Item 1. Business
Overview
NeuLion, Inc. (“NeuLion,” “we,” “us” or “our”) is a technology product and service provider that specializes in the digital video broadcasting, distribution and monetization of live and on-demand content to Internet-enabled devices. Through our cloud-based end-to-end solution, we build, secure and manage interactive digital networks that enable our customers to provide a destination for their viewers to view and interact with their content. We were incorporated on January 14, 2000 under the Canada Business Corporations Act and were domesticated under Delaware law on November 30, 2010. Our common stock is listed on the Toronto Stock Exchange (“TSX”) under the symbol NLN. On January 30, 2015, we consummated the acquisition of DivX Corporation (“DivX”), which creates, distributes, and licenses digital video technologies for PCs, smart TVs, and mobile devices. MainConcept, its subsidiary, provides a high-quality video compression-decompression, or codec, software library to consumer electronics manufacturers and others.
We are a provider of customized, end-to-end, interactive content services for a wide range of professional and collegiate sports properties, cable networks and operators, content owners and distributors, and telecommunication companies. With a fundamental shift in the way media is now being consumed, technological advancements are affecting how, when and where consumers connect to content. Our technology enables our customers to seamlessly manage and deliver interactive and high-quality content, up to ultra HD/4K screen resolution, to multiple types of Internet-enabled devices such as PCs, smartphones and tablets. Our cloud-based technology platform offers a variety of digital technology and services for content rights holders, including content ingestion, live encoding, live video editing, digital rights management, advertising insertion and management, pay flow and premium content payment support, video player software development kits, multi-platform device delivery, content management, subscriber management, digital rights management, billing services, app development, website design, analytics and reporting. To our new consumer electronics manufacturing customers gained in the DivX acquisition, NeuLion offers technology and products that enable premium screen resolution, also up to ultra HD/4K, for a wide range of Internet-enabled devices that include smart TVs, smartphones and tablets.
Customer Relationships
Our business is comprised of three main market sectors: professional sports; college sports; and TV Everywhere. In addition, through the DivX acquisition, we gained consumer electronics manufacturing customers. Our relationships are predominantly business-to-business (“B2B”). These relationships generally involve entering into distribution and service agreements with our customers to provide them with end-to-end solutions for the delivery of their content, by way of a custom-built digital platform, to their viewers. A B2B customer typically aggregates the content, negotiates the licensing rights and directly markets the availability of the content. This customer can avail itself of a range of our distribution and technology services to delivery its content to its end users. The consumer electronics market and third-party integrators license technology software development kits (SDKs) and certification test kits (CTKs) from us to ensure the delivery of secure, high-quality video playout on, respectively, their devices and software.
Our three existing categories of customers, and our new consumer electronics manufacturing and third-party integrator customers, are described below:
Professional Sports
Through our NeuLion Sports platform, we provide our professional sports programming customers with the ability to deliver live and on-demand content. We maintain agreements with leading professional sports properties such as the National Football League (NFL), the National Hockey League (NHL), the National Basketball Association (NBA), Ultimate Fighting Championship (UFC), Major League Soccer (MLS), the American Hockey League (AHL), the Western Hockey League (WHL), the Ontario Hockey League (OHL), and the Professional Bowlers Association (PBA).
College Sports
We provide our college partners with our NeuLion College platform, comprised of a suite of digital services that includes delivery of live and on-demand content, web publishing, electronic ticketing, donor management, e-commerce and advertising solutions. We partner with many National Collegiate Athletic Association (NCAA) schools and conferences and have agreements in place with over 160 colleges, universities or related sites, including the University of North Carolina, Duke University, the University of Oregon, Louisiana State University, Mississippi State University, Florida State University, the University of Nebraska, Texas A&M University, the University of Oklahoma, the University of Maryland, the Big 12 Conference, the Southern Conference, Pac 12 member schools and the Ivy League Digital Network.
TV Everywhere
NeuLion also provides a TV Everywhere platform that allows over-the-air and cable television broadcasters, cable operators, entertainment companies, content aggregators, multichannel video programming distributors (“MVPDs”) and broadcasting distribution undertakings (“BDUs”) to deliver their live and on-demand content to multiple devices. We have agreements with ESPN, Tennis Channel, Univision, China Network Television (a new media agency of China Central Television), Sport TV, Rogers Media, Sportsnet, Outdoor Channel, TVG Network, CBC, the Independent Film Channel, Cablevision, MSG Varsity, Shaw Communications, the Big Ten Network, Participant Media and the Gospel Music Channel.
Consumer Electronics Manufacturers and Third-Party Integrators
Through our recent acquisition of DivX, we provide consumer electronics manufacturers and third-party integrators with a variety of technology and products. Our consumer electronics manufacturing customers, which include Samsung, LG, Sharp, Toshiba and others, license our technology to empower Internet-enabled consumer devices they manufacture, such as smart TVs, smartphones and tablets, with premium, up to ultra HD/4K, screen resolution, secured playout and certification technology. Our third-party integrators license our technology to integrate our video/audio codecs into their software applications and plug-ins for video/audio encoding.
Technology and Services
Our technology and services are available to our customers from our cloud-based end-to-end solution and include the following options:
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interactive television video device player design and development;
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signal capture, encoding and transcoding of both live and on demand video content;
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support and management of multiple content delivery networks (CDNs), which involves real-time performance measurement of CDN providers with automated switching to different providers to ensure high-quality video for our customer’s viewers;
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live video editing and tagging, which involves clipping video highlights to make them available for viewing in real time on Internet-enabled devices;
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content management, which involves preparing, scheduling and formatting various digital and analog TV signals and file-based video formats for streaming over the Internet to a range of devices;
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subscriber management, pay-per-view transaction support, advertising insertion and management, and subscriber authentication services;
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security, encryption and digital rights management, which preserves the integrity of the content and protects it from unauthorized access;
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billing services that enable our customers to manage the subscriber accounts of their viewers and also to provide pay-per-view transactions to their viewers;
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website design and hosting, as well as app design and creation;
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high-definition delivery of streamed audio, video and other multimedia content;
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game highlights, polls and alerts;
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advertising integration and substitution, which involves adding digital advertising into streamed video players;
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quality of service monitoring;
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subscriber support services;
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Internet marketing services to drive traffic to our customers’ digital destinations;
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social media integration, which involves the connection of social networks such as Facebook and Twitter to online viewing experiences;
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reporting and analytics;
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user authentication services;
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online electronic ticketing and donor management;
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facilitating online merchandise sales;
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college market auction engine services (e.g., for sports memorabilia and experiences); and
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marketing and advertising sales.
In addition, with the acquisition of DivX, NeuLion now offers consumer electronics licensing to the consumer electronics industry, which enables device manufacturers to license DivX technology for high-quality video playback and adaptive bitrate streaming on their electronic device screens. The DivX certification license verifies that the video playback process profile requirements have been tested and met, including the proper implementation of the DivX DRM for secure playback of protected video streams. NeuLion licenses technology such as SDKs and CTKs to, and works with, chipset and consumer electronics manufacturers to certify their devices for reliable, secure, high-quality playback of personal and premium video content across multiple screens.
Finally, MainConcept’s codec SDK provides extensive audiovisual codec and format support for the video industry and third-party integrators. Codec enables distribution of content across the Internet and through recordable media in either physical or streamed forms. MainConcept codecs are embedded in third-party video software applications to enable the playback of digital media for consumers. MainConcept SDKs encompass a large library of video codecs, supporting major industry codec formats in use both in consumer and professional markets.
Distribution Methods
We distribute content through two primary methods:
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Internet-enabled apps and browser-based devices, including:
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personal computers and laptops;
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mobile devices such as the iPhone, BlackBerry and Android;
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gaming consoles such as Sony PS3/PS4 and Xbox 360/ONE;
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tablets such as the iPad;
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Internet-enabled TVs such as those manufactured by Samsung, Panasonic and LG;
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third-party set-top boxes (“STBs”), including Roku and Apple TV;
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other Internet-enabled consumer accessories; and
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Standard television sets through use of our Internet-connected STBs.
All of our distribution methods make use of IP-based content-delivery networks. As a result, content delivered by NeuLion is available globally and is potentially unlimited in reach and interactive functionality.
Revenue
We earn revenue from three categories of customers: Pro Sports, TV Everywhere and College Sports. Within these three categories we earn revenue from set-up fees, monthly, quarterly and annual fees, and variable fees. Our current revenue streams are described in detail under Item 7 below under the heading “OPERATIONS.” The United States and Canada are the principal markets in which our sales have occurred. With our recent acquisition of DivX, we expect to categorize revenues into two broad categories of customers - content owners and consumer electronics manufacturers - and that our principal markets will be expanded to include South Korea and Japan.
Competition
The sizable technology investment required to deliver and monetize live and on-demand interactive content to Internet-enabled devices has created high barriers to entry into this market. Nonetheless, various types of both direct and indirect competitors present themselves across the professional sports, college sports and TV Everywhere market sectors of our business.
First, we face direct competition from the in-house technology teams of current and prospective customers that are not, at their core, technology companies and other managed service providers. As various “point product” technology companies make their technology available in the marketplace, in-house technology teams have the option of buying, building and integrating these products. A point product is one that addresses one single problem. An “end-to-end” solution such as NeuLion provides is more comprehensive and integrated. The aggregate purchasing and programming costs of buying and integrating numerous point products can run high, and the time required for integration can delay the time to market. By contrast, our end-to-end solution solves multiple problems at once and generally offers a customer faster time to market at a lower overall cost. Additionally, we compete for business with managed service providers, such as MLB Advanced Media, who go outside and market their end-to-end platforms to third parties.
Second, we are seeing increasing competition directly from software and, to a lesser extent, hardware companies that were not previously active in our markets. These technology companies are developing more and more video technology point product tools to enable companies to deliver content over the Internet themselves. Further, companies such as Elemental, Akamai and Harmonic are aggressively pushing their video platform technologies into the digital video market to attempt to acquire a portion of the revenues available there.
Third, an increasing number of online video provider competitors is focusing on only one piece of the digital video delivery process, such as content management or video players. These types of companies (such as Bright House, CSG and thePlatform) often initially develop a deep expertise in one niche component of the digital video ecosystem, and we expect them to continue to increase the breadth of their offerings.
Fourth, we also see indirect competition from media technology companies, such as Hulu, YouTube, Sports/Entertainment Networks and Netflix, who license or develop their own technologies internally, then license content rights from content producers and then distribute and monetize their licensed content on their platform. Our prospective customers who are content producers or aggregators (such as TV networks and studios) may elect to license and distribute their content via these types of third party platforms instead of building out their own platforms with our technology.
Finally, NeuLion’s acquisition of DivX opens up new competition with companies providing products similar to those developed by DivX. Digital rights management provided by DivX is also offered by Microsoft, Verimatrix and Google. DivX software lets consumers play, create and stream industry-leading video formats; open source providers like the VideoLAN organization also provide similar software. And finally, DivX consumer electronics technology licenses that enable device manufacturers to support DivX video playback and adaptive bitrate streaming up to 4K on screen can also be found from other open source providers.
To distinguish our offerings from those of our competitors, we seek to offer our customers a comprehensive solution for the distribution and monetization of their content. Our key differentiator is our ability to provide a complete, integrated, end-to-end solution with a comprehensive suite of interactive digital services, whereas the far narrower point product solutions offered by many companies in our markets ultimately cost the buyer more in terms of invested capital and time to market. Our suite of technology and other services is directed at the entire spectrum of content distribution: aggregation; quality of delivery; monetization; reporting; support and maintenance; and services that support continued business growth for our customers. Further, a cornerstone of our service is our ability to design, develop and launch interactive and social end user interactive experiences more advanced than those of our competitors. Because of our deep experience in the market, and our commitment to and investment in research and development, our enterprise platform is able to accommodate the largest and smallest of clients with a variety of needs.
Customer Dependence
For the years ended December 31, 2014 and 2013, the NHL accounted for 18% and 20% of revenue, respectively. As at December 31, 2014, three customers accounted for 53% of accounts receivable: 28%, 13% and 12%, respectively. As at December 31, 2013, two customers accounted for 26% of accounts receivable: 14% and 12%, respectively. As at December 31, 2014, two customers accounted for 59% of accounts payable: 49% and 10%, respectively. As at December 31, 2013, two customers accounted for 60% of accounts payable: 47% and 13%, respectively.
Seasonality
Our sports content business is seasonal because demand for such programming corresponds to the seasons of the sports for which we stream content. Because the majority of our sports contracts contain a variable revenue share or usage component, our revenues are the highest during the months when the sports content is streamed live.
Intellectual Property
Our ability to protect our intellectual property, including our technology, is an important factor in the success and continued growth of our business. We protect our intellectual property through trade secrets law, patents, copyrights, trademarks and contracts. Some of our technology relies upon third-party licensed intellectual property.
Through the DivX transaction, we acquired dozens of US and foreign patents along with dozens more pending patent applications in both the US and overseas. Prior to the acquisition, DivX’s strategy, which we expect to continue, was to file patent and trademark applications in the United States and any other country that represents an important potential commercial market.
In addition to the foregoing, we have established business procedures designed to maintain the confidentiality of our proprietary information, including the use of confidentiality agreements and assignment-of-inventions agreements with employees, independent contractors, consultants and companies with which we conduct business.
Regulation
Governmental and regulatory authorities in some jurisdictions in which our customers’ viewers reside or content originates may impose rules and regulations regarding content distributed over the Internet. Regulatory schemes can vary significantly from country to country. We may, directly or indirectly, be affected by broadcasting or other regulations in countries in which our customers have viewers or from which live linear feeds are distributed to us, and we may not be aware of those regulations or their application to us. Further, governmental and regulatory authorities in many jurisdictions regularly review and modify their broadcasting rules and policies, including the application of those rules and policies to new and emerging media. International or governmental quality of service or other technical standards could be adopted that could impact our services.
Traditional over-the-air and cable television broadcasting businesses are generally subject to extensive government regulation and significant regulatory oversight in many of the countries from which our customer’s content originates and many of the countries into which we distribute our customers’ content to their viewers. Regulations typically govern the issuance, amendment, renewal, transfer and ownership of and investment in over-the-air and cable television broadcasting licenses, cable franchise licenses, competition and cross ownership and sometimes also govern the timing and content of programming, the timing, content and amount of commercial advertising and the amount of foreign versus domestically produced programming. In many jurisdictions, including the United States and Canada, there are also significant restrictions on the ability of foreign entities to own or control traditional over-the-air television broadcasting businesses; in Canada, such restrictions also preclude foreign entities from owning or controlling other types of broadcasting undertakings, including pay and specialty programming undertakings and BDUs. We are not aware of any regulations in any of the jurisdictions in which our customers’ viewers reside that would require us to be licensed to distribute content over the public Internet.
United States
In the United States, we may fall within the statutory definition of an MVPD, making us subject to the provisions of the Communications Act of 1934, as amended, and Federal Communications Commission (“FCC”) regulations applicable to MVPDs. The FCC has determined that cable television system regulatory fees should be imposed on IPTV service, and each year IPTV service providers must pay the cable television fee on subscribers as of the end of the prior year. “IPTV” refers to the distribution of streamed audio, video and other multimedia content over a broadband network. While the FCC had previously not ruled whether providers of IPTV content over the Internet are MVPDs, on March 30, 2012, in MB Docket No. 12-83, the FCC issued a notice seeking comment on whether the definition of MVPD should be expanded to include services delivered via Internet protocol, such as those delivered by us, thereby expanding the scope of the MVPD rules to possibly apply to programming our customers distribute. On December 19, 2014, the FCC terminated MB Docket No. 12-83, and placed in abeyance a complaint filed by Sky Angel against Discovery Communications. On December 19, 2014, the FCC also issued a Notice of Proposed Rulemaking, MB Docket No. 14-261 (“MVPD NPRM”), to determine whether IPTV providers fall within the statutory definition of a MVPD, including the application of all MVPD rules to IPTV providers. The MVPD NPRM tentatively concludes that the statutory definition of MVPDs should include certain Internet based distributors of video programming, specifically including all entities that make available for purchase multiple programming streams at prescheduled times, and seeks comment on whether the definition should include a broader class of video providers. The comment windows are still open in the MVPD NPRM and no decision has been made, however, we note that the Copyright Office provisionally accepted a filing by Aereo to pay copyright fees as a cable system, pending further legal and regulatory developments. While the statutory and regulatory requirements of MVPDs do not currently apply to us, except for the payment of regulatory fees, we anticipate that status to change upon the FCC’s issuance of a final order in the MVPD NPRM. If we were found to be an MVPD, we are likely to be required to: scramble any sexually explicit programming our customers distributed (currently, our customers do not distribute any such programming); provide “closed caption” for programs offered to viewers; comply with certain FCC advertising regulations (including advertising loudness rules, which may require report filing and investment in monitoring hardware and software); face possible exposure to state and local franchise registration or regulation; comply with all other rules applicable to MVPDs; and comply with the FCC’s equal employment opportunity rules.
On January 14, 2014, the D.C. Circuit Court of Appeals struck down the net neutrality rules adopted by the FCC, determining that the FCC did not have the authority to issue or enforce net neutrality rules, as it had failed to identify certain service providers as “common carriers,” but leaving certain transparency rules in effect. These rules require broadband Internet providers to disclose network management practices, performance characteristics and terms and conditions. On May 15, 2014, the FCC issued a Notice of Proposed Rulemaking, GN Docket No. 14-28 (“Open Access NPRM”) that proposed the retention and enhancement of the FCC’s prior transparency and no-blocking rules, and prohibition of priority services. It also proposed other rule changes, including the re-classification of broadband as a common carrier service. On February 26, 2015, the FCC adopted new rules pursuant to the Open Access NPRM, and although as of the writing of this disclosure the exact language of the adopted order had not been published, FCC statements and reports indicated that the FCC will re-classify broadband services as common carrier services and strengthen net neutrality. Republican Members of Congress have voiced strong opposition to the FCC’s position and have proposed legislation that would reverse the actions of the FCC. In addition, the new rules adopted by the FCC are likely to be challenged in court, and there is no certainty as to how a court will rule. AT&T filed several patent applications for methods to take advantage of the dissolution of the net neutrality rules, and complaints continue to mount that certain carriers are slowing access to various third party on-line and cloud services, and providing “fast-lane” access or other preferential terms at increased rates paid by those customers. Unless the FCC’s new rules withstand legal challenge, and Congress is not successful in passing a law reversing the FCC’s action, it is possible that broadband service providers could impose restrictions on bandwidth and service delivery that may adversely impact our download speeds or our customers’ ability to deliver content over those facilities, or impose significant end user or other fees.
Canada
In Canada, the Canadian Radio-television and Telecommunications Commission (“CRTC”), an independent public administrative tribunal, exercises regulatory jurisdiction over the provision of broadcasting and telecommunications services in Canada, pursuant to the Broadcasting Act (Canada) (the “Act”) and the Telecommunications Act (Canada), respectively. Our activities are affected primarily by the provisions of the Act. The Commission’s statutory jurisdiction is strictly limited to that set out in its governing legislation. For purposes of broadcasting, that jurisdiction is set out in the Act and the regulations made under the Act. In exercising its jurisdiction over broadcasting, the CRTC is required to act in accordance with the objectives of the broadcasting policy and regulatory policy set out in the Act.
In October 2009, the CRTC issued Broadcasting Order CRTC 2009-660, reaffirming its previous determination to exempt from licensing (and other requirements under the Act) all “new media broadcasting undertakings”, defined as an undertaking that “provides broadcasting services that are: a. delivered and accessed over the Internet; or b. delivered using point-to-point technology and received by way of mobile devices.” Any undertaking operating pursuant to this “New Media Exemption Order” (now known as the Digital Media Exemption Order, which exempts “digital media broadcasting undertakings”, or “DMBUs”) is exempted from the requirement under the Act to obtain a license from the CRTC before carrying on a broadcasting undertaking. Moreover, the Exemption Order does not contain any conditions with respect to compliance with the Canadian ownership and control rules governing undertakings carrying on broadcasting in Canada.
Under the Digital Media Exemption Order, a DMBU must comply with two conditions to continue to fall under the scope of the Exemption Order. The first condition requires the undertaking to submit such information regarding its activities in broadcasting in digital media, and such other information that is required by the Commission in order to monitor the development of broadcasting in digital media, at such time and in such form, as requested by the Commission from time to time. This condition does not apply to our activities in Canada, although the CRTC indicated in Broadcasting Regulatory Policy CRTC 2010-582 that it may decide to extend these requirements in a manner that may affect companies like ours.
The second condition is an anti-discrimination rule prohibiting granting any person an “undue preference” or subjecting any person to an “undue disadvantage” in connection with the provision of access to a DMBU’s platforms and customer base. The scope of the undue preference rule was considered by the CRTC in 2010 (Broadcasting Notice of Consultation CRTC 2010-783).
Subsequently, the CRTC set out its regulatory framework for vertical integration in Broadcasting Regulatory Policy CRTC 2011-601 and implemented that framework through amendments to various regulations (Broadcasting Regulatory Policy CRTC 2012-407) and through amendments to the Digital Media Exemption Order (see Broadcasting Order CRTC 2012-409). Pursuant to the vertical integration framework, the CRTC has established a code of conduct for commercial arrangements and interactions between BDUs, programming undertakings and DMBUs. Because the continued exemption of DMBUs from regulation is conditional on compliance with the above-noted undue preference prohibition, our customers may have to abandon or change business practices in Canada if the CRTC deems them to be “unduly preferential.” If this content is obtainable from other providers on more attractive terms, our customers could lose these subscribers, which could negatively impact our results of operations. The CRTC may address the scope of this anti-discrimination rule as part of the Let’s Talk TV proceeding (see below).
The CRTC has amended the Digital Media Exemption Order and other various regulations to implement the safeguards established under the vertical integration framework. In Broadcasting Order CRTC 2012-409, the CRTC determined that the regulatory safeguards under the vertical integration framework (prohibitions on exclusivity of content, anti-competitive head starts and dispute resolution) would be applicable to the distribution of programming on mobile and retail Internet platforms. The CRTC prohibits the offering of programming on an exclusive or otherwise preferential basis in a manner that is that is dependent upon subscription to a particular mobile or retail Internet access service. The CRTC also amended the Digital Media Exemption Order to require a DMBU to make available programming not previously distributed in Canada, under the “no head start” rule. The term “head start” refers to situations where a programming service is launched on a given entity’s distribution platform prior to the service having been made available for distribution to other entities on the same platform on commercially reasonable terms. The no head start rule requires availability through alternate entities at the same time that a new pay or specialty programming service is launched. The CRTC has also adopted a rule that in the event of a dispute, programming must be supplied while the dispute is pending. All of these changes may have an impact on our operations and may cause us to make changes in the manner in which we deliver programming to our customers.
Our customers rely on the Digital Media Exemption Order to operate as DMBUs free from Canadian licensing and Canadian ownership and control requirements. The CRTC’s exemption determination may be subject to review by late 2015 or early 2016, or at such time as events dictate. If the CRTC decides, upon review, to rescind or limit the scope of the Digital Media Exemption Order, our customers could become subject to licensing or other regulatory requirements under the Act and regulations made under the Act, which could harm our ability to conduct business in Canada.
Citing rapid technological developments, the CRTC issued Notice of Consultation 2011-344 (“Consultation 2011-344”), asking for broad public commentary on developments in “new media” and “over-the-top” (“OTT”) programming. OTT programming is programming that is delivered via the Internet and that can be accessed without a subscription to a BDU. The Commission considers that Internet access to programming independent of a facility or network dedicated to its delivery (via, for example, cable or satellite) is the defining feature of what have been termed OTT services. Consultation 2011-344 was issued partially in response to the urging of the “Over-the-Top Services Working Group” (a coalition of private sector executives from the distribution, telecommunications, broadcasting, production and creative sectors in Canada) who asked the CRTC to note the growing role for foreign OTT services in Canada. The working group asked the CRTC to initiate a public consultation to investigate whether and how non-Canadian companies should support Canadian cultural programming, as recommended by a Canadian Parliamentary Committee on Canadian Heritage. In Consultation 2011-344, the CRTC also stated that it has been monitoring the development of broadcasting in new media, adding that OTT programming accessed over the Internet is increasingly available to consumers at attractive price points.
In October 2011, the CRTC issued its “Results of the fact-finding exercise on over-the-top programming services.” The CRTC found that the evidence did not demonstrate “that the presence of OTT providers in Canada and greater consumption of OTT content is having a negative impact on the ability of the system to achieve the policy objectives of the Broadcasting Act or that there are structural impediments to a competitive response by licensed undertakings to the activities of OTT providers.” Subsequently, in April 2012, the CRTC issued a written determination that OTT services “have not had an impact sufficient to warrant another fact-finding exercise at this time.” However, the CRTC will continue to “closely monitor OTT services in the context of the evolving Canadian communications landscape.”
Throne Speech and Government Direction
In its October 2013 Speech from the Throne, the Canadian Government stated that it believed Canadians should have more ability to choose unbundled television channels, while protecting Canadian jobs. On November 14, 2013 the Minister of Canadian Heritage released an Order-in-Council (“OIC”) requiring the CRTC to report to the Government by April 30, 2014 on how Canadian consumers could subscribe to pay and specialty television services on an unbundled basis, having regard to the broadcasting and regulatory objectives of the Broadcasting Act. The OIC also required the CRTC to consider the effect of any proposed measures on: consumers with respect to their affordable access to a variety of services, distribution undertakings, Canadian pay and specialty services and Canadian independent producers. In addition, the OIC made it clear that any proposed measures to maximize consumers’ ability to subscribe service-by-service ensure that the majority of programming services received by subscribers remain Canadian.
The CRTC responded to the OIC by commencing a proceeding now known as “Let’s Talk TV” (described below in more detail). Any determinations from the “Let’s Talk TV” proceeding could lead to changes in the regulatory requirements applicable to television programming and BDUs, including in areas such as the offering to consumers of basic cable service, as well as packaging and standalone programming service options.
CRTC Hearing on the Future of Television - Let’s Talk TV
The Let’s Talk TV proceeding, which took place in 2014, provided for a major review of the regulatory and policy framework for the Canadian television broadcasting system, during the course of calendar 2014. This proceeding became commonly known as the “Let’s Talk TV” proceeding. Among the issues for which the CRTC called for comments include the requirement to allow subscribers to select all discretionary services on a standalone (pick-and-pay) basis and build their own custom packages of discretionary programming services (while BDUs would be permitted to continue to offer pre-assembled packages); access provisions for non-vertically integrated programming services; redefining broadcasting revenues of licensees to include revenues from programming offered online or on other exempt platforms. The CRTC’s decision is expected in Spring 2015 and it is anticipated that the proposed regulatory framework would come into force on December 15, 2015. While the outcome of the hearing (including the scope and implementation period for each proposal) is uncertain, this review could lead to changes in the regulatory requirements applicable to television programming and broadcasting distribution undertakings and, indirectly, to companies like ours.
Our operations are also affected by CRTC rules adopted under the Telecommunications Act (Canada) that prevent Internet access providers from discriminating against traffic transmitted to and from end users under the Internet Traffic Management Practice (“ITMP”) regulatory framework issued in Telecom Regulatory Policy CRTC 2009-657. The ITMP framework regulates how Internet access providers handle traffic on the public Internet. The ITMP framework prohibits content-blocking; requires detailed prior public notice (followed by a 30-day warning period) before any retail traffic-shaping measures are implemented; and prohibits traffic-shaping that does not address a justifiable purpose in a manner that is narrowly tailored, minimizes harm, and could not have been reasonably avoided through network investment or economic approaches. These limitations could have an impact on the content delivered to our Canadian customers.
United Kingdom
The United Kingdom Office of Communications (“Ofcom”) implemented regulations in 2010 dealing with On-Demand Programme Services (“ODPS”). It adopted a co-regulatory structure with The Authority for Television On Demand (“ATVOD”) having primary responsibility over content issues and the Advertising Standards Association regulating advertising on ODPS. Ofcom amended its designation of ATVOD in September 2012 confirming its designation of ATVOD as an entity permitted to collect regulatory fees and charged with implementing and enforcing advertising, content (including “European Works”) and other regulations, and further amended its designation on December 1, 2014, to grant ATVOD authority to determine what constitutes an “on-demand programme service,” subject to appeal to Ofcom. Ofcom has backstop powers to regulate both content and advertising on such services. ATVOD has issued guidance on what on-demand services fall within its regulatory scope. Ofcom has clarified that its regulations are meant to provide equal regulatory treatment of linear and on-demand video services. In reviews of ATVOD decisions Ofcom has determined that an on-demand service is an ODPS subject to ATVOD regulation when “its principal purpose is the provision of programmes the form and content of which are comparable to the form and content of programmes normally included in television programme services.” Fee-based programs that are the length of comparable linear television programs and which also appear on linear television are more likely to fall within the regulatory regime. Service providers caught by this regulatory regime for ODPS have to register their service with ATVOD, pay a license fee and conform to the regulations. Edition 2.1 of the applicable Rules and Guidance, published February 26, 2014, should be consulted for more details. ATVOD has set the license fees to be paid in 2014-2015. Other European Union member states have implemented different regulatory structures to deal with video-on-demand (“VOD”) services under their jurisdiction. While challenges to the regulatory scope of ATVOD have often been upheld by Ofcom, not all have been, and ATVOD continues to work to expand its jurisdiction over “TV-like” services, partly to ensure a level playing field over alternative “TV-like” services, but also to expand statutory protections to any service that is comparable in form and content to linear television services. While we continue to believe that our services do not currently meet the definition of an ODPS or otherwise fall within the jurisdiction of Ofcom and ATVOD, a determination of comparability is a factual determination that relies on the programmes and services being provided. We cannot be certain in the future whether ATVOD and Ofcom would determine that services like ours qualify for regulation. Moreover, as we believe that we are not currently established in the UK or any other European Union member state for the purposes of the directive, we believe that neither our streamed nor our on-demand video services will be regulated within the European Union. Websites operated from outside of the UK are not subject to the ATVOD rules.
European Union
An update to the European Union “Audiovisual Media Services Directive” was adopted on April 15, 2010. This amendment expanded the original directive to cover all non-linear VOD services, such as IPTV service providers and content, including subscription-based IPTV content that is distributed over the public Internet in the United Kingdom and to other European Union member states, and subjected these to certain regulatory requirements. A streamed IPTV service could be subject to regulation as a broadcast service in certain situations. Under the directive, whether a broadcast or on-demand service, it will be regulated in the member state in which the service provider is established (for example, where it has its head office and editorial control is exercised), and may be subject to any stricter rules of the target country, particularly in instances of “unsuitable content.” The directive also requires broadcasters to reserve a majority of time for “European works,” and places European work support requirements on on-demand providers. “European works,” as defined in the European Convention on Transfrontier Television of the Council of Europe, are works that are produced both in a European country (by both member states of the European Union and state parties to such Convention) and “within the framework of bilateral production treaties” between member states and non-member countries when the majority share of the production, cost and control of the production is provided by persons (and entities) that are citizens of a member state, and where the non-member state has not imposed discriminatory conditions. Editorial transparency rules have been extended to VOD providers, as have rules protecting children from certain content and advertising. Only the basic tier of regulations otherwise apply to VOD providers, with the more extensive regulations applying only to broadcasters. Again, as we believe that we are not currently established in the UK or any other European Union member state for the purposes of the directive, neither our streamed nor our on-demand video services should be regulated within the European Union. On April 24, 2013, the European Commission issued a Green Paper seeking consultation on the current state of media delivery and regulation, and the convergence of delivery methods, with the Consultation closing on September 30, 2013. The European Commission published its summary of comments on December 9, 2014. No regulatory actions have been proposed at this time, but a dialogue with stakeholders remains open and the European Commission reserves the right to propose regulatory or self-regulatory actions in response to the consultation. To the extent that new or expanded regulations are published in the future, such regulations could have an impact on our delivery of services in the EU, and the costs of delivery.
International Telecommunications Union (“ITU”)
The ITU is the United Nations agency for information and communication technologies. It allocates global radio spectrum and satellite orbits, and develops the technical standards for the interconnection of networks and technologies. Some members of the ITU have initiated a review of international treaties governing use and regulation of the Internet, including proposals that could lead to granting new regulatory and fee-based rights to individual countries, challenging the current open nature of the Internet. If adopted, these directives could be used to restrict access to IPTV or subject it to additional fees. It is too soon to determine the direction of these efforts.
The ITU has also undertaken the drafting and adoption of global standards for IPTV. In January of 2008 the IPTV Focus Group (established by the ITU to coordinate the recommendations of various study groups reviewing IPTV standards, and promote the development of unified global IPTV standards) completed its recommendations regarding the IPTV Global Standards Initiative and transmitted its recommendations to the umbrella Global Standards Initiative (the IPTV-GSI). The purpose of the IPTV-GSI is to organize events for the development of IPTV standards that may be adopted by the ITU. As part of the establishment of the IPTV-GSI, the Telecommunication Standardization Advisory Group (which is principally responsible for the development of telecommunications standards) confirmed the mandate for and expanded the membership of the IPTV-JCA (Joint Coordination Activities), which is charged with the continued development of global IPTV standards and coordination of various study groups. The membership is being extended to include other standards organizations involved with the ITU-T in the IPTV work stemming from the results of the IPTV Focus Group. An IPTV-GSI Technical and Strategic Review (TSR) process has been set up which will operate at every IPTV-GSI event and will bring to the IPTV-JCA any issues requiring guidance or recommendations for action parent group for the development of draft recommendations. While the work of these study groups and the IPTV-GSI focus primarily on technical and quality delivery and measurement standards, the adoption of standards could have an impact on our operations in various countries.
Other International Laws and Regulations
Any future or proposed regulatory initiatives regulating IPTV content in any of the jurisdictions in which our customers’ viewers reside may require us to modify or block content in particular jurisdictions in order to continue distributing content in those jurisdictions, or to minimize the potential negative impact of distribution on our operations.
Our business may also be adversely affected by foreign import, export and currency regulations and global economic conditions. Our current and future development opportunities partly relate to geographical areas outside of the United States and Canada. There are a number of risks inherent in international business activities, including:
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government policies concerning the import and export of goods and services;
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government-imposed sanctions policies prohibiting commerce and transactions with certain persons, countries or regions;
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potentially adverse tax consequences;
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limits on repatriation of earnings;
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the burdens of complying with a wide variety of foreign laws;
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nationalization; and
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potential social, labor, political and economic instability.
We cannot assure you that such risks will not adversely affect our business, financial condition and results of operations.
Furthermore, a portion of our expenditures and revenues will be in currencies other than the U.S. dollar. Our foreign exchange exposure may vary over time with changes in the geographic mix of our business activities. Foreign currencies may be unfavorably impacted by global developments, country-specific events and many other factors. As a result, our future results may be adversely affected by significant foreign exchange fluctuations.
Employees
As of March 1, 2015, we had 767 total employees, 567 of whom were full-time employees.
Executive Officers
The following sets forth information regarding our executive officers. The term of each officer is for one year or until a successor is elected. Officers are normally elected annually.
Kanaan Jemili has been our Chief Executive Officer since January 30, 2015. Dr. Jemili became chief executive officer of DivX, LLC, a wholly owned subsidiary of DivX, in March 2014 upon its acquisition by Parallax Capital Partners, LLC and StepStone Group, LP from Rovi Corporation (“Rovi”). From March 2011 until March 2014, he served as Rovi’s Senior Vice President of Products. From January 2006 until its acquisition by Rovi in March 2011, Dr. Jemili was employed in executive capacities with DivX, LLC. From October 2010 through February 2011, Dr. Jemili was Senior Vice President of Products and Technology at Sonic Solutions, which was the parent company of DivX at that time. Dr. Jemili holds a Master of Science degree in Electrical Engineering from l’Ecole Nationale d’Ingénieurs de Tunis (ENIT) and a Ph.D. degree in in Electrical Engineering from the University of Dayton.
Nancy Li has been our Executive Vice Chairman since January 30, 2015. She was our President and Chief Executive Officer from October 2008 through January 30, 2015. She is the founder of NeuLion USA, Inc. (“NeuLion USA”), our wholly-owned subsidiary, and has been its Chief Executive Officer since its inception in 2003. From 2001 to 2003, Ms. Li established and ran iCan SP, a provider of end-to-end service management software for information technology operations and a wholly-owned subsidiary of CA Inc., which was formerly known as Computer Associates International, Inc. (“Computer Associates”). From 1990 to 2001, Ms. Li was Executive Vice President and Chief Technology Officer for Computer Associates, and prior to that held a variety of management positions covering virtually every facet of Computer Associates’ business from a development and engineering perspective. Ms. Li holds a Bachelor of Science degree from New York University. Ms. Li is married to Charles B. Wang, the chairman of our Board of Directors.
G. Scott Paterson has been our Vice Chairman since October 2008. Prior to his current position, Mr. Paterson was our Chairman from January 2002 until October 2008 and Chief Executive Officer from May 2005 until October 2007 and again from June 2008 until October 2008. Mr. Paterson is a Director, Chairman of the Audit Committee and a member of the Strategic Committee of Lions Gate Entertainment (NYSE:LGF). Mr. Paterson is also Chairman of Symbility Solutions Inc., formerly Automated Benefits Corp (TSX:SY (formerly TSX:AUT)). He is also the Chairman of the Merry Go Round Children’s Foundation and a Governor of Ridley College. From October 1998 until December 2001, Mr. Paterson was Chairman and CEO of Yorkton Securities Inc., which under his leadership became Canada’s leading technology investment bank. Mr. Paterson has served in the past as Chairman of the Canadian Venture Stock Exchange and as Vice Chairman of the TSX. Mr. Paterson is a graduate of Ridley College and earned a Bachelor of Arts (Economics) degree from the University of Western Ontario. In 2009, Mr. Paterson obtained the ICD.D designation by graduating from the Rotman Institute of Corporate Directors at the University of Toronto.
Arthur J. McCarthy has been our Chief Financial Officer since November 2008. Mr. McCarthy is also an Alternate Governor of the New York Islanders Hockey Club, L.P. (“New York Islanders”) on the NHL Board of Governors. From 1985 until November 2008, Mr. McCarthy was the Senior Vice President and Chief Financial Officer of the New York Islanders and was responsible for the financial affairs of the club and its affiliated companies. From 1977 to 1985, Mr. McCarthy was a member of the Audit Practice of KPMG Peat Marwick, reaching the position of Senior Manager. Mr. McCarthy was licensed in the State of New York as a Certified Public Accountant in 1980 and holds a Bachelor of Science degree from Long Island University - C.W. Post College.
Horngwei (Michael) Her has been our Co-Chief Technology Officer since January 30, 2015. He was the Executive Vice President, Research and Development, of NeuLion from October 2008 through January 30, 2015 and has been the Executive Vice President of Research and Development of NeuLion USA since January 2004. From 2000 to 2003, Mr. Her ran the development team for iCan SP. Prior to that, Mr. Her served as Senior Vice President for Research & Development at Computer Associates. He is also the co-inventor of several computer systems patents. Mr. Her holds a college degree from Taipei Teaching College and a Master of Computer Science degree from the New York Institute of Technology.
Eric Grab has been our Co-Chief Technology Officer since January 30, 2015. He was the Chief Technology Officer of DivX, LLC from March 2014 through January 30, 2015 and the Vice President - Technology of Rovi from February 2011 to March 2014. Prior to that, Mr. Grab was Vice President - Advanced Technology of Walt Disney Studios, Disney Corporation. Mr. Grab holds a Bachelor of Science degree in Computer Science and Physics from San Diego State University.
Roy E. Reichbach has been our General Counsel and Corporate Secretary since October 2008 and has been the General Counsel and Corporate Secretary of NeuLion USA since 2003. Mr. Reichbach is also an Alternate Governor of the New York Islanders on the NHL Board of Governors. From 2000 until October 2008, Mr. Reichbach was the General Counsel of the New York Islanders and was responsible for the legal affairs of the club and its affiliated real estate companies. From 1994 until 2000, Mr. Reichbach was Vice President - Legal at Computer Associates. Prior to that, he was a trial lawyer in private practice. Mr. Reichbach holds a Bachelor of Arts degree from Fordham University and a Juris Doctorate degree from Fordham Law School. He has been admitted to practice law since 1988.
Ronald Nunn has been our Executive Vice President, Business Operations since October 2008 and the Executive Vice President of Business Operations of NeuLion USA since January 2004. From 2000 to 2003, Mr. Nunn was in charge of business operations at iCan SP. Between 1987 and 2000, Mr. Nunn held a number of senior management positions at Computer Associates. From 1982 to 1987, Mr. Nunn directed certain research and development and operating projects with UCCEL (formerly University Computing Company).
J. Christopher Wagner has been our Executive Vice President, Marketplace Strategy since November 2010 and the Executive Vice President of Marketplace Strategy of NeuLion USA since February 2004. Mr. Wagner was our Executive Vice President of Sales from October 2008 until November 2010. From 2000 to 2003, Mr. Wagner worked as the Chief Executive Officer and member of the Board of Directors of several private equity and venture capital firms, including Metiom, MetaMatrix, Exchange Applications and Digital Harbor. From 1984 to 2000, Mr. Wagner held several positions at Computer Associates, culminating in his becoming Executive Vice President and General Manager of Services, responsible for building that company’s Government Partner Program and Global Consulting Business. Mr. Wagner received a Bachelor of Science degree from the University of Delaware.
Item 1A.
Item 1A. Risk Factors
An investment in our common stock is highly speculative and involves a high degree of risk. The following are specific and general risks that could affect us. If any of the circumstances described in these risk factors actually occurs, or if additional risks and uncertainties not presently known to us or that we do not currently believe to be material in fact occur, our business, financial condition or results of operations could be harmed or otherwise negatively affected. In that event, the trading price of our common stock could decline, and you could lose part or all of your investment. In addition to carefully considering the risks described below, together with the other information contained in this Annual Report on Form 10-K, you should also consider the risks described under the captions “Competition” and “Regulation” in Item 1 hereof, which risk factors are incorporated by reference into this Item 1A. In addition, these factors represent risks and uncertainties that could cause actual results to differ materially from those implied by forward-looking statements contained in this Annual Report on Form 10-K.
We may need additional capital to fund continued growth, which may not be available on acceptable terms or at all, and could result in our business plan being limited and our business being harmed.
Our ability to increase revenue will depend in part on our ability to continue growing the business and acquiring new customers, which may require significant additional capital that may not be available to us. We may need additional financing due to future developments, changes in our business plan or failure of our current business plan to succeed. Our actual funding requirements could vary materially from our current estimates. If additional financing is needed, we may not be able to raise sufficient funds on favorable terms or at all. If we issue common stock, or securities convertible into common stock, in the future, such issuance will result in the then-existing stockholders sustaining dilution to their relative proportion of our outstanding equity. If we fail to obtain any necessary financing on a timely basis, then our ability to execute our current business plan may be limited, and our business, liquidity and financial condition could be harmed.
We may not realize the anticipated benefits of the DivX acquisition.
On January 30, 2015, we completed our acquisition of DivX. We expect that this acquisition will provide us with the opportunity to capitalize on the rapidly accelerating adoption of ultra HD/4K video and Over-The-Top Services in the fast-growing online video market and enable us to leverage DivX’s relationships within the consumer electronics industry to provide our customers with greater choices in the building and management of their digital video platforms. A variety of factors may adversely affect our ability to achieve the anticipated benefits of this acquisition, including our ability to successfully integrate DivX’s operations and employees with ours, our ability to cross sell the combined company’s technology and services, and other circumstances beyond our control.
DivX may have undisclosed material liabilities.
In connection with the acquisition of DivX, we performed a due diligence investigation of that company’s assets and liabilities. There may be liabilities that we failed or were unable to discover in our due diligence, and we may not be indemnified for some or all of these liabilities. The discovery of any material liabilities could have a material adverse effect on our business, financial condition and results of operations.
The costs of network access may rise, which could negatively impact our profitability.
We rely on Internet providers for our principal connections and network access to stream audio and video content to our customers’ viewers. As demand for streamed media continues to increase, we cannot assure you that Internet providers will continue to price their network access services on reasonable terms. The distribution of streaming media requires distribution of large content files and providers of network access may change their business model and increase their prices significantly. In order for our distribution services to be successful, there must be a reasonable price model in place to allow for the continuous distribution of large streaming media files. To the extent that Internet providers implement usage-based pricing, institute bandwidth caps, or otherwise try to monetize access to their networks by data providers, we could incur greater operating expenses. In addition, the FCC has begun to impose regulatory fees on MPVDs that mirror the charges levied on cable companies. Additional regulatory costs could be added. Please see “Regulation-United States” in Item 1 above for additional detail.
If Internet providers engage in discriminatory practices against certain types of traffic on their networks, our business could be negatively affected.
As discussed under “Regulation-United States” in Item 1 above, loss of protection provided by the so-called net neutrality rules, which help insure non-discriminatory pricing, access and speed, could negatively affect our services. If discriminatory pricing or other restrictions were put into place, our costs could increase (because our customers decided to pay to be included in the favored category of providers), or the viewership of our customers’ content could decline (due to a decline in the speed with which our customers’ content was streamed to viewers or the imposition of other access restrictions). Within such a regulatory environment, coupled with the significant political and economic power of Internet providers, our customers could experience discriminatory or anti-competitive practices that could impede their growth, which could negatively impact our profitability or otherwise negatively affect our business.
Our business depends on continued and unimpeded access to the Internet at non-discriminatory prices. Internet access providers and Internet backbone providers may be able to block, limit, degrade or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users.
Our products and services depend on the ability of our customers’ viewers to access the Internet, and certain of our customers’ products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant and increasing market power in the broadband and Internet access marketplace, including incumbent telephone companies, cable companies and mobile communications companies. Some of these providers have stated that they may take measures that could degrade, disrupt or increase the cost of user access by restricting or prohibiting the use of their infrastructure to support or facilitate offerings, or by charging increased fees to provide offerings, while others, including some of the largest providers of broadband Internet access services, have committed to not engaging in such behavior. The inability or unwillingness of regulators to protect net neutrality, as discussed under “Regulation-United States” in Item 1 above, could permit broadband service providers to impose restrictions on bandwidth and service delivery that may adversely impact our download speeds or ability to deliver content over those facilities, or impose significant fees upon us, end users or other fees that could impact the cost of our services to end users, or our delivery costs. Current and future actions by broadband Internet access providers may also result in limitations on access to our services, a loss of existing users, or increased costs to us, our users or our customers, thereby impairing our ability to attract new users, or limiting our opportunities and models for revenue and growth.
Our reputation and relationships with customers would be harmed if their subscribers’ data, particularly billing data, were to be accessed by unauthorized persons.
We maintain personal data regarding our customers’ subscribers, including names and, in many cases, mailing addresses, and we take measures to protect against unauthorized access to subscriber data. If, despite these measures, we experience any unauthorized access of subscriber data, customers may elect to not continue to work with us, we could face legal claims, and our business could be adversely affected. Similarly, recent well-publicized cases of unauthorized access to consumer data could lead to general public loss of confidence in the use of the Internet for commerce transactions, which could adversely affect our business.
Demand for the content our customers offer may be insufficient for us to achieve and sustain profitability.
One of our objectives is to offer programming that sustains loyal audiences in or across various demographic groups. The attractiveness of our customers’ content offerings and ability to retain and grow the audiences for their programs will be an important factor in their ability to sell subscriptions and will depend, among other things, upon:
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whether they offer, market and distribute high-quality programming consistent with subscribers’ tastes;
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the marketing and pricing strategies that they employ relative to those of their competitors; and
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subscribers’ willingness to pay pay-per-view or subscription fees to access our customers’ content.
Their content offerings may not attract or retain the anticipated number of subscribers and some content may offend or alienate subscribers that are outside of the target audience for that content. Our results of operations will depend in part upon our ability and that of our customers to increase their subscriber bases while maintaining their preferred pricing strategies, managing costs and controlling subscriber turnover rates.
We may have difficulty, and incur substantial costs, in scaling and adapting our existing systems architecture to accommodate increased traffic, technology advances or customer requirements.
Our future success will depend on our ability to adapt to rapidly changing technologies, to adapt our services to evolving industry standards and to improve the performance and reliability of our services. The IPTV industry, the Internet and the video entertainment industries in general are characterized by rapid technological change, frequent new product innovations, changes in customer requirements and expectations and evolving industry standards. We cannot assure you that one or more of the technologies we use will not become obsolete or that our services will be in demand at the time they are offered. If we or our customers are unable to keep pace with technological and industry changes, our business may be unsuccessful.
In the future, we may be required to make changes to our systems architecture or move to a completely new architecture. To the extent that demand for our services and media offerings increases, we will need to expand our infrastructure, including the capacity of our hardware servers and the sophistication of our software. If we are required to switch architectures, we may incur substantial costs and experience delays or interruptions in our service. These delays or interruptions in our service may cause customers and their viewers to become dissatisfied and move to competing providers of IPTV services. An unanticipated loss of traffic, increased costs, inefficiencies or failures to adapt to new technologies or user requirements and the associated adjustments to our systems architecture could harm our operating results and financial condition.
In addition, we may introduce new services and/or functionalities to increase our customers’ subscriber bases and long-term profitability. These services are dependent on successful integration of new technologies into our distribution infrastructure.
We depend on third parties to develop technologies used in key elements of our services. More advanced technologies that we may wish to use may not be available to us on reasonable terms or in a timely manner. Further, our competitors may have access to technologies not available to us, which may enable these competitors to offer products of greater interest to consumers or at more competitive costs.
Our business depends on the continued growth and maintenance of the Internet infrastructure.
The success and the availability of Internet-based products and services depends in part upon the continued growth and maintenance of the Internet infrastructure itself, including its protocols, architecture, network backbone, data capacity and security. Spam, viruses, worms, spyware, denial of service or other attacks by hackers and other acts of malice may affect not only the Internet’s speed, reliability and availability but also its continued desirability as a vehicle for commerce, information and user engagement. If the Internet proves unable to meet the new threats and increased demands placed upon it, our business plans, user and advertiser relationships, site traffic and revenues could be harmed.
We may be unable to manage rapidly expanding operations.
We are continuing to grow and diversify our business both domestically and internationally. As a result, we will need to expand and adapt our operational infrastructure. To manage growth effectively, we must, among other things, continue to develop our internal and external sales forces, our distribution infrastructure capability, our customer and subscriber service operations and our information systems, maintain our relationships with our customers, effectively enter new areas of the sports and other programming markets and effectively manage the demands of day-to-day operations in new areas while attempting to execute our business strategy and realize the projected growth and revenue targets developed by our management. We will also need to continue to expand, train and manage our employee base, and our management must assume even greater levels of responsibility. If we are unable to manage growth effectively, we may experience a decrease in customer growth and an increase in customer turnover, which could negatively impact our financial condition, profitability and cash flows.
Acquisitions and strategic investments could adversely affect our operations and result in unanticipated liabilities.
We may in the future acquire or make strategic investments in a number of companies, including through joint ventures. Such transactions may result in dilutive issuances of equity securities, use of our cash resources, incurrence of debt and amortization of expenses related to intangible assets. Any such acquisitions and strategic investments would be accompanied by a number of risks, including:
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the difficulty of assimilating operations and personnel of acquired companies into our operations;
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the potential disruption of ongoing business and distraction of management;
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additional operating losses and expenses of the businesses acquired or in which we invest;
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the difficulty of integrating acquired technology and rights into our services and unanticipated expenses related to such integration;
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the potential for patent and trademark infringement claims against the acquired company;
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the impairment of relationships with customers of the companies we acquired or with our customers as a result of the integration of acquired operations;
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the impairment of relationships with employees of the acquired companies or our employees as a result of integration of new management personnel;
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the difficulty of integrating the acquired company’s accounting, management information, human resources and other administrative systems;
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in the case of foreign acquisitions, uncertainty regarding foreign laws and regulations and difficulty integrating operations and systems as a result of cultural, systems and operational differences; and
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the impact of known potential liabilities or unknown liabilities associated with the companies we acquire or in which we invest.
Our failure to address or mitigate such risks in connection with future acquisitions and strategic investments could prevent us from realizing the anticipated benefits of such acquisitions or investments, causing us to incur unanticipated liabilities and harming our business generally.
We could suffer failures or damage due to events that are beyond our control, which could harm our brand and operating results.
Our success as a business depends, in part, on our ability to provide consistently high-quality video streams to our customers’ viewers through our infrastructure and IPTV technology on a consistent basis. Our infrastructure is susceptible to natural or man-made disasters such as hurricanes, earthquakes, floods, fires, power loss and sabotage, as well as interruptions from technology malfunctions, computer viruses and hacker attacks. Other potential service interruptions may result from unanticipated demands on network infrastructure, increased traffic or problems in customer service. Significant disruptions in our infrastructure would likely affect the quality and continuity of our service, could harm our goodwill and the NeuLion brand and ultimately could significantly and negatively impact the amount of revenue we may earn from our service. We may not carry sufficient business interruption insurance to compensate for losses that could occur as a result of an interruption in our services.
Anything that negatively impacts our customers’ businesses could harm our business as well.
The success of our business depends significantly on our relationships with our customers. We enter into agreements to distribute content. Our realization of our business goals depends in part on the cooperation, good faith, programming and overall success of our customers. Because of our dependency on our customers, should a customer’s business suffer as a result of increased competition, increased costs of programming, technological problems, regulatory changes, adverse effects of litigation or other factors, our business may suffer as well. Financial difficulties experienced by our customers, such as bankruptcy, insolvency, liquidation or winding up of daily operations, could also have negative consequences on our business. A failure by one of our customers to perform its obligations under its agreement could have detrimental financial consequences for our business. The agreements are for various terms and have varying provisions regarding renewal or extension. If we are unable to renew or extend these agreements at the conclusion of their respective terms, our business and results of operations could be harmed.
Our customers may be required to abandon or change business practices in Canada if the regulator deems them to be unduly preferential.
Because the CRTC conditions its exemption from regulation of DMBUs on compliance with the anti-discrimination rule prohibiting the exercise of an “undue preference,” our customers may have to abandon or change business practices in Canada if the CRTC deems them to be “unduly preferential.” If this content is obtainable from other providers on more attractive terms, our customers could lose these subscribers, which could negatively impact our results of operations. The CRTC oversees the scope of the undue preference rule on an ongoing basis primarily through the complaints and dispute resolution process (and to the extent that it announces a policy proceeding to examine the framework from time to time).
Regulation of DMBUs or other amendments to the Digital Media Exemption Order may have an impact on our business.
As noted above, the CRTC’s Let’s Talk TV proceeding sought public input concerning the future direction of Canada’s television regulatory framework, including the ability of subscribers to select all discretionary services on a standalone (pick-and-pay) basis and build their own custom packages of discretionary programming services; access provisions for non-vertically integrated programming services; redefining broadcasting revenues of licensees to include revenues from programming offered online or on other exempt platforms. Therefore, there is a small chance that the tensions between traditional business models that have been pervasive in the television industry and new media development will be resolved in a manner that is less favorable to our business. This might particularly be the case if the CRTC decides to introduce regulation of DMBUs to require them to produce, acquire or exhibit domestic Canadian content programming.
As mentioned, our customers rely on the CRTC’s Digital Media Exemption Order and the exemption it provides for Internet-based broadcasting from Canadian licensing and Canadian ownership and control requirements. The exemption allows them to attract and serve Canadian subscribers without being subject to such requirements. The CRTC’s exemption determination could be reviewed by late 2015 or early 2016, or at such time as events dictate. If the CRTC decides, upon review, to rescind or limit the scope of the Digital Media Exemption Order, our customers could become subject to licensing or other regulatory requirements under the Act and regulations made under the Act, which could harm or impede our ability to conduct business in Canada.
Our business may be impaired by third-party intellectual property rights in the programming content of our customers.
We are exposed to liability risk in respect of the content that our customers distribute over the Internet, relating to both infringement of third-party rights to the content and infringement of the laws of various jurisdictions governing the type and/or nature of the content. We rely in large part on our customers’ obligations under our agreements to ensure intellectual property rights compliance globally, including securing the primary rights to distribute programming and other content over the Internet, and to advise us of any potential or actual infringement so that we may take appropriate action if such content is not intellectual property rights-compliant or is otherwise obscene, defamatory or indecent. In the event that our partners are in breach of the rights related to specific programming and other content, they may be required to cease distributing or marketing the relevant content to prevent any infringement of related rights, and may be subject to claims of damages for infringement of such rights.
We may be subject to other third-party intellectual property rights claims.
Companies in the Internet, technology and media industries often own large numbers of patents, copyrights, trademarks and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. As we face increasing competition, the possibility of intellectual property rights claims against us grows. Our technologies may not be able to withstand third-party claims or rights against their use. Intellectual property claims, whether having merit or otherwise, could be time-consuming and expensive to litigate or settle and could divert management resources and attention. In addition, many of our agreements with network service providers require us to indemnify these providers for third-party intellectual property infringement claims, which could increase our costs as a result of defending such claims and may require that we pay the network service providers’ damages if there were an adverse ruling in any such claims.
If litigation is successfully brought by a third party against us in respect of intellectual property, we may be required to cease distributing or marketing certain products or services, obtain licenses from the holders of the intellectual property at material cost, redesign affected products in such a way as to avoid infringing intellectual property rights or seek alternative licenses from other third parties that may offer inferior programming, any or all of which could hurt our business, financial condition and results of operations. If those intellectual property rights are held by a competitor, we may be unable to obtain the intellectual property at any price, which could also negatively impact our competitive position. Any of these results could harm our business, financial condition and results of operations.
Internet transmissions may be subject to theft and malicious attacks, which could cause us to lose customers and revenue.
Like all Internet transmissions, streaming content may be subject to interception and malicious attack. Pirates may be able to obtain or redistribute programs without paying fees. Our distribution infrastructure is exposed to spam, viruses, worms, spyware, denial of service or other attacks by hackers and other acts of malice. Theft of our content or attacks on our distribution infrastructure would reduce future potential revenue and increase our infrastructure costs.
We use security measures intended to make theft of content and consumer data more difficult. However, if we are required to upgrade or replace existing security technology, the cost of such security upgrades or replacements could negatively impact our financial condition, profitability and cash flows. In addition, other illegal methods that compromise Internet transmissions may be developed in the future. If we cannot control compromises of our service, then our customers’ net subscriber acquisition costs and subscriber turnover could increase, our revenue could decrease and our ability to contract with new customers could be impaired.
Privacy concerns could harm our business and operating results, and deter current and potential users from using our products and services.
In the ordinary course of business, we collect and utilize data supplied by our customers’ subscribers. Increased regulation of data utilization practices, including self-regulation or findings under existing laws, that limit our ability to use collected data, could have an adverse effect on our business. In addition, if we were to disclose data about our customers’ subscribers in a manner that was objectionable to the subscribers, our reputation could be damaged, the number of subscribers could decline, and both our customers and we could face potential legal claims that could ultimately impact our operating results. As our business evolves and grows, we may become subject to additional and/or more stringent legal obligations concerning the treatment of subscriber information. Finally, classification of IPTV as an MVPD, or application of common carrier rules, as discussed under "Regulation - United States" in Item 1 above, could each cause the imposition of new rules on our maintenance and use of customer data. Failure to comply with these obligations could subject us to liability, and to the extent that we need to alter our business model or practices to adapt to these obligations, we could incur additional expenses or lost revenues.
We depend on key personnel and relationships, and the loss of their services or the inability to attract and retain them may negatively impact our business.
We are dependent on key members of our senior management. In addition, innovation is important to our success, and we depend on the continued efforts of our executive officers and key employees, who have specialized technical knowledge regarding our distribution infrastructure and information technology systems and significant business knowledge regarding the IPTV industry and subscription services. The market for the services of qualified personnel is competitive and we may not be able to attract and retain key employees. If we lose the services of one or more of our executive officers or key employees, or fail to attract qualified replacement personnel, then our business and future prospects could be harmed.
We may have exposure to greater than anticipated tax liabilities.
We are subject to income and other taxes in a variety of jurisdictions, and our tax structure is subject to review by both domestic and foreign taxation authorities. The determination of our world-wide provision for income taxes and other tax liabilities requires significant judgment and, in the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe that our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded on our consolidated financial statements and may materially affect our financial results in the period or periods for which such determination is made.
We are subject to foreign business, political and economic disruption risks.
We contract with various entities around the world, including in respect of the acquisition of rights to distribute content via the Internet. As a result, we are exposed to foreign business, political and economic risks, including:
·
political and economic instability;
·
less developed infrastructures in newly industrializing countries;
·
susceptibility to interruption of feeds in foreign areas due to war, terrorist attacks, medical epidemics, changes in political regimes and general interest rate and currency instability;
·
exposure to possible litigation or claims in foreign jurisdictions; and
·
competition from foreign-based technology service providers, and the existence of protectionist laws and business practices that favor such entities.
If any of these risks are realized, it could hurt our business, financial position and results of operations.
Item 1B.
Item 1B. Unresolved Staff Comments
As of January 1, 2015, we no longer qualified as a smaller reporting company. However, because we are permitted to satisfy our obligations under this Annual Report on Form 10-K by complying with the requirements applicable to a smaller reporting company, we are not required to include information called for by this item.
Item 2.
Item 2. Properties
Our principal executive offices are located in Plainview, New York. We lease the following properties:
Item 3.
Item 3. Legal Proceedings
There is no material litigation currently pending or threatened against us or, to our knowledge, any of our officers or directors in their capacity as such.
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
Market Price Information
There is no established public trading market for our common stock in the United States. The TSX is the principal established foreign public trading market for our common stock, which trades under the symbol NLN. The table below sets forth, for the periods indicated, the high and low sales prices of our common stock on the TSX, in Canadian dollars, for each full quarterly period within the two most recent fiscal years, as reported by the TSX.
Stockholders
As of March 2, 2015, there were 212 holders of record of our common stock.
Dividends
We have paid no dividends on our common stock since our inception. At the present time, we intend to retain earnings, if any, to finance the expansion of our business. The payment of dividends in the future will depend on our earnings and financial condition and on such other factors as the Board of Directors may consider appropriate.
The Delaware General Corporation Law (“DGCL”) sets out when a company is restricted from declaring or paying dividends. Under Section 170 of the DGCL, a company may not declare or pay a dividend out of net profits if the capital of the company is less than the aggregate amount of the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets until the deficiency in the amount of such capital has been repaired.
Our Certificate of Incorporation, as amended, also sets forth limits on the payment of dividends on our common stock in preference to our preferred stock. Except with the consent in writing of the holders of a majority of the Class 4 Preference Shares outstanding, no dividend will at any time be declared and paid on or set apart for payment on our common stock, Class 3 Preference Shares or on any other shares ranking junior to the Class 4 Preference Shares in any financial year unless and until certain cumulative dividends on all the Class 4 Preference Shares outstanding have been declared and paid or set apart for payment. Similarly, except with the consent in writing of the holders of a majority of the Class 3 Preference Shares outstanding, no dividend will at any time be declared and paid on or set apart for payment on our common stock or on any other shares ranking junior to the Class 3 Preference Shares in any financial year unless and until certain cumulative dividends on all the Class 3 Preference Shares outstanding have been declared and paid or set apart for payment.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2014 with respect to compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance:
Equity Compensation Plan Information
(1)
The maximum number of shares of common stock issuable upon exercise of securities granted pursuant to the 2012 Omnibus Securities and Incentive Plan (the “2012 Plan”) shall be 30,000,000.
(2)
The maximum number of shares of common stock issuable upon exercise of options granted pursuant to the Fourth Amended and Restated Stock Option Plan (the “Stock Option Plan”) is equal to the greater of (i) 4,000,000 shares of common stock and (ii) 12.5% of the number of issued and outstanding shares of common stock from time to time. As a result, any increase in the issued and outstanding shares will result in an increase in the number of shares of common stock available for issuance under the Stock Option Plan, and any exercises of options will make new grants available under the Stock Option Plan. No new option awards will be made under the Stock Option Plan, however, outstanding awards under the Stock Option Plan will remain in effect pursuant to their terms. All future awards of options will be made under the 2012 Plan.
(3)
Shares of common stock are issued directly under the Amended and Restated Directors’ Compensation Plan (“Directors’ Compensation Plan”) without exercise of any option, warrant or right.
(4)
We have not issued shares under the Employee Share Purchase Plan since its approval by our stockholders.
On May 9, 2012 (the “Issuance Date”), we executed a warrant certificate in favor of Raine Advisors LLC, a consultant, for the issuance of up to 3,789,482 warrants to purchase up to such number of shares of common stock of the Company at an exercise price of $0.2201 per share (a weighted-average exercise price of $0.2201 per share). On the Issuance Date, 1,894,741 warrants automatically vested. The remaining 1,894,741 warrants shall vest on such date that occurs prior to the expiration date, which shall be 10 years from the Issuance Date, upon Raine’s satisfaction of certain conditions set forth in the warrant certificate. All of such warrants were outstanding as of December 31, 2014.
Recent Sales of Unregistered Securities
Information regarding other securities sold by us but not registered under the Securities Act of 1933, as amended (the “Securities Act”), during the fiscal year ended December 31, 2014 has been previously included in our Quarterly Reports on Form 10-Q for the periods ended March 31, 2014, June 30, 2014 and September 30, 2014. Information regarding securities sold by us but not registered under the Securities Act subsequent to the quarter ended September 30, 2014 through December 31, 2014 that were not reported on a Current Report on Form 8-K filed with the SEC during that period is as follows:
1. On December 23, 2014, we issued shares of common stock without registration under the Securities Act to non-management directors, in payment pursuant to our Directors’ Compensation Plan of their semi-annual directors’ fees for the six-month period ended December 31, 2014, in the following aggregate amounts:
The aggregate value of the 84,252 shares of common stock issued to Dr. Kenny and Messrs. Anderson, Battista, Bostrom, Kronfeld and Wang was $89,277 on the date of issuance. We issued these shares of common stock pursuant to the exemption from registration set forth in Section 4(2) of the Securities Act and Regulation D promulgated thereunder. This issuance qualified for exemption from registration under the Securities Act because (i) each of the directors was an accredited investor at the time of the issuance, (ii) we did not engage in any general solicitation or advertising in connection with the issuance, and (iii) each of the directors received restricted securities.
2. Certain subscribers to the Company’s September 25, 2012 private placement residing outside the United States exercised an aggregate of 2,750 Warrants and received 1,965 shares of common stock. Per the terms of the Warrant certificates, the Warrant exercise took place on a cashless basis, which resulted in the holder receiving the number of shares of common stock determined by dividing the “intrinsic value” of the Warrants being exercised by the “fair market value.” The “intrinsic value” per share was determined by subtracting the exercise price of $0.30 per share from the fair market value (conversion from Canadian dollars to US dollars took place). The “fair market value” means the average of the closing prices of the common stock of the Company from the five days immediately prior to the date on which the Company received an exercise notice from a holder. As a result of the cashless exercise, the holder did not make any payment to the Company in connection with exercising the Warrants. The Company offered and sold the common stock in reliance on the exemption from registration afforded by Regulation S under the Securities Act.
3. Four employees residing in the United States exercised an aggregate of 123,750 stock options for total cash proceeds of $46,725 and received 123,750 shares of the Company’s common stock. Three employees residing outside of the United States exercised an aggregate of 10,500 stock options for total cash proceeds of $5,195 and received 10,500 shares of the Company’s common stock. The Company offered and sold the common stock and stock options in reliance on the exemption from registration afforded by Section 4(2) under the Securities Act.
4. Two employees residing outside the United States exercised an aggregate of 4,250 stock options on a “net basis” and received 2,406 shares of the Company’s common stock. The Company offered and sold the common stock and stock options in reliance on the exemption from registration afforded by Section 4(2) under the Securities Act. Exercising on a “net basis” means the holder receives shares of common stock equal to the in-the-money value of his or her options. The “in-the-money value” is calculated as the five-day volume-weighted average stock price prior to the date of exercise (i.e., the “fair market value”) minus the exercise price, with the resultant difference being multiplied by the number of options exercised and the resultant product being divided by the fair market value.
Repurchases of Equity Securities During the Fourth Quarter of the Fiscal Year Ended December 31, 2014
None.
Item 6.
Item 6. Selected Financial Data
As of January 1, 2015, we no longer qualified as a smaller reporting company. However, because we are permitted to satisfy our obligations under this Annual Report on Form 10-K by complying with the requirements applicable to a smaller reporting company, we are not required to include information called for by this item.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This management’s discussion and analysis (“MD&A”) of the financial condition and results of operations of the Company should be read in conjunction with our audited consolidated financial statements and accompanying notes for the years ended December 31, 2014 and 2013, which have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”). All dollar amounts are in U.S. dollars (“US$” or “$”) unless stated otherwise. As at March 2, 2015 the Bank of Canada noon rate for conversion of United States dollars to Canadian dollars (“CDN$”) was US$1 to CDN$1.2535.
Our MD&A is intended to enable readers to gain an understanding of our current results and financial position. To do so, we provide information and analysis comparing the results of operations and financial position for the current year to those of the preceding comparable year. We also provide analysis and commentary that we believe is required to assess our future prospects. Accordingly, certain sections of this report contain forward-looking statements that are based on current plans and expectations. These forward-looking statements are affected by risks and uncertainties that are discussed in Item 1A of this Annual Report on Form 10-K and below in the section titled “Cautions Regarding Forward-Looking Statements” and that could have a material impact on future prospects. Readers are cautioned that actual results could vary from those forecasted in this MD&A.
Cautions Regarding Forward-Looking Statements
This MD&A contains certain forward-looking statements that reflect management’s expectations regarding our growth, results of operations, performance and business prospects and opportunities.
Statements about our future plans and intentions, results, levels of activity, performance, goals, achievements or other future events constitute forward-looking statements. Wherever possible, words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” or “potential” or the negative or other variations of these words, or similar words or phrases, have been used to identify these forward-looking statements. These statements reflect management’s current beliefs and are based on information available to management as of the date of this Annual Report on Form 10-K.
Forward-looking statements involve significant risk, uncertainties and assumptions. Although the forward-looking statements contained in this MD&A are based upon what management believes to be reasonable assumptions, we cannot assure readers that actual results will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this Annual Report on Form 10-K and we assume no obligation to update or revise them to reflect new events or circumstances, except as required by law. Many factors could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including: our ability to derive anticipated benefits from the acquisition of DivX Corporation (“DivX”); our ability to successfully integrate the operations of DivX; our ability to realize some or all of the anticipated benefits of our partnerships; our ability to increase revenue; general economic and market segment conditions; our customers’ subscriber levels and financial health; our ability to pursue and consummate acquisitions in a timely manner; our continued relationships with our customers; our ability to negotiate favorable terms for contract renewals; competitor activity; product capability and acceptance rates; technology changes; regulatory changes; foreign exchange risk; interest rate risk; and credit risk. These factors should be considered carefully and readers should not place undue reliance on the forward-looking statements. A more detailed assessment of the risks that could cause actual results to materially differ from current expectations is contained in Item 1A, “Risk Factors.”
Overview
NeuLion is a technology product and service provider that specializes in the digital video broadcasting, distribution and monetization of live and on-demand content to Internet-enabled devices. Through our cloud-based end-to-end solution, we build and manage interactive digital networks that enable our customers to provide a destination for their viewers to view and interact with their content. On January 30, 2015, we consummated the acquisition of DivX, which creates, distributes, and licenses digital video technologies for PCs, smart TVs, and mobile devices. MainConcept, its subsidiary, provides a high-quality video compression-decompression, or codec, software library to consumer electronics manufacturers and others.
Our core business and business model have evolved from being a provider of professional information technology services and international programming to a provider of customized, end-to-end, interactive content services for a wide range of professional and collegiate sports properties, cable networks and operators, content owners and distributors, and telecommunication companies. With a fundamental shift in the way media is now being consumed, technological advancements are affecting how, when and where consumers connect to content. Our technology enables our customers to seamlessly manage and deliver interactive and high-quality content, up to ultra HD/4K screen resolution, to multiple types of Internet-enabled devices such as PCs, smartphones and tablets. Our cloud-based technology platform offers a variety of digital technology and services for content rights holders, including content ingestion, live encoding, live video editing, digital rights management, advertising insertion and management, pay flow and premium content payment support, video player software development kits, multi-platform device delivery, content management, subscriber management, digital rights management, billing services, app development, website design, analytics and reporting. To our new consumer electronics manufacturing customers gained in the DivX acquisition, NeuLion offers technology and products that enable premium screen resolution, also up to ultra HD/4K, for a wide range of Internet-enabled devices that include smart TVs, smartphones and tablets.
Recent Developments
At our Annual Meeting of Stockholders on June 5, 2014, our stockholders approved an amendment to our Certificate of Incorporation, as amended, permitting the Board, in its sole discretion, to implement a reverse stock split at a ratio of 1-for-8.8. Our Board of Directors proposed the reverse stock split in order to increase the per share trading price of our Common Stock such that we may achieve a price per share for our Common Stock that may increase the marketability, trading volume and liquidity of our Common Stock and would satisfy the listing requirements of the NASDAQ. The Board has not implemented the reverse stock split amendment or the reverse stock split.
On January 30, 2015, we completed the acquisition of 100% of the outstanding securities of DivX for total consideration of approximately $64.5 million. The unaudited cash balance of DivX on closing was approximately $9.4 million. We incurred approximately $0.8 million of acquisition-related expenses during the year ended December 31, 2014 that are included in selling, general and administrative expenses, including stock-based compensation in the Consolidated Statements of Operations and Comprehensive Income (Loss). On closing, we issued 35,890,216 shares of common stock of the Company valued at $37.5 million and a $27 million two-year convertible promissory note (the “Note”). The Note includes a $2 million working capital adjustment. The Note is convertible into shares of the Company’s common stock at a conversion price of approximately $1.045 per share, subject to adjustment for stock splits and similar events, on the terms set forth in the Merger Agreement (“Merger Agreement”). The Note bears interest at the rate of 6% per annum and matures on January 2, 2017 (the “Maturity Date”), subject to earlier conversion of the Note into shares of common stock either (i) automatically upon the receipt of all applicable stockholder and regulatory approvals or (ii) at the option of the Company or the holder if such approvals are not required and, if applicable, the waiting period provided for in applicable antitrust rules has been satisfied. In the event the Note has not been converted prior to the Maturity Date, then in addition to principal and accrued interest on the Note (the “Repayment Amount”), the Company is obligated to pay the holder an amount in cash equal to the amount, if any, by which the fair market value (as defined in the Merger Agreement) of the Conversion Shares the holder would have received on the date immediately preceding the Maturity Date exceeds the Repayment Amount.
DivX is a leading provider of next-generation digital video solutions. DivX licenses its technology to global brands spanning consumer electronics manufacturers, entertainment content rights holders and cable network operators. We believe that by bringing together NeuLion’s managed services and DivX's technology products, we will be able to give customers the choice of either building and managing digital video platforms internally or licensing a fully integrated managed services solution.
Key Performance Indicators
(1)
Recurring revenues include variable fees earned from subscriptions, usage, advertising, eCommerce and support fees in addition to fixed fees charged to our customers on a monthly, quarterly or annual basis for ongoing hosting, support and maintenance. Non-recurring revenues include setup fees for design, setup and implementation services and equipment revenue.
(2)
A percentage point (“pp”) is the unit for the arithmetic difference between two percentages.
(3)
We report non-GAAP Adjusted EBITDA because it is a key measure used by management to evaluate our results and make strategic decisions about the Company, including potential acquisitions. Non-GAAP Adjusted EBITDA represents net income (loss) before interest, income taxes, depreciation and amortization, stock-based compensation, acquisition-related expenses, discount on convertible notes, investment income and foreign exchange gain/loss. This measure does not have any standardized meaning prescribed by U.S. GAAP and therefore is unlikely to be comparable to the calculation of similar measures used by other companies, and should not be viewed as an alternative to measures of financial performance or changes in cash flows calculated in accordance with U.S. GAAP. A reconciliation is provided below.
(4)
A petabyte is 1015 bytes of digital information. One petabyte is equivalent to 1000 terabytes. The figures shown in the table above represent the amount of video streamed on all of our business-to-business (“B2B”) platforms (Pro Sports, College Sports and TV Everywhere). We believe the amount of video streamed is a key performance indicator because our contracts typically include a revenue share or usage fee component.
Overall Performance - Three months ended December 31, 2014 vs three months ended December 31, 2013
Total revenue for the three months ended December 31, 2014 was $16.5 million, an increase of $2.4 million, or 17%, from $14.1 million for the three months ended December 31, 2013. The $2.4 million increase in total revenue was primarily attributable to increases in our TV Everywhere and Pro Sports category of customers.
Cost of revenue as a percentage of revenue was 25% for the three months ended December 31, 2014, compared with 28% for the three months ended December 31, 2013. The 3 percentage point improvement was primarily due to improved operating costs on streaming.
Our non-GAAP Adjusted EBITDA (as defined above and reconciled below) was $3.5 million for the three months ended December 31, 2014, compared with $2.2 million for the year ended December 31, 2013. The improvement in non-GAAP Adjusted EBITDA of $1.3 million was due to an increase in revenue of $2.4 million offset by increases in selling, general and administrative expenses, excluding stock-based compensation, and research and development expenses of $1.1 million.
Our consolidated net income for the three months ended December 31, 2014 was $1.6 million, or income of $0.01 per basic and diluted share of common stock, compared with net income of $1.1 million, or income of $0.00 per basic and diluted share of common stock, for the three months ended December 31, 2013. The improvement of $0.5 million was primarily attributable to the items discussed above relating to non-GAAP Adjusted EBITDA.
The reconciliation from net income to non-GAAP Adjusted EBITDA is as follows:
Consolidated Statement of Operations Reconciliation:
Overall Performance - Year ended December 31, 2014 vs year ended December 31, 2013
Total revenue for fiscal 2014 was $55.5 million, an increase of $8.4 million, or 18%, from $47.1 million in fiscal 2013. The $8.4 million increase in revenue was primarily attributable to increases in our TV Everywhere and Pro Sports category of customers.
Cost of revenue as a percentage of revenue was 25% for the year ended December 31, 2014, compared with 28% for the year ended December 31, 2013. The 3 percentage point improvement was primarily due to improved operating costs on streaming.
Our non-GAAP Adjusted EBITDA (as defined above and reconciled below) was $8.4 million for the year ended December 31, 2014, compared with $3.5 million for the year ended December 31, 2013. The improvement in non-GAAP Adjusted EBITDA of $4.9 million was due to an increase in revenue of $8.4 million offset by an increase in cost of revenue of $0.6 million and an increase of $2.9 million in selling, general and administrative expenses, excluding stock-based compensation, and research and development expenses.
Our consolidated net income for the year ended December 31, 2014 was $3.6 million, or income of $0.01 per basic and diluted share of common stock, compared with a net loss of $2.3 million, or a loss of $0.01 per basic and diluted share of common stock, for the year ended December 31, 2013. The improvement in consolidated net income of $5.8 million was primarily attributable to the items discussed above relating to non-GAAP Adjusted EBITDA.
The reconciliation from net income (loss) to non-GAAP Adjusted EBITDA is as follows:
Consolidated Statement of Operations Reconciliation:
OPERATIONS
Revenue
We earn revenue from three broad categories of customers:
• Professional Sports
This category contains all of our professional sports programming customers. These customers include the National Football League (NFL), the National Hockey League (NHL), the National Basketball Association (NBA), Ultimate Fighting Championship (UFC), Major League Soccer (MLS), the American Hockey League (AHL), the Western Hockey League (WHL), the Ontario Hockey League (OHL), and the Professional Bowlers Association (PBA).
• College Sports
This category contains all of our college and collegiate conference customers. We partner with many National Collegiate Athletic Association (NCAA) schools and conferences and have agreements in place with over 160 colleges, universities or related sites. These customers include the University of North Carolina, Duke University, the University of Oregon, Louisiana State University, Mississippi State University, Florida State University, the University of Nebraska, Texas A&M University, the Big 12 Conference and the Southern Conference, Pac 12 member schools, the University of Oklahoma, the Ivy League Digital Network and the University of Maryland.
• TV Everywhere
This category contains all of our cable networks and operators, entertainment companies, content aggregators and Multichannel Video Program Distributors (“MPVDs”). These customers include ESPN, Univision, China Network Television (a new media agency of China Central Television), Sport TV, Rogers Media, Outdoor Channel, TVG Network, CBC, Independent Film Channel, Cablevision, MSG Varsity, Shaw Communications, the Big Ten Network, Participant Media and the Gospel Music Channel.
Within each of these three categories of customers, revenue is categorized as follows:
• Setup fees - non-recurring and charged to customers for design, setup and implementation services.
• Monthly/annual fees - recurring and charged to customers for ongoing hosting, support and maintenance.
• Variable fees - recurring and earned through subscriptions, usage, advertising, support and eCommerce:
§
Subscription revenue consists of recurring revenue based on the number of subscribers. Revenue is typically generated on a monthly, quarterly or annual basis and can be either a fixed fee per user or a variable fee based on a percentage of the subscription price.
§
Usage fees are charged to customers for bandwidth and storage.
§
Advertising revenues are earned through the insertion of advertising impressions on websites and in streaming video at a cost per thousand impressions.
§
Support revenue consists of fees charged to our customers for providing customer support to their end users.
§
eCommerce revenues are earned through providing customers with ticketing and retail merchandising web solutions.
• Equipment revenue - non-recurring, consists of the sale of STBs to content partners and/or end users and is recognized when title to an STB passes to our customer. Shipping revenue, STB rentals and computer hardware sales are also included in equipment revenue.
Cost and Expenses
Cost of revenue
Cost of revenue primarily consists of:
• revenue share payments; and
• broadcast operating costs (teleport fees, bandwidth usage fees, colocation fees).
Selling, general and administrative expenses, including stock-based compensation
Selling, general and administrative (“SG&A”) expenses, including stock-based compensation, include:
• Wages and benefits - represents compensation for our full-time and part-time employees, excluding R&D employees shown below, as well as fees for consultants we use from time to time. The majority of our employees are located in the US and China;
• Stock-based compensation - primarily represents the estimated fair value of our stock options, prepared using the Black-Scholes-Merton model, which requires a number of subjective assumptions, including assumptions about the expected life of the stock option, risk-free interest rates, dividend rates, forfeiture rates and the future volatility of the price of our shares of common stock. The estimated fair value of the stock option is expensed over their expected life;
• Acquisition-related expenses - represents direct costs related to acquisitions;
• Professional fees - represents legal, accounting, and public and investor relations expenses; and
• Other SG&A expenses - represents travel expenses, rent, office supplies, corporate IT services, marketing, credit card processing fees and other general operating expenses.
Research and development
Research and development costs (“R&D”) primarily consist of wages and benefits for R&D department personnel. R&D personnel are primarily located in the US and China.
Key Trends and Factors That May Impact our Performance
We believe that there are many factors that will continue to affect our ability to sustain and increase both revenue and profitability and impact the nature and amount of our expenditures, including:
• Market acceptance of our services. We compete in markets where the value of certain aspects of our services are still in the process of market acceptance. We believe that our future growth depends in part on the continued and increasing acceptance and realization of the value of our service offerings.
• Technological change. Our success depends in part on our ability to keep pace with technological changes and evolving industry standards in our service offerings and to successfully develop, launch, and drive demand for new and enhanced, innovative, high-quality solutions that meet or exceed customer needs.
• Technology spending. Our growth and results depend in part on general economic conditions and the pace and level of technology spending by potential customers to take their content digital.
In January 2015, we completed the acquisition of DivX. The integration of the two companies will impact our future revenues, expenses and operating results.
See also "Risk Factors" under Item 1A of this report for a more complete description of these and other risks that may impact future revenue and profitability.
RESULTS OF OPERATIONS
Comparison of Three Months Ended December 31, 2014 to Three Months Ended December 31, 2013 (unaudited)
Our consolidated financial statements for the three months ended December 31, 2014 and 2013 have been prepared in accordance with U.S. GAAP. A comparison of our results of operations for those periods is as follows:
Revenue
Revenue increased to $16.5 million for the three months ended December 31, 2014 from $14.1 million for the three months ended December 31, 2013. Total revenue includes revenue from Pro Sports, College Sports, and TV Everywhere customers and is comprised of set-up fees, annual/monthly fixed fees, variable fees and equipment revenue. Period-over-period variances in each sector are detailed below:
Pro Sports
Revenue from Pro Sports customers increased to $7.9 million for the three months ended December 31, 2014 from $6.7 million for the three months ended December 31, 2013. The $1.2 million improvement was primarily the result of an increase in variable subscription fees.
College Sports
Revenue from College Sports customers decreased to $3.6 million for the three months ended December 31, 2014 from $3.9 million for the three months ended December 31, 2013. The $0.3 million decrease was primarily a result of a decrease in variable subscription fees as the Company lost their ability to sell subscriptions for certain colleges, as colleges move to consolidate into conferences and sports networks.
TV Everywhere
Revenue from TV Everywhere customers increased to $5.0 million for the three months ended December 31, 2014 from $3.5 million for the three months ended December 31, 2013. The $1.5 million increase was primarily the result of an increase in monthly/annual fixed fees and variable usage fees.
Costs of Revenue
Cost of revenue was $4.0 million for the three months ended December 31, 2014 and 2013. Cost of revenue as a percentage of revenue improved from 28% for the year ended December 31, 2013 to 25% for the three months ended December 31, 2014. The 3 percentage point improvement (as a percentage of revenue) primarily resulted from improved operating costs on streaming.
Selling, general and administrative expenses, including stock-based compensation
Selling, general and administrative expenses, including stock-based compensation, increased by $1.7 million, or 26%, from $6.3 million for the three months ended December 31, 2013 to $8.0 million for the three months ended December 31, 2014. The individual variances are as follows:
• Wages and benefits increased from $4.4 million for the three months ended December 31, 2013 to $4.6 million for the three months ended December 31, 2014. The $0.2 million increase was primarily a result of the hire of new employees and consultants.
• Acquisition-related expenses were $0.8 million for the three months ended December 31, 2014. There were no comparable expenses for the three months ended December 31, 2013. These expenses primarily related to legal and consulting expenses incurred during our acquisition of DivX.
• Professional fees increased from $0.4 million for the three months ended December 31, 2013 to $0.6 million for the three months ended December 31, 2014. The $0.2 million increase was the result of fees relating to Sarbanes-Oxley (“SOX”) 404 compliance.
• Other SG&A expenses increased from $1.5 million for the three months ended December 31, 2013 to $2.0 million for the three months ended December 31, 2014. Other SG&A expenses include travel expenses, rent, office supplies, corporate IT services, marketing, credit card processing fees and other general operating expenses.
Research and development
Research and development costs increased from $2.0 million for the three months ended December 31, 2013 to $2.1 million for the three months ended December 31, 2014.
Depreciation and amortization
Depreciation and amortization decreased from $0.8 million for the three months ended December 31, 2013 to $0.5 million for the three months ended December 31, 2014. The $0.3 million decrease was the result of certain intangible assets becoming fully depreciated during the quarter ended December 31, 2014.
RESULTS OF OPERATIONS
Comparison of Year Ended December 31, 2014 to Year Ended December 31, 2013
Our consolidated financial statements for our fiscal years ended December 31, 2014 and 2013 have been prepared in accordance with U.S. GAAP. A comparison of our results of operations for those years is as follows:
Revenue
Revenue increased to $55.5 million for the year ended December 31, 2014 from $47.1 million for the year ended December 31, 2013. Total revenue includes revenue from Pro Sports, College Sports, TV Everywhere and Other Customers and is comprised of set-up fees, annual/monthly fees and variable fees. Year-over-year variances in each sector are detailed below:
Pro Sports
Revenue from Pro Sports customers increased to $24.6 million for the year ended December 31, 2014 from $21.0 million for the year ended December 31, 2013. The $3.6 million improvement was primarily the result of an increase in monthly/annual fees and variable subscription fees.
College Sports
Revenue from College Sports customers increased to $13.8 million for the year ended December 31, 2014 from $12.6 million for the year ended December 31, 2013. The $1.2 million increase was primarily a result of an increase in variable advertising fees.
TV Everywhere
Revenue from TV Everywhere customers increased to $17.1 million for the year ended December 31, 2014 from $13.5 million for the year ended December 31, 2013. The $3.6 million increase was primarily a result of an increase in variable usage fees.
Costs and Expenses
Cost of Revenue
Cost of revenue increased from $13.3 million for the year ended December 31, 2013 to $13.9 million for the year ended December 31, 2014. Cost of revenue as a percentage of revenue improved from 28% for the year ended December 31, 2013 to 25% for the year ended December 31, 2014. The 3 percentage point improvement (as a percentage of revenue) primarily resulted from improved operating costs on streaming.
Selling, general and administrative expenses, including stock-based compensation
Selling, general and administrative expenses, including stock-based compensation, increased by $2.8 million, or 12%, from $24.3 million for the year ended December 31, 2013 to $27.1 million for the year ended December 31, 2014. The individual variances are as follows:
• Wages and benefits increased from $17.2 million for the year ended December 31, 2013 to $18.5 million for the year ended December 31, 2014. The $1.3 million increase was primarily the result of the hire of new employees and related costs.
• Acquisition-related expenses were $0.8 million for the year ended December 31, 2014. There were no comparable expenses for the year ended December 31, 2013. These expenses primarily related to legal and consulting expenses incurred during our acquisition of DivX.
• Professional fees increased from $1.3 million for the year ended December 31, 2013 to $1.6 million for the year ended December 31, 2014. The $0.3 million increase was primarily the result of fees relating to SOX 404 compliance.
• Other SG&A expenses increased from $5.8 million for the year ended December 31, 2013 to $6.2 million for the year ended December 31, 2014. Other SG&A expenses include travel expenses, rent, office supplies, corporate IT services, marketing, credit card processing fees and other general operating expenses.
Research and development
Research and development costs increased from $7.4 million for the year ended December 31, 2013 to $8.4 million for the year ended December 31, 2014. The increase of $1.0 million was primarily due to the hire of new R&D employees.
Depreciation and amortization
Depreciation and amortization decreased from $3.8 million for the year ended December 31, 2013 to $2.6 million for the year ended December 31, 2014. The $1.2 million decrease was the result of certain intangible assets becoming fully depreciated during the year ended December 31, 2014.
LIQUIDITY AND CAPITAL RESOURCES
Our cash position was $25.9 million at December 31, 2014. In 2014, we generated $7.2 million from operations, which included cash of $0.7 million provided by operating activities. Additionally, cash provided by financing activities included $0.9 million from the exercise of stock options and broker units and cash used in investing activities included $1.8 million to purchase fixed assets.
As of December 31, 2014, our principal sources of liquidity included cash and cash equivalents of $25.9 million and trade accounts receivable of $8.1 million offset by $14.4 million in accounts payable. We continue to closely monitor our cash balances to ensure that we have sufficient cash on hand to meet our operating needs. Management believes that we have sufficient liquidity to meet our working capital and capital expenditure requirements for at least the next twelve months.
At December 31, 2014, approximately 83% of our cash and cash equivalents were held in accounts with a U.S. bank that received a BBB+ rating from Standard and Poor’s and an A3 rating from Moody’s. The Company believes that this U.S. financial institution is secure notwithstanding the current global economy and that we will be able to access the remaining balance of bank deposits. Our investment policy is to invest in low-risk short-term investments which are primarily term deposits. We have not had a history of any defaults on these term deposits, nor do we expect any in the future given the short term maturity of these investments.
Working Capital Requirements
Our net working capital at December 31, 2014 was $7.0 million, an improvement of $7.1 million from the December 31, 2013 net working capital of $(0.1) million. Our working capital ratios at December 31, 2014 and 2013 were 1.24 and 1.00, respectively. Included in current liabilities at December 31, 2014 and 2013 are approximately $9.6 million and $8.9 million, respectively, of liabilities (deferred revenue and convertible note) that we do not anticipate settling in cash.
The change in working capital was primarily due to an increase in current assets of $9.1 million offset by an increase in current liabilities of $2.0 million.
Current assets at December 31, 2014 were $36.3 million, an increase of $9.1 million from the December 31, 2013 balance of $27.2 million. The change was primarily due to an increase of $6.3 million in cash and cash equivalents and an increase of $2.8 million in accounts receivable.
Current liabilities at December 31, 2014 were $29.2 million, an increase of $2.0 million from the December 31, 2013 balance of $27.2 million. The increase was primarily due to increases in accounts payable of $1.4 million and deferred revenue of $0.7 million.
Off Balance Sheet Arrangements
The Company did not have any off balance sheet arrangements as of December 31, 2014.
Financial Instruments
Our financial instruments are comprised of cash and cash equivalents, accounts receivable, other receivables, deposits, accounts payable, accrued liabilities and amounts due to/from related parties.
Fair value of financial instruments
Fair value of a financial instrument is defined as the amount for which the instrument could be exchanged in a current transaction between willing parties. The estimated fair value of our financial instruments approximates their carrying value due to the short maturity term of these financial instruments.
Risks associated with financial instruments
Foreign exchange risk
We are exposed to foreign exchange risk as a result of transactions in currencies other than our functional currency, the United States dollar. The majority of our revenues are transacted in U.S. dollars, and the majority of our expenses are transacted in U.S. dollars. We do not use derivative instruments to hedge against foreign exchange risk.
Interest rate risk
We are exposed to interest rate risk on our invested cash and cash equivalents and our short-term investments. The interest rates on these instruments are based on bank rates and therefore are subject to change with the market. We do not use derivative financial instruments to reduce our interest rate risk.
Credit risk
We sell our services to a variety of customers under various payment terms and therefore are exposed to credit risk. We have adopted policies and procedures designed to limit this risk. The maximum exposure to credit risk at the reporting date is the carrying value of receivables. We establish an allowance for doubtful accounts that represents our estimate of incurred losses in respect of accounts receivable.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements are prepared in conformity with U.S. GAAP, which 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 consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. On an ongoing basis, management reviews its estimates to ensure they appropriately reflect changes in our business and new information as it becomes available. If historical results and other factors used by management to make these estimates do not reasonably predict future actual results, our consolidated financial position and results of operations could be materially impacted.
We believe the following critical accounting policies involve the more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue recognition
We earn revenue as follows:
(a)
Setup fees are charged to customers for design, setup and implementation services. Setup fees are deferred at the beginning of the service period and recognized over the term of the arrangement, which is generally three to five years.
(b)
Annual and/or monthly fees are charged to customers for ongoing hosting, support and maintenance. Annual hosting fees are deferred at the beginning of the service period and recognized evenly over the service period.
(c)
Subscription revenue consists of recurring revenue based on the number of subscribers. The subscriber revenue is typically generated on a monthly, quarterly or annual basis and can be a fixed fee per user, a variable fee per user or a variable fee based on a percentage of the subscription price. We defer the appropriate portion of cash received for the services that have not yet been rendered and recognizes the revenue over the term of the subscription, which is generally between thirty days and one year. Pay-per-view revenues are deferred and recognized in the period when the content is viewed. Subscription revenues are recorded on either a gross or net basis depending on the transaction arrangement with the customer. Where subscription revenues are recorded on a gross basis, the total amount of the subscription is deferred and recognized over the subscription term and the share of revenue owing to our customer is deferred and recognized as a cost of revenue over the term of the subscription. Where subscription revenues are recorded on a net basis, only our share of revenue from the subscription is deferred and recognized over the term of the subscription. Under U.S. GAAP guidance related to reporting revenue gross as a principal versus net as an agent, the indicators used to determine whether an entity is a principal or an agent to a transaction are subject to judgment. When we apply the indicators to our facts where we consider ourselves the principal in the subscription transaction to the user, revenue is recorded on a gross basis, the total amount of the subscription is deferred and recognized over the subscription term and the share of revenue to our customer is deferred and recognized as a cost of revenue over the term of the subscription. When we apply the indicators to our facts where we consider ourselves the agent in the subscription transaction to the user, revenue is recorded on a net basis; only our share of revenue from the subscription is deferred and recognized over the term of the subscription.
(d)
eCommerce revenues are earned through providing customers with ticketing and retail merchandising web solutions. eCommerce revenues are recorded on a net basis when the service has been provided. We record as revenue the portion of the fees they are entitled to as opposed to the amount billed for tickets or retail merchandise sold.
(e)
Advertising revenues are earned through the insertion of advertising impressions on websites and in streaming video at a cost per thousand impressions. Advertising revenue is recognized based on the number of impressions displayed (“served”) during the period. Deferred revenue for advertising represents the timing difference between collection of advertising revenue and when the advertisements are served, which is typically between thirty and ninety days. Advertising revenues are recorded on a gross basis, whereby the total amount billed to the advertiser is recorded as revenue and the share of revenue to our customer is recorded as a cost of revenue.
(f)
Support revenues are earned for providing customer support to our customers’ end users. Support fees are recognized evenly over the service period.
(g)
Usage fees are charged to customers for bandwidth and storage. Usage fees are billed on a monthly or quarterly basis and are recognized as the service is being provided.
(h)
Equipment revenue consists of the sale and rental of set-top boxes (“STBs”) to content partners and/or end users to enable the end user to receive content over the Internet and display the signal on a standard television. Shipping charges are included in total equipment revenue. Revenue is recognized generally upon shipment to the customer. The customer does not have any right of return on STBs. Revenue is recognized when persuasive evidence of an arrangement exists, prices are determinable, collectability is reasonably assured and the goods or services have been delivered. If any of these criteria are not met, revenue is deferred until such time as all of the criteria are met.
Allowance for doubtful accounts
We maintain a provision for estimated losses resulting from the inability of our customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends and changes in customer payment terms. If the financial conditions of our customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. As of December 31, 2014 and 2013, the allowance for doubtful accounts was $220,803 and $105,292, respectively.
Inventory
We evaluate our ending inventories for estimated excess quantities and obsolescence. This evaluation includes analyses of sales levels and projections of future demand within specific time horizons. Inventories in excess of future demand are reserved. In addition, we assess the impact of changing technology and market conditions on our inventory on hand and write off inventories that are considered obsolete.
Property, plant and equipment
We review the carrying value of property, plant and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. If these future undiscounted cash flows are less than the carrying value of the asset, then the carrying amount of the asset is written down to its fair value, based on the related estimated discounted future cash flows. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the property, plant and equipment is used and the effects of obsolescence, demand, competition and other economic factors. Based on this assessment, no impairment was recorded for the years ended December 31, 2014 and 2013.
Intangible assets
We review the carrying value of our definite lived intangible assets for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. If these future undiscounted cash flows are less than the carrying value of the asset, then the carrying amount of the asset is written down to its fair value, based on the related estimated discounted future cash flows. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the intangible assets are used and the effects of obsolescence, demand, competition and other economic factors. Based on this assessment, no impairment was recorded for the years ended December 31, 2014 and 2013.
Goodwill
Goodwill is not amortized but is subject to an annual impairment test at the reporting unit level and between annual tests if changes in circumstances indicate a potential impairment. The Company performs this annual goodwill impairment test as of October 1 of each calendar year. Goodwill impairment is assessed based on a comparison of the fair value of each reporting unit to the underlying carrying value of the reporting unit's net assets, including goodwill. If the carrying value of the reporting unit exceeds its fair value, the Company performs the second step of the goodwill impairment test to determine the amount of the impairment loss. The second step of the impairment test involves comparing the implied fair value of the reporting unit's goodwill with its carrying amount to measure the amount of impairment loss, if any. The Company's impairment test is based on its single operating segment and reporting unit structure. For the years ended December 31, 2014 and 2013, there was no impairment loss.
Stock-based compensation
We account for all stock options and warrants using a fair value-based method. The fair value of each stock option and warrant granted is estimated on the date of the grant using the Black-Scholes-Merton option pricing model and the related stock-based compensation expense is recognized over the expected life of the stock option or warrant. The fair value of the warrants granted to non-employees is measured and expensed as the warrants vest.
Amortization policies and useful lives
We amortize the cost of property, plant and equipment and intangible assets over the estimated useful service lives of these items. The determinations of estimated useful lives of these long-lived assets involve considerable judgment. In determining these estimates, we take into account industry trends and Company-specific factors, including changing technologies and expectations for the in-service period of these assets. On an annual basis, we reassess our existing estimates of useful lives to ensure they match the anticipated life of the technology from a revenue producing perspective. If technological change happens more quickly than anticipated, we might have to shorten our estimate of the useful life of certain equipment, which could result in higher amortization expense in future periods or an impairment charge to write down the value of this equipment.
Taxes
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax expense, together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. The carrying value of our deferred tax assets is adjusted by a valuation allowance to recognize the extent to which the future tax benefits will be recognized on a more likely than not basis. Our net deferred tax liability consists primarily of indefinite lived intangibles.
We record valuation allowances in order to reduce our deferred tax assets to the amount expected to be realized. In assessing the adequacy of recorded valuation allowances, we consider a variety of factors, including the scheduled reversal of deferred tax liabilities, future taxable income, and prudent and feasible tax planning strategies. Under the relevant accounting guidance, factors such as current and previous operating losses are given significantly greater weight than the outlook for future profitability in determining the deferred tax asset carrying value.
Relevant accounting guidance addresses how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under such guidance, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such uncertain tax positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution.
7A. Quantitative and Qualitative Disclosures About Market Risk
As of January 1, 2015, we no longer qualified as a smaller reporting company. However, because we are permitted to satisfy our obligations under this Annual Report on Form 10-K by complying with the requirements applicable to a smaller reporting company, we are not required to include information called for by this item.
Item 8.
Item 8. Financial Statements and Supplementary Data
Financial statements are attached hereto beginning with page.
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
The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This term refers to the controls and procedures of a company that are designed to ensure that information required to be disclosed in reports filed under the Exchange Act is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to the company’s management as appropriate to allow timely decisions regarding required disclosure.
Our Chief Executive Officer and Chief Financial Officer, with the assistance of other members of our management, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2014 (the “Evaluation”). Based upon the Evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) were effective as of December 31, 2014.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate “internal control over financial reporting” (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)). Management evaluates the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission Internal Control - Integrated Framework (2013). Our Chief Executive Officer and Chief Financial Officer, with the assistance of other members of our management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2014, and concluded that it is effective.
Our independent registered public accounting firm, EisnerAmper LLP, has audited the Company’s consolidated financial statements and the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014. Their reports appear on pages and hereof in this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting
During the fiscal quarter ended December 31, 2014, no change in our internal control over financial reporting has been identified that has materially affected, or is 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
The information required by this item regarding executive officers is incorporated herein by reference to the section titled “Executive Officers” in Item 1 of this Annual Report on Form 10-K. The other information required by this item is incorporated herein by reference to the section titled “PROPOSAL 1 - Election of Directors” of the proxy statement for our Annual Meeting of Stockholders scheduled to be held on or about June 4, 2015. Definitive proxy materials will be filed with the SEC pursuant to Regulation 14A no later than April 30, 2015.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated herein by reference to the section titled “STATEMENT OF EXECUTIVE COMPENSATION” of the proxy statement for our Annual Meeting of Stockholders scheduled to be held on or about June 4, 2015. Definitive proxy materials will be filed with the SEC pursuant to Regulation 14A no later than April 30, 2015.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item related to securities authorized for issuance under our equity compensation plans is incorporated herein by reference to the section titled “Equity Compensation Plan Information” under Item 5 of this Annual Report on Form 10-K.
The information required by this item related to security ownership of certain beneficial owners is incorporated herein by reference to the section titled “SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT” of the proxy statement for our Annual Meeting of Stockholders scheduled to be held on or about June 4, 2015. Definitive proxy materials will be filed with the SEC pursuant to Regulation 14A no later than April 30, 2015.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item is incorporated herein by reference to the sections titled “SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - Certain Relationships and Related Transactions” and “CORPORATE GOVERNANCE MATTERS - Independence of Directors” of the proxy statement for our Annual Meeting of Stockholders scheduled to be held on or about June 4, 2015. Definitive proxy materials will be filed with the SEC pursuant to Regulation 14A no later than April 30, 2015.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this item is incorporated herein by reference to the section titled “PROPOSAL 2 - RATIFICATION OF THE APPOINTMENT OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS - Services and Fees of Independent Registered Public Accountants” of the proxy statement for our Annual Meeting of Stockholders scheduled to be held on or about June 4, 2015. Definitive proxy materials will be filed with the SEC pursuant to Regulation 14A no later than April 30, 2015.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)
(1)
Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Operations and Comprehensive Income (Loss)
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
(2)
Financial Statement Schedules
None.
(b)
Exhibits
The following exhibits are filed as part of this report:
# Management contract or compensatory plan or arrangements
* Filed herewith
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.
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.
Signature
Capacity
Date
/s/ Charles B. Wang
Chairman of the Board and Director
March 4, 2015
Charles B. Wang
/s/ Nancy Li
Executive Vice Chairman and Director
March 4, 2015
Nancy Li
/s/ Kanaan Jemili
Chief Executive Officer
March 4, 2015
Kanaan Jemili
(Principal Executive Officer)
/s/ G. Scott Paterson
Vice Chairman of the Board and Director
March 4, 2015
G. Scott Paterson
/s/ Arthur J. McCarthy
Chief Financial Officer
March 4, 2015
Arthur J. McCarthy
(Principal Financial and Accounting Officer)
/s/ Roy E. Reichbach
General Counsel, Corporate Secretary
March 4, 2015
Roy E. Reichbach
and Director
/s/ John R. Anderson
Director
March 4, 2015
John R. Anderson
/s/ Gabriel A. Battista
Director
March 4, 2015
Gabriel A. Battista
/s/ Robert E. Bostrom
Director
March 4, 2015
Robert E. Bostrom
/s/ John A. Coelho
Director
March 4, 2015
John A. Coelho
/s/ James R. Hale
Director
March 4, 2015
James R. Hale
/s/ Shirley Strum Kenny
Director
March 4, 2015
Shirley Strum Kenny
/s/ David Kronfeld
Director
March 4, 2015
David Kronfeld
NeuLion, Inc.
Index to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
NeuLion, Inc.
We have audited the accompanying consolidated balance sheets of NeuLion, Inc. (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2014. The financial statements are the responsibility of the Company’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. 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 audits provide 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 NeuLion, Inc. as of December 31, 2014 and 2013, and the consolidated results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), NeuLion, Inc.'s internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated March 3, 2015 expressed an unqualified opinion thereon.
/s/ EisnerAmper LLP
New York, New York
March 3, 2015
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
NeuLion, Inc.
We have audited NeuLion, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). 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 Annual 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, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included 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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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, NeuLion, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control - Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of NeuLion, Inc. as of December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2014, and our report dated March 3, 2015 expressed an unqualified opinion thereon.
/s/ EisnerAmper LLP
New York, New York
March 3, 2015
NEULION, INC.
CONSOLIDATED BALANCE SHEETS
(Expressed in U.S. dollars)
See accompanying notes
NEULION, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME (LOSS)
(Expressed in U.S. dollars)
See accompanying notes
NEULION, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Expressed in U.S. dollars)
See accompanying notes
NEULION, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in U.S. dollars)
See accompanying notes
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
1. Nature of Operations
NeuLion, Inc. (“NeuLion” or the “Company”) is a technology product and service provider that specializes in the digital video broadcasting, distribution and monetization of live and on-demand content to Internet-enabled devices. Through the Company’s cloud-based end-to-end solution, the Company builds and manages interactive digital networks that enable the Company’s customers to provide a destination for their viewers to view and interact with their content. The Company was incorporated on January 14, 2000 under the Canada Business Corporations Act and was domesticated under Delaware law on November 30, 2010. The Company’s common stock is listed on the Toronto Stock Exchange (“TSX”) under the symbol NLN. On January 30, 2015, the Company consummated the acquisition of DivX Corporation (“DivX”), which creates, distributes, and licenses digital video technologies for PCs, smart TVs, and mobile devices. MainConcept, its subsidiary, provides a high-quality video compression-decompression, or codec, software library to consumer electronics manufacturers and others.
We are a provider of customized, end-to-end, interactive content services for a wide range of professional and collegiate sports properties, cable networks and operators, content owners and distributors, and telecommunication companies. With a fundamental shift in the way media is now being consumed, technological advancements are affecting how, when and where consumers connect to content. The Company’s technology enables our customers to seamlessly manage and deliver interactive and high-quality content, up to ultra HD/4K screen resolution, to multiple types of Internet-enabled devices such as PCs, smartphones and tablets. The Company’s cloud-based technology platform offers a variety of digital technology and services for content rights holders, including content ingestion, live encoding, live video editing, digital rights management, advertising insertion and management, pay flow and premium content payment support, video player software development kits, multi-platform device delivery, content management, subscriber management, digital rights management, billing services, app development, website design, analytics and reporting. To our new consumer electronics manufacturing customers gained in the DivX acquisition, NeuLion offers technology and products that enable premium screen resolution, also up to ultra HD/4K, for a wide range of Internet-enabled devices that include smart TVs, smartphones and tablets.
2. Basis of Presentation and Significant Accounting Policies
The accompanying consolidated financial statements reflect the accounts of the Company and all of its wholly-owned and majority-owned subsidiaries and have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”). As at December 31, 2014, the Company had an 11.8% equity interest in KyLin TV (2013 - 11.8%). This investment is accounted for using the equity method of accounting. All significant intercompany balances and transactions have been eliminated.
Use of estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates made by management include the determination of the useful lives of long-lived assets, impairment of intangible assets and goodwill, inventory obsolescence, assumptions used in stock-based compensation and the allowance for doubtful accounts. On an ongoing basis, management reviews its estimates to ensure they appropriately reflect changes in the Company's business and new information as it becomes available. If historical experience and other factors used by management to make these estimates do not reasonably reflect future actual results, the Company's consolidated financial position and results of operations could be materially impacted.
Revenue recognition
The Company earns revenue as follows:
(a)
Setup fees are charged to customers for design, setup and implementation services. Setup fees are deferred at the beginning of the service period and recognized over the term of the arrangement, which is generally three to five years.
(b)
Annual and/or monthly fees are charged to customers for ongoing hosting, support and maintenance. Annual hosting fees are deferred at the beginning of the service period and recognized evenly over the service period.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
(c)
Subscription revenue consists of recurring revenue based on the number of subscribers. The subscriber revenue is typically generated on a monthly, quarterly or annual basis and can be a fixed fee per user, a variable fee per user or a variable fee based on a percentage of the subscription price. The Company defers the appropriate portion of cash received for the services that have not yet been rendered and recognizes the revenue over the term of the subscription, which is generally between thirty days and one year. Pay-per-view revenues are deferred and recognized in the period when the content is viewed. Subscription revenues are recorded on either a gross or net basis depending on the transaction arrangement with the customer. Where subscription revenues are recorded on a gross basis, the total amount of the subscription is deferred and recognized over the subscription term and the share of revenue owing to our customer is deferred and recognized as a cost of revenue over the term of the subscription. Where subscription revenues are recorded on a net basis, only the Company’s share of revenue from the subscription is deferred and recognized over the term of the subscription. Under U.S. GAAP guidance related to reporting revenue gross as a principal versus net as an agent, the indicators used to determine whether an entity is a principal or an agent to a transaction are subject to judgment. When we apply the indicators to our facts where we consider ourselves the principal in the subscription transaction to the user, revenue is recorded on a gross basis, the total amount of the subscription is deferred and recognized over the subscription term and the share of revenue to our customer is deferred and recognized as a cost of revenue over the term of the subscription. When we apply the indicators to our facts where we consider ourselves the agent in the subscription transaction to the user, revenue is recorded on a net basis; only the Company’s share of revenue from the subscription is deferred and recognized over the term of the subscription.
(d)
eCommerce revenues are earned through providing customers with ticketing and retail merchandising web solutions. eCommerce revenues are recorded on a net basis when the service has been provided. The Company records as revenue the portion of the fees they are entitled to as opposed to the amount billed for tickets or retail merchandise sold.
(e)
Advertising revenues are earned through the insertion of advertising impressions on websites and in streaming video at a cost per thousand impressions. Advertising revenue is recognized based on the number of impressions displayed (“served”) during the period. Deferred revenue for advertising represents the timing difference between collection of advertising revenue and when the advertisements are served, which is typically between thirty and ninety days. Advertising revenues are recorded on a gross basis, whereby the total amount billed to the advertiser is recorded as revenue and the share of revenue to our customer is recorded as a cost of revenue.
(f)
Support revenues are earned for providing customer support to our customers’ end users. Support fees are recognized evenly over the service period.
(g)
Usage fees are charged to customers for bandwidth and storage. Usage fees are billed on a monthly or quarterly basis and are recognized as the service is being provided.
(h)
Equipment revenue consists of the sale and rental of set-top boxes (“STBs”) to content partners and/or end users to enable the end user to receive content over the Internet and display the signal on a standard television. Shipping charges are included in total equipment revenue. Revenue is recognized generally upon shipment to the customer. The customer does not have any right of return on STBs. Revenue is recognized when persuasive evidence of an arrangement exists, prices are determinable, collectability is reasonably assured and the goods or services have been delivered. If any of these criteria are not met, revenue is deferred until such time as all of the criteria are met.
Cash and cash equivalents
Cash and cash equivalents consist of cash and short-term investments, such as money market funds, that have original maturities of less than three months.
Accounts receivable
Accounts receivable are carried at original invoice amount. The Company maintains a provision for estimated losses resulting from the inability of its customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness; past transaction history with the customer; current economic industry trends; and changes in customer payment terms. If the financial conditions of the Company's customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. As of December 31, 2014 and 2013, the allowance for doubtful accounts was $220,803 and $105,292, respectively.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
Inventory
Inventory consists of set-top boxes and parts for set-top boxes. Inventories are recorded at the lower of cost and net realizable value. Cost is accounted for on a first-in, first-out basis. The Company evaluates its ending inventories for estimated excess quantities and obsolescence. This evaluation includes analyses of sales levels and projections of future demand within specific time horizons. Inventories in excess of future demand are reserved. In addition, the Company assesses the impact of changing technology and market conditions on its inventory-on-hand and writes off inventories that are considered obsolete.
Property, plant and equipment
Property, plant and equipment are carried at cost less accumulated depreciation. Expenditures for maintenance and repairs are expensed currently, while renewals and betterments that materially extend the life of an asset are capitalized. The cost of assets sold, retired or otherwise disposed of, and the related allowance for depreciation, are eliminated from the accounts, and any resulting gain or loss is recognized.
Depreciation is provided using the straight-line method over the estimated useful lives of the assets, which are as follows:
The Company reviews the carrying value of property, plant and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. If these future undiscounted cash flows are less than the carrying value of the asset, then the carrying amount of the asset is written down to its fair value, based on the related estimated discounted future cash flows. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the property, plant and equipment are used and the effects of obsolescence, demand, competition and other economic factors. Based on this assessment, no impairment was recorded for the years ended December 31, 2014 and 2013.
Intangible assets
Intangible assets are recorded at cost less amortization. Cost of intangible assets acquired through business combinations represents their fair market value at the date of acquisition. Amortization is calculated using the straight-line method over the estimated useful lives of the intangible assets, which are as follows:
The Company reviews the carrying value of its definite lived intangible assets for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. If these future undiscounted cash flows are less than the carrying value of the asset, then the carrying amount of the asset is written down to its fair value, based on the related estimated discounted future cash flows. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the intangible assets are used and the effects of obsolescence, demand, competition and other economic factors. Based on this assessment, no impairment was recorded for the years ended December 31, 2014 and 2013.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
Goodwill
Goodwill represents the excess, at the date of acquisition, of the cost of an acquired business over the fair value of the identifiable assets acquired and liabilities assumed. Goodwill is not amortized but is subject to an annual impairment test at the reporting unit level and between annual tests if changes in circumstances indicate a potential impairment. The Company performs an annual goodwill impairment test as of October 1 of each calendar year. Goodwill impairment is assessed based on a comparison of the fair value of each reporting unit to the underlying carrying value of the reporting unit’s net assets, including goodwill. If the carrying value of the reporting unit exceeds its fair value, the Company performs the second step of the goodwill impairment test to determine the amount of the impairment loss. The second step of the impairment test involves comparing the implied fair value of the reporting unit's goodwill with its carrying amount to measure the amount of impairment loss, if any. The Company’s impairment test is based on its single operating segment and reporting unit structure. For the years ended December 31, 2014 and 2013, there was no impairment loss.
Investment in affiliate
Investee companies that are not consolidated, but over which the Company exercises significant influence, are accounted for under the equity method of accounting. Whether or not the Company exercises significant influence with respect to an investee depends on an evaluation of several factors including, among others, representation on the investee’s board of directors and voting rights. Under the equity method of accounting, an investee's accounts are not reflected within the Company's consolidated balance sheets and statements of operations and comprehensive loss; however, the Company's share of the losses of the investee company is reflected under the caption “Equity in loss of affiliate” in the consolidated statements of operations and comprehensive loss. Due to KyLin TV’s accumulated losses, the Company’s investment in KyLin TV was reduced to zero as at December 31, 2008. No further charges will be recorded because the Company has no obligation to fund the losses of KyLin TV. If KyLin TV becomes profitable in the future, the Company will resume applying the equity method only after its share of that net income equals the Company’s share of net losses not recognized during the period in which the equity method was suspended.
Income taxes
Income taxes are accounted for under the provisions of ASC Topic 740, “Income Taxes Recognition” (“ASC 740”). ASC 740 requires that income tax accounts be computed using the liability method. Deferred taxes are determined based upon the estimated future tax effects of differences between the financial reporting and tax reporting bases of assets and liabilities given the provisions of currently enacted tax laws.
ASC 740 requires an entity to recognize the financial statement impact of a tax position when it is more likely than not that the position will be sustained upon examination. If the tax position meets the more-likely-than-not recognition threshold, the tax effect is recognized at the largest amount of the benefit that has a greater-than-fifty-percent likelihood of being realized upon ultimate settlement. ASC 740 also provides guidance for classification, interest and penalties, accounting in interim periods, disclosure, and transition. ASC 740 requires that a liability created for unrecognized tax benefits be presented as a separate liability and not combined with deferred tax liabilities or assets.
The Company operates in a number of countries worldwide. Its income tax liability is therefore a consolidation of its tax liabilities in various locations. Its tax rate is affected by the profitability of its operations in various locations, the tax rates and taxation systems of the countries in which the Company operates, its tax policies and the impact of certain tax planning strategies which have been implemented.
To determine its worldwide tax liability, the Company makes estimates of possible tax liabilities. Tax filings, positions and strategies are subject to review under local or international tax audit and the outcomes of such reviews are uncertain. In addition, these audits generally take place years after the period in which the tax provision in question was determined and it may take a substantial amount of time before the final outcome of any audit is known. Future tax audits could result in income tax liabilities that differ materially from the amounts recorded in our financial statements.
A valuation allowance is recorded to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company has recorded substantial tax losses over the years: therefore, a full valuation allowance has been recorded against all net deferred tax assets at December 31, 2014 and 2013.
Foreign currency transactions
The functional currency of the Company is the U.S. dollar. Monetary assets and liabilities denominated in foreign currencies are re-measured into U.S. dollars at exchange rates in effect at the balance sheet dates. These transactional foreign exchange gains or losses are included in the consolidated statements of operations and comprehensive loss.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
Financial instruments
The Company's financial instruments consist of cash and cash equivalents, accounts receivable, other receivables, due from/to related parties, accounts payable and accrued liabilities, which are primarily denominated in U.S. dollars. The carrying amounts of such instruments approximate their fair values principally due to the short-term nature of these items. Unless otherwise noted, it is management's opinion that the Company is not exposed to significant interest rate, currency or credit risk arising from these financial instruments.
With respect to accounts receivable, the Company is exposed to credit risk arising from the potential for counterparties to default on their contractual obligations to the Company. The Company controls credit risk through credit approvals, credit limits and monitoring procedures. The Company performs credit evaluations on its customers, but generally does not require collateral to support accounts receivable. The Company establishes an allowance for doubtful accounts that corresponds with the specific credit risk of its customers, historical trends and economic circumstances.
Research and Development
Costs incurred for research and development are expensed as incurred and are included in the consolidated statements of operations and comprehensive loss.
Advertising
Advertising costs are expensed as incurred and totaled $429,844 and $325,157 for the years ended December 31, 2014 and 2013, respectively, and are included in selling, general and administrative expenses on the consolidated statements of operations and comprehensive loss.
Stock-based compensation and other stock-based payments
The Company accounts for all stock options and warrants using a fair value-based method. The fair value of each stock option and warrant granted to employees is estimated on the date of the grant using the Black-Scholes-Merton option pricing model and the related stock-based compensation expense is recognized over the expected life of the option. The fair value of the warrants granted to non-employees is measured and expensed as the warrants vest.
Restricted stock awards give the holder the right to one share of common stock for each vested share of restricted stock. These awards vest on an annual basis over a four-year vesting period. Stock-based compensation expense is recorded based on the market value of the common stock on the grant date and recognized over the vesting period of these awards.
Recently Issued Accounting Standards
In August 2014, the Financial Accounting Standards Board (“FASB”) issued guidance on the disclosure of uncertainties about an entity’s ability to continue as a going concern. This standard provides guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The guidance is effective for annual reporting periods ending after December 15, 2016, and early adoption is permitted. We expect to adopt this guidance on January 1, 2017. We do not expect the adoption of this guidance to have any impact on our financial position, results of operations or cash flows.
In May 2014, the FASB issued guidance on revenue recognition. This guidance provides 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. This guidance also requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. This guidance is effective for interim and annual reporting periods beginning after December 15, 2016, early adoption is not permitted, and must be applied retrospectively or modified retrospectively. We expect to adopt this guidance on January 1, 2017. We are currently evaluating the impact of this guidance on our operations and therefore have not yet determined the impact the adoption of this guidance will have on our financial position, results of operations or cash flows, if any.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
3. Inventory
Inventory consists of the following:
4. Property, Plant and Equipment
The details of property, plant and equipment and the related accumulated depreciation are set forth below:
Depreciation expense for the years ended December 31, 2014 and 2013 was $1,377,604 and $1,389,712, respectively.
5. Goodwill and Intangible Assets
The net carrying amount of goodwill is set forth below:
The details of intangible assets and the related accumulated amortization are set forth below:
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
Amortization expense for the years ended December 31, 2014 and 2013 was $1,243,763 and $2,365,342, respectively. The weighted-average life remaining on these intangible assets is 1.6 years.
Based on the amount of intangible assets subject to amortization, the Company's estimated amortization expense over the next three years is as follows:
6. Economic Dependence and Concentration of Credit Risk
For the years ended December 31, 2014 and 2013, the National Hockey League (“NHL”) accounted for 18% and 20% of revenue, respectively. No other customers accounted for more than 10% of revenues in 2014 and 2013.
As at December 31, 2014, three customers accounted for 53% of accounts receivable: 28%, 13% and 12%. As at December 31, 2013, two customers accounted for 26% of accounts receivable: 14% and 12%.
As at December 31, 2014, two customers accounted for 59% of accounts payable: 49% and 10%. As at December 31, 2013, two customers accounted for 60% of accounts payable: 47% and 13%.
At December 31, 2014, approximately 83% of the Company’s cash and cash equivalents were held in accounts with a U.S. bank that received a BBB+ rating from Standard and Poor’s and an A3 rating from Moody’s.
7. Related Party Transactions
The Company has entered into certain transactions and agreements in the normal course of operations with related parties. Significant related party transactions are as follows:
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
KyLinTV
KyLin TV is an IPTV company that is controlled by the Chairman of the Board of Directors of the Company. On June 1, 2008, the Company entered into an agreement with KyLin TV to build and deliver the setup and back office operations for KyLin TV’s IPTV service. Effective April 1, 2012, the Company amended its agreement with KyLin TV, such that, in addition to the services previously provided, KyLin TV was appointed the exclusive distributor of the Company’s business to consumer (“B2C”) IPTV interests. As exclusive distributor, KyLin TV obtains, advertises and markets all of the Company’s B2C content, in accordance with the terms of the amendment. Accordingly, KyLin TV records the gross revenues from the Company’s B2C content as well as the associated license fees, whereas the Company records revenues in accordance with the revised fee schedule in the amendment. The Company also provides and charges KyLin TV for administrative and general corporate support. For each of the periods presented, the amounts charged for these services provided by the Company for the years ended December 31, 2014 and 2013 were $123,333 and $253,837, respectively, and were recorded as a recovery in selling, general and administrative expense. Additionally, the Company purchased set-top boxes from KyLin TV. For each of the periods presented, the amounts paid for this equipment for the years ended December 31, 2014 and 2013 were $46,400 and $169,500, respectively.
New York Islanders Hockey Club, L.P. (“New York Islanders”)
The Company provides IT-related professional services and administrative services to the New York Islanders, a professional hockey club that is owned by the Chairman of the Board of Directors of the Company.
Renaissance Property Associates, LLC (“Renaissance”)
The Company provides IT-related professional services to Renaissance, a real estate management company owned by the Chairman of the Board of Directors of the Company. In June 2009, the Company signed a sublease agreement with Renaissance for office space in Plainview, New York. The sublease agreement expired in December 2013, and the Company is now leasing its office month-to-month. Rent expense paid by the Company to Renaissance of $430,344, inclusive of taxes and utilities, is included in selling, general and administrative expense for both of the years ended December 31, 2014 and 2013, respectively.
Smile Train, Inc. (“Smile Train”)
The Company provides IT-related professional services to Smile Train, a public charity whose founder and significant benefactor is the Chairman of the Board of Directors of the Company.
The Company recognized revenue from related parties as follows:
The amounts due from (to) related parties are as follows:
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
Investment in affiliate - KyLin TV
The Company records its investment in KyLin TV using the equity method.
From January 1, 2008 through February 26, 2010, the Company’s equity interest in KyLin TV was 17.1%. On February 26, 2010, a group of private investors invested $10.0 million in KyLin TV, which reduced the Company’s equity interest to 11.8%. Of the total $10.0 million investment, $1.0 million was invested by AvantaLion LLC, a company controlled by the Chairman of the Board of Directors of the Company. Management has determined that, as a result of the 11.8% equity interest combined with the services that the Company provides KyLin TV, the Company continues to have significant influence on the operating activities of KyLin TV; therefore, the Company continues to account for its investment in KyLin TV using the equity method. As previously discussed, the Company also provides and charges KyLin TV for administrative and general corporate support.
The Company’s proportionate share of the equity loss from KyLin TV has been accounted for as a charge on the Company's consolidated statements of operations and comprehensive loss. Due to KyLin TV’s accumulated losses, the investment was reduced to zero as at December 31, 2008. No further charges will be recorded as the Company has no obligation to fund the losses of KyLin TV. If KyLin TV becomes profitable in the future, the Company will resume applying the equity method only after its share of that net income equals the Company’s share of net losses not recognized during the period the equity method was suspended. From 2008 to 2014, the Company’s share of cumulative losses in KyLin TV that have not been recognized as of December 31, 2014 was $4,186,168.
8. 401(k) Profit Sharing Plan
The Company sponsors a 401(k) Profit Sharing Plan to provide retirement and incidental benefits to its eligible employees. Employees may contribute a percentage of their annual compensation through salary reduction, subject to certain qualifications and Internal Revenue Code limitations. The Company provides for voluntary matching contributions up to certain limits. Matching contributions vest immediately.
For the years ended December 31, 2014 and 2013, the Company made aggregate matching contributions of $485,367 and $436,415, respectively.
9. Redeemable Preferred Stock
The Company has 50,000,000 authorized shares of preferred stock, $0.01 par value per share, of which 17,176,818 shares have been designated as Class 3 Preference Shares and 10,912,265 have been designated as Class 4 Preference Shares.
Class 3 Preference Shares
On September 29, 2010, the Company issued 17,176,818 Class 3 Preference Shares, at a price of CDN$0.60 per share in a private offering, for aggregate gross proceeds of $10,000,000. Expenses related to the share issuance were $245,662. The principal terms of the Class 3 Preference Shares are as follows:
Voting rights - The Class 3 Preference Shares have voting rights (one vote per share) equal to those of the Company’s common stock.
Dividend rights - The Class 3 Preference Shares carry a fixed cumulative dividend, as and when declared by our Board of Directors, of 8% per annum, accrued daily, compounded annually and payable in cash upon a liquidation event for up to five years, as well as the right to receive any dividends paid to holders of common stock.
Conversion rights - The holders of the Class 3 Preference Shares have the right to convert any or all of their Class 3 Preference Shares, at the option of the holder, at any time, into common stock on a one for one basis. In addition, the Class 3 Preference Shares will automatically be converted into common stock in the event that the holders of a majority of the outstanding Class 3 Preference Shares consent to such conversion. In the event of conversion to common stock, accrued but unpaid dividends shall be paid in cash and shall not increase the number of shares of common stock issuable upon such conversion.
Redemption rights - At any time after five years from the date of issuance, the holders of a majority of the Class 3 Preference Shares may elect to have the Company redeem the Class 3 Preference Shares for an amount equal to CDN$0.60 per Class 3 Preference Share plus all accrued and unpaid dividends (the “Class 3 Redemption Amount”). At any time after five years from the date of issuance, the Company may, at its option, redeem the Class 3 Preference Shares for an amount equal to CDN$0.60 per Class 3 Preference Share plus all accrued and unpaid dividends.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
On June 7, 2011, shareholders of the Company approved a resolution to amend the Company’s Certificate of Incorporation to change the Redemption Amount (as defined in the Certificate of Incorporation) of the Class 3 Preference Shares from CDN$0.60 to US$0.58218 per share, plus all accrued and unpaid dividends thereon.
Liquidation entitlement - In the event of any liquidation, dissolution or winding up of the Company, the holders of the Class 3 Preference Shares shall be entitled to receive, in preference to the holders of common stock, an amount equal to the aggregate Class 3 Redemption Amount.
Other provisions - There will be proportional adjustments for stock splits, stock dividends, recapitalizations and the like.
Accounting for Class 3 Preference Shares
If certain criteria are met, companies must bifurcate conversion options from their host instruments and account for them as free-standing derivative instruments. The Company has evaluated the conversion option on the Class 3 Preference Shares and determined that the embedded conversion option should not be bifurcated. Additionally, the Company analyzed the conversion feature and determined that the effective conversion price was higher than the market price at the date of issuance; therefore, no beneficial conversion feature was recorded. The Company has classified the Class 3 Preference Shares as temporary equity because they are redeemable upon the occurrence of an event that is not solely within the control of the issuer. As noted above, the holders of the Class 3 Preference Shares may demand redemption at any time after five years from the date of issuance. As the redemption amount was originally denominated in Canadian dollars, the Company re-measured the redeemable preferred stock amount recorded in the consolidated balance sheet each period, based on prevailing exchange rates. The resulting adjustment, along with the accretion of the issuance costs, was recorded in stockholders’ equity.
As a result of the aforementioned change in the Class 3 Redemption Amount, from CDN$0.60 to US$0.58218 per share, the Company adjusted the carrying amount of the Class 3 Preference Shares on June 7, 2011 to US$10 million.
Class 4 Preference Shares
On June 29, 2011, the Company issued 10,912,265 Class 4 Preference Shares, at a price of US$0.4582 per share in a private offering, for aggregate gross proceeds of $5,000,000. Expenses related to the share issuance were $150,454. The principal terms of the Class 4 Preference Shares are as follows:
Voting rights - The Class 4 Preference Shares have voting rights (one vote per share) equal to those of the Company’s common stock.
Dividend rights - The Class 4 Preference Shares carry a fixed cumulative dividend at a rate of 8% per annum to be paid as and when declared by the Company’s Board of Directors. Notwithstanding the foregoing, such dividends are automatically payable in cash upon a liquidation event or redemption by the Company for up to five years.
Conversion rights - The holders of the Class 4 Preference Shares have the right to convert any or all of their Class 4 Preference Shares, at the option of the holder, at any time, into common stock on a one for one basis. In addition, the Class 4 Preference Shares will automatically be converted into common stock in the event that the holders of a majority of the outstanding Class 4 Preference Shares consent to such conversion. In the event of conversion to common stock, declared and accrued, but unpaid dividends shall be paid in shares of common stock based on a conversion price equal to the trading price of the common stock at the close of business on the last trading day prior to the date of conversion.
Redemption rights - At any time after five years from the date of issuance, the holders of a majority of the Class 4 Preference Shares may elect to have the Company redeem the Class 4 Preference Shares for an amount equal to $0.4582 per Class 4 Preference Share plus all declared and accrued, but unpaid, dividends (the “Class 4 Redemption Amount”). At any time after five years from the date of issuance, the Company may, at its option, redeem the Class 4 Preference Shares for an amount equal to $0.4582 per Class 4 Preference Share plus all accrued and unpaid dividends.
Liquidation entitlement - In the event of any liquidation, dissolution or winding up of the Company, the holders of the Class 4 Preference Shares shall be entitled to automatically receive, in preference to the holders of common stock and Class 3 Preference Shares, an amount equal to $0.4582 per Class 4 Preference Share plus all accrued and unpaid dividends.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
Other provisions - There will be proportional adjustments for stock splits, stock dividends, recapitalizations and the like.
Accounting for Class 4 Preference Shares
If certain criteria are met, companies must bifurcate conversion options from their host instruments and account for them as free-standing derivative instruments. The Company has evaluated the conversion option on the Class 4 Preference Shares and determined that the embedded conversion option should not be bifurcated. Additionally, the Company analyzed the conversion feature and determined that the effective conversion price was higher than the market price at the date of issuance; therefore, no beneficial conversion feature was recorded. The Company has classified the Class 4 Preference Shares as temporary equity because they are redeemable upon the occurrence of an event that is not solely within the control of the issuer.
10. Private Placement and Convertible Note
On September 25, 2012, the Company completed a private placement for aggregate gross proceeds of approximately $4.6 million. The Company sold an aggregate of 22,782,674 units at CDN$0.20 each (the “Units”), with each Unit consisting of one share of common stock and one-half of one common stock purchase warrant (“Warrant”) with each full Warrant entitling the holder thereof to purchase one share of common stock at US$0.30 for thirty (30) months following closing (the “Offering”). The Vice Chairman of our Board of Directors purchased 1,745,000 Units in the Offering for CDN$349,000. The Chairman of our Board of Directors purchased 2,334,500 Units in the Offering for CDN$466,900 and loaned the Company CDN$533,100 (evidenced by a convertible note in the amount of $545,628). As described in more detail below, upon receipt of stockholder approval, all outstanding principal and any accrued and unpaid interest owing on the convertible note automatically converted into shares of common stock at a rate of US$0.20 per share (the “Conversion Shares”) and the number of Warrants equal to one-half of the number of Conversion Shares. If stockholder approval had not been received, all principal and interest (calculated (but not compounded) daily and payable in arrears at a rate of 6% per annum) would have been paid on the maturity date, September 25, 2013.
The agent for a portion of the subscriptions received from the Company a cash commission equal to 8% of the gross proceeds of the offering (excluding proceeds arising from Units purchased by the Chairman and Vice Chairman noted above) and broker warrants (“Broker Warrants”) equal to 4% of the number of Units issued in the Offering. Each Broker Warrant is exercisable for one Unit at an exercise price of US$0.21 per Broker Warrant (“Broker Unit”) at any time prior to the 30-month anniversary of the closing date of the Offering. Each Broker Unit consists of one share of common stock and one-half of a Warrant, and each full Warrant entitles the holder thereof to purchase one share of common stock at US$0.30 for 30 months following the closing date of the Offering.
At the Company’s Annual Meeting of Stockholders on June 5, 2013, the Company’s stockholders approved the conversion of the convertible note held by the Chairman. Upon such approval, the loan principal of $545,628 plus accrued interest of $22,692 automatically converted into 2,841,600 shares of common stock and 1,420,800 Warrants.
Accounting for Convertible Note
If certain criteria are met, companies must bifurcate conversion options from their host instruments and account for them as free-standing derivative instruments. The Company analyzed the conversion feature on the convertible note and determined that the embedded conversion feature did not require bifurcation; however, the effective conversion price was lower than the market price at the date of issuance; therefore, a beneficial conversion feature was recorded. Additionally, the Company bifurcated the fair value of the warrants from the convertible note. The discount on the note created by the beneficial conversion feature and the fair value of the warrants were amortized into interest expense over the period from when the convertible note was issued to when it was converted. The Company classified the convertible note as a current liability because it was convertible within a year. On June 5, 2013, upon conversion, the Company reclassified the note from a current liability to equity.
11. Stock Option and Stock-Based Compensation Plans
The total stock-based compensation expense included in the Company’s consolidated statement of operations for the years ended December 31, 2014 and 2013 was $1,437,982 and $1,416,892, respectively.
(i) 2012 Omnibus Securities and Incentive Plan (the “New Plan”)
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
The New Plan applies to all grants of distribution equivalent rights, incentive stock options, non-qualified stock options, performance share awards, performance unit awards, restricted stock awards, restricted stock unit awards, stock appreciation rights, tandem stock appreciation rights and unrestricted stock awards (“equity securities”) to directors, officers, employees and consultants of the Company or any entity controlled by the Company. The exercise price for any new security granted under the New Plan is determined by the closing price of the Company’s common stock on the trading day prior to the grant date. If the security is granted on a pre-determined basis, the exercise price is determined using the five-day volume weighted average price of the Company's common stock on the Toronto Stock Exchange immediately prior to the date of grant. In all cases the exercise price may not be less than fair market value. Securities are exercisable during a period established at the time of their grant provided that such period will expire no later than five years after the date of grant, subject to early termination of the option in the event the holder of the option dies or ceases to be a director, officer or employee of the Company or ceases to provide ongoing management or consulting services to the Company or entity controlled by the Company. The maximum number of shares of common stock issuable upon exercise of securities granted pursuant to the New Plan is 30,000,000 shares of common stock.
[a] Stock Options
A summary of stock option activity under the New Plan is as follows:
The following table summarizes information regarding stock options granted under the New Plan as at December 31, 2014:
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of fiscal 2014 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2014. The amount changes based on the fair market value of the Company’s common stock.
For the years ended December 31, 2014 and 2013, $838,267 and $268,127, respectively, were recorded for total stock-based compensation expense related to stock options under the New Plan.
The Company estimates the fair value of stock options granted using a Black-Scholes-Merton option pricing model.
The assumptions used in determining the fair value of stock options granted are as follows:
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
The exercise price of stock options granted on a pre-determined basis is calculated using the five-day volume weighted average price of the Company’s common stock on the Toronto Stock Exchange preceding the grant date. The Company estimates volatility based on the Company’s historical volatility. The Company estimates the risk-free rate based on the Federal Reserve rate. The Company currently estimates the expected life of its stock options to be seven years.
As at December 31, 2014, there was $5.9 million of total unrecognized compensation cost related to non-vested stock options under the New Plan, which is expected to be recognized over a weighted-average period of six years.
[b] Unrestricted Stock
On August 13, 2013, the Company issued one million unrestricted stock awards to various employees of the Company, with a fair value on the date of issuance of $454,396. This amount was expensed on the Company’s consolidated statements of operations and comprehensive loss during the year ended December 31, 2013.
(ii) Fourth Amended and Restated Stock Option Plan (the “Old Plan”)
The Old Plan applied to all grants of options to directors, officers, employees and consultants of the Company or any entity controlled by the Company. The exercise price for any option granted under the Old Plan was determined by the closing price of the Company’s common stock on the trading day prior to the grant date. If the option was granted on a pre-determined basis, the exercise price was determined using the five-day volume weighted average price of the Company's common stock on the Toronto Stock Exchange immediately prior to the date of grant. In all cases the exercise price was not less than fair market value. Options were exercisable during a period established at the time of their grant provided that such period will expire no later than five years after the date of grant, subject to early termination of the option in the event the holder of the option dies or ceases to be a director, officer or employee of the Company or ceases to provide ongoing management or consulting services to the Company or entity controlled by the Company. The maximum number of shares of common stock issuable upon exercise of options granted pursuant to the Old Plan was equal to the greater of (i) 4,000,000 shares of common stock and (ii) 12.5% of the number of issued and outstanding shares of common stock. Since the adoption of the New Plan, no options have been or will be issued under the Old Plan.
A summary of stock option activity under the Old Plan is as follows:
The following table summarizes information regarding stock options granted under the Old Plan as at December 31, 2014:
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of fiscal 2014 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2014. The amount changes based on the fair market value of the Company’s common stock.
For the years ended December 31, 2014 and 2013, $420,938 and $601,467, respectively, were recorded for total stock-based compensation expense related to stock options under the Old Plan.
The Company estimates the fair value of stock options granted using a Black-Scholes-Merton option pricing model.
No options were granted under the Old Plan during the years ended December 31, 2014 and 2013.
As at December 31, 2014, there was $0.3 million of total unrecognized compensation cost related to these non-vested stock options, which is expected to be recognized over a weighted-average period of one year.
(iii) Warrants
On October 20, 2008, the Company granted 5,000,000 fully-vested warrants with an exercise price of $0.63 exercisable for two years to employees of the Company in connection with a merger. On June 15, 2010, the stockholders of the Company approved a resolution to extend the expiration date of these warrants from October 20, 2010 to October 20, 2013. These warrants expired on October 20, 2013.
On January 4, 2010, the Company granted 2,000,000 Series D Warrants to a customer of the Company that were exercisable if the customer achieved certain subscriber levels. In accordance with ASC Topic 505-50, “Equity-Based Payments to Non-Employees,” the Company did not recorded any expense for the year ended December 31, 2012 as the subscriber levels were not met. These warrants were forfeited on August 21, 2012.
On May 9, 2012, the Company granted 1,894,741 warrants to a merchant bank that were fully vested upon the merchant bank signing an engagement letter with the Company for various consulting services. The fair value of these warrants, in the amount of $373,264, were included in selling, general and administrative, including stock-based compensation on the Company’s consolidated statement of operations and comprehensive loss in 2012. Additionally, the Company granted 1,894,741 warrants to the merchant bank that are exercisable if the merchant bank achieves certain performance targets. In accordance with ASC Topic 505-50, “Equity-Based Payments to Non-Employees,” the Company has not recorded any expense for the years ended December 31, 2014 and 2013 as the performance targets have not been met. These warrants expire on May 9, 2022.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
On September 25, 2012, the Company completed a private placement for aggregate gross proceeds of approximately $4.6 million. The Company sold an aggregate of 22,782,674 Units, with each Unit consisting of one share of Common Stock and one-half of one Subscriber Warrant, with each full Warrant entitling the holder thereof to purchase one share of Common Stock at US$0.30 for 30 months following closing. The agent for a portion of the subscriptions received from the Company a cash commission equal to CDN$299,251 (8% of the gross proceeds of the Offering, excluding proceeds arising from Units purchased by the Chairman and Vice Chairman) and 748,127 Broker Warrants (4% of the number of Units issued in the Offering). Each Broker Warrant is exercisable for one Broker Unit at an exercise price of US$0.21 per Warrant at any time prior to the 30-month anniversary of the closing date of the Offering. Each Broker Unit consists of one share of Common Stock and one-half of a Warrant, and each full Warrant entitles the holder thereof to purchase one share of Common Stock at US$0.30 for 30 months following the closing date of the Offering. The fair value of both the Subscriber Warrants and the Broker Warrants, have been included in the included in additional paid-in capital on the Company’s consolidated balance sheet.
The total stock-based compensation expense related to warrants during the years ended December 31, 2014 and 2013 was $0.
A summary of the warrant activity is as follows:
The fair value of warrants was determined using the Black-Scholes-Merton option pricing model.
The following table summarizes the warrant information as at December 31, 2014:
There were no warrants were granted during the years ended December 31, 2014 and 2013.
(iv) Directors’ Compensation Plan (“Directors’ Plan”)
Non-management directors of the Company receive a minimum of 50% of their retainers and fees in the form of common stock and may elect to receive a greater portion of their retainers and fees in common stock. The number of shares of common stock to be issued to non-management directors is determined by dividing the dollar value of the retainers and fees by the closing price of the common stock on the relevant payment date. The maximum number of shares of common stock available to be issued by the Company under the Directors’ Plan is 5,000,000.
During the year ended December 31, 2014, the Company issued 156,226 shares of common stock with a fair value of $178,777 as payment of fees and retainers due to non-management directors. During the year ended December 31, 2013, the Company issued 295,244 shares of common stock with a fair value of $142,500 as payment of fees and retainers due to non-management directors.
12. Promissory Notes Receivable
On October 17, 2008, prior to its merger with NeuLion Inc., NeuLion USA, Inc. loaned employees an aggregate of $209,250 through promissory notes to exercise stock options. The promissory notes bear interest at 3.16% per annum and were repayable on October 17, 2013. The Company extended the repayment of the promissory notes from October 17, 2013 to October 17, 2015.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
13. Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing net income (loss) for the year by the weighted average number of shares of common stock outstanding for the period. Diluted earnings (loss) per share is computed by dividing net income (loss) for the year by the weighted average number of shares of common stock outstanding adjusted for the dilutive effect of preferred stock, stock options and warrants.
The following table presents the calculation of basic and diluted earnings (loss) per share for the years ended December 31, 2014 and 2013.
The following table summarizes the securities convertible into common stock that were outstanding as at December 31, 2014 and 2013 and (i) were included in the computation of diluted income per share for the year ended December 31, 2014 and (ii) were not included in the computation of diluted loss per share for the year ended December 31, 2013 because their effect would have been anti-dilutive. See note 11 for additional details.
14. Supplemental Cash Flow Information
For each of the years presented, the Company did not pay any cash income taxes or cash interest expense.
15. Commitments and Contingencies
Commitments
The Company has operating lease commitments for its premises in the United States (Plainview, New York; New York, New York; and Sanford, Florida), Canada (Toronto, Ontario and Vancouver, British Columbia), United Kingdom (London, England) and China (Beijing; Shanghai; and Shenzhen). In addition, the Company has operating leases for certain computer hardware and infrastructure equipment. Future minimum annual payments over the next five years and thereafter (exclusive of taxes, insurance and maintenance costs) under these commitments are as follows:
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
The Company periodically enters into contracts with customers in which the Company guarantees the customer a minimum amount of revenue share for services the Company provides under the contract. The minimum guarantees shown above primarily relate to (i) these minimum fixed revenue guarantees that the Company has committed to its customers over the next 4 years and (ii) minimum fixed bandwidth fees commitments with certain vendors over the next 12 to 18 months. As at balance sheet date, the Company believes that the future commitments are probable. During the years ended December 31, 2014 and 2013, the company recorded $787,064 and $693,171, respectively, related to these minimum guarantee agreements.
The Company has subleased a portion of its Toronto office, which is expected to generate a total recovery of $1,871,278 over the next three years.
Rent expense for the years ended December 31, 2014 and 2013 was $1,207,253 and $1,261,482, respectively, which includes rent expense to Renaissance, a related party, of $430,344 in both years.
Contingencies
During the ordinary course of its business activities, the Company may be contingently liable for litigation and a party to claims. Management believes that adequate provisions have been made where required. Although the extent of potential costs and losses, if any, is uncertain, management believes that the ultimate resolution of such contingencies will not have an adverse effect on the consolidated financial position or results of operations of the Company.
16. Segmented Information
The Company operates, as one reportable segment, to deliver live and on-demand content to Internet-enabled devices. Substantially all of Company’s revenues are generated and long-lived assets are located in the United States.
17. Income Taxes
The Company is subject to income and other taxes in a variety of jurisdictions, including the United States, Canada, and various state jurisdictions. A reconciliation of income taxes computed at the United States statutory rate to the Company's effective income tax rate is shown below.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
Deferred income taxes result principally from temporary differences in the recognition of loss carry-forwards and expense items for financial and income tax reporting purposes. Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2014 and 2013 were as follows:
The Company has approximately $97 million in net operating tax loss (“NOLs”) carryforwards available to be applied against future years’ income that, if not utilized, will begin to expire in 2027. Various state NOLs which do not follow the federal carry forward period have historically expired and will continue to expire in the future if not utilized. The $97 million does not include $12.3 million related to tax goodwill amortization that will not be realized for financial reporting purposes until the Company is able to take a tax benefit for those deductions. Historically, the Company has entered into certain transactions that may limit the use of NOLs. From the Company’s inception, significant losses have been recorded. Accordingly, a valuation allowance was recorded due to the uncertainty of realizing the benefits of operating loss carryforwards and other tax deferred assets. The Company has recorded a net deferred tax liability because deferred tax liabilities related to indefinite lived intangibles cannot be offset against deferred tax assets when determining the need for a valuation allowance.
The Company accounts for income taxes in accordance with ASC Topic 740, “Income Taxes Recognition.” The Company does not believe there are any uncertain tax provisions under ASC 740. The Company’s federal and state tax returns remain open and subject to potential government audit for the years 2011, 2012 and 2013.
NEULION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in U.S. dollars, unless otherwise noted)
December 31, 2014 and 2013
18. Subsequent Event
On January 30, 2015, the Company completed the acquisition of 100% of the outstanding securities of DivX for total consideration of approximately $64.5 million. We incurred approximately $0.8 million of acquisition-related expenses during the year ended December 31, 2014 that are included in selling, general and administrative expenses, including stock-based compensation in the Consolidated Statements of Operations and Comprehensive Income (Loss). On closing, we issued 35,890,216 shares of common stock of the Company valued at $37.5 million and a $27 million two-year convertible promissory note (the “Note”). The Note includes a $2 million working capital adjustment. The Note is convertible into shares of the Company’s common stock at a conversion price of approximately $1.045 per share, subject to adjustment for stock splits and similar events, on the terms set forth in the Merger Agreement (“Merger Agreement”). The Note bears interest at the rate of 6% per annum and matures on January 2, 2017 (the “Maturity Date”), subject to earlier conversion of the Note into shares of common stock either (i) automatically upon the receipt of all applicable stockholder and regulatory approvals or (ii) at the option of the Company or the holder if such approvals are not required and, if applicable, the waiting period provided for in applicable antitrust rules has been satisfied. In the event the Note has not been converted prior to the Maturity Date, then in addition to principal and accrued interest on the Note (the “Repayment Amount”), the Company is obligated to pay the holder an amount in cash equal to the amount, if any, by which the fair market value (as defined in the Merger Agreement) of the Conversion Shares the holder would have received on the date immediately preceding the Maturity Date exceeds the Repayment Amount.
DivX is a leading provider of next-generation digital video solutions. DivX licenses its technology to global brands spanning consumer electronics manufacturers, entertainment content rights holders and cable network operators. The Company believes that by bringing together NeuLion’s managed services and DivX's technology products, we will be able to give customers the choice of either building and managing digital video platforms internally or licensing a fully integrated managed services solution.
At the time of the Company’s filing of this Form 10-K, the Company is still completing the audits for DivX for the year ended December 31, 2013 and the three months ended March 31, 2014 (the period in which DivX was operating as a component of a larger business, Rovi Corporation (“Rovi”) (NASDAQ: ROVI)) and April 1, 2014 to December 31, 2014 (the period in which DivX was operating as a stand-alone company). As the acquisition of DivX was considered “significant” as defined by Regulation S-X, Rule 3-0, the Company is required to file an 8-K within 75 days of the acquisition, or April 15, 2015, which will include audited financial statements for the aforementioned periods as well as pro forma financial statements.
The unaudited pro forma consolidated GAAP revenues and earnings for the years ended December 31, 2013 and 2014 have not been presented as it is impracticable to provide this information as of the date of this Form 10-K. The reasons for it being impracticable are set forth below.
• DivX has not been accounted for as a separate entity, subsidiary or division of Rovi’s business prior to April 1, 2014.
• Rovi did not manage DivX as a stand-alone business or prepare stand-alone financial statements for DivX.
• Stand-alone financial statements of DivX have never previously been prepared for the period from January 1, 2013 to March 31, 2014.
• Rovi never allocated certain corporate expenses to DivX, including interest expense, corporate overhead expenses and income taxes.