CALGARY, ALBERTA — (Marketwired) — 05/21/15 — Computer Modelling Group Ltd. (“CMG” or the “Company”) (TSX: CMG) is very pleased to report our financial results for the fiscal year ended March 31, 2015.
MANAGEMENT–S DISCUSSION AND ANALYSIS
This Management–s Discussion and Analysis (“MD&A”) for Computer Modelling Group Ltd. (“CMG,” the “Company,” “we” or “our”), presented as at May 20, 2015, should be read in conjunction with the audited consolidated financial statements and related notes of the Company for the years ended March 31, 2015 and 2014. Additional information relating to CMG, including our Annual Information Form, can be found at . The financial data contained herein have been prepared in accordance with International Financial Reporting Standards (“IFRS”) and, unless otherwise indicated, all amounts in this report are expressed in Canadian dollars.
On May 21, 2014, the Board of Directors of the Company approved a two-for-one stock split of the Company–s issued and outstanding Common Shares. The Common Shares were traded on a “due bill” basis from the opening on June 23, 2014 to July 2, 2014, inclusively. The stock split record date was June 25, 2014. Accordingly, all comparative number of shares and per share amounts have been retroactively adjusted to reflect the two-for-one split.
CORPORATE PROFILE
CMG is a computer software technology company serving the oil and gas industry. The Company is a leading supplier of advanced processes reservoir modelling software with a blue chip customer base of international oil companies and technology centers in approximately 60 countries. The Company also provides professional services consisting of highly specialized support, consulting, training, and contract research activities. CMG has sales and technical support services based in Calgary, Houston, London, Caracas, Dubai, Bogota and Kuala Lumpur. CMG–s Common Shares are listed on the Toronto Stock Exchange (“TSX”) and trade under the symbol “CMG”.
VISION, BUSINESS AND STRATEGY
CMG–s vision is to become the leading developer and supplier of dynamic reservoir modelling systems in the world. Early in its life CMG made the strategic decision to focus its research and development efforts on providing solutions for the simulation of difficult hydrocarbon recovery techniques, a decision that created the foundation for CMG–s dominant market presence today in the simulation of advanced hydrocarbon recovery processes. CMG has continued this commitment by increasing spending on research and development and working closely with its customers to develop simulation tools relevant to the challenges and opportunities they face today. This includes the CoFlow project (formerly known as the DRMS project), a collaborative effort with our partners Shell International Exploration and Production BV (“Shell”) and Petroleo Brasileiro S.A. (“Petrobras”) to jointly develop the newest generation of reservoir simulation software. Our target is to develop a dynamic system that does more than optimize reservoir recovery; it will model the entire hydrocarbon reservoir system, including production systems.
Since its inception more than 35 years ago, CMG has remained focused on assisting its customers in unlocking the value of their hydrocarbon reservoirs. With petroleum production using conventional methods on the decline, the petroleum industry must use more difficult and costly advanced process extraction methods, while being faced with more governmental and regulatory requirements over environmental concerns. CMG–s success can, in turn, be correlated with the oil industry becoming more reliant on the use of simulation technology due to the maturity of conventional petroleum reservoirs and the complexities of both current and emerging production processes.
CMG–s success can specifically be attributed to a number of factors: advanced physics, ongoing enhancements to the Company–s already robust product line, improved computational speed, parallel computing ability, ease of use features of the pre- and post-processor applications, cost effectiveness of the CMG solution for customers, and the knowledge base of CMG–s personnel to support and advance its software.
CMG currently licenses reservoir simulation software to more than 500 oil and gas companies, consulting firms and research institutions in approximately 60 countries. In combination with its principal business of licensing its software, CMG also provides professional services consisting of highly specialized consulting, support, training, and funded research activities for its customers. While the generation of professional services revenue specifically tied to the provision of consulting services is not regarded as a core part of CMG–s business, offering this type of service is important to CMG operationally. CMG performs a limited amount of specialized consulting services, which are typically of a highly complex and/or experimental nature. These studies provide hands-on practical knowledge, allowing CMG staff to test the boundaries of our software, and provide us the opportunity to increase software license sales to both new and existing customers. In addition, providing consulting services is important from the customer service perspective as it enables our customers to become more proficient users of CMG–s software. The funded research revenue is derived from the customers who partner with CMG to assist in the development, testing and refinement of new simulation technologies. In addition to consulting, we allocate significant resources to training, which is an instrumental part of our company–s success. Our training programs enable our customers to become more efficient and effective users of our software, which, in turn, contributes to higher customer satisfaction. Our training is continuous in nature and it helps us in developing and maintaining long-term relationships with our customers.
CMG remains true to its strategy of growing its revenue base while advancing its technological superiority over its competition. CMG firmly believes that, to become the dominant supplier of dynamic reservoir modelling systems in the world, it must be responsive to customers– needs today and accurately predict their needs in the future.
CMG invests a significant amount of resources each year towards maintaining its technological superiority. During fiscal 2015, CMG increased its overall spending on research and development by 16% (representing 20% of total revenue) and expects to continue spending at a similar level in relation to its revenue base in fiscal 2016. The increasing level of investment by CMG in its current product suite offering helps to ensure that its existing proven technology continues to be industry-leading. These significant levels of investment, in combination with partnering with Shell and Petrobras in the CoFlow project (formerly known as the DRMS project) to jointly develop the newest generation of reservoir simulation software, are targeted strategies to achieve our vision to become the leading developer and supplier of dynamic reservoir modelling systems in the world.
OVERALL PERFORMANCE
KEY PERFORMANCE DRIVERS AND CAPABILITY TO DELIVER RESULTS
One of the challenges the petroleum industry faces in trying to overcome barriers to production growth is the continuing need for breakthrough technologies. The facts facing the petroleum industry today are that brand new fields are increasingly difficult to find, especially on a large scale, and that there are a large number of mature fields and unconventional prospects where known petroleum reserves exist; the question is how to economically extract the petroleum reserves in place and do so utilizing environmentally conscious processes. These challenges have been made even more formidable given that the current economic environment and global political climate have led to increased uncertainty regarding capital markets and commodity prices.
The petroleum industry utilizes reservoir simulation to provide both vital information and a visual interpretation on how reservoirs will behave under various recovery techniques. Understanding the science of how a petroleum reservoir will react to difficult hydrocarbon recovery processes through simulation prior to spending the capital on drilling wells and injecting expensive chemicals and steam, for instance, is far less costly and risky than trying the various techniques on real wells.
CMG–s existing product suite of software is the market leader in the simulation of difficult hydrocarbon recovery techniques. To maintain this dominant market position, CMG actively participates in research consortia that experiment with new petroleum extraction processes and technologies. CMG then incorporates the simulation of new recovery methods into its product suite and focuses on overcoming existing technological barriers to advance speed and ease of use, amongst other benefits, in its software.
In October 2014, CMG announced the naming of its newest generation of dynamic reservoir modelling system, previously referred to as the “DRMS project,” to CoFlow. The newest generation of reservoir modelling software will provide a collaborative, integrated modelling framework to allow asset teams, including reservoir, production and geomechanical engineers, to work together on multiple, integrated reservoirs and production networks. The most recent version of the software, referred to as R9, achieved its target of successfully simulating a complex integrated asset model. The next version, R10, is scheduled for release in the second half of calendar 2015, for the application on additional target assets selected by our partners, Shell and Petrobras.
The development of our CoFlow system, the newest generation reservoir and production system simulation software, is a significant project for CMG and its partners; a project that to-date has represented over 345 man-years of development. The CoFlow team consists of 70 full-time equivalent persons made up of 44 CMG employees and consultants and 5 partner-seconded staff members, all working in CMG–s Calgary offices, with an additional 21 partner staff members working remotely from their respective offices in the Netherlands, Brazil and the United States. CMG, through its participation in this joint project, will have full commercialization rights to the developed technology. CMG and its partners are committed to the ongoing funding of the project, with the Company–s share of project costs estimated to be $6.4 million ($3.4 million net of overhead recoveries) for the upcoming fiscal year. As project operator, CMG receives a fee for operator services, which is reflected in revenue as professional services.
During fiscal 2015, CMG launched iSegWell, an advanced analytical wellbore modelling tool in IMEX black oil reservoir simulator, designed to simultaneously optimize well design and reservoir productivity by modelling flow and pressure changes throughout wellbore branches, tubing and equipment.
We expect CMG–s share of the market for all petroleum recovery simulation to increase as the amount of easy-to-extract oil declines and as production from unconventional sources increases. The speed and the magnitude of growth in licenses sold for use of CMG–s advanced recovery process simulators is enhanced by the shift in production from conventional means to more complex recovery methods.
CMG is in a very strong financial position with $60.9 million in working capital, no bank debt and a long history of generating earnings and cash from operating activities. In addition to its financial resources, CMG–s real strength lies in the outstanding quality and dedication of its employees in all areas of the Company. While it has never been easy to find qualified staff as CMG has grown through the years, our expanding reputation as a challenging and rewarding place to work has somewhat eased this burden. CMG added 16 new full-time equivalent staff members to its employee complement in fiscal 2015 and is planning for a potential increase in its staff complement by a similar number by the end of fiscal 2016.
Our focus will remain on increasing software license sales to both existing and new customers and, with diversification of our geographic profile, we plan to strengthen our position in the global marketplace. Over 80% of our software license revenue is derived from our annuity and maintenance contracts, which generally represent a recurring source of revenue. Sustained revenue growth, combined with solid control over corporate costs, will continue to be the key variables in ensuring CMG–s future profitability. During the fiscal year ended March 31, 2015, our EBITDA represented 51% of total revenue which demonstrates our ability to effectively manage our corporate costs.
We continue to return value to our shareholders in the form of regular quarterly dividend payments. During the year ended March 31, 2015, as compared to the prior fiscal year, we increased total dividends declared and paid by 3%.
We are confident that our sustainable business model driven by superior technology, commitment to research and development initiatives, and customer-oriented approach will continue contributing to CMG–s future success.
HIGHLIGHTS
During the year ended March 31, 2015, as compared to the previous fiscal year, CMG:
CMG–s revenue is comprised of software license sales, which provide the majority of the Company–s revenue, and fees for professional services.
Total revenue increased by 2% for the three months ended March 31, 2015, compared to the previous fiscal year, mainly due to an increase in software license revenue partially offset by a decrease in fees for professional services.
Total revenue increased by 14% for the year ended March 31, 2015, compared to the previous fiscal year, mainly due to an increase in software license revenue.
SOFTWARE LICENSE REVENUE
Software license revenue is made up of annuity/maintenance license fees charged for the use of the Company–s software products which is generally for a term of one year or less and perpetual software license sales, whereby the customer purchases the-then-current version of the software and has the right to use that version in perpetuity. Annuity/maintenance license fees have historically had a high renewal rate and, accordingly, provide a reliable revenue stream while perpetual license sales are more variable and unpredictable in nature as the purchase decision and its timing fluctuate with the customers– needs and budgets. The majority of CMG–s customers who have acquired perpetual software licenses subsequently purchase our maintenance package to ensure ongoing product support and access to current versions of CMG–s software
Total software license revenue grew by 3% and 16% in the three months and year ended March 31, 2015, respectively, compared to the same periods of the previous fiscal year, due to increases in both annuity/maintenance revenue and perpetual license sales.
CMG–s annuity/maintenance license revenue increased by 2% during the three months ended March 31, 2015, compared to the same period of the previous fiscal year, due to the positive impact of the strengthening of the US dollar. CMG–s annuity/maintenance license revenue increased by 11% during the year ended March 31, 2015, compared to the previous fiscal year, driven by sales to existing and new customers, an increase in maintenance revenue tied to perpetual sales and the positive impact of the strengthening of the US dollar.
All of our regions, with the exception of South America, experienced growth in annuity/maintenance revenue during the three months and year ended March 31, 2015, compared to the same periods of the previous fiscal year, with the most significant dollar growth being generated from our US market.
Our annuity/maintenance revenue is impacted by the revenue recognition from a long-standing customer for which revenue recognition criteria are fulfilled only at the time of the receipt of funds (see the discussion about revenue earned in the current period that pertains to usage of products in prior quarters above the “Quarterly Software License Revenue” graph). The variability of the amounts of the payments received and the timing of such payments may skew the comparison of the recorded annuity/maintenance revenue amounts between periods. To provide a normalized comparison, if we were to remove revenue from this particular customer from the fourth quarter of the current and previous fiscal years, we will notice that the annuity/maintenance revenue increased by 11%, instead of 2%, as compared to the same period of the previous fiscal year. Similarly, if we were to remove revenue from this particular customer from the years ended March 31, 2015 and 2014, we will notice that the annuity/maintenance revenue increased by 14%, instead of 11%, as compared to the previous fiscal year. Historically we have received payments from this particular customer, however, there is increasing uncertainty associated with the receipt of payments due to the economic conditions in the country where this customer is located. Payments from this customer will continue to be recorded on a cash basis which may introduce some variability in our reported quarterly annuity/maintenance revenue results.
Perpetual license sales increased by 10% for the three months ended March 31, 2015, compared to the same period of the previous fiscal year, mainly due to growth in perpetual sales in South America partially offset by fewer perpetual sales being realized in the US market.
Perpetual license sales increased by 48% for the year ended March 31, 2015, compared to the previous fiscal year, mainly due to a large perpetual sale to an existing customer in South America during the third quarter of the current fiscal year. The increase in South America was partially offset by decreases in the Eastern Hemisphere and US markets, compared to the previous fiscal year.
Software licensing under perpetual sales may fluctuate significantly between periods due to the uncertainty associated with the timing and the location where sales are generated. For this reason, even though we expect to achieve a certain level of aggregate perpetual sales on an annual basis, we expect to observe fluctuations in the quarterly perpetual revenue amounts throughout the fiscal year.
We can observe from the tables below that the exchange rates between the US and Canadian dollars during the three months and year ended March 31, 2015, compared to the same periods of the previous fiscal year, had a positive impact on our reported license revenue.
The following table summarizes the US dollar denominated revenue and the weighted average exchange rate at which it was converted to Canadian dollars:
The following table quantifies the foreign exchange impact on our software license revenue:
During the three months ended March 31, 2015, on a geographic basis, total software license sales increased across all regions, with the exception of South America, as compared to the same period of the previous fiscal year, whereas all regions experienced growth during the year ended March 31, 2015, compared to the previous fiscal year.
The Canadian market (representing 34% of year-to-date total software revenue) experienced growth in annuity/maintenance license sales during the three months and year ended March 31, 2015, compared to the same periods of the previous fiscal year. This increase was mainly supported by sales to existing customers, but we also added new customers during the fiscal year. Perpetual revenue for the three months and year ended March 31, 2015 remained comparable to the respective periods of the previous fiscal year.
The US market (representing 21% of year-to-date total software revenue) had the most significant growth in annuity/maintenance license sales during the three months and year ended March 31, 2015, compared to the same periods of the previous fiscal year, driven by sales to existing and new customers. Perpetual revenue decreased during the three months and year ended March 31, 2015, compared to the same periods of the previous fiscal year. We continue to experience successive increases in annuity/maintenance license sales in the US as evidenced by the quarterly year-over-year increases of 16%, 16%, 30%, and 22% recorded during Q4 2014, Q1 2015, Q2 2015, and Q3 2015, respectively. This double-digit growth trend has continued into the fourth quarter of the current fiscal year with the recorded increase of 32%.
South America (representing 20% of year-to-date total software revenue) experienced a decrease in annuity/maintenance license sales during the three months and year ended March 31, 2015, compared to the same periods of the previous fiscal year. The revenue in our South American region can be impacted by the variability of the amounts recorded from a customer for which revenue is recognized only when cash is received (see the discussion about revenue earned in the current period that pertains to usage of products in prior quarters above the “Quarterly Software License Revenue” graph). To provide a normalized comparison, if we were to remove revenue from this particular customer from the fourth quarter of the current and previous fiscal years, we will notice that the annuity/maintenance revenue increased by 14%, instead of a decrease of 43%, as compared to the same period of the previous fiscal year. Similarly, if we were to remove revenue from this particular customer from the years ended March 31, 2015 and 2014, we will notice that the annuity/maintenance revenue increased by 15%, instead of a decrease of 4%, as compared to the previous fiscal year. The South American region experienced an increase in perpetual license sales during the three months and year ended March 31, 2015, compared to the same periods of the previous fiscal year. A large perpetual sale made during the third quarter of the current fiscal year contributed significantly to the increase in year-to-date perpetual revenue.
The Eastern Hemisphere (representing 25% of the year-to-date total software revenue) grew annuity/maintenance license sales by 4% and 7%, respectively, during the three months and year ended March 31, 2015, compared to the same periods of the previous fiscal year, driven by sales to existing and new customers. While perpetual revenue for the three months ended March 31, 2015 was comparable with the same period of the previous fiscal year, it decreased during the year ended March 31, 2015, compared to the previous fiscal year.
Software license revenue in the US, South America and the Eastern Hemisphere was positively affected by the strengthening of the US dollar during the three months and year ended March 31, 2015, compared to the same periods of the previous fiscal year.
Movements in perpetual sales across regions are indicative of the unpredictable nature of the timing and location of perpetual license sales. Overall, our recurring annuity/maintenance revenue base continued to grow during fiscal 2015. We will continue to focus our efforts on increasing our license sales to both existing and new customers and, supported by our product suite offering and our customer-oriented approach, we will endeavor to continue expanding our market share globally.
As footnoted in the Quarterly Performance table, in the normal course of business, CMG may complete the negotiation of certain annuity/maintenance contracts and/or fulfill revenue recognition requirements within a current quarter that includes usage of CMG–s products in prior quarters. This situation particularly affects contracts negotiated with countries that face increased economic and political risks leading to the revenue recognition criteria being satisfied only at the time of the receipt of cash. The dollar magnitude of such contracts may be significant to the quarterly comparatives of our annuity/maintenance revenue stream and, to provide a normalized comparison, we specifically identify the revenue component where revenue recognition is satisfied in the current period for products provided in previous quarters.
To view Quarterly Software License Revenue graph, please click on the following link:
CMG–s deferred revenue consists primarily of amounts for pre-sold licenses. Our annuity/maintenance revenue is deferred and recognized on a straight-line basis over the life of the related license period, which is generally one year or less. Amounts are deferred for licenses that have been provided and revenue recognition reflects the passage of time.
The increase in deferred revenue year-over-year as at the end of Q1, Q2, Q3 and Q4 is reflective of the growth in annuity/maintenance license sales. The above table illustrates the normal trend in the deferred revenue balance from the beginning of the calendar year (which corresponds with Q4 of our fiscal year), when most renewals occur, to the end of the calendar year (which corresponds with Q3 of our fiscal year). Our fourth quarter corresponds with the beginning of the fiscal year for most oil and gas companies, representing a time when they enter a new budget year and sign/renew their contracts.
Deferred revenue as at Q4 of fiscal 2015 increased by 11%, compared to Q4 of fiscal 2014, due to both the renewal of existing and signing of new annuity and maintenance contracts in the quarter.
PROFESSIONAL SERVICES REVENUE
CMG recorded professional services revenue of $2.1 million for the three months ended March 31, 2015, representing a slight decrease of $0.1 million, compared to the same period of the previous fiscal year. Professional services for the year ended March 31, 2015 amounted to $8.0 million, representing a slight decrease of $0.3 million, compared to the previous fiscal year, as a result of a decrease in project activities by our customers.
Professional services revenue consists of specialized consulting, training, and contract research activities. CMG performs consulting and contract research activities on an ongoing basis, but such activities are not considered to be a core part of our business and are primarily undertaken to increase our knowledge base and hence expand the technological abilities of our simulators in a funded manner, combined with servicing our customers– needs. In addition, these activities are undertaken to market the capabilities of our suite of software products with the ultimate objective to increase software license sales. Our experience is that consulting activities are variable in nature as both the timing and dollar magnitude of work are dependent on activities and budgets within customer companies.
CMG–s total operating expenses increased by 14% and 15% for the three months and year ended March 31, 2015, respectively, compared to the same periods of the previous fiscal year, due to increases in both direct employee costs and other corporate costs.
DIRECT EMPLOYEE COSTS
As a technology company, CMG–s largest area of expenditure is its people. Approximately 79% of the total operating expenses in the year ended March 31, 2015 related to direct employee costs, compared to 80% recorded in the comparative period of the previous fiscal year. Staffing levels for the current fiscal year grew in comparison to the previous fiscal year to support our continued growth. At March 31, 2015, CMG–s full-time equivalent staff complement was 205 employees and consultants, up from 189 full-time equivalent employees and consultants as at March 31, 2014. Direct employee costs increased during the three months and year ended March 31, 2015, compared to the same periods of the previous fiscal year, due to staff additions, increased levels of compensation, and related benefits.
OTHER CORPORATE COSTS
Other corporate costs increased by 17% for the three months ended March 31, 2015, compared to the same period of the previous fiscal year, mainly attributable to an increase in rent and other office costs related to our international offices.
Other corporate costs increased by 21% for the year ended March 31, 2015, compared to the previous fiscal year, mainly attributable to the inclusion of the costs associated with CMG–s biennial technical symposium which took place during the first quarter of the current fiscal year, a decrease in SR&ED credits and an increase in rent and other office costs related to our international offices.
CMG maintains its belief that its strategy of growing long-term value for shareholders can only be achieved through continued investment in research and development. CMG works closely with its customers to provide solutions to complex problems related to proven and new advanced recovery processes.
The above research and development costs include CMG–s share of joint research and development costs associated with the CoFlow project of $1.3 million and $4.7 million for the three months and year ended March 31, 2015, respectively (2014 – $1.0 million and $4.0 million). See discussion under “Commitments, Off Balance Sheet Items and Transactions with Related Parties.”
The increases of 9% and 11% in our gross spending on research and development for the three months and year ended March 31, 2015, respectively, compared to the same periods of the previous fiscal year, demonstrate our continued commitment to the advancement of our technology which is the focal point of our business strategy.
Research and development costs, net of SR&ED credits, increased by 12% during the three months ended March 31, 2015, compared to the same period of the previous fiscal year, mainly due to an increase in employee compensation costs.
Research and development costs, net of SR&ED credits, increased by 16% during the year ended March 31, 2015, compared to the previous fiscal year, mainly due to an increase in employee compensation costs and a decrease in SR&ED credits.
SR&ED credits decreased for the year ended March 31, 2015, compared to the previous fiscal year, due to both a decrease in the Federal SR&ED input tax credit rate (from 20% to 15% effective January 1, 2014) and a decrease in SR&ED eligible expenditures associated with the CoFlow project.
Depreciation in the three months and year ended March 31, 2015 was relatively flat, as compared to the same periods in the previous fiscal year.
Interest income in the three months ended March 31, 2015 was relatively flat, as compared to the same period of the previous fiscal year, while it increased in the year ended March 31, 2015, compared to the previous fiscal year, mainly due to investing larger cash balances.
CMG is impacted by the movement of the US dollar against the Canadian dollar as approximately 74% (2014 – 72%) of CMG–s revenue for the year ended March 31, 2015 is denominated in US dollars, whereas only approximately 25% (2014 – 24%) of CMG–s total costs are denominated in US dollars.
The following chart shows the exchange rates used to translate CMG–s US dollar denominated working capital at March 31, 2015, 2014 and 2013 and the average exchange rates used to translate income statement items during the years ended March 31, 2015, 2014 and 2013:
CMG recorded a net foreign exchange gain of $2.6 million for the three months ended March 31, 2015, compared to a net foreign exchange gain of $1.0 million recorded in the same period of the previous fiscal year, due to a weakening in the Canadian dollar during the quarter which contributed positively to the valuation of our US-denominated working capital.
CMG recorded a net foreign exchange gain of $3.4 million for the year ended March 31, 2015, compared to a net foreign exchange gain of $1.7 million recorded in the previous fiscal year, as the net foreign exchange gains recorded in Q2, Q3 and Q4 of fiscal 2015 were partially offset by the foreign exchange loss recorded in Q1 of fiscal 2015.
INCOME AND OTHER TAXES
CMG–s effective tax rate for the year ended March 31, 2015 is reflected as 28.40% (2014 – 29.41%), whereas the prevailing Canadian statutory tax rate is now 25.0%. This difference is primarily due to the non-tax deductibility of stock-based compensation expense.
The benefit recorded in CMG–s books on the SR&ED investment tax credit program impacts deferred income taxes. The investment tax credit earned in the current fiscal year is utilized by CMG to reduce income taxes otherwise payable for the current fiscal year and the federal portion of this benefit bears an inherent tax liability as the amount of the credit is included in the subsequent year–s taxable income for both federal and provincial purposes. The inherent tax liability on these investment tax credits is reflected in the year the credit is earned as a non-current deferred tax liability and then, in the following fiscal year, is transferred to income taxes payable.
Operating profit as a percentage of total revenue for the three months ended March 31, 2015 decreased to 42%, compared to 48% in the same period of the previous fiscal year. While our revenue for the three months ended March 31, 2015 grew by 2%, as compared to the same period of the previous fiscal year, our operating expenses grew by 14%, having a negative impact on our operating profit. As discussed previously, our annuity/maintenance revenue is impacted by the revenue recognition from a long-standing customer for which revenue recognition criteria are fulfilled only at the time of the receipt of funds. If we were to normalize total revenue for this customer, the operating profit as a percentage of total revenue for the three months ended March 31, 2014 would have been 44%.
Operating profit as a percentage of total revenue for the year ended March 31, 2015 remained consistent at 49%, compared to the previous fiscal year (normalizing for the revenue amount described above does not impact the comparability between the fiscal years ended March 31, 2015 and 2014).
Net income for the period as a percentage of revenue remained consistent at 39% for the three months ended March 31, 2015, compared to the same period of the previous fiscal year.
Net income for the period as a percentage of revenue increased to 38% for the year ended March 31, 2015, compared to 37% for the previous fiscal year.
We have continued to maintain our profitability by focusing our efforts on increasing license sales while, at the same time, effectively controlling our operating costs. Managing these variables will continue to be imperative to our future success.
EBITDA decreased by 11% for the three months ended March 31, 2015 and increased by 12% for the year ended March 31, 2015, compared to the same periods of the previous fiscal year. Similarly as explained under the “Operating Profit and Net Income” heading, our EBITDA was impacted by the revenue recognition from a long-standing customer for which revenue recognition criteria are fulfilled only at the time of the receipt of funds. If we were to normalize for this customer, EBITDA for the three months ended March 31, 2015 would have increased by 3%, rather than decreasing by 11%, as compared to the same period of the previous fiscal year. EBITDA for the year ended March 31, 2015 would have increased by 16%, instead of 12%, as compared to the previous fiscal year.
EBITDA as a percentage of total revenue decreased to 44% for the three months ended March 31, 2015, compared to 50% recorded in the same period of the previous fiscal year (47% normalized for the revenue amount described above).
EBITDA as a percentage of total revenue for the year ended March 31, 2015 was at 51%, which was comparable to 52% recorded in the previous fiscal year (normalizing for the revenue amount described above does not impact the comparability between the fiscal years ended March 31, 2015 and 2014).
OPERATING ACTIVITIES
Cash flow generated from operating activities increased by $3.7 million in the three months ended March 31, 2015, compared to the same period of the previous fiscal year, mainly due to the change in the deferred revenue balance, the timing difference of when sales are made and when the resulting receivables are collected, and the timing difference of when trade payables and accrued liabilities are recorded and paid.
Cash flow generated from operating activities increased by $7.9 million in the year ended March 31, 2015, compared to the previous fiscal year, mainly due to an increase in net income, the timing difference of when trade payables and accrued liabilities are recorded and paid, and the timing difference of when sales are made and when the resulting receivables are collected partially offset by the change in the deferred revenue balance.
FINANCING ACTIVITIES
Cash used in financing activities during the three months ended March 31, 2015 increased by $1.9 million, compared to the same period of the previous fiscal year, due to receiving lower proceeds from the issuance of Common Shares and paying larger dividends.
Cash used in financing activities during the year ended March 31, 2015 increased by $17.0 million, compared to the previous fiscal year, due to buying back Common Shares, receiving lower proceeds from the issuance of Common Shares and paying larger dividends.
During the year ended March 31, 2015, CMG employees and directors exercised options to purchase 876,000 Common Shares, which resulted in cash proceeds of $5.3 million (2014 -2,161,000 options exercised to purchase Common Shares which resulted in cash proceeds of $11.3 million).
In the year ended March 31, 2015, CMG paid $31.5 million in dividends, representing the following quarterly dividends:
In the year ended March 31, 2014, CMG paid $30.3 million in dividends, representing the following quarterly dividends:
On May 20, 2015, CMG announced the payment of a quarterly dividend of $0.10 per share on CMG–s Common Shares. The dividend will be paid on June 15, 2015 to shareholders of record at the close of business on June 5, 2015.
In the fiscal 2012 Management–s Discussion and Analysis, we reported that, beginning in fiscal 2013, we would increase the relative proportion of dividends paid quarterly and lower and/or eliminate the amount paid as a special dividend at the end of the fiscal year, in order to provide a more regular income stream to our shareholders throughout the year. The Company–s focus will remain on a sustainable quarterly dividend; however, we may consider a special dividend as appropriate.
Based on our expectation of solid profitability and cash-generating ability driven by the predictability of our software revenue base and effective management of costs, we are cautiously optimistic that the company is well positioned for future growth which will enable us to continue to pay quarterly dividends.
On April 29, 2013, the Company announced a NCIB commencing on May 1, 2013 to purchase for cancellation up to 7,076,000 of its Common Shares. This NCIB finished on April 30, 2014 and no Common Shares were purchased.
On May 5, 2014, the Company announced a NCIB commencing on May 5, 2014 to purchase for cancellation up to 7,440,000 of its Common Shares. During the year ended March 31, 2015, 808,000 Common Shares were purchased at market price for a total cost of $9.8 million. This NCIB ends on May 4, 2015.
INVESTING ACTIVITIES
CMG–s current needs for capital asset investment relate to computer equipment and office infrastructure costs, all of which will be funded internally. During the year ended March 31, 2015, CMG expended $1.7 million on property and equipment additions, primarily composed of computing equipment, furniture and leasehold improvements. CMG has a capital budget of $2.5 million for fiscal 2016.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2015, CMG has $75.3 million in cash, no debt, and has access to approximately $0.8 million under a line of credit with its principal banker.
During the year ended March 31, 2015, 25,830,000 shares of CMG–s public float were traded on the TSX. As at March 31, 2015, CMG–s market capitalization based upon its March 31, 2015 closing price of $12.72 was $998.4 million.
COMMITMENTS, OFF BALANCE SHEET ITEMS AND TRANSACTIONS WITH RELATED PARTIES
The Company is the operator of the CoFlow project, a collaborative effort with its partners Shell and Petrobras, to jointly develop the newest generation of reservoir and production system simulation software. The project has been underway since 2006 and, with the ongoing support of the participants, it is expected to continue until ultimate delivery of the software. The Company–s share of costs associated with the project is estimated to be $6.4 million ($3.4 million net of overhead recoveries) for fiscal 2016. CMG plans to continue funding its share of the project costs associated with the development of the newest generation reservoir simulation software system from internally generated cash flows.
CMG has very little in the way of other ongoing material contractual obligations other than for pre-sold licenses, which are reflected as deferred revenue on its statement of financial position, and contractual obligations for office leases which are estimated for our fiscal years as follows: 2016 – $2.4 million; 2017 – $1.9 million; 2018 – $3.5 million; 2019 – $4.7 million; 2020 – $4.6; thereafter – $86.6 million. During the third quarter of the current fiscal year, CMG finalized a twenty year operating lease for our new Calgary offices which will commence in fiscal 2018.
CRITICAL ACCOUNTING ESTIMATES
The preparation of 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 dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. By their nature, these estimates are subject to estimation uncertainty. The effect on the financial statements of changes in such estimates in future periods could be material and would be accounted for in the period in which the estimates are revised and in any future periods affected.
Revenue recognition
Revenue consists primarily of software license fees with some fees for professional services. We recognize revenue in accordance with the current rules of IFRS. We follow specific and detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue recognition policies.
Software license revenue is comprised of annuity/maintenance license fees charged for the use of our software products which is generally for a term of one year or less, and perpetual software licensing, whereby the customer purchases the-then-current version of the software and has the right to use that version in perpetuity. We recognize software license revenue when persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed or determinable, and collection of the resulting receivable is probable. In cases where collectability is not deemed probable, revenue is recognized upon receipt of cash, assuming all other criteria have been met.
Annuity/maintenance revenue is deferred and recognized on a straight-line basis over the life of the related license period, which is generally one year or less. License fees for perpetual licenses are recognized fully in revenue when all recognition conditions are satisfied.
Certain software license agreements contain multiple-element arrangements as they may also include maintenance fees. Judgment is used in determining a fair value of each element of a contract.
Professional services revenue earned from certain consulting contracts is recognized by the stage of completion of the transaction determined using the percentage-of-completion method. Judgment is used in determining progress of each contract at period end. In assessing revenue recognition, judgment is also used in determining the ability to collect the corresponding account receivable.
Functional currency
The determination of the functional currency is a matter of determining the primary economic environment in which an entity operates. IAS 21, The Effects of Changes in Foreign Exchange Rates, sets out a number of factors to apply in making the determination of the functional currency. However, applying the factors in IAS 21 does not always result in a clear indication of functional currency. Where IAS 21 factors indicate differing functional currencies within a subsidiary, the Company uses judgment in the ultimate determination of that subsidiary–s functional currency, including an assessment of the nature of the relationship between the Company and the subsidiary. Judgment was applied in the determination of the functional currency of certain of the Company–s operating entities.
Research and development
Assumptions are made in respect to the eligibility of certain research and development projects in the calculation of SR&ED investment tax credits which are netted against the research and development costs in the statement of operations. SR&ED claims are subject to audits by relevant taxation authorities and the actual amount may change depending on the outcome of such audits.
Stock-based compensation
Assumptions and estimates are used in determining the inputs used in the Black-Scholes option pricing model, including assumptions regarding volatility, dividend yield, risk-free interest rates, forfeiture estimates and expected option lives.
Property and equipment
Estimates are used in determining useful economic lives of property and equipment for the purposes of calculating depreciation.
Deferred income taxes
Assumptions and estimates are made regarding the amount and timing of realization and/or settlement of the temporary differences between the accounting carrying value of the Company–s assets versus the tax basis of those assets, and the tax rates at which the differences will be recovered or settled in the future.
NEW ACCOUNTING STANDARDS AND INTERPRETATIONS ADOPTED:
The Company adopted the following new standards and interpretations effective as of April 1, 2014:
Amendments to IAS 32 Offsetting Financial Assets and Liabilities
Clarify when an entity has a legally enforceable right to set-off and net versus gross settlement mechanisms. The Company adopted the amendments to IAS 32 in its consolidated financial statements for the annual period beginning on April 1, 2014. The amendments to IAS 32 did not have a material impact on the consolidated financial statements.
Amendments to IAS 36 Impairment of Assets
Clarify IASB–s original intention to require the disclosure of the recoverable amount of impaired assets as well as additional disclosures about the measurement of the recoverable amount of impaired assets. The Company adopted the amendments to IAS 36 in its consolidated financial statements for the annual period beginning on April 1, 2014. The amendments to IAS 36 did not have a material impact on the consolidated financial statements.
ACCOUNTING STANDARDS AND INTERPRETATIONS ISSUED BUT NOT YET EFFECTIVE
The following standards and interpretations have not been adopted by the Company as they apply to future periods:
OUTSTANDING SHARE DATA
The following table represents the number of Common Shares and options outstanding:
On July 13, 2005, CMG adopted a rolling stock option plan which allows the Company to grant options to its employees, officers and directors to acquire Common Shares of up to 10% of the outstanding Common Shares at the date of grant. Based upon this calculation, at May 20, 2015, CMG could grant up to 7,854,000 stock options.
BUSINESS RISKS
The Company has the following business risks:
Commodity Price Risk
CMG–s customers are oil and gas companies and it might, therefore, be assumed that its financial results are significantly impacted by commodity prices. CMG–s actual experience of growth in software license revenues during depressed oil price markets makes us believe that software license sales are influenced more by the utility of the software as opposed to the prevailing commodity price but different circumstances could prevail in the future. Low commodity prices and resulting lower cash flow in the industry could impact how customers license CMG software; one could expect sales of perpetual licenses to decrease in favour of leasing software on a term basis.
Volatility in commodity prices could have an impact on CMG–s consulting business; however, this business segment generates less than 10% of total revenues and CMG has no current plans to significantly expand this area of business.
Credit and Liquidity Risks
Our product demand is dependent on the customers– overall spending plans, which are driven by commodity prices and the availability of capital. The Company–s accounts receivable balances are with customers involved with the oil and gas industry. During times of depressed oil and gas markets, our customers may experience financial constraints. While the Company monitors its exposure to credit risk, lack of payment from multiple clients may have a material adverse effect on the Company–s financial condition. This risk is mitigated by having a diversified customer base with the majority of revenue being derived from larger entities which are not as affected by the market volatility or cyclical downturns in commodity prices. In addition, our diversified geographic profile helps to mitigate the effects of economic recessions and instability experienced in any particular geographic region.
The Company mitigates the collection risk by closely monitoring its accounts receivable and assessing creditworthiness of its customers. The Company has not had any significant losses to date.
In terms of liquidity, the Company held $75.3 million of cash at March 31, 2015, which more than covers its obligations and it has approximately $0.8 million of the credit facility available for its use. The Company–s cash is held with a reputable banking institution. For the described reasons, we believe that our liquidity risk is low.
Sales Variability Risk
CMG–s software license revenue consists of annuity/maintenance software licensing, which is generally for a term of one year or less, and perpetual software licensing, whereby the customer purchases the-then-current version of the software and has the right to use that version in perpetuity. Software licensing under perpetual sales is a significant part of CMG–s business but is more variable in nature as the purchase decision, and its timing, fluctuate with customers– needs and budgets. CMG has found that a number of customers prefer to acquire perpetual software licenses rather than leasing the software on an annual basis. The experience over the last few years is that a number of these customers are purchasing additional licenses to allow more users to access CMG technology in their operations. CMG has found that a large percentage of its customers who have acquired perpetual software licenses are subsequently purchasing maintenance licenses to ensure they have access to current CMG technology.
The variability in sales of perpetual licenses may cause significant fluctuations in the Company–s quarterly and annual financial results, and these results may not meet the expectations of analysts or investors. Accordingly, the Company–s past results may not be a good indication of its future performance.
CMG–s customers are both domestic and international oil and gas companies and for the years ended March 31, 2015 and March 31, 2014, no customer represented revenue in excess of 10% of total revenue.
Foreign Exchange Risk
CMG–s reported results are affected by the exchange rate between the Canadian dollar and the US dollar as approximately 74% (2014 – 72%) of product revenues in fiscal 2015 were denominated in US dollars. Approximately 25% of CMG–s total costs in fiscal 2015 (2014 – 24%) were denominated in US dollars and provided a partial economic hedge against the fluctuation in currency exchange between the US and the Canadian dollar on revenues. CMG–s residual revenues and costs are primarily denominated in Canadian dollars and its policy is to convert excess US dollar cash into Canadian dollars when received.
Geopolitical Risks
CMG sells its products and services in approximately 60 countries worldwide, and has operations in a number of different countries. Some of these countries have greater economic, political and social risks than experienced in North America which may adversely affect the Company–s sales, costs and operations in those jurisdictions. Some of those risks include:
Any disruption in our ability to complete a sale cycle, including disruption of travel to customers– locations to provide training and support, and the cost of reorganizing daily activities of foreign operations, could have an adverse effect on our financial condition. CMG mitigates the potential adverse effect on sales by invoicing for the full license term in advance for the majority of software license sales and by invoicing as frequently as the contract allows for consulting and contract research services. CMG closely monitors the business and regulatory environments of the countries in which it conducts operations to minimize the potential impact on costs and operations.
Non-compliance with applicable anti-corruption and bribery laws could subject the Company to onerous penalties and the costs of prosecution. CMG has established business practices and internal controls to minimize the potential occurrence of any irregular payments. In addition, the Company has established well-defined anti-corruption and bribery policies and procedures that each employee and contractor is required to sign indicating their compliance.
Competition Risk
Competition is a risk for CMG as it is for almost every company in every sector. The reservoir simulation software industry currently consists of three major suppliers (including CMG) and a number of small suppliers. Some of the other suppliers, including two major suppliers, offer products or oil field services outside the scope of reservoir simulation. Some potential customers may prefer to deal with such multi-service suppliers, while others prefer an independent supplier, such as CMG.
Although competition is very active, CMG believes that its proven technology and the comprehensive scope of its products, combined with its international presence and recognition as a major independent supplier, provide distinct competitive advantages.
Sustaining competitive advantage is another issue, which CMG addresses by making a significant ongoing commitment to research and development spending. CMG expended $17.0 million (2014 – $14.6 million) in product research and development in its most recently completed fiscal year.
The introduction by competitors of products embodying new technology and the emergence of new industry standards and practices could render CMG–s products obsolete and unmarketable and could exert price pressures on existing products, which could have negative effects on the Company–s business, operating results and financial condition.
There is a significant barrier for new entrants into the reservoir simulation software industry. The cost of entry is substantial as a significant investment in research and development is required. In addition, to become a major supplier, a significant time investment is required to build up quality relationships with potential customers.
Labour Risk
The Company–s continued success is substantially dependent on the performance of its key employees and officers. The loss of the services of these personnel as well as failure to attract additional key personnel could have a negative impact upon the Company–s business, operating results and financial condition. Due to high levels of competition for qualified personnel, there can be no assurance that the Company will be successful in retaining and attracting such personnel. The Company attempts to overcome this by offering an attractive compensation package and providing an environment that provides the intellectual and professional stimulation sought by our employee group.
Intellectual Property Risk
CMG regards its software as proprietary and attempts to protect it with copyrights, trademarks and trade secret measures, including restrictions on disclosure and technical measures. Despite these precautions, it may be possible for third parties to copy CMG–s programs or aspects of its trade secrets. CMG has no patents, and existing legal and technical precautions afford only limited practical protection. CMG could incur substantial costs in protecting and enforcing its intellectual property rights. Moreover, from time to time third parties may assert patent, trademark, copyright and other intellectual property rights to technologies that are important to CMG. In such an event, CMG may be required to incur significant costs in litigating a resolution to the asserted claim. There can be no assurance that such a resolution would not require that CMG pay damages or obtain a license of a third party–s proprietary rights in order to continue licensing its products as currently offered, or, if such a license is required, that it will be available on terms acceptable to CMG.
CMG does not know of any infringement of any third party–s patent rights, copyrights, trade secrecy rights or other intellectual property disputes in the development or support of its products.
DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining disclosure controls and procedures (“DC&P”) and internal control over financial reporting (“ICFR”) as defined under National Instrument 52-109.
At March 31, 2015, the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) concluded that the design and operation of the Company–s DC&P were effective (in accordance with the COSO control framework (1992)) and that material information relating to the Company, including its subsidiaries, was made known to them and was recorded, processed, summarized and reported within the time periods specified under applicable securities legislation. Further, the CEO and the CFO concluded that the design and operation of the Company–s ICFR were effective at March 31, 2015 in order to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. It should be noted that while the Company–s CEO and CFO believe that the Company–s disclosure controls and procedures and internal controls over financial reporting provide a reasonable level of assurance that they are effective, they do not expect that such controls and procedures will prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The Company is in the process of implementing the updated COSO control framework (2013) which will supersede the 1992 framework.
During the year ended March 31, 2015, there have been no significant changes to the Company–s ICFR that have materially affected, or are reasonably likely to materially affect, the company–s ICFR.
NON-IFRS FINANCIAL MEASURES
This MD&A includes certain measures which have not been prepared in accordance with IFRS such as “EBITDA”, “direct employee costs” and “other corporate costs.” Since these measures do not have a standard meaning prescribed by IFRS, they are unlikely to be comparable to similar measures presented by other issuers. Management believes that these indicators nevertheless provide useful measures in evaluating the Company–s performance.
“Direct employee costs” include salaries, bonuses, stock-based compensation, benefits, commission expenses, and professional development. “Other corporate costs” include facility-related expenses, corporate reporting, professional services, marketing and promotion, computer expenses, travel, and other office-related expenses. Direct employee costs and other corporate costs should not be considered an alternative to total operating expenses as determined in accordance with IFRS. People-related costs represent the Company–s largest area of expenditure; hence, management considers highlighting separately corporate and people-related costs to be important in evaluating the quantitative impact of cost management of these two major expenditure pools. See “Expenses” heading for a reconciliation of direct employee costs and other corporate costs to total operating expenses.
“EBITDA” refers to net income before adjusting for depreciation expense, finance income, finance costs, and income and other taxes. EBITDA should not be construed as an alternative to net income as determined by IFRS. The Company believes that EBITDA is useful supplemental information as it provides an indication of the results generated by the Company–s main business activities prior to consideration of how those activities are amortized, financed or taxed. See “EBITDA” heading for a reconciliation of EBITDA to net income.
FORWARD-LOOKING INFORMATION
Certain information included in this MD&A is forward-looking. Forward-looking information includes statements that are not statements of historical fact and which address activities, events or developments that the Company expects or anticipates will or may occur in the future, including such things as investment objectives and strategy, the development plans and status of the Company–s software development projects, the Company–s intentions, results of operations, levels of activity, future capital and other expenditures (including the amount, nature and sources of funding thereof), business prospects and opportunities, research and development timetable, and future growth and performance. When used in this MD&A, statements to the effect that the Company or its management “believes”, “expects”, “expected”, “plans”, “may”, “will”, “projects”, “anticipates”, “estimates”, “would”, “could”, “should”, “endeavours”, “seeks”, “predicts” or “intends” or similar statements, including “potential”, “opportunity”, “target” or other variations thereof that are not statements of historical fact should be construed as forward-looking information. These statements reflect management–s current beliefs with respect to future events and are based on information currently available to management of the Company. The Company believes that the expectations reflected in such forward-looking information are reasonable, but no assurance can be given that these expectations will prove to be correct and such forward-looking information should not be unduly relied upon.
With respect to forward-looking information contained in this MD&A, we have made assumptions regarding, among other things:
Forward-looking information is not a guarantee of future performance and involves a number of risks and uncertainties, only some of which are described herein. Many factors could cause the Company–s actual results, performance or achievements, or future events or developments, to differ materially from those expressed or implied by the forward-looking information including, without limitation, the following factors which are discussed in greater detail in the “Business Risks” section of this MD&A:
Should one or more of these risks or uncertainties materialize, or should assumpti
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