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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

 

 

  

FORM 10-K

 

FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

(Mark One)

 

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

  

For the fiscal year ended December 31, 2011

 

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 (I.R.S. Employer
of Incorporation or Organization) 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)

 

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Title of Each Class Name of Each Exchange on Which Registered
Common Stock, par value $0.001 per share The New Zealand Stock Exchange

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

 

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. Yes x 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to their Form 10-K. x

 

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 “accelerated filer, “large accelerated filer” and smaller company: in Rule 12b-2 of the Exchange Act. (Check One):

 

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company x

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

 

The aggregate market value of common equity held by non-affiliates as of the last business day of the registrant’s second fiscal quarter, computed by reference to the last sales price as reported by NZX on June 30, 2011 of NZD 1.06 (US$ 0.88) per share, was US$42.7 million.

 

The number of shares of the registrant’s common stock outstanding as of March 1, 2012 was 81,817,524.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The following documents are incorporated herein by reference:

 

(1)Proxy Statement for the Annual Meeting to be held April 17, 2012, New Zealand Time.

 

 
 

 

CONTENTS

 

  PAGE
   
Forward Looking Statements ii
Available Information ii
   
PART I  
     
Item 1. Business 1
Item 1A. Risk Factors 7
Item 1B. Unresolved Staff Comments 7
Item 2. Properties 8
Item 3. Legal Proceedings 8
Item 4 [Reserved] 8
     
PART II  
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 9
Item 6. Selected Financial Data 11
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 11
Item 7A. Quantitative and Qualitative Disclosure About Market Risk 20
Item 8. Financial Statements and Supplementary Data 21
Item 9. Changes in and Disagreements with Accountants on Accounting and  
  Financial Disclosure 43
Item 9A. Controls and Procedures 43
Item 9B. Other Information 43
     
PART III  
     
Item 10. Directors, Executive Officers and Corporate Governance 44
Item 11. Executive Compensation 44
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 44
Item 13. Certain Relationships and Related Transactions, and Director Independence 44
Item 14. Principal Accountant Fees and Services 44
     
PART IV  
     
Item 15. Exhibits, Financial Statement Schedules 45
     
SIGNATURES   46
     
INDEX TO EXHIBITS   48

 

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-K 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

 

ITEM 1. BUSINESS

 

As used herein, unless the context otherwise requires, the terms “Company”, “we”, “us”, “our” and words of similar import refer to the combined business of Diligent Board Member Services, Inc. and its consolidated subsidiaries.

 

GENERAL INFORMATION

 

History

 

We are a Delaware corporation that was incorporated on September 27, 2007. On October 1, 2007, our accounting predecessor entity and sole stockholder at that time, Services Share Holding, LLC, (previously known as Diligent Board Member Services, LLC and referred to in this document as “SSH LLC”), contributed substantially all of its assets and its Diligent Boardbooks® 1 business to Diligent Board Member Services, Inc. SSH LLC was founded in 1994 and developed complex database-driven software for large and small companies until 2003, when it shifted its focus to corporate governance service delivery software.

 

Company Overview

 

We develop and sell an online software application called Diligent Boardbooks, which is a web-based portal that directors and administrative staff use to compile, update and examine board materials before, during and after board meetings. Each of our clients enters into a service agreement whereby we agree to provide and support the Diligent Boardbooks service. Diligent provides clients with subscription-based access to its software and also provides associated services including securely hosting the clients’ data and customer service and support for the application.

 

The Boardbooks product features an on-screen interface that resembles a book and displays documents in single web-viewable pages, from a secure central database. The software is accessed via the internet and is a “point and click” system that gives directors the ability to navigate throughout the entire virtual book.

 

Diligent 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, Diligent offers annual renewable subscriptions for customer access to its Boardbooks product which is hosted on Diligent’s secure servers, and offers a complete suite of related services including training, support, data migration and data security/backup.

 

The SaaS model allows Diligent 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 companies to retain control over access to the application while outsourcing to Diligent the support activities, such as managing the IT infrastructure and maintaining the software.

 

The first phase of our business focus was developing and testing the Boardbooks system, building a loyal core of blue chip customers to become champions of the product, and promoting product awareness through exposure in print media. During this phase we did not focus on revenue growth or profitability, and sales and marketing had been conducted by two to three staff members, who fit this role alongside their other responsibilities. By 2007 we had a commercially viable product and shifted our focus to commit substantial resources to the sales and marketing of our Boardbooks product. We are now in the customer acquisition phase of our business and currently provide the Boardbooks service to over 1,025 companies and 27,500 users.

 

 

1 Diligent Boardbooks is a registered trademark of Diligent Board Member Services, Inc.

 

1
 

 

Development Timeline

 

The paragraphs below provide a general timeline of the development of the Diligent Boardbooks system:

 

·Development and Testing (1998-2006). We began developing components of the Diligent Boardbooks system starting in 1998. In 2001, SunAmerica Funds requested a solution to automate the management of its board meeting papers. The development process took more than three years to create the first commercially viable version of Diligent Boardbooks.  With SunAmerica Funds as an anchor client, we began marketing and selling subscriptions and establishing our own credentials.  In many cases, the sales process took more than a year prior to clients having the comfort to move their board materials to our servers. 

 

·Roll-out (2007-2008). The roll-out of a sales force commenced in 2007 and by the end of the 3rd quarter our sales force had increased from 3 to 23 full time salespeople, which was subsequently reduced to 18 following performance evaluations. At the end of 2008, a general workforce reduction, due to a difficult worldwide economic climate, further reduced the sales force to 10.

 

·Growth (2009-2011). Despite the global economic crisis and sales force reduction, the Company had exceptional years from 2009 through 2011. The fourth quarter of 2011 was the sixth consecutive record breaking quarter for new sales, with the addition of 203 new client agreements for our Boardbooks service and $6.0 million in annual recurring revenue. For the full year 2011, we added 570 new client agreements and $15.9 million in annual recurring revenue. Additionally, our revenues for 2011 increased 116% to $18.0 million.

 

New Zealand Offering

 

On December 12, 2007, we completed an offshore offering of 24,000,000 common shares to members of the public in conjunction with a listing of our stock on the New Zealand Stock Exchange. The net proceeds of the offering were approximately $16.4 million, which we used to: recruit additional staff to grow our business, including more sales people in North America, Europe and the Pacific Rim; invest in the operational infrastructure required to scale the business; provide working capital to sustain the operations of the business while we further built our revenue streams; and retire certain debt obligations incurred by SSH LLC in connection with the development of the Diligent Boardbooks business.

 

Our common stock is listed on the New Zealand Stock Exchange and trades under the symbol “DIL”.

 

Activities of Foreign Subsidiaries

 

The Company has a wholly-owned subsidiary located in New Zealand, Diligent Board Member Services NZ Limited (“DBMS NZ”), which primarily provides research and development services, as well as customer support 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 account management. 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 had no operations in 2011. Diligent, together with its subsidiaries, are hereinafter referred to as “the Company”.

 

2
 

 

Market Opportunity

 

The online board portal industry remains in its early stages with market penetration still relatively low. Our client base was previously comprised of blue chip companies predominantly in the financial services sector.  These entities had previously been prime targets because their board materials are crucial to effectively managing the corporate governance process. Public recognition by prominent publications has helped us become a leader in the provision of online board portal software in this sector, and we believe a vast opportunity still remains in the global financial services sector.

 

In addition to the financial services sector, Diligent has successfully expanded into numerous other sectors as well, including energy, oil and gas, health care and universities. In spite of the financial stress in the key U.S. market, an impressive list of new clients has been added, including several international brand names. Further inroads have also been made into Canada, EMEA (Europe, Middle East and Africa) and the Asia Pacific region. Sales momentum in the U.K. in particular was gratifying as Diligent Boardbooks now serves 20% of the FTSE 100. To put our growth in international markets in perspective, Diligent’s new subscription agreements for the fourth quarter of 2011 outside the U.S. were higher than the overall total of new subscription agreements for all regions during the fourth quarter of 2010.

 

In 2011, Diligent achieved sales revenue of $18.0 million, a year-to-year increase of 116%. The Company’s ability to continue to significantly grow its recurring income each quarter confirms that its SaaS business model is strongly positioned for the future.

 

The drivers behind Diligent’s significant sales growth include:

 

·Greater brand recognition of the Diligent Boardbooks product.

 

·A highly skilled and focused sales force.

 

·Faster sales turnaround driven by the increasing confidence in and acceptance of Diligent’s Boardbooks product.

 

·The introduction of an Apple iPad compatible version of Diligent Boardbooks in September 2010, and the acceptance of Boardbooks for iPad 1.0 into the Apple App Store in early January 2011. The Apple iPad version of Diligent Boardbooks has since been upgraded to iPad 1.3 as of February 2012.

 

·High customer confidence in, and satisfaction with, the product; supporting a trend where existing clients continue to upgrade services, add new users and provide new client referrals. In 2011, client upgrades added $2.2 million to annual recurring revenue; an increase of 231% over 2010.

 

·Tremendous growth in international markets. Diligent’s new sales in international markets for the fourth quarter of 2011 were $1.83 million. This is higher than the total of new sales for all regions during the fourth quarter in 2010, which were $1.56 million.

 

Also, an important factor to note is that this growth has been achieved even though the number of trained sales staff has remained relatively consistent from 2009 through 2011. 

 

3
 

 

Most importantly, Diligent has not sacrificed profitability for growth. The Company achieved operating profitability in 2011 for the first time in its history. Management expects Diligent’s operating margins and cash position to continue to improve.

 

Our Product Strengths

 

Established Brand. We compete against several companies within the board portal industry. Notably however, we began development in early 2001 ahead of many of our competitors. As a result, we believe our brand is more established in the marketplace.

 

Ease of Use. In an article published in The Wall Street Journal on October 23, 2006, the author commented that “The portal from Diligent Board Member Services may be the easiest to use. The Diligent layout looks like a paper book. A binding coil and divider tabs are drawn onto the screen and directors “flip” pages with the click of a mouse.” This “ease of use” has been one of the many key elements to Diligent Boardbooks' popularity among executives with little time to learn a new system.

 

Flexible Online and Offline Viewing. Diligent Boardbooks may be viewed online via the Internet or offline on the user’s computer. The offline version of Diligent Boardbooks allows a user to download a secure encrypted database of their own corporation’s entire Diligent Boardbooks database. This allows meetings to be run off-site without an Internet connection. The same book-like interface is used to view offline as well as online. This system is secured through high-level security and encryption technology.

 

Additionally, when paper copies are requested, Diligent Boardbooks has a “Print Book” feature that allows directors to print the entire collated Boardbook complete with page numbers, agenda-related footers and more. This feature is controlled by the user, allowing a page, a tab or a whole book to be printed. This is a password-specific functionality controlled by the users.

 

Offline Synchronization. The main distinction between Diligent Boardbooks and other systems is that Diligent Boardbooks maintains a single copy and does not download information that has already been downloaded, making synchronization an efficient and rapid process. Accordingly, there is no risk of having multiple copies or outdated documents floating on the computer desktop.

 

Regular Upgrades. The Diligent Boardbooks software is regularly updated by our software development team. Updates are applied automatically and users receive the benefit of enhanced functionality without the inconvenience of software reinstallation.

 

Application Security. We designed a powerful and secure triple redundant network to promote absolute protection and availability of client data. Primaries, secondaries and fail-over servers and systems are located in geographically diverse locations for application and data delivery security. An automated intrusion detection system blocks malicious activity and reverse proxy authentication provides another barrier of protection for sensitive data. For complete security, each individual Diligent Boardbooks user has a distinct user name and password that is required to access the Diligent Boardbooks site. All data is encrypted.

 

We are SAS 70 – Series II Audited (Statement on Auditing Standards – Service Organizations). This means our client base can be assured that their most intimate corporate information is secure.

 

Global Support. We serve the highest level officers of some of the largest companies in the world. To assist with completely meeting the expectations of these directors and their key employees, we have staff and contractors in four countries. Our support team is trained to work with its high-level clients to solve any problem a user might encounter. This high level of support is a core competency that has helped to ensure successful implementation and retention of over 1,025 companies and over 27,500 users to date, while keeping client attrition rates to less than five percent per year.

 

4
 

 

Full Management and Implementation Team. We provide personalized and high quality account management and implementation to our clients. Each client has a dedicated team that includes an assigned day-to-day account manager, an assigned security engineer and an assigned executive.

 

Rapid, Cost Effective Deployment. Diligent Boardbooks can be rapidly deployed for use within an organization. Once a company chooses to use Diligent Boardbooks, it can begin to realize the benefits almost immediately. Director training typically takes less than 45 minutes and full product administration training less than 10 hours. We consider this a very important distinguishing factor relative to key competitors whose systems can take considerably longer to implement.

 

Business Model

 

We use the SaaS model to distribute our Diligent Boardbooks software to the market and maintain the security and integrity of our clients’ data. Under this model, we grant customer access to our Diligent Boardbooks product, which is hosted on our secure servers, and offer a complete suite of related services including training, support, data migration and data security/backup.

 

The SaaS model is characterized by a company providing on-demand access to its complex software through a web-based interface in return for subscription-based revenue. The SaaS industry has undergone significant growth over the past five years, spurred on by several factors:

 

·SaaS providers can cost-effectively share one application across hundreds or thousands of companies;

 

·Clients can accelerate the deployment process and eliminate additional infrastructure costs;

 

·A continuing decline in the cost of bandwidth has meant web-based solutions have become more viable;

 

·Lower cost of implementation. Clients do not pay large sums for a product with a long development and implementation timeframe with no guarantee of success. Instead, clients that pay a nominal set-up and/or training fee (installation fee), and a recurring subscription fee, can begin to use the fully developed service immediately and retain the ability to cancel the service, if unsatisfied;

 

·The success of on-demand services in the consumer market (e.g., Google, iTunes and YouTube) have made accessing content and services commonplace in professionals’ personal lives. Professionals are now demanding similar features in business software; and

 

·The success of early leaders such as salesforce.com has demonstrated the viability and value proposition of the SaaS model.

 

Central characteristics of implementing the SaaS model include the:

 

·Ability to obtain rapid growth in market share and revenue over a sustained period of time;

 

·Highly scalable operations that can support sales growth with much lower increases in operating costs;

 

·Significant up-front investment in sales and marketing in order to maximize the market penetration; and

 

·Negative earnings over the expansion period offset by equity capital.

 

5
 

 

Marketing; Growth Strategy

 

We believe building a successful sales and marketing team to present to and serve the boards of the world’s major corporations is a significant undertaking. Staff must have a deep understanding of corporate governance issues while also being able to interact credibly with the board members and senior executives of major U.S. and international corporations.

 

The roll-out of our sales force commenced in 2007. By the beginning of the 4th quarter 2008, our sales force had increased to 23 full-time salespeople and then was subsequently reduced to 18. In November 2008, after consideration of the then current market environment and economic conditions, and the concern about the Company’s ability to raise additional growth financing on historically favorable terms, management decided to implement a cost reduction program that reduced staff by 13 people, including 8 in sales and 2 in marketing, leaving a total of 10 active in sales. Although this was a dramatic cut in sales force, the Company retained its most effective salespeople and continued the pattern of growth necessary to maintain its market position. We currently have 11 fully trained sales people and we continue on an ongoing basis to evaluate the performance of our sales team and make adjustments as prudent and/or necessary.

 

Intellectual Property

 

We have protected our unique graphical user interface by copyright. We have registered our “Diligent Boardbooks” trademark and will continue to take steps to protect our intellectual property.

 

All software developed by us is protected by copyright and has been developed entirely by our employees. Employees and contractors have no rights to the application source code, design, user interface or any other aspect of the application, which is protected by copyright and provisions in our employment contracts.

 

Clients have no rights, other than the right to access the application source code, and generally have no visibility of the source code. We make occasional exceptions to allow clients to perform due diligence security audits, which are protected by non-disclosure/non-use agreements. Client rights to the application are defined and protected by the client service agreement with us.

 

Customers and Certain Contracts

 

Diligent Boardbooks is used by large and small corporations and institutions around the globe, across multiple industry sectors. While confidentiality arrangements limit Diligent from disclosing its client base, clients who have permitted disclosure include SunAmerica Funds, New York Life Investment Management, AOL, Kraft Foods, Kellogg, General Mills, MasterCard and the New York Times. We have implemented the Diligent Boardbooks system for over 1,025 companies and over 27,500 users, including over 160 Fortune 1000 companies and 20% of the FTSE 100 companies in the U.K.

 

Research and Development

 

Our research and development efforts are now focused on improving and enhancing our Diligent Boardbooks system.

 

Competition

 

We are subject to significant competition that could increase the price pressure on our service, and impact our ability to gain market share and win business. We face strong competition from a wide variety of firms, both large and small. Some of our primary direct competitors are the following:

 

·Thomson Reuters, headquartered in New York, which provides a board portal service through a product called Thomson BoardLink;

 

6
 

 

·BoardVantage, Inc., located in California, which provides a product called BoardVantage Board Portal;
·Directors Desk, located in New York and Washington, which provides a product called Directors Desk; and
·ICSA Software International, headquartered in the United Kingdom, which provides a product called Blueprint BoardPad 2.

 

We believe the principal factors that generally determine a company’s competitive advantage in the market in which Diligent Boardbooks competes are:

 

·software development capabilities;
·functionality and reliability of products and services;
·competitive sales and marketing capabilities;
·high quality support services;
·proven testing record of software products and services; and
·market share.

 

We believe that we compete favorably regarding each of these factors.

 

Regulation

 

Our business is not subject to any industry-specific regulation that affects our business as currently conducted, although we are subject to general tax, corporate, securities, employment, privacy and other laws and regulations that affect businesses generally. We are a beneficiary of the push to improve corporate governance and oversight stimulated by the Sarbanes-Oxley Act of 2002, which we believe has increased demand for our Diligent Boardbooks product.

 

Environmental Matters

 

We do not believe that the costs and effects of compliance with environmental laws will be material to our business.

 

Employees

 

As of March 1, 2012, we had approximately 100 full-time employees. Of these, the majority are located in our New York offices. The remaining employees are located predominantly in our Christchurch, New Zealand office, which provides software and help desk support for several large corporations, as well as providing the software development of the Diligent Boardbooks product. We also have small sales offices in London, Singapore and Hong Kong, and an administrative office in Wayne, New Jersey.

 

ITEM 1A. RISK FACTORS

 

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 1B. UNRESOLVED STAFF COMMENTS

 

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.

 

7
 

 

ITEM 2. PROPERTIES

 

Our headquarters are located at 39 West 37 St., New York, NY 10018, where our primary executive, sales and administrative offices are located. We also have an ancillary administrative office located at 155 Willowbrook Boulevard, Suite 410, Wayne, NJ 07470. We have sales offices in Canada, England, Singapore, and Hong Kong. We also have an office at 49 Carlyle Street, Christchurch, New Zealand, where our software development takes place. We lease all of these properties and do not own any real property.

 

We believe that our current facilities are suitable and adequate to meet our current needs, and that suitable additional or substitute space will be available as needed to accommodate expansion of our operations. We intend to open additional sales offices as our geographic sales footprint warrants.

 

We believe that our facilities are adequately covered by insurance.

 

ITEM 3. LEGAL PROCEEDINGS

 

The Company is not a party to any material legal proceeding required to be disclosed under Item 103 of Regulation S-K.

 

ITEM 4. [RESERVED]

 

8
 

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

 

There is no United States established public trading market for our common stock. 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.”

 

The following table shows the high and low closing sales prices for our common stock in New Zealand dollars.

 

  Closing Price of Common Stock (NZD)  
Period   High     Low  
2010 – 1st Quarter   .52     .25  
2010 – 2nd Quarter   .70     .46  
2010 – 3rd Quarter   .68     .56  
2010 – 4th Quarter   .69     .57  
2011 – 1st Quarter   .86     .64  
2011 – 2nd Quarter   1.26     .78  
2011 – 3rd Quarter   1.37     1.02  
2011 – 4th Quarter   1.96     1.22  

 

Holders

 

As of March 1, 2012 there are 944 holders of record of our common stock.

 

Dividends

 

We have not paid any dividends on our common stock within the past two fiscal years or during the current fiscal year.

 

Equity Compensation Plan Information

 

As of December 31, 2011, no shares of common stock are issuable by us upon the exercise of options, warrants and rights under any equity compensation plan, except as follows:

 

Plan category  Number of securities 
to be issued 
upon exercise of 
outstanding options
   Weighted-average
exercise price of
outstanding options
   Number of securities
remaining available for
future issuance under
equity 
compensation plans
(excluding securities
reflected in column (a))
 
   (a)   (b)   (c) 
Equity compensation plan approved by security holders   8,822,001    .4277    1,441,664 

 

Recent Sales of Unregistered Securities

 

The following is a summary of transactions by our company within the past three years involving sales of its securities that were not registered under the Securities Act of 1933 (or “Securities Act”).

 

9
 

 

On March 11, 2009, we issued 30,000,000 shares of newly created Series A Preferred Stock to Spring Street Partners, L.P. and Carroll Capital Holdings, LLC for US$0.10 per share. The Series A Preferred Stock was issued pursuant to the exemption from registration provided by Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933 (based on the issuance not involving any public offering and the shares being issued solely to accredited investors). The Preferred Shares carry a fixed, cumulative, dividend of 11% per annum (adjusted for stock splits, consolidation, etc). The dividend is payable on the first business day of each calendar year for the prior year and may be paid either in cash or in kind (at Diligent’s option) by the issuance of additional Preferred Shares (PIK Shares), to be issued at the same issue price of US$0.10 per share. The 11% annual dividend on the Preferred Shares will rank ahead of the declaration or payment of any dividends on Diligent’s common stock (ordinary shares). In addition to the 11% preferred dividend, the holders of the Preferred Shares will also be entitled to participate pro rata in any dividend paid on Diligent’s common stock. The Preferred Shares will be convertible at any time, at the option of the holders, into Diligent common stock on a one-for-one basis. For the year 2009, the Board of Directors of the Company approved the issuance of 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 on January 4, 2010. During 2010, the Company anticipated that a cash dividend would be paid on the Series A Preferred Stock and accrued $359,338 for such dividend. In January 2011, Spring Street Partners, L.P., one of the holders of the Series A Preferred Stock, waived its right to $200,000 of the dividend due on January 1, 2011, and directed the Company to retain those funds to support future growth. In December 2011, Spring Street Partners, L.P., waived its right to $239,557 of the dividend due on January 1, 2012. The founder and managing partner of Spring Street Partners, L.P. is also the chairman of the board of directors of the Company.

 

On October 19, 2010, we completed an offshore private placement for 3,000,000 shares of newly issued common stock by First NZ Capital Securities Limited at NZ$0.62 (US$0.47) per share, for total proceeds of NZ$1,824,000 (US$1,380,950), net of expenses. The private placement was conducted in reliance upon Regulation S promulgated under the Securities Act of 1933.

 

Issuer Purchases of Equity Securities

 

In the three months ended December 31, 2011, the Company repurchased shares of its common stock, as follows:

 

Period  (a)
Total
Number of
Shares
Purchased (1)
   (b)
Average
Price Paid
per Share
   (c)
Total Number of
Shares Purchased
as Part of
Publicly
Announced Plans
or Programs
   (d)
Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs
 
October 1 – October 31, 2011   225,000    NZD1.45         
November 1 – November 31, 2011                
December 1 – December 31, 2011                
Total   225,000             —  

 

(1)The Company purchased 225,000 shares of its stock from a shareholder for NZD1.45 (US$1.19) per share, which was the market price at date of purchase. The shares were subsequently cancelled.

 

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

 

10
 

 

Item 6. Selected Financial Data

 

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 7. 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-K. 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 clients’ 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 Company has 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.

 

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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.

 

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 treated as a public company in the U.S. subject to the 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.

 

Today, we are pleased to report that Diligent has continued its exceptional growth with another record-breaking quarterly revenue result. Diligent recorded quarterly revenue of $6.5 million for the fourth quarter of 2011, which brings full year 2011 revenue to $18.0 million, more than double the 2010 revenue ($8.3 million). Diligent records its revenue from subscription-based sales and installation fees ratably over the contract period. For the fourth quarter of 2011, Diligent signed new contracts with annual recurring revenue of $6.0 million, which is $1.0 million higher than in the third quarter of 2011 and a 287% increase over the fourth quarter of 2010. New contracts for 2011, with annual recurring revenue of $15.9 million, are more than four times the value of new contracts in 2010 ($3.7 million). This remarkable growth is evidence of a dramatically heightened demand for the Diligent Boardbooks product.

 

The Company now serves over 1,025 public and private companies with over 1,500 boards and 27,500 users in the U.S., Canada, EMEA (Europe, Middle East and Africa) and the Asia Pacific region. During the fourth quarter of 2011, Diligent signed a total of 203 net new client agreements versus 59 in the same quarter last year—an increase of 244%. Included among the new clients are 53 NYSE and 23 NASDAQ companies. Diligent now services 163 Fortune 1000 companies, of which 29 were added in the fourth quarter.

 

Critical Accounting Policies and Estimates

 

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these consolidated financial statements 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 revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, deferral of costs, the net realizable value of assets, software development costs, the impairment of long-lived assets and note receivable, income taxes and assumptions for stock-based compensation. Management bases its estimates and judgments on historical experience, known trends or events and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

12
 

 

We define our “critical accounting policies” as those that require us to make subjective estimates about matters that are uncertain and are likely to have a material impact on our financial condition and results of operations or that concern the specific manner in which we apply GAAP. Our estimates are based upon assumptions and judgments about matters that are highly uncertain at the time the accounting estimate is made and applied and require us to assess a range of potential outcomes.

 

We believe the following critical accounting policies to be those most important to the portrayal of our financial condition and those that require the most subjective judgment.

 

Revenues and Accounts Receivable

 

We derive our revenues from set-up and training fees (“installation fees”) of the Boardbooks system and subscription fees for the ongoing use of our Diligent Boardbooks software. We have no other significant sources of revenues at this time.

 

The Company recognizes revenue when all of the following criteria are met: (a) persuasive evidence of the arrangement exists, (b) delivery has occurred or services have been rendered, (c) the seller’s price to the buyer is fixed and determinable and (d) collectability is reasonably assured. Revenue from the Boardbooks service agreements is recorded ratably over the contract period, which is generally twelve months. Subscription fees paid in advance are recorded as deferred revenue until recognized. The Company also earns fees for set-up and training (“installation fees”) of the Boardbooks system. Installation fees are recorded ratably over the contract period.

 

Accounts receivable are recorded at estimated net realizable value. A provision for doubtful accounts is based on management’s assessment of amounts considered uncollectable for specific customers based on age of debt, history of payments and other relevant information. An allowance for doubtful accounts is provided for accounts receivable which management determines will not be collectable in full.

 

Cost of Revenues and Operating Expenses

 

Cost of Revenues. Cost of revenues consists of direct expenses related to account management, customer support and IT services. We do not allocate indirect overhead to cost of revenues.

 

Selling and Marketing Expenses. Selling and marketing expenses are comprised of sales commissions, salaries for sales and marketing employees, and direct advertising expenses, including mailings and travel. We do not allocate indirect overhead to selling and marketing.

 

General and Administrative Expenses. General and administrative expenses consist of compensation and related expenses for executive, finance, accounting, administrative, legal, professional fees, other corporate expenses and overhead costs such as rents, utilities etc.

 

Research and Development Expenses. Research and development expenses are incurred as we upgrade and maintain our software, and develop product enhancements. Such expenses include compensation and employee benefits of engineering and testing personnel, materials, travel and all direct overhead associated with design and required testing of our product line. We do not allocate indirect overhead to research and development.

 

Software development costs are expensed as they are incurred until technological feasibility has been established, at which time those costs are capitalized until the product is available for general release to customers. To date, software has been available for general release concurrent with the establishment of technological feasibility and, accordingly, the Company has not capitalized any development costs. Costs incurred to enhance products after the general release of the service using the product are expensed in the period they are incurred and included in research and development costs in our consolidated statements of income.

 

13
 

 

Share-Based Compensation. In November 2007 we adopted our 2007 Stock Option and Incentive Plan and in June 2010 we adopted the 2010 Stock Option and Incentive Plan, pursuant to which we have issued share-based compensation from time to time, in the form of stock options and other equity based awards.

 

Share-based compensation consists of stock issued to employees and contractors for services rendered. 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.

 

Interest Income (Expense), net

 

Interest income is derived from interest bearing deposits held by U.S., U.K. and New Zealand banks, together with investment income from a loan receivable due from a related party, SSH LLC.

 

Foreign Exchange

 

As a worldwide company, certain of Diligent’s revenues and expenses are denominated in foreign currencies, which are recorded at the approximate rates of exchange in effect at the transaction dates. Assets and liabilities are translated at the exchange rates in effect at the balance sheet dates, with differences recorded as foreign exchange gains or losses in the statements of income. Additionally, the Company has cash balances maintained in New Zealand Dollars (NZD) and British Pound Sterling (GBP).

 

The Company’s wholly-owned subsidiaries, DBL, DBMS NZ and APAC, utilize the GBP, NZD, and Singapore Dollar (SGD), respectively, as their functional currencies. Assets and liabilities of these subsidiaries are translated to U.S. dollars at exchange rates in effect at the balance sheet dates, with the resulting translation adjustments directly recorded to a separate component of accumulated other comprehensive income.

 

From time to time, the Company uses foreign currency option contracts or foreign currency forward contracts that are not designated as hedging instruments to manage exposure to fluctuations in foreign currency. The Company uses these instruments as economic hedges and not for speculative or trading purposes. The fair value of the foreign currency contracts represents the amount we would receive or pay to terminate the contract at the reporting date, and is recorded in other assets or liabilities, depending on whether the net amount is a gain or loss.

 

Income taxes

 

Diligent Board Member Services, Inc. files U.S. federal and state income tax returns. Foreign operations file income tax returns in their respective foreign jurisdictions. The Company accounts for deferred income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

A valuation allowance is recorded if it is considered more likely than not that some or all of a deferred tax asset may not be realized. Significant management judgment is required in determining any valuation allowance recorded against deferred tax assets. At December 31, 2011, the Company released a portion of the valuation allowance previously provided on all net U.S. deferred tax assets, based upon the future taxable income expected to be generated from existing contracts. The Company will continue to evaluate the expected realizability of its deferred tax assets each quarter, and will recognize the tax benefit of its net operating loss carryforwards only to the extent that the Company has contracts or firm commitments which are expected to produce sufficient taxable income, or until such point as the Company has sustained positive operating results.

 

14
 

 

The Company and its subsidiaries are subject to regular audits 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 examination by the respective taxing jurisdictions.

 

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), under a Promissory Note and Security Agreement dated October 1, 2007, as amended by the Prepayment and Amendment Agreement entered into in February 2010 and approved by the Company’s stockholders in June 2010.

 

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 December 31, 2011, the Note is secured by 4,930,597 shares of Diligent common stock held by SSH LLC and pledged as collateral.

 

Prior to the 2010 prepayment and amendment, the principal balance of the Note was $7,161,791, which was reduced by a valuation allowance of $5,500,000. The Note was originally secured by 25,000,000 shares of the Company’s stock which was pledged as collateral by members of SSH LLC. A portion of the pledged shares were subsequently sold by SSH LLC in order to obtain funds for interest due on the Note. Additionally, the 2010 prepayment and amendment provided for the surrender of 11,650,000 pledged shares to the Company as consideration for the prepayment of an additional $3,075,676 of principal.

 

The Note is collateral dependent, as SSH LLC’s primary means of repayment is through liquidation of the underlying collateral. In the absence of an active market for the Company’s common stock, or other observable inputs for similar instruments, the Company originally based its valuation of the underlying collateral on the value of the March 2009 issuance of Series A Preferred Stock, adjusted using an assumed discount rate of 20%, which was management’s estimate of the fair value of the preferred features of the Series A Preferred Stock. In addition, management assumed that SSH LLC and/or its members would sell a portion of the underlying collateral to meet their quarterly interest payments, thereby reducing the amount of collateral expected to be available when the Note was to mature. During the years ended December 31, 2011 and 2010, the Company recorded recoveries in the value of the Note of $1,200,000 and $4,300,000, respectively, reducing the valuation allowance to zero at December 31, 2011. The recoveries were based on the re-measurement of the value the stock pledged as collateral for the Note to reflect prices obtained in public and private sales of blocks of Diligent stock, and management’s determination that the enterprise value of the Company has increased significantly due to improvement in operating margins and cash flows.

 

Recent Accounting Pronouncements

 

See Note 2 to the consolidated financial statements at Item 8 of this Form 10-K.

 

Results of Operations for the Years Ended December 31, 2011 and 2010

 

Revenues

 

   Year ended December 31,     
   2011   2010   Increase/(Decrease) 
Revenues  $17,966,114   $8,300,958   $9,665,156 

 

15
 

 

The growth in total revenues of 116% for the twelve months ended December 31, 2011 is a result of the significant increase in subscription agreements. The Company has continued to add subscription agreements each quarter since inception. At December 31, 2011, the cumulative subscription agreements were 1,026, compared with 456 at December 31, 2010. A net of 570 new subscriptions were added during 2011, compared with 172 in 2010, an increase of 231%. A key driver of our sales growth was the development of a Boardbooks app for the Apple iPad®, and the increasing use of the iPad by executives around the world. Additionally, net upgrades from existing customers in 2011 grew 231% over 2010.

 

Revenue is recorded ratably over the contract period, which is generally twelve months. The unearned portion of existing contracts for services to be provided is recorded as deferred revenue. Accordingly, the full impact of the growth in subscription agreements during the year will be recognized over the remaining twelve months. This increase in revenues is in line with our targets and was achieved at a significantly lower customer acquisition cost. All of the deferred revenue of $8.5 million recorded on the balance sheet at December 31, 2011 will be recognized as revenue in the next twelve months.

 

Cost of Revenues and Operating Expenses

 

Cost of Revenues

 

   Year ended December 31,     
   2011   2010   Increase/(Decrease) 
Cost of Revenues  $5,029,894   $2,774,217   $2,255,677 

 

Cost of revenues is comprised of account management, customer support and IT services. The Company increased headcount in account management and customer support in order to service our larger client base, resulting in an increase in U.S. employee costs of approximately $1.6 million for the year ended December 31, 2011, as compared to 2010. Cost of revenues for our U.K. subsidiary increased by approximately $0.4 million, consisting principally of employee costs to service our expanded European client base. Hosting costs increased by approximately $0.1 million, and other expenses, including office costs, printing, travel and recruitment fees, also increased as a direct result of the increase in headcount.

 

Cost of revenues as a percentage of revenues was 28.0% for 2011, compared with 33.4% for 2010, as a result of the greater economies that we have achieved as our client base increased.

 

Selling and Marketing Expenses

 

   Year ended December 31,     
   2011   2010   Increase/(Decrease) 
Selling and Marketing Expenses  $5,203,245   $2,658,301   $2,544,944 

 

Selling expenses increased by approximately $2.6 million in 2011, offset by a decrease of approximately $0.1 million in marketing expenses. The increase in selling expenses consists almost entirely of increases in commissions and salaries of $2.5 million, including $1.9 million in the U.S. and $0.6 million in our foreign operations. The decrease in marketing expenses of $0.1 million is primarily due to the reduction in our marketing staff.

 

General and Administrative Expenses

 

   Year ended December 31,     
   2011   2010   Increase/(Decrease) 
General & Administrative Expenses  $4,692,722   $3,847,156   $845,566 

 

The primary contributors to the increase in general and administrative expenses are an increase in share-based compensation expense of $0.3 million relating to stock options, an increase of $0.2 million in employee compensation and benefits due to salary increases, and an increase of $0.2 million in rent and office costs due to the expansion of our New York office space, offset by a decrease in professional fees of $0.1 million.

 

16
 

 

General and administrative expenses of our foreign subsidiaries increased by approximately $0.1 million due to expansion of our foreign operations.

 

Research and Development Expenses

 

   Year ended December 31,     
   2011   2010   Increase/(Decrease) 
Research and Development Expenses  $1,533,494   $963,916   $569,578 

 

Our research and development is performed primarily by our New Zealand subsidiary. DBMS NZ accounted for $0.5 million of the increase over 2010, due to increased staffing for new product development and support, including development of a Diligent Boardbooks app for the Apple iPad®. In local currency, DBMS NZ expenses increased by 48%; however, the difference in the average US$/NZD exchange rates for the periods resulted in an additional increase when translated into U.S. dollars. Additional staffing in the U.S. accounted for the remainder of the increase.

 

Depreciation and Amortization

 

   Year ended December 31,     
   2011   2010   Increase/(Decrease) 
Depreciation and Amortization  $592,426   $472,593   $119,833 

 

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

 

   Year ended December 31,     
   2011   2010   Increase/(Decrease) 
Impairment recovery on note receivable from affiliate  $1,200,000   $4,300,000   $(3,100,000)

 

The carrying value of the Note had been reduced by a valuation allowance to reflect the estimated fair value of the Company’s common stock, which is held as collateral for the Note. The Company has recorded adjustments to the valuation allowance based on the remeasurement of the underlying collateral, including recoveries of $3.2 million in the first quarter of 2010 and $1.1 million in the third quarter of 2010. At June 30, 2011, the Company determined that the value of the Note was no longer impaired and the remaining balance of the valuation allowance of $1.2 million was reversed and recorded as income. Accordingly, at December 31, 2011, the Note is recorded at its full contractual value.

 

Interest Income, net

 

   Year ended December 31,     
   2011   2010   Increase/(Decrease) 
Interest Income, net  $181,349   $233,388   $(52,039)

 

Interest income, net, consists primarily of interest income on the Note Receivable from our affiliate, as well as interest on the Company’s cash and cash equivalents and term deposits which are interest-bearing. Interest income decreased by approximately $70 thousand, primarily due to the reduction in the principal balance on the Note as part of the prepayment and amendment in June 2010. This is offset by a decrease in interest expense of approximately $20,000 due to the expiration of several capital leases during 2011.

 

17
 

 

Foreign Exchange Transaction Loss

 

   Year ended December 31,     
   2011   2010   Increase/(Decrease) 
Foreign Exchange Transaction Loss  $(95,318)  $(13,000)  $(82,318)

 

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. In 2011, the U.S. dollar strengthened against both the NZD and GBP, while in 2010 the U.S. dollar recovered against the GBP and experienced just a slight weakening against the NZD.

 

Income Tax (Benefit) Expense

   Year ended December 31,     
   2011   2010   Increase/(Decrease) 
Income Tax (Benefit) Expense  $(1,102,019)  $24,219   $(1,126,238)

 

The income tax benefit in 2011 includes a U.S. tax benefit of $1,145,091 offset by New Zealand tax expense of $43,072. The U.S. tax benefit consists of $1,154,008 tax benefit from the partial release of the valuation allowance on deferred tax assets, offset by a provision of $8,917 for alternative minimum taxes. The 2010 income tax expense consists entirely of the New Zealand tax provision.

 

At December 31, 2011, management concluded that it is more likely than not that a portion of our net deferred tax assets would be realized through future taxable income, and released a portion of the valuation allowance which had been provided on the Company’s deferred tax assets. Due to a history of tax losses, resulting in a cumulative loss position, the Company had recorded a full valuation allowance against all its U.S. net deferred tax assets as of December 31, 2010. The release of a portion of the valuation allowance was based upon the future taxable income expected to be generated from existing contracts only. The Company will continue to evaluate the expected realizability of its deferred tax assets each quarter, and will recognize the tax benefit of its net operating loss carryforwards only to the extent that the Company has contracts or firm commitments which are expected to produce sufficient taxable income, or until such point as the Company has sustained positive operating results.

 

Liquidity and Capital Resources

 

At December 31, 2011, the Company’s sources of liquidity consist of cash and term deposits of approximately $9.0 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 December 31, 2011, the Company has had no borrowings under this credit facility.

 

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, resulting in overall positive cash flow from operations for the full year of approximately $18 thousand. This marked the first year since inception of the Company that Diligent achieved positive cash flow from operations. The Company continued this trend in 2011, generating positive cash flows from operations each quarter for a total of $6.9 million for the year. While we have continued to invest in property and equipment needed to support our product and our growing client base, our cash receipts in 2011 exceeded the increases in our cash operating expenses and capital expenditures. We have no debt 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, resulting in additional cash inflow of $3.1 million.

 

18
 

 

The Company is evaluating strategic growth opportunities that could change our current expense and capital forecasts, particularly in light of our expansion into the Asia-Pacific region.

 

In order to minimize credit and market risk, the Company has invested $5 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

 

   Year ended December 31, 
   2011   2010 
Cash provided by (used in):          
Operating activities  $6,939,638   $17,843 
Investing activities  $(662,813)  $(257,339)
Financing activities  $(554,482)  $2,324,749 

 

Net Cash Flows from Operating Activities

 

Cash provided by operating activities was $6,939,638 for the year ended December 31, 2011, compared with $17,843 for 2010. This was achieved through increased revenues year over year of 116% while cash-based operating expenses increased by only 61%. Additionally, deferred revenue increased $5.6 million, to $8.5 million at December 31, 2011 from $2.8 million at December 31, 2010.

 

Net Cash Flows from Investing Activities

 

Cash used in investing activities is comprised primarily of purchases of property and equipment, which increased to $662,813 in 2011 from $232,339 in 2010. Property and equipment additions each year are due to the necessary expansion in order to accommodate our growing customer base.

 

In 2010, the Company invested an additional $25,000 in a New Zealand term deposit.

 

Net Cash Flows from Financing Activities

 

For the year ended December 31, 2011, cash used in financing activities was $554,482. This included $0.3 million for the repurchase of common stock, $0.2 million for cash dividends paid on preferred stock and $0.1 million for repayment of capital lease obligations. In 2010, cash provided by financing activities was $2,324,749, consisting principally of approximately $1.0 million received from a prepayment of the Note receivable from affiliate and $1.4 million received from the issuance of common stock in a private placement in the fourth quarter of 2010.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, results of operations, liquidity, capital expenditures or capital resources that is material to stockholders.

 

19
 

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

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.

 

20
 

 

ITEM 8. FINANCIAL STATEMENTS

INDEX TO FINANCIAL STATEMENTS

 

  PAGE
   
Report of Independent Registered Public Accounting Firm 22
   
Consolidated Balance Sheets as of December 31, 2011 and December 31, 2010 23
   
Consolidated Statements of Income for the years ended December 31, 2011 and December 31, 2010 24
   
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Loss for the years ended December 31, 2011 and December 31, 2010 25
   
Consolidated Statements of Cash Flows for the years ended December 31, 2011 and December 31, 2010 26
   
Notes to Consolidated Financial Statements 27

 

21
 

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Stockholders of

Diligent Board Member Services, Inc.

 

We have audited the accompanying consolidated balance sheets of Diligent Board Member Services, Inc. as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders' equity and comprehensive loss, and cash flows for each of the years ended December 31, 2011 and 2010. Diligent Board Member Services, Inc.'s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated 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 audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements and assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Diligent Board Member Services, Inc. as of December 31, 2011 and 2010 and the results of their operations and their cash flows for each of the years ended December 31, 2011 and 2010, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Holtz Rubenstein Reminick LLP

 

New York, New York

March 26, 2012

 

22
 

 

Diligent Board Member Services, Inc.

Consolidated Balance Sheets

 

   December 31,   December 31, 
  2011   2010 
ASSETS         
Current assets:          
Cash and cash equivalents  $8,930,695   $3,212,449 
Term deposit   97,188    97,300 
Accounts receivable   1,956,527    494,048 
Prepaid expenses and other current assets   764,518    306,046 
Deferred tax assets, net of valuation allowance   300,840    17,865 
Note receivable from affiliate, net of valuation allowance - current portion   3,071,563    —   
Total current assets   15,121,331    4,127,708 
           
Property and equipment, net   2,088,495    1,082,104 
Deferred tax assets, net of valuation allowance   882,600    —   
Intangible assets, net   362,170    —   
Note receivable from affiliate, net of valuation allowance - non-current portion   —      1,875,685 
Restricted cash - security deposits   97,885    226,617 
           
Total assets  $18,552,481   $7,312,114 
           
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY          
Current liabilities:          
Accounts payable  $857,883   $84,388 
Accrued expenses and other liabilities   1,436,824    915,431 
Deferred revenue   8,495,661    2,849,225 
Current portion of obligations under capital leases   99,250    86,230 
Total current liabilities   10,889,618    3,935,274 
           
Non-current liabilities:          
Obligations under capital leases, less current portion   70,009    60,861 
Other non-current liabilities   268,842    50,255 
Total non-current liabilities   338,851    111,116 
           
Total liabilities   11,228,469    4,046,390 
           
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 $5,019,849 and $5,259,406 at December 31, 2011 and 2010, respectively)   3,204,993    3,177,291 
           
Stockholders' equity:          
Common Stock, $.001 par value, 250,000,000 shares authorized, 81,861,335 and 81,968,001 shares issued and outstanding   81,861    81,968 
Additional paid-in capital   23,837,196    23,107,919 
Accumulated deficit   (19,797,321)   (23,099,704)
Accumulated other comprehensive loss   (2,717)   (1,750)
Total stockholders' equity   4,119,019    88,433 
Total liabilities, redeemable preferred stock and stockholders' equity  $18,552,481   $7,312,114 

 

See accompanying notes to consolidated financial statements

 

23
 

 

Diligent Board Member Services, Inc.

Consolidated Statements of Income

 

   Year   Year 
   ended   ended 
   December 31,   December 31, 
   2011   2010 
Revenues  $17,966,114   $8,300,958 
Cost of revenues   5,029,894    2,774,217 
Gross profit   12,936,220    5,526,741 
           
Operating expenses:          
Selling and marketing expenses   5,203,245    2,658,301 
General and administrative expenses   4,692,722    3,847,156 
Research and development expenses   1,533,494    963,916 
Depreciation and amortization   592,426    472,593 
Total operating expenses   12,021,887    7,941,966 
           
Operating income (loss)   914,333    (2,415,225)
           
Other income (expenses):          
Impairment recovery on note receivable from affiliate   1,200,000    4,300,000 
Interest income, net   181,349    233,388 
Foreign exchange transaction loss   (95,318)   (13,000)
Total other income, net   1,286,031    4,520,388 
           
Income before provision for income taxes   2,200,364    2,105,163 
           
Income tax (benefit) expense   (1,102,019)   24,219 
           
Net income  $3,302,383   $2,080,944 
           
Net income per share:          
Basic  $0.04   $0.02 
Diluted  $0.03   $0.02 
Weighted average shares outstanding:          
Basic   81,965,079    84,487,207 
Diluted   117,168,176    119,388,351 

 

See accompanying notes to consolidated financial statements

 

24
 

 

Diligent Board Member Services, Inc.

Consolidated Statements of Changes in Stockholders’ Equity

and Comprehensive Loss

 

                   Accumulated   Total 
       Common   Additional       Other   Stockholders' 
   Common   Stock   Paid-in-   Accumulated   Comprehensive   Equity 
   Shares   $.001 Par Value   Capital   Deficit   Loss   (Deficiency) 
                               
Balance at January 1, 2010   90,440,000   $90,440   $24,532,622   $(25,180,648)  $(8,523)  $(566,109)
Net income   —      —      —      2,080,944    —      2,080,944 
Foreign exchange translation adjustment   —      —      —      —      6,773    6,773 
Total comprehensive income   —      —      —      —      —      2,087,717 
Share-based compensation, net of forfeitures   —      —      601,541    —      —      601,541 
Cancellation of common stock   (11,650,000)   (11,650)   (3,064,026)   —      —      (3,075,676)
Issuance of shares in private placement   3,000,000    3,000    1,395,096    —      —      1,398,096 
Exercise of stock options   178,001    178    29,464    —      —      29,642 
Amortization of preferred stock offering costs   —      —      (27,440)   —      —      (27,440)
Preferred stock dividend   —      —      (359,338)   —      —      (359,338)
                               
Balance at December 31, 2010   81,968,001   $81,968   $23,107,919   $(23,099,704)  $(1,750)  $88,433 
Net income   —      —      —      3,302,383    —      3,302,383 
Foreign exchange translation adjustment   —      —      —      —      (967)   (967)
Total comprehensive income   —      —      —      —      —      3,301,416 
Capital contributions   —      —      439,557    —      —      439,557 
Share-based compensation   —      —      907,543    —      —      907,543 
Repurchase and cancellation of common stock   (225,000)   (225)   (250,107)   —      —      (250,332)
Exercise of stock options   118,334    118    19,324    —      —      19,442 
Amortization of preferred stock offering costs   —      —      (27,702)   —      —      (27,702)
Preferred stock dividend   —      —      (359,338)   —      —      (359,338)
Balance at December 31, 2011   81,861,335   $81,861   $23,837,196   $(19,797,321)  $(2,717)  $4,119,019 

 

See accompanying notes to consolidated financial statements

 

25
 

 

Diligent Board Member Services, Inc.

Consolidated Statements of Cash Flows

 

   Year   Year 
   ended   ended 
   December 31,   December 31, 
   2011   2010 
Cash flows from operating activities:          
Net income  $3,302,383   $2,080,944 
Adjustments to reconcile net income to net cash provided by operating activities:          
Impairment recovery on note receivable from affiliate   (1,200,000)   (4,300,000)
Partial release of valuation allowance on deferred tax assets   (1,154,008)   - 
Depreciation and amortization   592,426    472,593 
Share-based compensation   907,543    601,541 
Other non-cash   1,285    6,003 
Changes in operating assets and liabilities:          
Accounts receivable   (1,462,479)   (190,717)
Prepaid expenses and other current assets   (470,037)   (140,543)
Restricted cash - security deposits   128,732    (4,731)
Accounts payable and accrued expenses   647,357    242,641 
Deferred revenue   5,646,436    1,255,874 
Payables to affiliates   -    (5,762)
Net cash provided by operating activities   6,939,638    17,843 
Cash flows from investing activities:          
Additional investment in term deposit   -    (25,000)
Purchase of property and equipment   (662,813)   (232,339)
Net cash used in investing activities   (662,813)   (257,339)
Cash flows from financing activities:          
Cash received from partial prepayment of note receivable from affiliate   4,122    1,010,430 
Proceeds from issuance of common stock through private placement   -    1,398,096 
Payment of preferred stock dividend, net of capital contribution in lieu of dividend   (159,338)   - 
Repurchase of common stock   (250,332)   - 
Proceeds from exercise of stock options   19,442    29,642 
Repayments of obligations under capital leases   (95,942)   (113,419)
Payments of obligations under software licensing agreements   (72,434)   - 
Net cash (used in) provided by financing activities   (554,482)   2,324,749 
Effect of exchange rates on cash and cash equivalents   (4,097)   (2,395)
Net increase in cash and cash equivalents   5,718,246    2,082,858 
Cash and cash equivalents at beginning of year   3,212,449    1,129,591 
Cash and cash equivalents at end of year  $8,930,695   $3,212,449 
           
Supplemental disclosure of cash flow information:          
Cash paid during the year for :          
Interest  $27,333   $47,155 
Income taxes  $51,355   $17,222 
           
Supplemental disclosure of noncash investing and financing activities:          
Capital contribution in lieu of preferred stock dividend  $439,557   $- 
Accrual of preferred stock dividend  $119,781   $359,338 
Property and equipment acquired under capital leases  $118,111   $- 
Acquisition of software licenses under long-term payment contracts  $434,604   $- 
Property and equipment acquired with accounts payable  $742,218   $- 
Prepayment of principal on note receivable from affiliate in exchange for 11,650,000 shares  $-   $3,075,676 

 

See accompanying notes to consolidated financial statements

 

26
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

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 before, 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 had no operations in 2011. 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.

 

2)Significant accounting policies

 

Basis of presentation The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America.

 

Principles of consolidation – The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.

 

Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles 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 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, which are carried at cost which approximates fair value. At December 31, 2010, cash equivalents consist of investments in money market funds of $2,277.

 

Term deposits – Term deposits are short-term investments with banks, with maturities greater than three months at inception.

 

Accounts receivable Accounts receivable are recorded at estimated net realizable value. A provision for doubtful accounts is recorded based on management’s assessment of amounts considered uncollectable for specific customers based on age of the receivable, history of payments and other relevant information. An allowance for doubtful accounts is provided for accounts receivable which management determines will not be collectable in full. At December 31, 2011 and 2010, management deemed all accounts receivable to be collectable and accordingly, the allowance for doubtful accounts was $0.

 

27
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

Property and equipment – Property and equipment consists of computer and office equipment, leasehold improvements and internal-use computer software. Property and equipment are carried at cost, less accumulated depreciation and amortization and any impairment losses.

 

Internal-use software The Company capitalizes certain costs incurred after the preliminary project stage in connection with developing or obtaining software for internal use. Internal use software is included in property and equipment.

 

Other assets – intangible assets – Other assets consist of software license fees which are capitalized and amortized over the estimated useful life of three years.

 

Depreciation and amortization – Depreciation on property and equipment is computed on a straight line basis at rates adequate to recover the cost of the assets over their estimated useful lives, which range from three to five years. Leasehold improvements are depreciated over estimated useful lives of the assets or the term of the underlying lease, whichever is shorter. Amortization of computer software is computed on the straight-line method over its estimated useful life, which is three years. Expenditures for repair and maintenance costs are expensed as incurred.

 

Impairment of long-lived assetsThe Company periodically reviews the carrying amounts of its tangible and intangible assets to determine whether events or changes in circumstances indicate the carrying amount of an asset may not be fully recoverable. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Measurement of an impairment loss for long-lived assets and certain identifiable intangible assets that management expects to hold and use is based on the fair value of the asset. An impairment loss is measured as the amount by which the carrying amount of the long-lived asset exceeds its fair value.

 

Revenue recognition – The Company recognizes revenue when all of the following criteria are met: (a) persuasive evidence of the arrangement exists, (b) delivery has occurred or services have been rendered, (c) the seller’s price to the buyer is fixed and determinable and (d) collectability is reasonably assured. Revenue from the Boardbooks service agreements is recorded ratably over the contract period, which is generally twelve months. Subscription fees paid in advance are recorded as deferred revenue until earned. The Company also earns fees for set-up and training (“installation fees”) of the Boardbooks system. Installation fees are recorded ratably over the contract period. 

 

Advertising Expenses – Advertising is expensed as incurred. Advertising expense was $350,287 and $320,822 for the years ended December 31, 2011 and 2010, respectively.

 

Research and developmentSoftware development costs are expensed as they are incurred until technological feasibility has been established, at which time those costs are capitalized until the product is available for general release to customers. To date, software has been available for general release concurrent with the establishment of technological feasibility and, accordingly, the Company has not capitalized any development costs. Costs incurred to enhance products after the general release of the service using the product are expensed in the period they are incurred and included in research and development costs in our consolidated statements of income.

 

Operating leases The Company records rental costs, including costs related to fixed rent escalation clauses and rent holidays, on a straight-line basis over the lease term.

 

28
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

Income taxes – Diligent files U.S. federal and state income tax returns. Foreign operations file income tax returns in their respective foreign jurisdictions. The Company accounts for deferred income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. A valuation allowance is recorded if it is considered more likely than not that some or all of a deferred tax asset may not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

Foreign exchange – The Company’s wholly-owned subsidiaries, DBL, DBMS NZ and APAC, utilize the British Pound Sterling, New Zealand Dollar (NZD) and Singapore Dollar, respectively, as their functional currencies. Assets and liabilities of these subsidiaries are translated to U.S. dollars at exchange rates in effect at the balance sheet dates, with the resulting translation adjustments directly recorded to a separate component of accumulated other comprehensive loss.

 

Transactions in foreign currencies are reported at the approximate rates of exchange at the transaction date. Assets and liabilities are translated at the rates of exchange in effect at the balance sheet date. All differences are recorded in results of operations.

 

From time to time, the Company uses foreign currency option contracts or foreign currency forward contracts that are not designated as hedging instruments to manage exposure to fluctuations in foreign currency. The Company uses these instruments as economic hedges and not for speculative or trading purposes. The fair value of the foreign currency contracts represents the amount we would receive or pay to terminate the contract at the reporting date, and is recorded in other assets or liabilities, depending on whether the net amount is a gain or loss.

 

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.

 

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 is recorded at estimated net realizable value, adjusted for any valuation allowance for amounts considered uncollectable. The valuation allowance is reviewed for adjustment each reporting period. See Note 7.

 

Segment reporting Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision-maker, or decision making group, in deciding how to allocate resources to an individual segment and in assessing performance of the segment. In light of the Company’s current product offering, management believes that the Company operates in one segment.

 

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 the applicable periods.

 

29
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

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

 

   Year ended December 31, 
   2011   2010 
Numerator:          
Net income  $3,302,383   $2,080,944 
Preferred stock dividends   (359,338)   (359,338)
Basic net income available to common shareholders  $2,943,045   $1,721,606 
Diluted net income available to common shareholders  $3,302,383   $2,080,944 
Denominator:          
Basic weighted average shares outstanding   81,965,079    84,487,207 
Dilutive effect of stock options   2,535,974    2,234,021 
Dilutive effect of convertible preferred stock   32,667,123    32,667,123 
Diluted weighted average shares outstanding   117,168,176    119,388,351 
Basic earnings per share  $0.04   $0.02 
Diluted earnings per share  $0.03   $0.02 

 

Recent accounting pronouncements – In May 2011, the Financial Accounting Standards Board (“FASB”) amended authoritative guidance related to fair value measurements, which clarifies the application of existing fair value measurement and expands the existing disclosure requirements. This guidance is effective in the first quarter of 2012. The Company does not believe that the adoption of this guidance will have a material impact on its consolidated financial statements.

 

In June 2011, the FASB issued new guidance regarding the presentation of comprehensive income, which requires 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 guidance is effective for fiscal years and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. The Company intends to implement this guidance when required in the first quarter of 2012, and does not believe that the adoption of this guidance will have a material impact on its consolidated financial statements.

 

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 December 31, 2011, 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$97,188 at December 31, 2011) bears interest at 4.00% and matures in March 2012.

 

30
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

At December 31, 2010, the Company had a term deposit with a New Zealand bank with a term of 98 days. The term deposit in the amount of NZD 125,000 (US$97,300 at December 31, 2010) bore interest at 4.02% and matured in March 2011.

 

4)Property and equipment, intangible assets and obligations under capital leases

 

Property and equipment is comprised of the following:

 

   December 31, 
   2011   2010 
         
Equipment  $2,852,055   $1,579,859 
Computer software   756,076    537,379 
Leasehold improvements   183,843    151,594 
    3,791,974    2,268,832 
Less: accumulated depreciation   1,703,479    1,186,728 
Net property and equipment  $2,088,495   $1,082,104 

 

Other assets – intangible assets consists of software license fees which are capitalized and amortized over the estimated useful life of three years. Accumulated amortization at December 31, 2011 and amortization expense for the year then ended was $72,434. Amortization expense is included in depreciation and amortization on the statement of income. Amortization expense for each of the next three years is as follows: 2012 – $144,868; 2013 – $144,868; 2014 – 72,434. There were no capitalized software license fees in 2010. The weighted average amortization period for intangible assets was three years at December 31, 2011.

 

Obligations under capital leases consist of various financing arrangements entered into by the Company to acquire computer equipment and software. The leases bear interest at rates ranging from 3% to 31% per annum, with monthly payments ranging from $2,257 to $4,229, and maturities from August 2012 through September 2014.

 

Each lease is secured by the underlying leased asset. Amortization of assets recorded under capital leases is included in depreciation expense. The equipment relating to capital leases, included in property and equipment on the balance sheet, is as follows:

 

31
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

   Year ended December 31, 
   2011   2010 
         
Capital lease assets included in property and equipment  $347,060   $246,449 
Accumulated depreciation   112,913    81,496 
   $234,147   $164,953 

 

   Year ended December 31, 
    2011    2010 
           
Depreciation expense relating to capital lease assets  $48,917   $52,139 

 

The following is a schedule of future minimum lease payments due under capital leases and software licensing agreements as of December 31, 2011:

 

Year ending    
December 31,     
2012  $282,528 
2013   214,804 
2014   120,089 
Total minimum lease payments   617,421 
Less interest portion of payments   (11,531)
Less executory costs   (84,054)
Present value of minimum lease payments  $521,836 

 

5)            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), under a Promissory Note and Security Agreement dated October 1, 2007, as amended by the Prepayment and Amendment Agreement entered into in February 2010 and approved by the Company’s stockholders in June 2010.

 

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 December 31, 2011, the Note is secured by 4,930,597 shares of Diligent common stock held by SSH LLC and pledged as collateral.

 

Prior to the 2010 prepayment and amendment, the principal balance of the Note was $7,161,791, which was reduced by a valuation allowance of $5,500,000. The Note was originally secured by 25,000,000 shares of the Company’s stock which was pledged as collateral by members of SSH LLC. A portion of the pledged shares were subsequently sold by SSH LLC in order to obtain funds for interest due on the Note. Additionally, the 2010 prepayment and amendment provided for the surrender of 11,650,000 pledged shares to the Company as consideration for the prepayment of an additional $3,075,676 of principal.

 

32
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

The Note is collateral dependent, as SSH LLC’s primary means of repayment is through liquidation of the underlying collateral. In the absence of an active market for the Company’s common stock, or other observable inputs for similar instruments, the Company originally based its valuation of the underlying collateral on the value of the March 2009 issuance of Series A Preferred Stock, adjusted using an assumed discount rate of 20%, which was management’s estimate of the fair value of the preferred features of the Series A Preferred Stock. In addition, management assumed that SSH LLC and/or its members would sell a portion of the underlying collateral to meet their quarterly interest payments, thereby reducing the amount of collateral expected to be available when the Note was to mature. During the years ended December 31, 2011 and 2010, the Company recorded recoveries in the value of the Note of $1,200,000 and $4,300,000, respectively, reducing the valuation allowance to zero at December 31, 2011. The recoveries were based on the re-measurement of the value the stock pledged as collateral for the Note to reflect prices obtained in public and private sales of blocks of Diligent stock, and management’s determination that the enterprise value of the Company has increased significantly due to improvement in operating margins and cash flows.

 

The change in the amount of the net receivable to $3,071,563 at December 31, 2011 from $1,875,685 at December 31, 2010 is due to the reversal of the remaining valuation allowance of $1,200,000 during the second quarter of 2011 and the reduction in principal of $4,122 from an overpayment of the January 1, 2011 interest payment.

 

The Company expects the principal balance of $3,071,563 to be fully repaid in cash at maturity on October 1, 2012, and accordingly the Note has been recorded as a current receivable in the balance sheet at December 31, 2011.

 

6)Derivatives

 

The Company uses foreign currency option and forward contracts that are not designated as hedging instruments to manage exposure to fluctuations in foreign currency. The Company uses these instruments as economic hedges and not for speculative or trading purposes. At December 31, 2011, the Company had three foreign currency forward exchange contracts outstanding to purchase NZD 525,000 in the aggregate. The contracts mature within the first quarter of 2012. As of December 31, 2011, the fair value of these contracts resulted in a gain of $15,132 which was recorded in foreign currency gain/loss and other current assets.

 

In 2010, mark-to-market gains on foreign currency contracts were not significant to the Company’s consolidated financial condition or results of operations, and there were no contracts outstanding at December 31, 2010.

 

7)Fair value measurements

 

The following table details the fair value measurements within the fair value hierarchy:

 

          Fair Value Measurements at December 31, 2011 using:
          Outside prices in         Significant  
          active markets   Significant other     unobservable  
          using identical   observable     inputs  
    Total     assets (Level 1)   inputs (Level 2)     (Level 3)  
Foreign currency forward contracts   $ 15,132     $ -   $ 15,132     $ -  
Note receivable from affiliate     3,071,563     $ -   $ -       3,071,563  
    $ 3,086,695     $ -   $ 15,132     $ 3,071,563  

 

The fair value of the foreign currency forward contracts is estimated based on the fair value of comparable contracts.

 

33
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

The Note is the only financial instrument held by the Company for which a fair value measurement was made using significant unobservable inputs (Level 3). A reconciliation of the beginning and ending balances of the Note follows:

 

   Year ended December 31, 
   2011   2010 
Balance at beginning of period  $1,875,685   $1,661,791 
Total gains or losses (unrealized/realized)          
Included in earnings (or changes in net assets)   1,200,000    4,300,000 
Included in other comprehensive income   -    - 
Purchases, issuances and settlements   (4,122)   (4,086,106)
Transfers in and/or out of Level 3   -    - 
Ending balance  $3,071,563   $1,875,685 
           
The amount of total gains or losses for the period included in earnings (or changes in net assets) attributable to the change in unrealized gains or losses relating to assets still held at the reporting date  $1,200,000   $4,300,000 

 

8) Accrued expenses and other liabilities

 

Accrued expenses and other current liabilities is comprised of the following:

 

   December 31, 
   2011   2010 
Accrued commissions, bonuses, and payroll  $615,003   $300,775 
Accrued Value Added Tax and Goods and Services Tax for foreign subsidiaries   344,559    78,386 
Accrued preferred stock dividend   119,781    359,338 
Software license commitments   144,868    - 
Other (individually less than 5% of total current liabilities)   212,613    176,932 
Total accrued expenses and other liabilities  $1,436,824   $915,431 

 

9)Line of credit facility

 

In March 2010, the Company entered into an agreement with Spring Street Partners, L.P. (“the Lender”) pursuant to which the Lender extended a $1.0 million revolving line of credit facility to the Company. The Lender is the holder of approximately 22 million shares of the Company’s Series A Preferred Stock and 5.5 million shares of the Company’s common stock. The founder and managing partner of the Lender is also the chairman of the board of directors of the Company.

 

The line of credit bore interest at a fixed rate of 9.50% per annum on outstanding borrowings and expired in September 2011. In September 2011, the Company amended this facility, reducing the interest rate under the facility to 7.0% and extending the maturity date to September 2012.

 

34
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

Upon an event of default, the Lender has the option to increase the interest rate on all outstanding obligations to 14.50% per annum. The line of credit is subject to a 0.5% per annum commitment fee on the unused portion, paid quarterly in arrears. Accrued interest must be paid quarterly on the last business day of each quarter. Upon maturity, all outstanding principal and unpaid interest and commitment fees are due in full.

 

The Lender has a first priority lien on all of the Company’s accounts receivable. The line of credit agreement includes restrictive covenants regarding liens, additional indebtedness, sales of assets and dividend payments on common stock. Additionally, the line of credit includes financial covenants with respect to the achievement of budgeted revenues and expenses.

 

The Company has not borrowed any amounts under this credit facility to date.

 

10)Related party transactions

 

Marketing expenseDuring the years ended December 31, 2011 and 2010, the Company incurred marketing expenses of approximately $228,000 and $176,000, respectively, for services rendered by an entity owned by a stockholder of the Company.

 

Legal services – A director is a partner of a law firm which provides legal services to the Company in New Zealand. Fees paid for the years ended December 31, 2011 and 2010 were approximately $4,600 and $20,000, respectively.

 

Payables to affiliates – There were no material payables to affiliates at December 31, 2011 and 2010.

 

11)Geographic information

 

The Company’s revenue, by geographic location of the customer, and long-lived assets located outside the United States are as follows:

 

   Year ended December 31, 
   2011   2010 
Revenues:          
United States  $13,618,645   $6,596,969 
Foreign   4,347,469    1,703,989 
Total  $17,966,114   $8,300,958 

 

   December 31, 
   2011   2010 
Long-lived assets outside the United States, net  $386,276   $383,416 

 

35
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

12)Income taxes

 

The significant components of income before provision for income taxes and the consolidated income tax provision are as follows:

 

   Year ended December 31, 
   2011   2010 
Income before provision for income taxes:          
Domestic  $2,010,721   $2,035,766 
Foreign   189,643    69,397 
Total  $2,200,364   $2,105,163 
           
Income tax (benefit) expense:          
Current:          
Federal  $8,917   $- 
State and local  $-      
Foreign   54,639    27,064 
Total current  $63,556   $27,064 
Deferred:          
Federal  $(904,894)  $- 
State and local  $(249,114)     
Foreign   (11,567)   (2,845)
Total deferred  $(1,165,575)  $(2,845)
Income tax (benefit) expense:  $(1,102,019)  $24,219 

 

The income tax provision differs from the amount of tax determined by applying the federal statutory rate as follows:

 

   Year ended December 31, 
   2011   2010 
   %   % 
Federal income tax statutory rate   34.00    34.00 
State income taxes, net of federal benefit   10.12    6.63 
Change in valuation allowance   (102.07)   (44.84)
Share-based compensation   5.51    5.28 
Foreign income taxes   -    1.19 
Other   2.36    (1.07)
Income tax (benefit) expense   (50.08)   1.19 

 

36
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

Significant components of deferred tax assets and liabilities are as follows:

 

   Year ended December 31, 
   2011   2010 
Deferred tax asset (liability)          
Net operating loss carryforwards  $7,368,418   $7,590,621 
Net fixed and intangible assets   (672,694)   (118,289)
Accruals and reserves   398,583    682,865 
Foreign   29,432    17,865 
Valuation allowance   (5,940,299)   (8,155,197)
Total  $1,183,440   $17,865 

 

At December 31, 2011, the Company has net operating loss carryforwards of U.S. income taxes of $16,996,180, which expire from 2027 through 2031.

 

The amounts recorded as net deferred tax assets represent the amount of tax benefits of existing deductible temporary differences and loss carryforwards that are more likely than not to be realized through the generation of sufficient future taxable income within the carryforward period. Significant management judgment is required in determining any valuation allowance recorded against deferred tax assets. Due to a history of tax losses, resulting in a cumulative loss position, management concluded that a full valuation allowance was needed to offset all of the U.S. net deferred tax assets as of December 31, 2010. At December 31, 2011, the Company released a portion of the valuation allowance, based upon the future taxable income expected to be generated from existing contracts. The Company will continue to evaluate the expected realizability of its deferred tax assets each quarter, and will recognize the tax benefit of its net operating loss carryforwards only to the extent that the Company has contracts or firm commitments which are expected to produce sufficient taxable income, or until such point as the Company has sustained positive operating results.

 

The Company has evaluated its uncertain tax positions and determined that any required adjustments would not have a material impact on the Company’s financial statements. The Company classifies interest and penalties on uncertain tax positions as interest expense and general and administrative expenses, respectively. In 2011, the Company recorded $2,500 in penalties related to the filing of its Canadian tax returns.

 

The Company and its subsidiaries are subject to regular audits 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 tax years 2007 through 2011 are open for examination by the federal, state and foreign taxing jurisdictions.

 

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. Due to changes in stock ownership some of our net operating loss carryforwards may be limited. At this time, the amount of the limitation has not been determined, since the Company has not completed its Section 382 study. However, the Company has determined that none of the tax benefit recognized at December 31, 2011 will be limited by Section 382.

 

13)          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 an aggregate of $3,000,000 in additional capital. Expenses relating to the share issuance were $138,850. The principal terms of the Preferred Shares are as follows:

 

37
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

Dividend rights – The Preferred Shares carry a fixed, cumulative, dividend of 11% per annum (adjusted for stock splits, consolidation, etc). The dividend, which is due on the first business day of each calendar year for the prior year, may (at the Company’s option) be paid either in cash or in kind by the issuance of additional Preferred Shares (PIK Shares), to be issued at the same issue price as the Series A Preferred Stock of $0.10 per share. The 11% annual dividend on the Preferred Shares will have preference over the declaration or payment of any dividends on the Company’s common stock (ordinary shares). In addition to the 11% preferred dividend, the holders of the Preferred Shares will also be entitled to participate pro rata in any dividend paid on the Company’s common stock.

 

Conversion rights – The Preferred Shares are convertible at any time at the option of the holders into the Company’s common stock on a one-for-one basis. In addition, Preferred Shares will automatically be converted into common stock upon the closing of an underwritten share offering by the Company on a registered stock exchange which realizes at least $40,000,000 of gross proceeds.

 

Redemption rights – The holders of the Preferred Shares have the option to require the Preferred Shares (including any PIK shares) to be redeemed in cash, at $0.10 per share plus accrued and unpaid dividends, at any time after 60 months from the date of issue of the Preferred Shares.

 

Anti-Dilution Provision – In the event of a future offering of the Company’s stock at a price per common share which is less than the Preferred Share conversion rate immediately before such offering, the conversion price for the Preferred Shares is adjusted according to a weighted average formula.

 

Liquidation entitlement – In the event of any voluntary or involuntary liquidation of the Company, the holders of Preferred Shares are entitled to an amount per Preferred Share equal to 1.5 times the original issue price of $0.10 plus any dividends which have become due but have not been paid.

 

Voting rights – Preferred Shares have equal voting rights (one vote per share) to common stock, except that Preferred Shares do not vote in the general election of directors.

 

Other provisions – For as long as not less than 15,000,000 Preferred Shares are outstanding, the holders of the Preferred Shares have the right between them to appoint one director, and the Company may not take action relating to certain major transactions without obtaining the consent of not less than 60% of the Preferred Shares or without obtaining the approval of the director appointed by the holder of the Preferred Shares (for matters requiring Board of Directors approval).

 

Accounting for Preferred 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 Preferred 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 date of issuance; therefore no beneficial conversion feature was recorded. The Company has classified the Preferred 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 Preferred Shares may demand redemption any time after 60 months from the date of issue. The securities are carried at their face value net of issuance costs plus accrued dividends (representing fair value) because the contingency has not been met. If the redemption were considered likely to occur, the carrying value would be adjusted to its liquidation value.

 

38
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

The carrying value of the Preferred Shares at December 31, 2011 and December 31, 2010 is as follows: 

 

   December 31, 
   2011   2010 
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 offering costs   77,131    49,429 
Balance at December 31, 2011  $3,204,993   $3,177,291 

  

For the year 2009, the Board of Directors of the Company approved the issuance of 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 on January 4, 2010.

 

14)Stockholders’ equity

 

On June 8, 2010, the Company’s shareholders approved the surrender of 11,650,000 pledged SSH LLC common shares as a prepayment associated with the Note. These shares were cancelled at June 8, 2010. See Note 5.

 

In October 2010, the Company announced the successful completion of a 3,000,000 common share private placement at $0.47 per share. These new shares were allotted and settled on October 20, 2010.

 

In 2011 and 2010, the aggregate shares of common stock issued to employees upon the exercise of stock options were 118,334 and 178,001, respectively.

 

In October 2011, the Company purchased 225,000 shares of its stock from a shareholder for NZD1.45 (US$1.19) per share, which was the market price at date of purchase. The shares were subsequently cancelled.

 

In January 2011, Spring Street Partners, L.P., one of the holders of the Series A Preferred Stock, waived its right to $200,000 of the preferred stock dividend due on January 1, 2011 and directed the Company to retain those funds to support future growth. The Company recorded this waiver as a capital contribution in the first quarter of 2011. The founder and managing partner of Spring Street Partners, L.P. is also the chairman of the board of directors of the Company.

 

In December 2011, Spring Street Partners, L.P. 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.

 

15)Stock option and incentive plan

 

In November 2007, the Company adopted the 2007 Stock Option and Incentive Plan (“the 2007 Plan”) authorizing the issuance of up to 10,000,000 shares of the Company’s common stock as awards to selected employees, directors and consultants of the Company and its affiliates, in the form of incentive stock options, non-qualified stock options, and stock awards. In June 2010, the Company adopted the 2010 Stock Option and Incentive Plan (“the 2010 Plan”) authorizing the issuance of up to 5,000,000 shares of the Company’s common stock to employees, directors and consultants of the Company and its affiliates, as incentive stock options and non-qualified stock options. After receiving a recommendation from the Remunerations and Nominations Committee, the Company's Board of Directors determines the number of shares, the term, the frequency and date, the type, the exercise periods, and any performance criteria pursuant to which stock option awards may be granted and the restrictions and other terms and conditions of each grant of restricted shares in accordance with the terms of the 2007 and 2010 Plans.

 

39
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

Stock Option Awards In August 2009, the Board of Directors awarded 3,650,000 stock options to officers and an additional 100,000 options to two former outside directors of the Company. On October 9, 2009, the Company granted an additional 910,003 shares to employees under the 2007 Plan. In July 2010, the Company granted 800,000 options to outside consultants, under the 2010 Plan. In January 2011, the Company granted 750,000 stock options to one of its executive officers, with graded vesting over three years. In June 2011, the Company granted 3,000,000 stock options to its Chief Executive Officer, with graded vesting over seven years.

 

The exercise price of each option is the market price of the Company’s stock for the last sale prior to the grant date, converted to U.S. dollars using the exchange rate in effect on the grant date. The options generally expire after a period not to exceed ten years, except in the event of termination, whereupon vested options must be exercised generally within three months, or upon death or disability, in which cases the vested options may be exercised within twelve months, but in all cases the exercise date may not exceed the expiration date.

 

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model and the resulting fair value is recorded as share-based compensation expense on a straight line basis over the option vesting period for employee stock options, ranging from six months to seven years. The value of the options granted to former directors was charged to expense as of the grant date. The value of options granted to nonemployees is initially measured at grant date and remeasured each quarter until the vesting date, which is the measurement date for share-based compensation issued to nonemployees.

 

The fair values of the options granted were estimated based on the following assumptions:

 

   Year Ended December 31, 
   2011   2010 
Expected volatility (1)   156.67 – 167.79%    167.79%
Expected term (2)   6.00 – 7.25 years    5.25 years 
Risk-free interest rate (3)   1.93 – 2.19%    1.85%
Dividend yield   -    - 
Weighted average grant-date fair value of granted options  $0.7234   $0.4266 

 

(1)The expected volatility was determined using historical volatility data for comparable companies.
(2)The expected term of the options has been estimated using the simplified method which calculates the average of the vesting period and the contractual term of the options.
(3)The risk free interest rate is based on the U.S. Treasury constant maturity nominal yield with a term approximately equal to the expected terms of the options.

 

40
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

A summary of stock option activity for the year ended December 31, 2011 is as follows: 

 

   Options   Weighted
average
exercise price
   Weighted average
remaining
contractual term
Outstanding at January 1, 2011   5,190,335   $0.19   8.78 years
Granted   3,750,000    0.75    
Exercised   (118,334)   0.16    
Forfeited   -         
Outstanding at December 31, 2011   8,822,001    0.43   8.43 years
Exercisable at December 31, 2011   4,022,001    0.20   7.93 years

 

During the years ended December 31, 2011 and 2010, the Company recognized share-based compensation expense related to stock options of $907,543 and $601,541, respectively, which is included in general and administrative expenses in the statements of income. At December 31, 2011 there was $2,224,440 of unrecognized share-based compensation expense that will be recognized over the next 6.5 years.

 

The aggregate intrinsic value of the stock options outstanding and exercisable at December 31, 2011 and 2010 was $5,171,261 and $912,424, respectively. The aggregate intrinsic value of options exercised during 2011 and 2010 was $114,403 and $55,127, respectively.

 

16)Commitments and contingencies

 

Operating leases – The Company has operating lease agreements for office space in New York City, New Jersey, New Zealand and the United Kingdom, which expire at various dates through 2018. Leases with rent escalations are recognized as rent expense over the term of the lease. Operating lease rent expense for the years ended December 31, 2011 and 2010 was approximately $406,431 and $307,778, respectively.

 

The lease agreements require security deposits in the amount of $97,885 at December 31, 2011.

 

Future minimum lease payments for leases that have initial or non-cancelable lease terms in excess of one year at December 31, 2011 are as follows:

 

Year ending
December 31,
     
 2012   $352,657 
 2013    338,913 
 2014    321,753 
 2015    314,584 
 2016    317,406 
 2017 and thereafter    373,780 
     $2,019,093 

 

Warranties and indemnificationThe Company’s service is warranted to perform in a manner materially consistent with its marketing and training materials, specifications and technical information provided to users. The Company’s arrangements generally include certain provisions for indemnifying customers against liabilities if its products or services infringe a third-party’s intellectual property rights. To date, the Company has not incurred any material costs as a result of such indemnifications and has not accrued any liabilities related to such obligations.

 

41
 

 

Diligent Board Member Services, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

 

The Company has also agreed to indemnify its directors and officers to the fullest extent allowed under Delaware law for costs associated with any fees, expenses, judgments, fines and settlement amounts incurred by any of these persons in any action or proceeding to which any of those persons is, or is threatened to be, made a party by reason of the person’s services as a director or officer of the Company, or arising as a result of that person serving at the request of the Company as a director, officer, employee or agent of another enterprise. The Company maintains director and officer insurance coverage that should enable the Company to recover a portion of any future amounts paid.

 

17)Risks and uncertainties

 

Interest rate risk - Interest rate risk is the risk that market interest rates will change and impact Diligent’s financial results by affecting the rate of interest charged or received by the Company. It is not expected that changes in interest rates will materially affect the Company’s results of operations.

 

Currency rate risk - The Company is subject to currency rate risk primarily from export sales to Canada, Europe, Australia, Singapore and New Zealand, and from cash balances maintained in foreign currencies.

 

Liquidity risk – The Company expects that its cash and cash equivalents will be adequate to support sales and growth. Particularly in light of current economic conditions, the Company intends to manage liquidity risk by continuously monitoring forecasted and actual cash flows and matching the maturity profiles of financial assets and liabilities. Additionally, in March 2010, the Company secured a $1 million revolving line of credit facility, which provides the Company cash flow protection if needed. The primary uncertainty concerning the Company’s capital needs pertains to its ability to continue to achieve the expected sales growth in a timely manner.

 

Concentrations of credit and other risks - The Company sells its service to a diverse number of customers and performs ongoing credit evaluations of its customers' financial condition as part of its accounts receivable monitoring procedures. Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. No single customer accounted for more than 10% of the accounts receivable balance at December 31, 2011 and 2010. No single customer generated more than 10% of revenue in 2011 or 2010.

 

Financial instruments which potentially subject the Company to significant concentration of credit risk include money market funds, time deposits and a term deposit. These financial instruments are classified as either cash and cash equivalents or term deposit and are maintained with high credit quality banking institutions in the United States, New Zealand and Great Britain. At times the cash balances may be in excess of the insurance limits at a particular bank.

 

18)Subsequent events

 

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 5). The shares were recorded at $1.492 per share, which was the market value on the last trading day prior to the transaction. The shares were subsequently cancelled.

 

42
 

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

 

ITEM 9A. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this Form 10-K. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as of the end of the period covered by this Form 10-K, were effective in ensuring that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in SEC’s rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Management’s Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2011.

 

Because the Company qualifies as a smaller reporting company, as defined by §229.10(f)(1), this annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.

 

Changes in Internal Control Over Financial Reporting

 

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934) that occurred during the year ended December 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

 

Not applicable

 

43
 

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

The information required by this Item is incorporated by reference from the information to be contained in our Proxy Statement.

 

ITEM 11. EXECUTIVE COMPENSATION

 

The information required by this Item is incorporated by reference from the information to be contained in our Proxy Statement.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The information required by this Item is incorporated by reference from the information to be contained in our Proxy Statement.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

The information required by this Item is incorporated by reference from the information to be contained in our Proxy Statement.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The information required by this Item is incorporated by reference from the information to be contained in our Proxy Statement.

 

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

a.The following documents are filed as a part of this Report:

 

1)Financial Statements: The information concerning our financial statements, and Report of Independent Registered Public Accounting Firm required by this Item is incorporated by reference herein to the section of this Report in Item 8, entitled “Consolidated Financial Statements and Supplementary Data.”

 

2)Financial Statement Schedules:

 

The Financial Statement Schedules not listed have been omitted because they are not applicable or are not required or the information required to be set forth herein is included in the Consolidated Financial Statements or Notes thereto.

 

3)Exhibits: See “Index to Exhibits.”

 

b.Exhibits. The exhibits listed below in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Annual Report on Form 10-K.

 

c.Financial Statement Schedules.

 

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SIGNATURES

 

Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

Dated:  March 26, 2012   DILIGENT BOARD MEMBER SERVICES, INC.
     
    By: /s/ Steven P. Ruse
           Steven P. Ruse, Chief Financial Officer (Principal Financial Officer )

 

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POWER OF ATTORNEY

 

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Steven P. Ruse and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all reports of the Registrant on Form 10-K and to sign any and all amendments to such reports and to file the same with all exhibits thereto, and other documents in connection therewith, with the Securities & Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

 

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 in the capacities indicated on the dates indicated.

 

Name   Title   Date
         
/s/ Alessandro Sodi   Chief Executive Officer,   March 26, 2012
Alessandro Sodi   President, Director (Principal Executive Officer)    
         
/s/ Steven P. Ruse   Chief Financial Officer (Principal   March 26, 2012
Steven P. Ruse   Financial Officer)    
         
/s/ Donald Meisner   Treasurer (Principal Accounting   March 26, 2012
Donald Meisner   Officer)    
         
/s/ David Liptak   Director   March 26, 2012
David Liptak        
         
/s/ Rick Bettle   Director   March 26, 2012
Rick Bettle        
         
/s/ Mark Russell   Director   March 26, 2012
Mark Russell        

 

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INDEX TO EXHIBITS 

 

Exhibit

Numbers

 

 

Exhibits

3.13   Amended and Restated Certificate of Incorporation
3.21   Amended and Restated Bylaws
4.11   Form of common stock certificate
10.11   Contribution Agreement dated October 1, 2007 between Diligent Board Member Services, LLC and Diligent Board Member Services, Inc.
10.4.11   Promissory Note and Security Agreement dated October 1, 2007 in the principal amount of $6,800,000 given by Diligent Board Member Services, LLC to the order of Diligent Board Member Services, Inc.
10.4.26   Prepayment and Amendment Agreement dated February 9, 2010 between Diligent Board Member Services, Inc. and Services Share Holding, LLC
10.5.11   Limited Pledge of Collateral for Loan dated February 18, 2008 given by Services Share Holding, LLC (f/k/a Diligent Board Member Services, LLC) to Diligent Board Member Services, Inc.
10.5.24   Amendment to Limited Pledge of Collateral for Loan dated January 14, 2009 given by Services Share Holding, LLC to Diligent Board Member Services, Inc.
10.5.34   Limited Pledge of Collateral for Loan dated January 14, 2009 given by Corcoran Consulting, LLC to Diligent Board Member Services, Inc.
10.61   2007 Stock Option and Incentive Plan of Diligent Board Member Services, Inc.
10.6.1   2010 Stock Option and Incentive Plan of Diligent Board Member Services, Inc.
10.71   Form of Restricted Stock Award Agreement for restricted stock awards under the 2007 Stock Option and Incentive Plan
10.93   Stock Purchase Agreement dated February 13, 2009 among Diligent Board Member Services, Inc., Spring Street Partners, L.P. and Carroll Capital Holdings, LLC
10.103   Investor Rights Agreement dated March 11, 2009 among Diligent Board Member Services, Inc., Spring Street Partners, L.P. and Carroll Capital Holdings, LLC
10.115   Employment agreement of CFO Steven P. Ruse
10.127   Credit Facility established by Spring Street Partners, L.P. as Lender in favor of Diligent Board Member Services, Inc. as Borrower
10.138   Employment agreement between APAC Board Services PTE. Ltd. (Singapore) and Eslinda Hamzah

 

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10.149   Employment agreement between Diligent Board Member Services, Inc and Alessandro Sodi
10.1510   First Amendment to Credit Facility established by Spring Street Partners, L.P. as Lender in favor of Diligent Board Member Services, Inc. as Borrower
21   Subsidiaries
25   Powers of Attorney executed by all officers and directors of the Company who have signed this report on Form 10-K
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

 

1 Filed with the Original Form 10 Filing on April 30, 2008.

 

2 Filed with Amendment No. 3 to Form 10 Filing on February 12, 2009.

 

3 Filed with Form 8-K Filing on March 13, 2009.

 

4 Filed with Form 10-K Filing on March 30, 2009.

 

5 Filed with Form 10-Q Filing on November 9, 2009.

 

6Filed with Form 8-K Filing on February 24, 2010.

 

7 Filed with Form 10-K Filing on March 18, 2010.

 

8 Filed with Form 10-K Filing on March 22, 2011.

 

9 Filed with Form 10-Q Filing on August 9, 2011.

 

10 Filed with Form 10-Q Filing on November 7, 2011.

 

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