Item 2. Management’s Discussion and Analysis or Plan of Operations
This Quarterly Report on Form 10-QSB includes a number of forward-looking statements that reflect our current views with respect to business strategies, products, future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including those discussed below, that could cause actual results to differ materially from historical results or those anticipated, including the risks and uncertainties described below, as well as in our annual report on Form 10-KSB/A for the year ended March 31, 2005, under the respective caption “Other Factors that May Affect Operating Results.” When used in this Report, the words “anticipate,” “believe,” “predict,” “intend,” “may,” “could,” “should,” “would,” “will,” “expect,” “future,” “continue,” and variations of such words and similar expressions as they relate to the Company are intended to identify such forward-looking statements, but are not the exclusive means of identifying such statements. Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. We do not undertake any obligation to revise these forward-looking statements to reflect any future events or circumstances. In addition, the disclosures under the caption “Other Factors that May Affect Operating Results” consist principally of a brief discussion of risks which may affect future results and are thus, in their entirety, forward-looking in nature. To facilitate readers in identifying forward-looking statements in this Report, we have attempted to mark sentences containing such statements with a single asterisk and paragraphs containing only forward-looking statements with double asterisks. However, no assurance can be made all such statements have been identified and marked. Therefore, readers are urged to carefully review and consider the various disclosures made in this report and in our other reports previously filed with the Securities and Exchange Commission (the “SEC”), including our periodic reports on Forms 10-KSB and 10-QSB, and those described from time to time in our press releases and other communications, which attempt to advise interested parties of the risks and factors that may affect the Company’s business.
OVERVIEW
Timeline, Inc., headquartered in Seattle, Washington, licenses intellectual property protected by patents granted by the U.S. Patent and Trademark Office and six other countries. We currently hold six patents issued by the U.S. Patent and Trademark Office on our technology (for a total of 136 issued claims), and we have also been issued patents in Australia, Canada, China, Hong Kong, Israel, Mexico and Singapore. Our wholly owned subsidiary, WorkWise also holds one U.S. patent. We have a number of pending patent applications, and believe additional international patents may be issued during fiscal 2006.*
Prior to August 31, 2005, we also developed, marketed and supported enterprise-wide financial management, budgeting and reporting software and event-based notification, application integration and process automation systems.
On July 20, 2005, we entered into an Asset Purchase Agreement with Global Software, Inc. for the sale to Global of all of our software licensing operations. (A copy of the Asset Purchase Agreement has been filed as an exhibit to a Current Report on Form 8-K, as filed with the SEC on July 25, 2005.) Under the terms of the Asset Purchase Agreement, the sale of our software business occurred in two stages, consisting of (1) the sale of 100% of stock in our U.K. subsidiary, Analyst Financials Limited, and certain other assets and customer contracts (the “Stock Sale”), and (2) the sale of our other software assets (the “Asset Sale”), in each case in exchange for cash, promissory notes, and assumption of certain liabilities. The Stock Sale was consummated on July 20, 2005 and the Asset Sale was consummated on August 31, 2005.
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With the net proceeds we received from the Stock Sale on July 20, 2005 and the Asset Sale on August 31, 2005, as discussed in notes 1 and 6 to the financial statements included herein, we believe that our current cash and cash equivalents, together with any net cash provided by operations, will be sufficient to meet anticipated cash needs for working capital and capital expenditures through fiscal 2006.**
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates including, among others, those affecting revenues, the allowance for doubtful accounts, and the useful lives of tangible and intangible assets. The discussion below is intended as a brief discussion of some of the judgments and uncertainties that can impact the application of these policies and the specific dollar amounts reported on our financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, or if management made different judgments or utilized different estimates. Our estimates or judgments are based in part on anticipated future events or performance, and as such are forward-looking in nature, and are subject to many risks and uncertainties, including those discussed below and elsewhere in this Report. We do not undertake any obligation to update or revise this discussion to reflect any future events or circumstances.
We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis or Plan of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and our other accounting policies, see the Notes to Condensed Consolidated Financial Statements of this Form 10-QSB and Note 2 to the Consolidated Financial Statements in our Annual Report on Form 10-KSB for the year ended March 31, 2005.
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists and delivery has occurred, provided the fee is fixed or determinable, and collectibility is probable. We assess whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a fee is based upon a variable such as a royalty based on units sold, we account for the fee as not being fixed and determinable. In these cases, we defer revenue and recognize it when it becomes due and payable. We assess the probability of collection based on a number of factors, including past transaction history with the licensee and the current financial condition of the licensee. We do not request collateral from our licensees. If we determine that collection of a fee is not reasonably assured, we defer revenue until the time collection becomes reasonably assured.
For all patent licenses, we use a signed agreement, as evidence of an arrangement.
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Allowance for Doubtful Accounts
We estimate the uncollectibility of our accounts receivable by analyzing licensee credit-worthiness, current economic trends and changes in our license payment terms in order to evaluate the adequacy of the allowance for doubtful accounts. Historically, we have experienced a minimal rate of doubtful accounts and therefore provide for an allowance of a set percentage based on aging of the receivable, i.e., 1% for receivables within 60 days of due date and 5% for those 61 days or more past the due date. However, material differences may result in the amount and timing of our bad debt expenses for any period if we had an increase in unpaid accounts, which could reduce our total current assets.* In fiscal 2004 or 2005, no bad debt expense was recorded against our bad debt reserves. Nevertheless, if we underestimated the collectibility of our accounts receivable, it would have a negative impact on our reported net receivables, net loss and our cash flow.*
Capitalized Patents
We capitalize the direct out-of-pocket costs to obtain patents on our technology. Such costs are amortized over the life of the patent, which has a typical contractual life of 20 years. Should we determine that we will not be able to generate future revenues as a result of a patent, we would need to write off the patent in the period we determine that the patent is impaired.* At September 30, 2005, such a write-off would reduce our total assets by approximately $273,000. It would have no effect on cash. Costs of defending our patents are expensed as incurred, which, depending on the nature and complexity of the legal defense strategy, could materially impact our results of operations in any given period.*
Impairment of Long-Lived Assets
Long-lived assets, including property and equipment and capitalized patents are amortized over their useful lives. We assess the impairment of these assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable based on estimated undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Our judgments regarding the existence of impairment indicators are based on legal factors and market conditions. Future events could cause us to conclude that impairment indicators exist and that certain assets are impaired.* Such an adjustment would have no effect on our cash.*
RESULTS OF OPERATIONS
The Results of Operations discussed below are presented in a format different than in prior periods to reflect the change in the Company’s business focus. We present management’s discussion on the basis of Results of Ongoing Operations, Discontinued Operations, and Gain on Sale of Software Operations. In order to provide comparative analysis, we also restate prior fiscal periods consistent with this presentation of discontinued operations and ongoing operations.
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Results of Ongoing Operations
Revenue/Gross Profit (Loss)
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Patent license revenue | | $ | 272 | | $ | — | | | N/A | | $ | 362 | | $ | 3,092 | | | (88 | )% |
Warranty and other revenue | | | 10,621 | | | — | | | N/A | | | 10,621 | | | — | | | N/A | |
Patent amortization expense | | | (6,268 | ) | | (5,487 | ) | | 14 | % | | (12,452 | ) | | (10,890 | ) | | 14 | % |
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Gross profit (loss) | | $ | 4,625 | | $ | (5,487 | ) | | 184 | % | $ | (1,469 | ) | $ | (7,798 | ) | | (81 | )% |
We received nominal patent license revenues of $272 during the second quarter of fiscal 2006. In the second quarter of fiscal 2005, no patent license revenue was earned. For the comparative six-month periods, patent license revenue was $362 in fiscal 2006 compared to $3,092 in fiscal 2005. Patent license revenue is very sporadic. The timing of any significant fees usually corresponds to the settlement of litigation and, therefore, is unpredictable. The patent license revenue in each of the comparable quarters and six-month periods represents ongoing royalties based on sales of product with a licensee with very low volumes. While we intend to continue to pursue additional patent license agreements during fiscal 2006, we cannot predict the outcome of ongoing and future negotiations and there are no assurances that we will be successful in entering into additional patent licenses, or the timing or amount of any such licenses.*
Warranty revenue in the quarter and six-month period ended September 30, 2005 reflects amortization of our 48-month covenant not to compete as set forth in the Asset Purchase Agreement with Global. Under the Asset Purchase Agreement, a total of $480,000 was allocated to the covenant not to compete (and shown as deferred revenue on the balance sheet), at a rate of $10,000 per month. As such, we will recognize this warranty revenue at the rate of $10,000 per month for each complete month that we fulfill the obligation of the covenant.* The covenant not to compete continues until August 31, 2009. No similar income was applicable to fiscal 2005.
Patent amortization expenses consist of amortization of capitalized costs of patent acquisition, filing and maintenance. We capitalize the cost of procuring patents which mainly consists of attorney and filing fees. Once a patent is granted, we also capitalize the expense of maintaining our registration in the various countries. These costs are amortized over the remaining life of the various patents on a straight line basis. The costs associated with litigation or negotiation of patent licenses with third parties is separately accounted for as “patent expenses” under ‘Operating Expense’ below. Patent amortization expenses for the second quarter and the first six months of fiscal 2006 increased by 14% and 14%, respectively, over the comparable periods in fiscal 2005 due to patent related fees incurred during the second quarter which were amortized.
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Operating Expense
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General & administrative | | $ | 145,692 | | $ | 109,392 | | | 33 | % | $ | 287,448 | | $ | 280,030 | | | 3 | % |
Patent | | | 39,745 | | | 33,503 | | | 19 | % | | 72,213 | | | 75,020 | | | (4 | )% |
Depreciation | | | 369 | | | 547 | | | (33 | )% | | 738 | | | 1,093 | | | (32 | )% |
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Total operating expense | | $ | 185,806 | | $ | 143,442 | | | 30 | % | $ | 360,399 | | $ | 356,143 | | | 1 | % |
Expenses of ongoing operations in all periods reflect costs associated with pursuing licenses of the patents and the costs of maintaining the public entity.
General and administrative expense consists of salaries, legal and accounting fees, rent, insurance and other expenses associated with maintaining the corporate entity. For the three- and six-month periods ended September 30 in both fiscal 2006 and 2005, these expenses included the salaries of the CEO (a portion of which was allocated to patent expense), the controller, a receptionist and Director of Investor Relations. Legal and accounting fees for the quarter ended September 30, 2005 included approximately $63,000 in professional fees as a one-time expense incurred in connection with the sale of our software business. There was no similar expense in the comparable periods ended September 30, 2004. For the remainder of fiscal 2006, we anticipate some additional accounting expenses in connection with several SEC filings and additional tax consulting associated with the sale to Global.
We expect the general and administrative expense associated with our patent licensing business decrease in future periods. This will most likely occur gradually as the remaining staff of four people decreases over time. We anticipate that our controller will remain on the payroll through December 31, 2005. Thereafter, we expect to require additional consulting expense for accounting advice; but not to the extent of the salary expense of a controller. Also, our CEO has agreed to a reduced salary which we anticipate will take effect within 6 months of the closing of the sale of assets (August 31, 2005). Finally, there will not be a requirement for a receptionist in future quarters. By comparison, we had 29 employees at September 30, 2004. We cannot as yet foresee the impact of the sale of our software business on insurance and audit fees for future periods.**
Patent expense includes the costs of litigation and negotiations with respect to patent licenses. Patent license expenses can vary dramatically quarter-to-quarter depending upon the level of activity required from legal counsel and experts. In June 2005, we filed an action in the Federal District Court for the Western District of Washington against ProClarity Corporation alleging patent infringement, and seeking monetary damages and an injunction against ProClarity licensing certain of its products. Nevertheless, patent expenses remained relatively flat during the three- and six-months ended September 30, 2005, as this case is being handled on a contingency fee basis. We will, however, be responsible for costs as incurred. For this reason, we expect patent expenses to increase in future periods as the costs of litigation increase.* Additionally, in the event there is a monetary recovery, legal fees will be accrued as an expense against such recovery.*
Depreciation expense decreased in the quarter ended September 30, 2005 to $369 from $547 in the quarter ended September 30, 2004. Amortization of intangible assets were $0 during the same periods due to the fact all intangible assets other than patents and goodwill have been fully amortized.
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Results of Discontinued Operations
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(Loss) income from Discontinued Operations | | $ | (57,181 | ) | $ | 16,394 | | | (456 | )% | $ | (108,551 | ) | $ | (159,181 | ) | | 31 | % |
Discontinued Operations consists of our prior software licensing operations (which were sold to Global pursuant to the Asset Purchase Agreement), presented in accordance with FASB 144.
For the quarter ended September 30, 2005, our total operating loss from discontinued operations was $57,000 compared to income of $16,000 for the quarter ended September 30, 2004. For the comparative six months, we had a loss of $109,000 for September 30, 2005 compared to a loss of $159,000 for September 30, 2004. The losses from our discontinued software operations for the three- and six-month periods ended September 30, 2005 reflect a substantial decrease in revenue (software licensing, maintenance and consulting), as well as significant costs associated with severance benefits, during the period. The decrease in revenues from our discontinued operations during this period was due in part to our announcement in June 2005 of the proposed sale of our software operations to Global Software. We believe this announcement and the process of negotiating and executing an asset purchase agreement was disruptive to our business and contributed to a number of current and prospective software customers delaying ordering software or services from us.
Gain on Stock Sale and Asset Sale
During the periods ended September 30, 2005, we recognized one-time gains from the sale of our software operations to Global Software, consisting of a gain of $1,287,000 from the Stock Sale, and a gain of $595,000 from the Asset Sale. The gain on the sale of our software operations is net of $480,000 allocated to a covenant not to compete which is noted above and which will be recognized as revenue ratably in each period of the covenant over a period of 48 months.* These gains reflect not only the receipt of cash and notes payable, but also the assumption of liabilities associated with the business segment; most notably the deferred income associated with ongoing maintenance obligations.
As a result of the closing of the Stock and Asset sales, Timeline received net cash proceeds of $886,000 (after payment of $252,000 on the bridge loan previously made by Global to us in June 2005). Offsetting this increase in cash was $81,000 of Analyst Financials Limited’s cash which was included in the assets sold to Global, and was no longer part of the consolidated group at September 30, 2005.
The remaining consideration in the Stock and Asset sales included two notes receivable in principal amount totaling $1,000,000 and the assumption of liabilities (see Liquidity and Capital Resources below for detail on the terms of the notes receivable).
Timeline also incurred approximately $47,000 in severance benefits and bonus payments associated with the sales, all of which are included in the expenses of discontinued operations.
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These gains are a one time event and no future gains are expected to be recorded from these transactions.* The Asset Purchase Agreement for the sale of our software operations included certain standard indemnification obligations by us of Global Software; accordingly, there is a possibility of some future expenses associated with potential future indemnification claims against us.* Following the closing of the Asset Sale, we and Global have agreed to approximately $56,000 in certain post-closing accounting adjustments in favor of Global, and these are reflected in notes payable on the September 30, 2005 balance sheet. We have not recorded any provision for future adjustments or any indemnification expenses as we do not consider any such expenses to be probable or material.
Other Income and Expense
Other income and expense (other than from the Stock Sale or Asset Sale) generated net income of $14,000 in the second quarter of fiscal 2006 compared to a loss of $5,000 in the second quarter of fiscal 2005. For the six months ended September 30, 2005, we had net income of $11,000 compared to a loss of $5,000 for the six months ended September 30, 2004. In all periods the major components of income and expense was from interest and foreign exchange transactions.
Income Tax
No income tax expense was recorded in the comparable quarter or six-month periods of either fiscal 2006 or fiscal 2005. All income or loss is offset by appropriate adjustments to the valuation allowance of our net operating loss carry-forwards. The gain form the Stock Sale and the Asset Sale will also be offset by the net operating loss carry-forwards, so no net provision for tax expense has been provided.*
LIQUIDITY AND CAPITAL RESOURCES
We have historically suffered recurring operating losses and negative cash flows from operations. As of September 30, 2005, we had positive net working capital of approximately $314,000 (positive working capital position of approximately $784,000 when excluding deferred revenue). At September 30, 2005, our deferred revenue was $470,000, comprised solely of the allocation to our 48-month covenant not to compete pursuant to the Asset Purchase Agreement, at a rate of $10,000 per month; although we recognize revenue from this covenant not to compete for each month during the 48-month term, we will not actually receive any additional cash payments for it.* Additionally, as of September 30, 2005, our cash and cash equivalents were $790,000 compared to cash and cash equivalents of $121,000 as of March 31, 2005. This increase was due to the receipt of net $805,000 cash proceeds from the sale of our software operations, offset by cash used in our discontinued operations and repayments under our former line of credit with Silicon Valley Bank and payment on a note payable to Global.
In addition, at September 30, 2005, we held two notes receivable from Global in principal amount totaling $1,000,000 from the sale of our software operations. These notes receivable consist of (1) a $480,000 promissory note issued on July 20, 2005, with $240,000, plus accrued and unpaid interest, payable on January 20, 2007 and $240,000, plus accrued and unpaid interest, payable on July 20, 2008, and (2) a $520,000 promissory note issued on August 31, 2005, with $260,000, plus accrued and unpaid interest, payable on February 28, 2007 and $260,000, plus accrued and unpaid interest, payable on August 31, 2008. Both promissory notes bear interest at a rate of 6% per annum, and are general unsecured obligations of Global. These notes are subject to set off in the event of indemnification claims or other claims by Global against us under the Asset Purchase Agreement. As of September 30, 2005, Global had not made any indemnification claims against us.
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Accounts receivable were approximately $83,000 and $285,000 at September 30, 2005 and March 31, 2005, respectively. All of these receivables were for software licenses and services generated by our discontinued software line of business but were not transferred as part of the asset sale to Global.
Total liabilities, excluding deferred revenue, were approximately $139,000 at September 30, 2005 compared to approximately $248,000 associated with ongoing operations at March 31, 2005. The decrease in total liabilities is attributable to significant decreases in accounts payable and accrued expenses resulting from the sale of our software operations.
With the net proceeds we received from the sale of software operations, as discussed in notes 1 and 6 to the financial statements included herein, we believe that our current cash and cash equivalents, together with any net cash provided by ongoing operations, will be sufficient to meet anticipated cash needs for working capital and capital expenditures through fiscal 2006.*
Other Factors That May Affect Operating Results
Our operating results may fluctuate due to a number of factors, including, but not limited to, the following factors:
• | our patent licensing strategies regarding when and the number of potential infringers we approach, |
• | our ability to pursue and successfully negotiate further patent licenses and generate patent revenues, |
• | challenges to the validity of our patents, |
• | costs of litigation associated with our patent enforcement, and |
• | the cost of maintaining our public status. |
These factors are difficult for us to forecast, and can materially adversely affect our business and operating results for one quarter or a series of quarters.**
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Item 3 Controls and Procedure
(a) Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, we performed an evaluation under the supervision and with the participation of management, including our Chief Executive Officer/Chief Financial Officers, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on this evaluation, we concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
(b) Changes in Internal Controls
During the most recent fiscal quarter, there were no significant changes in our internal controls over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect our internal controls.
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PART II – OTHER INFORMATION
Item 6. | Exhibits |
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Exhibits: |
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| 3.1 | Articles of Incorporation of Timeline, Inc., as amended October 7, 2005. |
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| 21.1 | Subsidiaries of Timeline, Inc. |
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| 31.1 | Certification of Charles R. Osenbaugh, President, Chief Executive Officer and Chief Financial Officer of Timeline, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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| 32.1 | Certification of Charles R. Osenbaugh, President, Chief Executive Officer and Chief Financial Officer of Timeline, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURE
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Timeline, Inc. |
| (Registrant) |
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Date: November 14, 2005 | By: | /s/ Charles R. Osenbaugh |
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| | Charles R. Osenbaugh
President/Chief Financial Officer |
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| | Signed on behalf of registrant and as principal |
| | financial officer. |
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