, in connection with the Spin-Off all DG equity-based incentive awards became fully vested and, to the extent they had intrinsic value, were converted into shares of DG common stock. Immediately prior to the Spin-Off, equity awards with no intrinsic value were cancelled and DG's equity incentive plans were terminated. Below is a summary of DG's equity-based incentive awards in which our employees participated:
DG Stock Options
In 2012, certain of our employees were awarded DG stock options to purchase 120,000 shares of DG's common stock. The weighted-average exercise price for the 2012 grants was $9.20. The stock options had a four year vesting period and a ten year contractual life. The fair value of the DG stock options granted was determined using the Black-Scholes option pricing model. The various inputs used to determine the fair value were specific to DG, and were not necessarily representative of the inputs we may have used.
DG RSUs
In 2013 and 2012, certain of our employees were awarded DG RSUs. The RSUs were granted to our employees at no cost and restrictions on transfer lapsed over a three year period. The fair value of each award was equal to the fair value of DG's common stock on the date of grant. For 2013 and 2012, the fair value of the DG RSUs granted to our employees was $1.0 million and $1.2 million, respectively, and the weighted-average fair value per share was $6.20 and $10.04, respectively.
Allocating Share-based Compensation of DG's Corporate Services Personnel
A portion of the cost of DG's corporate-related services, which includes executive management and administrative personnel, has been allocated to us in these financial statements. In addition, DG has allocated to us a portion of the cost of its share-based compensation programs for these
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
10. Stock Plan and Stock Repurchase Program (Continued)
corporate-related services personnel. For 2014, 2013 and 2012, DG allocated $3.8 million, $3.0 million and $1.8 million, respectively, to us for share-based compensation of its corporate services personnel.
Stock Repurchase Program
In August 2014, our Board of Directors approved a $15 million share repurchase program. In March 2015, our Board of Directors increased the share repurchase program to $30 million. The program allows us to repurchase shares of our common stock through open market purchases, privately negotiated transactions or otherwise, subject to certain conditions. The share repurchase program does not have an expiration date. Through December 31, 2014, we made share repurchases totaling $2.0 million. Depending on market conditions and other factors, these repurchases may be commenced or suspended from time to time without notice. We have no obligation to repurchase shares under the share repurchase program.
11. Related Party Transactions
Prior to the Spin-Off, DG provided certain management and administrative services to us. These services included, among others, accounting, treasury, audit, tax, legal, executive oversight, human resources, real estate, information technology and risk management. These expenses have been allocated to us on a basis of direct usage when identifiable, with the remainder allocated on the basis of revenue, headcount, or other measures. Further, DG also allocated to us (i) merger, integration and other expenses and (ii) share-based compensation, largely based on revenues. DG's allocation of these expenses to us was as follows (in thousands):
Included in the above allocations are costs of DG's employee benefit plans and other employee incentives. Employee benefits and incentives include 401(k) matching contributions, participation in DG's long-term incentive compensation award plans and healthcare plans. The employee benefit and incentive costs are reflected in the statements of operations and are classified consistently with how the underlying employee's salary and other compensation costs have been recorded.
We consider the allocated cost for corporate services, employee benefits and incentives to be reasonable based on our utilization of such services. However, we believe the allocated cost for the services are different from the cost we would have incurred if we had been an independent publicly-traded company during those periods.
In addition, DG primarily used a centralized approach to cash management and the financing of its operations with all related activity between DG and us reflected in stockholders' equity or business capital in the accompanying balance sheets. The transactions included:
• our cash deposits that were transferred to DG's bank accounts on a regular basis;
• cash infusions from DG to fund our operations, capital expenditures and acquisitions;
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
11. Related Party Transactions (Continued)
• allocations of DG's corporate services, employee benefits and other incentives; and
• intercompany charges for expenses related to facilities we shared with DG's other business segment.
The following is a reconciliation of the amounts presented as "Net contributions from Parent" on the statement of stockholders' equity or business capital and the amounts presented as "Net contributions from Parent" and monetization of other Parent contributions on the statements of cash flows (in thousands):
Pursuant to the Merger Agreement, shortly prior to the Spin-Off, DG contributed to us all of its cash, and most of its other current assets and liabilities relating to its TV business. The vast majority of the assets have since been monetized and the liabilities have been paid. The remaining identifiable TV assets and liabilities are summarized in Note 2.
12. Litigation and Commitments
Litigation
Although the Company is not a party to any of the litigation discussed below, under the Separation and Redemption Agreement that we entered into with DG in connection with the Spin-Off, we have agreed to indemnify and hold harmless DG and its former directors for the costs of defending the cases, and any damages that may be awarded to the plaintiff and purported class of former DG stockholders.
On January 14, 2014, a purported holder of common stock of Digital Generation, Inc. ("DG"), Equity Trading ("Plaintiff"), filed a complaint in the Supreme Court of the State of New York, County of New York, Equity Trading v. Scott K. Ginsburg, et al., No. 050112/2014, on behalf of itself and all others similarly situated, against DG, all directors of DG, Extreme Reach, Inc. ("Extreme Reach") and Dawn Blackhawk Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of Extreme Reach ("Acquisition Sub"), alleging breaches of fiduciary duty in connection with the then pending Agreement and Plan of Merger, dated as of August 12, 2013, by and among Extreme Reach,
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
12. Litigation and Commitments (Continued)
Acquisition Sub and DG. The complaint sought an injunction barring the consummation of the transaction and unspecified monetary damages.
On January 16, 2014, Plaintiff filed with the New York state court a request seeking an order (i) preliminarily enjoining the Merger, (ii) requiring expedited discovery and (iii) scheduling a post-discovery hearing to continue the injunction (Plaintiff's "Request"), and on January 17, 2014, the New York state court issued an order setting a briefing schedule and a hearing for January 30, 2014, on Plaintiff's Request. On January 27, 2014, the defendants removed this action from the New York state court to the United States District Court for the Southern District of New York, causing the matter to now be captioned Equity Trading v. Scott K. Ginsburg, et al., 14 Civ. 499 (RWS) (RLE). The defendants also submitted briefing in opposition to the Request. At a hearing held on January 30, 2014, the Court denied Plaintiff's Request. On February 4, 2014, the Court agreed to a Stipulation for Extension of Time and Order (the "Scheduling Order"), providing a proposed briefing schedule. On February 26, 2014, Plaintiff filed a Motion to Remand the action to the Supreme Court of the State of New York, County of New York. On March 12, 2014, the defendants stipulated to remand. On April 11, 2014, Plaintiff filed an amended complaint, asserting the same causes of action as the initial complaint and adding certain additional factual allegations. On July 18, 2014, the defendants filed motions to dismiss the amended complaint. On September 16, 2014, Plaintiff filed oppositions to the motions to dismiss and a cross-motion to strike exhibits to the motions to dismiss. On October 24, 2014, the defendants filed replies in support of the motions to dismiss and an opposition to the cross-motion to strike. On November 14, 2014, Plaintiff filed a reply in support of the cross-motion to strike. Oral argument on the motions to dismiss and cross-motion to strike took place on February 5, 2015.
On March 13, 2015, Plaintiff and the defendants entered into a stipulation providing for the above-described action to be discontinued in its entirety without prejudice, with all of the parties bearing their own costs. The stipulation was filed with the Supreme Court of the State of New York, County of New York on March 15, 2015, and the court thereafter dismissed the action.
Leases
We lease office and storage facilities under non-cancelable operating leases. Generally, these leases are for periods of three to ten years and usually contain one or more renewal options. Our two most significant leases are in New York City, NY and Herzliya, Israel. The New York lease is for ten years and expires in 2024. The Herzliya lease is for ten years and expires in 2021. The table below summarizes our lease obligations for office and storage facilities, including amounts for escalating operating lease rental payments, at December 31, 2014 (in thousands):
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
12. Litigation and Commitments (Continued)
Rent expense totaled $6.0 million, $5.3 million and $6.8 million in 2014, 2013 and 2012, respectively. Certain of our leases have been subleased to others. At December 31, 2014, sublease rentals to be received in the future (2015 to 2017) totaled $1.3 million.
13. Earnings (Loss) per Share
Basic earnings (loss) per common share excludes dilution and is calculated by dividing net earnings (loss) by the weighted-average number of common shares outstanding during the period. Diluted earnings (loss) per common share is calculated by dividing net earnings (loss) by the weighted-average number of common shares outstanding during the period, as adjusted for the potential dilutive effect of non-participating share-based awards such as stock options and RSUs.
On February 7, 2014, 30.4 million shares of our common stock were distributed to DG stockholders in conjunction with the Spin-Off. For comparative purposes, and to provide a more meaningful calculation of the weighted-average shares outstanding, we have assumed this amount to be outstanding throughout each period presented prior to the Spin-Off in the calculation of weighted-average shares outstanding. The following table presents earnings (loss) per common share for the years ended December 31, 2014, 2013 and 2012 (in thousands, except per share data):
14. Geographical Information
We have one operating segment. Our chief operating decision maker is considered to be our Chief Executive Officer. The chief operating decision maker allocates resources and assesses performance of the business and other activities at the operating segment level.
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
14. Geographical Information (Continued)
The following summarizes our revenue by geographic area (in thousands):
In 2014, about 51% of our revenue was attributable to foreign jurisdictions. However, no one country other than the United States represented more than 10% of our consolidated revenues.
The following summarizes our revenues by product category (in thousands):
The following summarizes our long-lived assets by country at December 31, 2014 and 2013 (in thousands):
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Continued)
15. Unaudited Quarterly Financial Information (in thousands, except per share amounts)
The comparability of the below quarterly results is impacted by acquisitions. In August and September 2014 we acquired Aerify Media and Pixel, respectively. In October 2013, we acquired Republic Project. See Note 3.
(a)In the third quarter of 2014, we recorded a goodwill impairment charge. See Note 5.
16. Trade Receivables-Allowances for Uncollectible Accounts and Credits (in thousands)
EXHIBIT INDEX
Exhibit Number
Exhibit Title
** The following materials from our Annual Report on Form 10-K for the year ended December 31, 2014 formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated and Combined Balance Sheets, (ii) Consolidated and Combined Statements of Operations, (iii) Consolidated and Combined Statements of Comprehensive Loss (iv) Consolidated and Combined Statement of Stockholders' Equity or Changes in Business Capital, (v) Consolidated and Combined Statements of Cash Flow, and (vi) Notes to Consolidated and Combined Financial Statements.
(a)Incorporated by reference to exhibit bearing the same or similar title filed with Amendment No. 1 to the Registrant's Registration Statement on Form 10, filed December 23, 2013.
(b)Incorporated by reference to the exhibit bearing the same title filed with the Registrant's Current Report on Form 8-K filed February 4, 2014.
(c)Incorporated by reference to the exhibit bearing the same title filed with the Registrant's Current Report on Form 8-K filed February 11, 2014.
(d)Incorporated by reference to Exhibit 99.1 filed with the Registrant's Registration Statement on Form S-8 filed February 14, 2014.
(e)Incorporated by reference to Exhibit 4.1 filed with the Registrant's Annual Report on Form 10-K filed March 14, 2014.
(f)Incorporated by reference to the exhibit bearing the same title filed with the Registrant's Quarterly Report on Form 10-Q filed May 9, 2014.
(g)Incorporated by reference to the exhibit bearing the same title filed with the Registrant's Current Report on Form 8-K filed November 3, 2014.
(h)Incorporated by reference to the exhibit bearing the same title filed with the Registrant's Quarterly Report on Form 10-Q filed November 13, 2014.
*Management contract or compensatory plan or arrangement.
**Filed herewith.