Diligent (DIL) 10-Q 2012 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012.

or

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________________________ to _________________________________

Commission File Number:000-53205

Diligent Board Member Services, Inc.
(Exact name of registrant as specified in its charter)

Delaware	26-1189601
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

39 West 37 St. 8th Floor

New York, NY 10018

(Address of principal executive offices)(Zip Code)

(212) 741-8181

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.x Yes¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).x Yes¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)

¨Large accelerated filer	¨Accelerated filer
¨Non-accelerated filer	xSmaller Reporting Company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨ Yesx No

The number of shares of the registrant’s common stock outstanding as of August 2, 2012 was 81,901,191.

(This page intentionally left blank) 

CONTENTS

		PAGE
Forward Looking Statements		ii
Available Information		ii
PART I – Financial Information
Item 1.	Condensed Consolidated Financial Statements	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	18
Item 4.	Controls and Procedures	18
PART II – Other Information
Item 1.	Legal Proceedings	19
Item 1A.	Risk Factors	19
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	19
Item 3.	Defaults Upon Senior Securities	19
Item 4.	[Reserved]	19
Item 5.	Other Information	19
Item 6.	Exhibits	19
SIGNATURES		20

i

FORWARD LOOKING STATEMENTS

Except for statements of historical fact, certain information described in this document contains "forward-looking statements" that involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "should," "will," "would" or similar words. The statements that contain these or similar words should be read carefully because these statements discuss our future expectations, contain projections of our future results of operations or of our financial position, or state other "forward-looking" information. Diligent Board Member Services, Inc. believes that it is important to communicate our future expectations to our investors. However, there may be events in the future that we are not able accurately to predict or control. Further, we urge you to be cautious of the forward-looking statements which are contained in this Form 10-Q because they involve risks, uncertainties and other factors affecting our operations, market growth, service, products and licenses. Events in the future may cause our actual results and achievements, whether expressed or implied, to differ materially from the expectations we describe in our forward-looking statements. The occurrence of future events could have a material adverse effect on our business, results of operations and financial position.

AVAILABLE INFORMATION

We file reports, proxy statements, information statements and other information with the Securities and Exchange Commission. You may read and copy this information, for a copying fee, at the SEC’s public reference room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for more information on its public reference rooms. Our Securities and Exchange Commission filings are also available to the public from commercial document retrieval services, and at the web site maintained by the Securities and Exchange Commission at http://www.sec.gov. Our internet address is http://www.boardbooks.com. We make available through our web site, electronic copies of our annual reports on Form 10-K and quarterly reports on Form 10-Q. To receive paper copies of our SEC materials, please contact us by mail addressed to Robert E. Norton, Corporate Secretary, Diligent Board Member Services, Inc., 39 West 37 St. 8th Floor, New York, NY 10018, (212) 741-8181.

ii

PART I—FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements.

Diligent Board Member Services, Inc.

Consolidated Balance Sheets

	June 30,			December 31,
	2012			2011
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	17,160,428		$	8,930,695
Term deposit		100,175			97,188
Accounts receivable		1,981,498			1,956,527
Prepaid expenses and other current assets		1,274,949			764,518
Deferred tax assets, net of valuation allowance		120,345			300,840
Note receivable from affiliate		3,071,563			3,071,563
Total current assets		23,708,958			15,121,331
Property and equipment, net		3,499,815			2,088,495
Deferred tax assets, net of valuation allowance		1,021,136			882,600
Intangible assets, net		289,736			362,170
Security deposits		221,171			97,885
Total assets	$	28,740,816		$	18,552,481
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	320,598		$	857,883
Accrued expenses and other liabilities		2,991,122			1,436,824
Deferred revenue		12,913,857			8,495,661
Current portion of obligations under capital leases		470,355			99,250
Total current liabilities		16,695,932			10,889,618
Non-current liabilities:
Obligations under capital leases, less current portion		867,494			70,009
Other non-current liabilities		223,832			268,842
Total non-current liabilities		1,091,326			338,851
Total liabilities		17,787,258			11,228,469
Commitments and contingencies
Redeemable preferred stock:
Series A convertible redeemable preferred stock, $.001 par value, 50,000,000 shares authorized 32,667,123 shares issued and outstanding (liquidation value $5,079,737 and $5,019,849)		3,218,904			3,204,993
Stockholders' equity:
Common Stock, $.001 par value, 250,000,000 shares authorized, 81,901,191 and 81,861,335 shares issued and outstanding		81,901			81,861
Additional paid-in capital		24,070,198			23,837,196
Accumulated deficit		(16,439,508	)		(19,797,321	)
Accumulated other comprehensive income (loss)		22,063			(2,717	)
Total stockholders' equity		7,734,654			4,119,019
Total liabilities, redeemable preferred stock and stockholders' equity	$	28,740,816		$	18,552,481

See accompanying notes to condensed consolidated financial statements

1

Diligent Board Member Services, Inc.

Consolidated Income Statements

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Revenues	$	10,118,298		$	3,665,065		$	18,332,784		$	6,641,294
Cost of revenues		2,427,885			1,140,626			4,592,830			1,960,475
Gross profit		7,690,413			2,524,439			13,739,954			4,680,819
Operating expenses:
Selling and marketing expenses		2,079,115			1,152,486			4,017,686			2,025,523
General and administrative expenses		2,606,278			1,124,100			4,115,826			2,176,457
Research and development expenses		579,338			370,516			1,053,635			690,070
Depreciation and amortization		267,700			123,536			495,782			241,505
Total operating expenses		5,532,431			2,770,638			9,682,929			5,133,555
Operating income (loss)		2,157,982			(246,199	)		4,057,025			(452,736	)
Other income (expense):
Impairment recovery on note receivable from affiliate		-			1,200,000			-			1,200,000
Interest income, net		51,958			43,942			100,340			88,762
Foreign exchange transaction gain (loss)		(20,260	)		17,461			(14,674	)		5,272
Total other income		31,698			1,261,403			85,666			1,294,034
Income before provision for income taxes		2,189,680			1,015,204			4,142,691			841,298
Income tax expense		732,259			5,243			784,878			18,990
Net income	$	1,457,421		$	1,009,961		$	3,357,813		$	822,308
Net income per share:
Basic	$	0.02		$	0.01		$	0.04		$	0.01
Diluted	$	0.01		$	0.01		$	0.03		$	0.01
Weighted average shares outstanding:
Basic		81,879,565			82,005,913			81,842,629			81,990,321
Diluted		118,992,830			115,790,889			119,037,374			118,171,243

See accompanying notes to condensed consolidated financial statements

2

Diligent Board Member Services, Inc.

Consolidated Statements of Comprehensive Income

(Unaudited)

	Three Months Ended March 31,					Six Months Ended June 30,
	2012			2011		2012		2011
Net income	$	1,457,421		$	1,009,961	$	3,357,813	$	822,308
Other comprehensive income (loss):
Foreign exchange translation adjustment		(20,945	)		15,001		24,780		9,115
Comprehensive income	$	1,436,476		$	1,024,962	$	3,382,593	$	831,423

See accompanying notes to condensed consolidated financial statements

3

Diligent Board Member Services, Inc.

Consolidated Statement of Changes in Stockholders’ Equity

Six Months Ended June 30, 2012

(Unaudited)

													Accumulated
				Common			Additional						Other			Total
	Common			Stock			Paid-in-			Accumulated			Comprehensive			Stockholders'
	Shares			$.001 Par Value			Capital			Deficit			Income (Loss)			Equity
Balance at
January 1, 2012		81,861,335		$	81,861		$	23,837,196		$	(19,797,321	)	$	(2,717	)	$	4,119,019
Net income		-			-			-			3,357,813			-			3,357,813
Foreign exchange translation adjustment		-			-			-			-			24,780			24,780
Share-based compensation		-			-			597,693			-			-			597,693
Tender of common stock in lieu of interest payment on note receivable from affiliate		(133,811	)		(134	)		(199,518	)		-			-			(199,652	)
Exercise of stock options		173,667			174			28,407			-			-			28,581
Amortization of preferred stock offering costs		-			-			(13,911	)		-			-			(13,911	)
Accrued preferred stock dividend		-			-			(179,669	)		-			-			(179,669	)
Balance at
June 30, 2012 (Unaudited)		81,901,191		$	81,901		$	24,070,198		$	(16,439,508	)	$	22,063		$	7,734,654

See accompanying notes to condensed consolidated financial statements

4

Diligent Board Member Services, Inc.

Consolidated Statements of Cash Flows

(Unaudited) 

	Six Months Ended June 30,
	2012			2011
Cash flows from operating activities:
Net income	$	3,357,813		$	822,308
Adjustments to reconcile net income to net cash provided by operating activities:
Impairment recovery on note receivable from affiliate		-			(1,200,000	)
Depreciation and amortization		495,782			241,505
Share-based compensation		597,693			378,192
Net deferred tax assets and liabilities		58,620			-
Other non-cash		10,763			952
Changes in operating assets and liabilities:
Accounts receivable		(24,971	)		(299,008	)
Prepaid expenses and other current assets		(484,915	)		(78,434	)
Security deposits		(123,285	)		138,179
Accounts payable and accrued expenses, net		876,520			(72,885	)
Deferred revenue		4,418,196			1,306,043
Net cash provided by operating activities		9,182,216			1,236,852
Cash flows from investing activities:
Purchase of property and equipment		(756,511	)		(450,895	)
Net cash used in investing activities		(756,511	)		(450,895	)
Cash flows from financing activities:
Payment of preferred stock dividend, net of capital contribution in lieu of dividend		(119,781	)		(159,338	)
Proceeds from exercise of stock options		28,581			8,318
Proceeds from repayment of principal on note receivable from affiliate		-			4,122
Payments of obligations under capital leases		(57,081	)		(42,577	)
Payments of obligations under software licensing agreements		(72,434	)		-
Net cash used in financing activities		(220,715	)		(189,475	)
Effect of exchange rates on cash and cash equivalents		24,743			7,466
Net increase in cash and cash equivalents		8,229,733	��		603,948
Cash and cash equivalents at beginning of period		8,930,695			3,212,449
Cash and cash equivalents at end of period	$	17,160,428		$	3,816,397
Supplemental disclosure of cash flow information:
Cash paid during the period for :
Interest	$	8,675		$	14,596
Income taxes	$	27,200		$	33,924
Supplemental disclosure of noncash investing and financing activities:
Capital contribution in lieu of preferred stock dividend	$	-		$	200,000
Accrual of preferred stock dividend	$	179,669		$	179,669
Tender of common stock in lieu of interest payment on note receivable from affiliate	$	199,652		$	-
Property and equipment acquired under capital lease agreements	$	1,000,503		$	-
Property and equipment in accrued expenses	$	80,604		$	-
Equipment maintenance costs financed	$	225,168		$	-

See accompanying notes to condensed consolidated financial statements

5

Diligent Board Member Services, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1) Organization and nature of the business

Diligent Board Member Services, Inc. (“Diligent” or the “Company”) is a global leader in web-based portals for Boards of Directors. The Company develops and sells an online software application called Diligent Boardbooks^®, a web-based portal that board members, management and administrative staff use to compile, update, review and archive board materials during and after board meetings. Diligent provides clients with subscription-based access to the software and also provides associated services including securely hosting the clients’ data, and customer service and support for the application.

The Company was incorporated in the State of Delaware on September 27, 2007 and is listed on the New Zealand Stock Exchange (“NZSX”). On December 12, 2007, the Company completed its initial public offering on the NZSX. The Company’s corporate headquarters are located in New York and Christchurch, New Zealand.

The Company has a wholly-owned subsidiary located in New Zealand, Diligent Board Member Services NZ Limited (“DBMS NZ”), which provides research and development services for the Company. The Company has a wholly-owned subsidiary, Diligent Boardbooks Limited (“DBL”), an England and Wales limited liability company which provides European sales and marketing services. The Company has a Singapore-based wholly-owned subsidiary, APAC Board Services PTE. Ltd. (“APAC”), which was formed on December 23, 2010 to provide Asia-Pacific sales and marketing services. At the end of 2011, the Company formed an Australian-based wholly-owned subsidiary, Diligent Board Services Australia PTY Ltd., which commenced operations in 2012. Diligent, together with its subsidiaries, are hereinafter referred to as “the Company”.

The Company’s consolidated financial statements are presented in U.S. dollars, rounded to the nearest dollar, which is the Company’s functional and presentational currency.

The Company has evaluated all subsequent events through the filing date of this Form 10-Q with the Securities and Exchange Commission (SEC), to ensure that this Form 10-Q includes subsequent events that should be recognized in the financial statements as of June 30, 2012, and appropriate disclosure of subsequent events which were not recognized in the financial statements.

2) Significant accounting policies

Basis of presentation –The accompanying interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions for Form 10-Q pursuant to the rules and regulations of the SEC. Accordingly, they do not include all information and notes required by GAAP and provided in the annual consolidated financial statements. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Form 10-K of the Company for the year ended December 31, 2011, as filed with the SEC on March 26, 2012.

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial statements. The results of operations for the six months ended June 30, 2012 are not necessarily indicative of the results to be expected for the full year.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and cash equivalents – The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The Company invests its excess cash primarily in bank and money market funds of major financial institutions. Accordingly, its cash equivalents are subject to minimal credit and market risk. At June 30, 2012, cash equivalents include investments in U.S. treasury bills of $5,999,470 and U.S. treasury money market funds of $6,002,186, which are carried at cost which approximates fair value. At December 31, 2011, cash equivalents include investments in U.S. treasury bills of $1,999,919, U.S. treasury money market funds of $3,000,046 and other money market funds of $2,750.

6

Diligent Board Member Services, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Fair value of financial instruments – The fair value of our cash and cash equivalents, term deposits, accounts receivable, accounts payable and accrued expenses approximates book value due to their short term settlements.The note receivable from affiliate (the “Note”) is recorded at estimated net realizable value, adjusted for any valuation allowance for amounts considered uncollectable. The Note is reviewed for impairment each reporting period.

Share-based compensation – The Company measures the cost of employee services received in exchange for an equity-based award using the fair value of the award on the date of the grant, and recognizes the cost over the period that the award recipient is required to provide services to the Company in exchange for the award.

The Company measures compensation cost for awards granted to non-employees based on the fair value of the award at the measurement date, which is the date performance is satisfied or services are rendered by the non-employee.

Net income per share – Basic net income per share is computed by dividing the net income attributable to common stockholders, after deducting accrued preferred stock dividends, by the weighted average number of common shares outstanding for the period.

Diluted net income per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock, unless the effect is anti-dilutive. Stock options and convertible preferred stock are included as potential dilutive securities for all periods applicable.

The components of the calculation of basic and diluted net income per common share are as follows:

	Three months ended June 30,						Six months ended June 30,
	2012			2011			2012			2011
Numerator:
Net income	$	1,457,421		$	1,009,961		$	3,357,813		$	822,308
Preferred stock dividends		(89,834	)		(89,834	)		(179,669	)		(179,669	)
Basic net income available to common shareholders	$	1,367,587		$	920,127		$	3,178,144		$	642,639
Diluted net income available to common shareholders	$	1,457,421		$	1,009,961		$	3,357,813		$	822,308
Denominator:
Basic weighted average shares outstanding		81,879,565			82,005,913			81,842,629			81,990,321
Dilutive effect of stock options		4,446,142			1,117,853			4,527,622			3,513,799
Dilutive effect of convertible preferred stock		32,667,123			32,667,123			32,667,123			32,667,123
Diluted weighted average shares outstanding		118,992,830			115,790,889			119,037,374			118,171,243
Basic earnings per share	$	0.02		$	0.01		$	0.04		$	0.01
Diluted earnings per share	$	0.01		$	0.01		$	0.03		$	0.01

Recent accounting pronouncements– In June 2011, the FASB issued new guidance regarding the presentation of comprehensive income, whichrequires entities to present the total of comprehensive income, the components of net income and the components of other comprehensive income (OCI) in either a single continuous statement of comprehensive income or in two separate consecutive statements. The guidance does not change the components of OCI or when an item of OCI must be reclassified to net income, or the earnings per share calculation. The Company implemented this guidance in the first quarter of 2012.

7

Diligent Board Member Services, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

From time to time, new accounting pronouncements are issued by the FASB and are adopted by the Company as of the specified effective date. Unless otherwise discussed, the impact of other recently issued accounting pronouncements will not have a material impact on the consolidated financial position, results of operations, and cash flows, or do not apply to the Company’s operations.

3) Term deposit

At June 30, 2012, the Company has a term deposit with a New Zealand bank with an initial term of 365 days. The term deposit in the amount of NZD 125,000 (US$100,175) bears interest at 4.4% and matures in March 2013.

4) Note receivable from affiliate

The Note receivable from affiliate (the “Note”) represents amounts due from Services Share Holding, LLC (“SSH LLC”, the Company’s predecessor entity).

The Note has a principal balance of $3,071,563, and matures on October 1, 2012. It bears interest at 6.5%,payable annually on January 1 of each year. At June 30, 2012, the Note is secured by 4,796,786 shares of Diligent common stock held by SSH LLC and pledged as collateral.

The Company expects to receive the principal balance of $3,071,563 in cash at maturity on October 1, 2012, and accordingly the Note has been recorded as a current receivable in the balance sheet at June 30, 2012.

5) Line of credit facility

As of June 30, 2012, the Company has not borrowed any amounts under its line of credit facility. The expiration date for this line of credit facility is September 12, 2012.

6) Redeemable Preferred Stock

On March 11, 2009, the Company issued 30,000,000 shares of newly-created Series A Preferred Stock for $0.10 per share in a private offering, for aggregate proceeds of $3,000,000 in additional capital. Expenses relating to the share issuance were $138,850.

For the year 2009, the Board of Directors of the Company approved the issuance of paid-in-kind (“PIK”) Shares in lieu of cash, which dividend was effective January 4, 2010. Accordingly, the holders of the Series A Preferred Stock received an aggregate of 2,667,123 PIK shares in January 2010.

The carrying value of the Preferred Shares at June 30, 2012 and December 31, 2011 is as follows:

	June 30,			December 31,
	2012			2011
Gross proceeds	$	3,000,000		$	3,000,000
Less: Issuance costs		(138,850	)		(138,850	)
		2,861,150			2,861,150
Issuance of PIK shares		266,712			266,712
Cumulative amortization of issuance costs		91,042			77,131
Balance	$	3,218,904		$	3,204,993

8

Diligent Board Member Services, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

In 2012, the Company anticipates that cash dividends will be paid on the Series A Preferred Stock. Accordingly, preferred stock dividends of $179,669 for the six months ended June 30, 2012 are included in accrued expenses.

In December 2011, Spring Street Partners, L.P., one of the holders of the Series A Preferred Stock, waived its right to the preferred stock dividend payable on January 1, 2012 of $239,557. This was recorded as a capital contribution in 2011 when waived. The founder and managing partner of Spring Street Partners, L.P. is also the chairman of the board of directors of the Company.

7) Stockholders’ equity

On January 4, 2012, the Company received 133,811 shares of its common stock from SSH LLC, in satisfaction of the interest due on the Note on January 1, 2012 of $199,652 (See Note 4). The shares were valued at $1.492 per share, which was the market value on the last trading day prior to the transaction. The shares were subsequently cancelled.

8) Stock option and incentive plan

During the first half of 2012, the Company issued 900,000 stock options to employees, which were valued at $2,192,931 and will be recognized as expense over a three year vesting period. Total share-based compensation expense recognized for the three and six months ended June 30, 2012 was $375,627 and $597,693, respectively. At June 30, 2012 there was $3,819,678 of unrecognized share-based compensation expense related to options granted that will be recognized over the next 6.0 years.

In July 2012, the Company issued an additional 400,000 stock options to employees. These options will be valued and recognized as expense over a three year vesting period starting in the third quarter of 2012.

9) Income taxes

Income tax expense is provided on an interim basis based upon management’s estimate of the annual effective tax rates in each tax jurisdiction. The income tax provision for the six months ended June 30, 2012 includes U.S. income taxes at an effective rate of 16.5 % and foreign tax obligations of our U.K. and New Zealand subsidiaries. The U.S. effective rate is lower than the statutory rate due to the expected utilization of approximately $6.5 million of net operating loss carryforwards in 2012, as discussed further below.

Section 382 of the U.S. Internal Revenue Code generally imposes an annual limitation on the amount of net operating loss carryforwards that can be used to offset taxable income when a corporation has undergone significant changes in stock ownership. During the second quarter of 2012, the Company completed its Section 382 study and determined that, due to changes in stock ownership in prior years, some of its net operating loss carryforwards will be limited. This limitation results in only $6.5 million available to offset expected taxable income in 2012. Beginning in 2013, a further limitation of approximately $0.5 million per year will be available to offset expected taxable income until expiration. Based on this limitation, the Company expects that approximately $2.5 million of its total net operating loss carryforwards of $16.7 million will expire unutilized in 2029. A full valuation allowance had previously been provided on the related deferred tax asset, and in the second quarter of 2012 the deferred tax asset and valuation allowance relating to the net operating loss carryforwards expected to expire unutilized were written off.

Significant management judgment is required in determining any valuation allowance recorded against deferred tax assets. At June 30, 2012, the Company recognized the benefit of the net operating loss carryforwards it expects to utilize in the current year through the reduction in its effective tax rate, and has recorded a partial valuation allowance against the remaining net operating loss carryforwards available to offset future income through 2029 to the extent that it believes is more likely than not that they will not be realized.

9

Diligent Board Member Services, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Company and its subsidiaries may be subject to, but are not currently under, audit by federal, state and foreign tax authorities. These audits may result in additional tax liabilities. The Company’s federal, state and foreign income tax returns for the 2007 through 2011 tax years are open for, but are not currently under, examination by the respective taxing jurisdictions.

10

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that appear elsewhere in this Form 10-Q. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements.

Overview

The Company develops and makes available an online software application called Diligent Boardbooks^®, a web-based portal that board members, management and administrative staff use to compile, update, review and archive board materials before, during and after board meetings. The Company provides clients with subscription-based access to its software and also provides associated services including securely hosting the client’s data, and customer service and support for the application.

The Company uses the Software-as-a-Service (“SaaS”) model to distribute its Diligent Boardbooks application to the market and maintain the security and integrity of its clients’ data. Under this model, the Company offers annual renewable subscriptions for customer access to its Boardbooks product which is hosted on the Company’s secure servers, and offers a complete suite of related services including training, support, data migration and data security/backup.

The SaaS model allows the Company to differentiate itself through technological innovation and customer service while the subscription billing approach results in a predictable and recurring revenue stream. This SaaS model also allows clients to retain control over access to the application while outsourcing to the Company the support activities, such as managing the IT infrastructure and maintaining the software.

The Company’s SaaS model addresses several difficulties found in the traditional software model and offers the following critical advantages for our company:

• Highly scalable operations.Because our clients’ boards do not ordinarily meet on a daily or monthly basis, our system has the capability to support many more Boards without absorbing increased costs associated with customer growth.

• Better revenue visibility.By offering renewable annual subscriptions instead of one time perpetual licenses, the Company has much better revenue foresight. This high revenue visibility allows the Company to undertake much better planning and budgeting, with significant advantages for corporate strategy and profitability.

• Lower cost of development.The Companyhas developed one application that is cost-effectively shared across thousands of end users. This is considerably less expensive than developing all the permutations (data bases, operating systems, etc) needed by customers who want to run the software on their own premises. These economies allow the Company to spend resources on developing increased functionalities for its Boardbooks application instead of on creating multiple versions of the same code.

• Longer corporate life.The SaaS model has a long tail of recurring revenue that reduces investment risk, simplifies corporate planning and leads to extended corporate life.

• Better expense visibility.Because revenue is more predictable, the Company is able to better plan expenses.

We began developing components of the Diligent Boardbooks system starting in 1998, culminating in the roll-out of an international sales force in 2007.

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On December 12, 2007 we completed a public share offering of 24,000,000 shares of our common stock in conjunction with a listing of our stock on the New Zealand Stock Exchange under the symbol “DIL.” As a result, the Company is subject to the regulation and reporting requirements imposed by the New Zealand Stock Exchange. There is no United States established public trading market for our common stock. However, because the Company is a U.S. company incorporated in Delaware with over 500 shareholders, it is also subject to the U.S. reporting and regulatory requirements of the Securities and Exchange Commission (“SEC”) and the Securities Exchange Act of 1934. Because of this dual regulation in New Zealand and the U.S., the Company is required to meet both standards, which means the Company sometimes is faced with conflicting requirements and always must comply with the more stringent rule.

We are pleased to report Diligent’s revenue growth. Diligent recorded quarterly revenue of $10.1 million for the second quarter of 2012, which represents a 176% increase over the second quarter of 2011. Diligent records its revenue from subscription-based sales and installation fees ratably over the contract period. In the second quarter of 2012, Diligent signed new contracts with annual recurring revenue of $7.0 million, which is a 137% increase over the second quarter of 2011. This growth is evidence of a heightened demand for the Diligent Boardbooks product.

The Company now serves 1,447 public and private companies with over 2,049 boards and 39,000 users in the U.S., Canada, EMEA (Europe, Middle East and Africa) and the Asia-Pacific region. During the second quarter of 2012, Diligent signed a total of 216 net new client agreements versus 133 in the same quarter last year—an increase of 62%. Diligent now services 224 Fortune 1000 companies, of which 35 were added in the second quarter.

Critical Accounting Policies and Estimates

There have been no material changes to the critical accounting policies as filed in our 2011 annual report on Form 10-K.

Recent Accounting Pronouncements

See Note 2 to the condensed consolidated financial statements at Item 1 of this Form 10-Q

Results of Operations for the Three Months Ended June 30, 2012 and 2011

Revenues

	Three months ended June 30,
	2012		2011		Increase/(Decrease)
Revenues	$	10,118,298	$	3,665,065	$	6,453,233

The growth in total revenues of 176% in the second quarter of 2012 when compared with the 2011 second quarter is a result of the significant increase in subscription agreements. The Company has continued to add subscription agreements each quarter since inception. At June 30, 2012, the cumulative client agreements were 1,447, compared with 653 at June 30, 2011. A net of 216 new subscription agreements were added during the second quarter of 2012, compared with 133 for the second quarter of 2011, an increase of 62%. Sales increased in all of our major regions, with particularly strong growth in Europe and the Asia-Pacific region. Additionally, upgrades from existing customers in the second quarter, based on dollar value added to existing annual contracts, increased 539% over the second quarter of 2011.

The Company recognizes revenue ratably over the contract period, which is generally twelve months. Accordingly, the full impact of the growth in subscription agreements during the quarter will be recognized over the next twelve months. All of the deferred revenue of $12.9 million recorded on the balance sheet at June 30, 2012 is expected to be recognized as revenue in the next twelve months.

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Cost of Revenues and Operating Expenses

Cost of Revenues

	Three months ended June 30,
	2012		2011		Increase/(Decrease)
Cost of Revenues	$	2,427,885	$	1,140,626	$	1,287,259

Cost of revenues is comprised of account management, customer support and IT services. The Company increased headcount in order to service our larger client base, resulting in an increase in employee salaries and incentive pay of approximately $0.8 million in total, consisting of $0.5 million in account management, $0.1 million in customer support and $0.2 million in IT services. Hosting costs increased by over $0.1 million due to the opening of an additional hosting center. The remainder of the increase consists of higher costs in support and maintenance, travel, bandwidth, printing and publications and other expenses related to supporting our larger client base. Included within these increases are higher customer service and account management costs in the U.K. ($0.2 million) and Australia ($0.1 million) as a result of the increase in European sales and the commencement of operations in Australia in 2012.

The gross profit ratio for the three months ended June 30, 2012 was 76%, compared with 69% for the second quarter of 2011.

Selling and Marketing Expenses

	Three months ended June 30,
	2012		2011		Increase/(Decrease)
Selling and Marketing Expenses	$	2,079,115	$	1,152,486	$	926,629

Selling and marketing expenses increased in the second quarter of 2012 as a result of an increase in commissions,for our U.S. sales force of approximately $0.5 million. Foreign salaries and commissions increased by approximately $0.4 million, primarily due to an increase in sales staff in the U.K., commissions for existing sales staff and our expansion into the Australian market. The remaining increase in selling and marketing expenses is due to increases in other selling expenses, including travel and support services, as well as a small increase in marketing, primarily due to web advertising.

General and Administrative Expenses

	Three months ended June 30,
	2012		2011		Increase/(Decrease)
General and Administrative Expenses	$	2,606,278	$	1,124,100	$	1,482,178

The increase in general and administrative expenses is comprised of increases in the U.S. of $1.3 million and increases in the U.K. of $0.2 million. The U.S. cost increases include executive compensation of $0.9 million, share-based compensation costs of $0.1 million, rent and other office costs of $0.1 million, and professional and directors’ fees of $0.1 million. The U.K. increase is due to the significant expansion of our European operations based in the U.K., and consists principally of salaries and office costs.

Research and Development Expenses

	Three months ended June 30,
	2012		2011		Increase/(Decrease)
Research and Development Expenses	$	579,338	$	370,516	$	208,822

The increase in research and development expenses is primarily due to increased staffing in our New Zealand subsidiary for product upgrades and enhancements.

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Depreciation and Amortization

	Three months ended June 30,
	2012		2011		Increase/(Decrease)
Depreciation and Amortization	$	267,700	$	123,536	$	144,164

The increase in depreciation and amortization is attributable to the net increase in property and equipment, consisting principally of computer equipment and computer software.

Impairment recovery on note receivable from affiliate

	Three months ended June 30,
	2012		2011		Increase/(Decrease)
Impairment recovery on note receivable from affiliate	$	-	$	1,200,000	$	(1,200,000	)

At June 30, 2011, the Company determined that the value of the note receivable from affiliate was no longer impaired and the remaining balance in the valuation allowance of $1.2 million was reversed and recorded as income. At June 30, 2012, the Note, which is due October 1, 2012, is recorded at its full contractual value of $3.1 million.

Interest Income, net

	Three months ended June 30,
	2012		2011		Increase/(Decrease)
Interest Income, net	$	51,958	$	43,942	$	8,016

Interest income, net, includes interest income on the note receivable from our affiliate and interest on the Company’s cash and cash equivalents and term deposits which are interest-bearing, offset by interest expense on our capital lease obligations. The increase in net interest income is attributable to a decrease in interest expense on our capital lease obligations as some of our older leases with higher interests were completed during the latter part of 2011.

Foreign Exchange Transaction Gain (Loss)

	Three months ended June 30,
	2012			2011		Increase/(Decrease)
Foreign Exchange Transaction Gain (Loss)	$	(20,260	)	$	17,461	$	(37,721	)

The Company’s U.S. and U.K. operations have transactions with customers and suppliers denominated in currencies other than their functional currencies, primarily the Canadian Dollar and the Euro, and the U.S. parent Company has transactions with its foreign subsidiaries in the subsidiaries’ functional currencies which create foreign currency intercompany receivables and payables. Additionally, the U.S. parent Company maintains a portion of its cash balances in foreign currencies, primarily the NZD and GBP. Foreign exchange transaction gains and losses arise on the settlement of foreign currency transactions at amounts different from the recorded amounts, and the measurement of the unrealized foreign currency gains and losses in the related assets and liabilities at the end of the period. The loss recorded in the second quarter of 2012 is primarily a result of the strengthening of the U.S. dollar against NZD and GBP.

Income Tax Expense

	Three months ended June 30,
	2012		2011		Increase/(Decrease)
Income Tax Expense	$	732,259	$	13,747	$	718,512

Income tax expense is provided on an interim basis based upon management’s estimate of the annual effective tax rates in each tax jurisdiction. The income tax provision for the three months ended June 30, 2012 includes U.S. income taxes at an expected effective rate of 16.5 %, and foreign tax obligations of our U.K. and New Zealand subsidiaries. The U.S. effective rate is lower than the statutory rate due to the expected utilization of approximately $6.5 million of net operating loss carryforwards in 2012, as discussed further in Note 9 to the condensed consolidated financial statements at Item 1 of this Form 10-Q. The significant increase in income tax expense is due to the fact that 2012 is the first year in which the Company expects to have taxable income after utilization of operating loss carryforwards.

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The income tax provision for the second quarter of 2011 consists entirely of foreign taxes.

Results of Operations for the Six Months Ended June 30, 2012 and 2011

Revenues

	Six months ended June 30,
	2012		2011		Increase/(Decrease)
Revenues	$	18,332,784	$	6,641,294	$	11,691,490

The growth in total revenues of 176% in the first half of 2012 when compared with the first half of 2011 is a result of the significant increase in subscription agreements. The Company has continued to add subscription agreements each quarter since inception. At June 30, 2012, the cumulative number of new client agreements was 1,447, compared with 653 at June 30, 2011. A net of 421 new subscription agreements were added during the first half of 2012, compared with 197 for the first half of 2011, an increase of 114%. Sales increased in all of our major regions, with particularly strong growth in Europe and the Asia-Pacific region. Additionally, upgrades from existing customers in the first half of the year, based on dollar value added to existing annual contracts, increased 427% over the first half of 2011.

The Company recognizes revenue ratably over the contract period, which is generally twelve months. Accordingly, the full impact of the growth in subscription agreements during the quarter will be recognized over the next twelve months. All of the deferred revenue of $12.9 million recorded on the balance sheet at June 30, 2012 is expected to be recognized as revenue in the next twelve months.

Cost of Revenues and Operating Expenses

Cost of Revenues

	Six months ended June 30,
	2012		2011		Increase/(Decrease)
Cost of Revenues	$	4,592,830	$	1,960,475	$	2,632,355

Cost of revenues is comprised of account management, customer support and IT services. The Company increased headcount in order to service our larger client base, resulting in an increase in employee salaries and incentive pay of approximately $1.8 million in total, consisting of $1.1 million in account management, $0.4 million in customer support and $0.3 million in IT services. Hosting costs increased by over $0.2 million due to the opening of an additional hosting center. The remainder of the increase consists of higher costs in support and maintenance ($0.2 million), travel ($0.1 million), recruiting ($0.1 million), software ($0.1million) and other expenses related to supporting our larger client base. Included within these increases are higher customer service and account management costs in the U.K. ($0.2 million) and Australia ($0.2 million) as a result of the increase in European sales and the commencement of operations in Australia in 2012.

The gross profit ratio for the six months ended June 30, 2012 was 75%, compared with 70% for the comparable 2011 period.

Selling and Marketing Expenses

	Six months ended June 30,
	2012		2011		Increase/(Decrease)
Selling and Marketing Expenses	$	4,017,686	$	2,025,523	$	1,992,163

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Selling and marketing expenses increased in the first half of 2012 when compared to the first half of 2011 as a result of an increase in salaries and commissions for our U.S. sales force of approximately $1.1 million. Foreign salaries and commissions increased by approximately $0.7 million, primarily due to an increase in sales staff in the U.K., commissions for existing sales staff and our expansion into the Australian market. The remaining $0.2 million increase in selling and marketing expenses is due to increases in other selling expenses, including travel and support services, as well as a small increase in marketing, primarily due to web advertising.

General and Administrative Expenses

	Six months ended June 30,
	2012		2011		Increase/(Decrease)
General and Administrative Expenses	$	4,115,826	$	2,176,457	$	1,939,369

The increase in general and administrative expenses is comprised of increases in the U.S. ($1.6 million), the U.K. ($0.2 million) and New Zealand ($0.1 million). The U.S. expense increases include executive compensation of $1.0 million, share-based compensation costs of $0.2 million, rent and other office costs of $0.1 million, and professional and directors’ fees of $0.2 million. The U.K. increase is due to the significant expansion of our European operations based in the U.K., and consists principally of salaries and office costs.

Research and Development Expenses

	Six months ended June 30,
	2012		2011		Increase/(Decrease)
Research and Development Expenses	$	1,053,635	$	690,070	$	363,565

The increase in research and development expenses is primarily due to increased staffing in our New Zealand subsidiary for product upgrades and enhancements.

Depreciation and Amortization

	Six months ended June 30,
	2012		2011		Increase/(Decrease)
Depreciation and Amortization	$	495,782	$	241,505	$	254,277

The increase in depreciation and amortization is attributable to the net increase in property and equipment, consisting principally of computer equipment and computer software.

Impairment recovery on note receivable from affiliate

	Six months ended June 30,
	2012		2011		Increase/(Decrease)
Impairment recovery on note receivable from affiliate	$	-	$	1,200,000	$	(1,200,000	)

At June 30, 2011, the Company determined that the value of the Note receivable from affiliate was no longer impaired and the remaining balance in the valuation allowance of $1.2 million was reversed and recorded as income. At June 30, 2012, the Note, which is due October 1, 2012, is recorded at its full contractual value of $3.1 million.

Interest Income, net

	Six months ended June 30,
	2012		2011		Increase/(Decrease)
Interest Income, net	$	100,340	$	88,762	$	11,578

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Interest income, net, includes interest income on the note receivable from our affiliate and interest on the Company’s cash and cash equivalents and term deposits which are interest-bearing, offset by interest expense on our capital lease obligations. The increase in net interest income is attributable to a decrease in interest expense on our capital lease obligations as some of our older leases with higher interests were completed during the latter part of 2011.

Foreign Exchange Transaction Gain/(Loss)

	Six months ended June 30,
	2012			2011		Increase/(Decrease)
Foreign Exchange Gain/(Loss)	$	(14,674	)	$	5,272	$	(19,946	)

The Company’s U.S. and U.K. operations have transactions with customers and suppliers denominated in currencies other than their functional currencies, primarily the Canadian Dollar and the Euro, and the U.S. parent Company has transactions with its foreign subsidiaries in the subsidiaries’ functional currencies which create foreign currency intercompany receivables and payables. Additionally, the U.S. parent Company maintains a portion of its cash balances in foreign currencies, primarily the NZD and GBP. Foreign exchange transaction gains and losses arise on the settlement of foreign currency transactions at amounts different from the recorded amounts, and the measurement of the unrealized foreign currency gains and losses in the related assets and liabilities at the end of the period. The loss recorded in the first half of 2012 is primarily a result of the strengthening of the U.S. dollar against NZD and GBP.

Income Tax Expense

	Six months ended June 30,
	2012		2011		Increase/(Decrease)
Income Tax Expense	$	784,878	$	18,990	$	765,888

Income tax expense is provided on an interim basis based upon management’s estimate of the annual effective tax rates in each tax jurisdiction. The income tax provision for the six months ended June 30, 2012 includes U.S. income taxes at an expected effective rate of 16.5 %, and foreign tax obligations of our U.K. and New Zealand subsidiaries. The U.S. effective rate is lower than the statutory rate due to the expected utilization of approximately $6.5 million of net operating loss carryforwards in 2012, as discussed further in Note 9 to the condensed consolidated financial statements at Item 1 of this Form 10-Q. The significant increase in income tax expense is due to the fact that 2012 is the first year in which the Company expects to have taxable income after utilization of operating loss carryforwards.

The income tax provision for the first half of 2011 consists entirely of foreign taxes.

Liquidity and Capital Resources

At June 30, 2012, the Company’s sources of liquidity consist of cash and cash equivalents and term deposits of approximately $17.3 million. The Company also has a $1.0 million revolving line of credit facility with Spring Street Partners, L.P. This line of credit offers the Company additional cash flow support, if needed. Through June 30, 2012, the Company has had no borrowings under this line of credit facility. The expiration date for this line of credit facility is September 12, 2012.

Historically, the Company’s primary sources of liquidity had been the cash received from stock issuances. Through the second quarter of 2010, our cash flow from operations was negative and we relied on capital raises to sustain and grow our business. By the third quarter of 2010, the Company began generating positive cash flows from operations and 2010 marked the first year since inception of the Company that Diligent achieved positive cash flow from operations. The Company has continued to generate positive cash flows each subsequent quarter. We have no long-term debt, except for obligations under capital leases and software licensing agreements, and thus far our financing costs have consisted principally of the dividend on our preferred stock and repayments of our capital lease obligations. We anticipate that this trend will continue through the foreseeable future, with increased cash growth expected from operations in 2012. Additionally in October 2012, the note receivable from our predecessor entity will mature and the Company expects to receive the principal balance of $3.1 million in cash at maturity.

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In order to minimize credit and market risk, the Company has invested $12.0 million of its cash in short-term U.S. treasury instruments, through the direct purchase of treasury bills and through a U.S. treasury money market fund. The remainder of our cash is held in various financial institutions by the parent company and its subsidiaries based on our projected cash needs. To minimize our foreign currency exposure, we maintain funds in foreign currency bank accounts, based on projected foreign currency expenditures.

Cash flows

	Six months ended June 30,
	2012			2011
Cash provided by (used in):
Operating activities	$	9,182,216		$	1,236,852
Investing activities	$	(756,511	)	$	(450,895	)
Financing activities	$	(220,715	)	$	(189,475	)

Net Cash Flows from Operating Activities

Cash provided by operating activities for the six months ended June 30, 2012 increased significantly compared with the first half of 2011. Note that $4.4 million of the cash generated by operating activities for the quarter came from the increase in deferred revenue, as subscription fees are paid in advance and recorded as deferred revenue until recognized.

Net Cash Flows from Investing Activities

Cash used in investing activities in the first six months of 2012 and 2011 consist entirely of purchases of property and equipment.

Net Cash Flows from Financing Activities

In the first half of 2012, financing activities consist principally of the $119,781 dividend paid on the Company’s preferred stock, as well as repayments of capital leases and software licensing agreements, offset by proceeds of stock option exercises. In the first half of 2011, cash used in financing activities included $159,338 of cash dividends paid on preferred stock and repayments of capital leases, offset by proceeds of stock option exercises.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Because the Company qualifies as a smaller reporting company, as defined by §229.10(f)(1) it is not required to provide the information required by this Item.

Item 4. Controls and Procedures.

(a) Evaluation of disclosure controls and procedures.As of the end of the quarter ended June 30, 2012, our Chief Executive Officer and Chief Financial Officer have each reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have each concluded that our current disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

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(b) Changes in Internal Controls.There has been no change in the Company’s internal control over financial reporting required by Exchange Act Rule 13a-15 or 15d-15 that occurred during the fiscal quarter ended June 30, 2012 that has materially affected, or is reasonably likely to materially affect Diligent Board Member Services, Inc.’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

None

Item 1A. Risk Factors.

Not required

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None

Item 3. Defaults Upon Senior Securities.

Not applicable

Item 4. [Reserved]

Item 5. Other Information.

Not applicable

Item 6. Exhibits.

Exhibit Numbers	Exhibits
10.16	Employment agreement between Diligent Boardbooks Limited and Charlie Horrell
31.1	CEO Certification pursuant to Rule 13a-14(a)
31.2	CFO Certification pursuant to Rule 13a-14(a)
32.1	CEO Certification furnished pursuant to Rule 13a-14(b) and 18 U.S.C. 1350
32.2	CFO Certification furnished pursuant to Rule 13a-14(b) and 18 U.S.C. 1350

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SIGNATURES

Pursuant to the requirements on 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.

	DILIGENT BOARD MEMBER SERVICES, INC.
Dated:  August 13, 2012	By:	/s/ Alessandro Sodi
		Alessandro Sodi, Chief Executive Officer (Principal Executive Officer)
Dated:  August 13, 2012	By:	/s/ Steven P. Ruse
		Steven P. Ruse, Chief Financial Officer (Principal Financial Officer)

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