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XPLORE TECHNOLOGIES CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Certain statements in our Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words "believe," "project," "expect," "anticipate," "estimate," "intend," "strategy," "plan," "may," "should," "will," "would," "will be," "will continue," "will likely result," and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section entitled "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended March 31, 2012 and elsewhere in this Form 10-Q. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. Overview We are engaged in the development, integration and marketing of rugged mobile PC systems. Our rugged tablet PCs are designed to withstand hazardous conditions such as extreme temperatures, driving rain, repeated vibrations, dirt, dust and concussive shocks. The intrinsically safe, ruggedized and reliable nature of our products enable the extension of traditional computing systems to a range of field personnel, including energy pipeline inspectors, public safety responders, warehouse workers and pharmaceutical scientists. Our tablets are fitted with a range of performance-matched accessories, including multiple docking solutions, wireless connectivity alternatives, global positioning system modules, biometric and smartcard options, as well as traditional peripherals, such as keyboards and cases. Additionally, our tablets are waterproof for up to 30 minutes up to a depth of three feet, impervious to drops from as high as seven feet, are readable in direct sunlight, can be mounted on vehicles and include LTE and WiFi connectivity options for real-time data access. Our end user customers include major utility companies, leading heavy equipment manufacturers, oil and gas companies, the military and first responders. Our revenue is derived through the sale of our iX104 systems in the rugged, tablet PC market. We are dependent upon the market acceptance of our iX104 systems. Our iX104C5TM introduced what we believe are "industry firsts" and differentiating features, including a tool-less removable dual solid state drive module, tool-less access to the SIM and MicroSD ports and an ingress protection rating of IP 67 for submersion in water. The C5 family also features an Intel® Core™ i7 processor and Windows® 7 operating system. Our specially designed AllVueTM screen is viewable in challenging lighting conditions, including direct sunlight and dimly lit environments, and also features a superior screen contrast ratio of 600:1. We launched our fifth generation iX104C line of rugged tablet PCs in May 2011 and have received favorable responses from our end user customers. From fiscal 2011 to fiscal 2012, our revenue increased by approximately 55%, primarily due to $17.5 million in purchase orders received during the last half of fiscal 2012 from AT&T. Shipment of those orders occurred in the third and fourth quarters of fiscal 2012 and in the first and second quarters of fiscal 2013. On October 15, 2012 we announced receipt of a $1.1 million purchase order from a leading medical device company and on December 7, 2012 we announced the receipt of a multi-million dollar purchase order for the U.S. military. The military purchase order was for over 900 of our iX104C5M rugged military tablets, which are scheduled for delivery over several quarters. These recent orders were our most significant orders from the medical device and military markets and we believe represent significant milestones. For the 12- month period ended December 31, 2012, we had revenue of $34.2 million and net income of $1.8 million. Our revenue for the quarter ended December 31, 2012 was approximately 34% less than the prior year period, in which shipments to AT&T accounted for approximately 43% of that quarter's revenue. The fluctuation in quarterly revenue reflects the variability in our business associated with the timing of large orders and the related shipping of the products. While we may experience some variability in our quarterly operating results as a consequence, we believe our year-over-year business is growing, as reflected by our fiscal year-to-date revenue numbers. On October 31, 2012, we completed the closing of an underwritten public offering of two million shares of our common stock, from which we received gross proceeds of $10 million. In connection with the closing of the public offering, each series of our outstanding preferred stock was automatically converted into shares of our common stock. In addition, our common stock began trading on the NASDAQ Capital Market under the symbol "XPLR." 14 -------------------------------------------------------------------------------- These actions strengthened our financial position and we believe improved the liquidity of our common stock. We intend to use the net proceeds from the offering to expand our sales and marketing efforts, increase our product offerings to broaden our addressable markets and for working capital and general corporate purposes. Consequently, we expect our operating expenses to increase based on these investments, and we may continue to incur operating losses, at least until we have completed the development of several new products. We currently estimate that development of those products will be completed, and the products will be launched, from mid 2013, through 2014. Looking forward, our strategy is to build increased marketplace awareness of our iX104 and new product families, in an effort that we believe will enable us to continue increasing our revenue and to expand our market share. You should read the following discussion and analysis in conjunction with our financial statements and notes included in this quarterly report on Form 10-Q. Critical Accounting Policies Our unaudited interim consolidated financial statements and accompanying notes included in this quarterly report are prepared in accordance with U.S. generally accepted accounting principles. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. These estimates and assumptions are affected by management's application of accounting policies. Estimates are deemed critical when a different estimate could have reasonably been used or where changes in the estimates are reasonably likely to occur from period to period, and would materially impact our financial condition, changes in financial condition or results of operations. Our significant accounting policies are discussed in Note 2 of the Notes to our unaudited consolidated financial statements as of December 31, 2012 and March 31, 2012 and for the three months and nine months ended December 31, 2012 and 2011. On an ongoing basis, we evaluate our estimates, including those related to our revenue recognition, allowance for doubtful accounts, inventory valuation, warranty reserves, tooling amortization, financial instruments, stock based compensation and income taxes. We base our estimates on historical experience and on various other assumptions that we believe are 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. Our critical accounting policies are as follows: Revenue Recognition. Our revenue is derived from the sale of rugged, mobile technology which includes rugged mobile tablet PC computers and related accessories. Our customers are predominantly resellers. However, we also sell directly to end-users. Revenue is recognized, net of an allowance for estimated returns, when title and risks of ownership are transferred to the customer, all significant contractual obligations have been satisfied, the sales price is fixed or determinable and the ability to collect is reasonably assured. Our revenue recognition criteria have generally been met when the product has been shipped. Shipments are based on firm purchase orders from our customers with stated terms. The shipping terms are F.O.B. shipping point. We do not have installation, training or other commitments subsequent to shipment that are other than incidental. Our prices are determined based on negotiations with our customers and are not subject to adjustment. Generally, we do not hold inventory at our resellers and we do not expect resellers to hold inventories of our products other than in limited circumstances where such inventory is monitored by us. As a result, we expect returns to be minimal. We have not had material adjustments as our returns have been minimal. Allowance for Doubtful Accounts. We regularly review and monitor collections of our accounts receivables and make estimated provisions, generally monthly, based on our experience, aging attributes, results of collection efforts and current market conditions. If our estimate for allowance for doubtful accounts is too low, additional charges will be incurred in future periods and these additional charges could have a material adverse effect on our financial position and results of operations. Our estimates have not required significant adjustment due to actual experience. Warranty Reserves. Provisions are made at the time of sale for warranties, which are based on our experience and monitored regularly. The revenue related to warranty is recognized when our obligations are generally covered by a warranty coverage agreement provided by a third party. Warranty obligations related to revenue recognized are primarily covered by warranty coverage agreements provided by Wistron Corporation, our contract manufacturer; however, we also provide the coverage on some of our obligations for which we establish related reserves at the time of sale. If our estimates for warranties and returns are too low, additional charges will be incurred in future periods and these additional charges could have a material adverse effect on our financial position and results of operations. Our estimates have not required significant adjustment due to actual experience. Inventory Valuation. We adjust our inventory values so that the carrying value does not exceed net realizable value. The valuation of inventory at the lower of average cost or net realizable value requires us to use estimates regarding the amount of current inventory that will be sold and the prices at which it will be sold and our assessment of expected orders from our customers. Additionally, the estimates reflect changes in our products or changes in demand because of various factors, including the market for our products, obsolescence, production discontinuation, technology changes and competition. While the estimates are subject to revisions and actual results could differ, our experience is that the estimates used by current management have not been required to be adjusted based on actual results. Accordingly, while any change to the estimates could have a material impact, there have been no material adjustments to originally provided amounts. 15-------------------------------------------------------------------------------- Tooling Amortization. We amortize tooling costs over a two year period or estimated life, whichever is shorter. Those costs are recorded as a cost of revenue, subject to an assessment that future revenue will be sufficient to fully recover the cost of the tooling. This assessment requires an assessment of the market for our products and our future revenue expectations. On a quarterly basis, this assessment is reviewed and the cost of tooling is written down to its net realizable value if its recoverability is not reasonably expected based on estimates of future revenue for the periods covered by these financial statements. There have been no instances where we determined that useful life was significantly less than two years. Accordingly, we have not recorded material adjustments. Income Taxes. We have significant valuation allowances that we intend to maintain until it is more likely than not the deferred tax assets will be realized. Our income tax expense recorded in the future will be reduced to the extent of decreases in our valuation allowances. Changes in the tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. We are not aware of any such changes that would have a material effect on our results of operations, cash flows or financial position. Financial Instruments. The warrants we issued in connection with the issuance of secured subordinated promissory notes or common stock or for services have been valued separately using the Black-Scholes methodology. The notes were originally reflected in our financial statements at a discounted value and the difference between this discount amount and the face value of the notes, which is repayable at maturity, was amortized as additional non-cash interest expense during the expected terms of the notes. The determination of the values attributed to the warrants required the use of estimates and judgments particularly related to the assumptions used in the Black-Scholes calculation. In addition, options and warrants to acquire common stock issued to employees, directors and consultants have been valued using a Black-Scholes calculation and their valuations are impacted by the assumptions used in this calculation. Stock-Based Compensation Expense. We apply the fair value method of accounting for all of our employee stock-based compensation. We use the Black-Scholes option pricing model to determine the fair value of stock option awards at the date of the issuance of the award. The value is expensed over the vesting period which is generally three years. See Note 7 to our consolidated financial statements for required disclosures. Our estimates of stock-based compensation expense require a number of complex and subjective assumptions including our stock price volatility, employee exercise patterns, future forfeitures, dividend yield, related tax effects and the selection of an appropriate fair value model. We estimate expected share price volatility based on historical volatility using daily prices over the term of past options. We use historical data to estimate pre-vesting forfeitures, and we record stock -based compensation expense only for those awards that are expected to vest. The dividend yield assumption is based on the Company's history and future expectations of dividend payouts. The assumptions used in calculating the fair value of stock-based compensation expense and related tax effects represent management's best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, or if we decide to use a different valuation model, our stock-based compensation expense could be materially different in the future from what we have recorded in the current period, which could materially affect our results of operations. Recent Accounting Pronouncements We have implemented all required new accounting pronouncements in effect that may impact our consolidated financial statements. We do not believe any such new accounting pronouncements might have a material impact on our consolidated financial position or results of operations. Results of Operations Revenue. We derive revenue from sales of our rugged tablet PC systems, which encompass a family of active pen and touch tablet PC computers, embedded wireless, desktop, vehicle, fork-lift or truck docking stations and a range of supporting performance-matched accessories, peripherals and support services. Our revenue also includes service revenue derived from out-of-warranty repairs. 16 -------------------------------------------------------------------------------- Cost of Revenue. Cost of revenue consists of the costs associated with manufacturing, assembling and testing our products, related overhead costs, maintenance, compensation, freight and other costs related to manufacturing support, including depreciation of tooling assets and logistics. We use contract manufacturers to manufacture our products and supporting components, which represents a significant majority of our cost of revenue. In addition, the costs associated with providing warranty repairs, as well as the costs associated with generating service revenue, are included in cost of revenue. Gross Profit. Gross profit has been, and will continue to be, affected by a variety of factors, including competition, product mix and average selling prices of products, maintenance, new product introductions and enhancements, the cost of components and manufacturing labor, fluctuations in manufacturing volumes, component shortages, the mix of distribution channels through which our products are sold, and warranty costs. Sales, Marketing and Support. Sales, marketing and support expenses include salaries, commissions, agent fees and costs associated with co-operative marketing programs, as well as other personnel-related costs, travel expenses, advertising programs, trade shows and other promotional activities associated with the marketing and selling of our products. We also believe part of our future success will be dependent upon establishing and maintaining successful relationships with a variety of resellers. Product Research, Development and Engineering. Product research, development and engineering expenses consist of salaries and related expenses for development and engineering personnel and non-recurring engineering costs, including prototype costs related to the design, development, testing and enhancement of our product families. We expense our research and development costs as they are incurred. There may be components of our research and development efforts that require significant expenditures, the timing of which can cause quarterly fluctuation in our expenses. General Administration. General administration expenses consist of salaries and related expenses for finance, accounting, procurement and information technology personnel, investor relations, professional fees, including litigation legal fees and settlement payments, corporate expenses, and costs associated with being a U.S. public company, including regulatory compliance costs. Interest. Interest expense includes interest on borrowings related to our credit facility. Other Income and Expense. Other income and expense includes gains and/or losses on dispositions of assets, foreign exchange and other miscellaneous income and expense. Inflation. During the three and nine month periods ended December 31, 2012 and 2011, we believe inflation and changing prices have not had a material impact on our net revenue, or on income (loss) from continuing operations. Three and Nine Months Ended December 31, 2012 vs. Three and Nine Months Ended December 31, 2011 Revenue. Total revenue for the three months ended December 31, 2012 was $5,927,000, as compared to $8,918,000 for the three months ended December 31, 2011, a decrease of $2,991,000, or approximately 34%. A decrease in unit sales accounted for a decrease in revenue of approximately 35% for the three months ended December 31, 2012, compared to the three months ended December 31, 2011, a period in which shipments to AT&T accounted for approximately 43% of revenue. The decrease in unit sales was partially offset by an increase in our average sales price of approximately 1% due to favorable changes in the product mix sold. The fluctuation in quarterly revenue reflects the variability in our business associated with the timing of the deployment of large orders. While we may experience some variability in our quarterly operating results, we believe our business is growing as reflected by our revenue growth of approximately 40% for the nine months ended December 31, 2012 as compared to the prior year period. Revenue for the nine months ended December 31, 2012 was $23,350,000, as compared to $16,696,000 for the nine months ended December 31, 2011, an increase of $6,654,000. An increase in unit sales accounted for an increase in revenue of approximate 32% for the nine months ended December 31, 2012, compared to the nine months ended December 31, 2011, along with an increase in our average sales price of approximately 8% due to favorable changes in the product mix sold. The increase in unit sales was principally attributable to the fulfillment of a portion of the significant purchase orders discussed above. We operate in one segment, the sale of rugged mobile tablet PC systems. The United States, Germany and England accounted for approximately 51%, 13%, and 10%, respectively, of our total revenue for the three months ended December 31, 2012. The United States, Germany and Canada accounted for approximately 67%, 11% and 10%, respectively, of our total revenue for the three months ended December 31, 2011. The United States and Canada accounted for approximately 65% and 14%, respectively, of our total revenue for the nine months ended December 31, 2012. The United States, Germany and Canada accounted for approximately 57%, 12%, and 11%, respectively, of our total revenue for the nine months ended December 31, 2011. 17 -------------------------------------------------------------------------------- We have a number of customers, and in any given period a single customer can account for a significant portion of our sales. For the three months ended December 31, 2012, we had two customers located in the United States, and one customer located in Germany who accounted for approximately 27% and 11%, respectively, of our revenue. For the nine months ended December 31, 2012, we had one customer located in the United States who accounted for approximately 36% of our revenue. For the three months ended December 31, 2011, we had one customer located in the United States who accounted for approximately 43% of our revenue. For the nine months ended December 31, 2011, we had two customers located in the United States and Germany who accounted for approximately 27% and 10%, respectively, of our revenue. At December 31, 2012, we had two customers with receivable balances that totaled approximately 40% of our outstanding receivables. At December 31, 2011, we had one customer with receivable balances that totaled approximately 54% of our outstanding receivables, which balances were subsequently collected. Cost of Revenue. Total cost of revenue for the three months ended December 31, 2012 was $3,864,000, compared to $6,182,000 for the three months ended December, 2011, a decrease of $2,318,000, or approximately 37%. A decrease in unit sales accounted for a decrease of approximately 32% in cost of revenue, along with a decrease in average unit cost of approximately 5% due to changes in the product mix sold. Total cost of revenue for the nine months ended December 31, 2012 was $15,676,000, compared to $11,758,000 for the nine months ended December 31, 2011, an increase of $3,918,000, or approximately 33%. An increase in unit sales accounted for an increase of approximately 30% in cost of revenue, along with an increase in average cost per unit of approximately 3% due to changes in the product mix sold. We rely on a single supplier for the majority of our finished goods. The inventory purchases and engineering services from this supplier for the nine months ended December 31, 2012 and 2011 were $12,094,000 and $8,096,000, respectively. At December 31, 2012 and 2011, we owed this supplier $1,302,000 and $3,199,000, respectively, which is recorded in accounts payable and accrued liabilities. Gross Profit. Total gross profit decreased by $673,000 to $2,063,000 (34.8% of revenue) for the three months ended December 31, 2012 from $2,736,000 (30.7% of revenue) for the three months ended December 31, 2011. The decrease in gross profit for the three months ended December 31, 2012 was due primarily to the decreases in unit sales and revenue and the increase in gross profit as a percentage of revenue was attributable to more favorable product mix. Total gross profit increased by $2,736,000 to $7,674,000 (32.9% of revenue) for the nine months ended December 31, 2012 from $4,938,000 (29.6% of revenue) for the nine months ended December 31, 2011. The increase in gross profit for the nine months ended December 31, 2012 was due primarily to the increase in unit sales and revenue and the increase in gross profit as a percentage of revenue was due to a more favorable product mix, as well as the favorable impact of spreading indirect labor and logistics costs, which are predominately fixed in nature, over more revenue. Sales, Marketing and Support Expenses. Sales, marketing and support expenses for the three months ended December 31, 2012 were $1,022,000, compared to $976,000 for the three months ended December 31, 2011. The increase of $46,000, or approximately 5%, was primarily due to an increase in headcount related costs of $68,000 for new sales and marketing personnel as well as incentive compensation paid to sales and marketing personnel for meeting performance objectives and an increase in marketing expenses of $47,000, primarily related to lead generation activities. These increases were partially offset by a decrease in costs related to demonstration units of $58,000, which were higher in the prior year due to the product launch of the C5 in May 2011, and a reduction in stock compensation of $18,000. Sales, marketing and support expenses for the nine months ended December 31, 2012 were $2,840,000, compared to $2,791,000 for the nine months ended December 31, 2011, an increase of $49,000. The increase was primarily due to an increase in commission expense of $204,000 commensurate with the increase in revenue, an increase in headcount related costs of $104,000 due to the aforementioned factors and an increase in marketing expenses of $14,000, partially offset by a decrease in costs related to demonstration units of $197,000, a reduction in stock compensation of $46,000 and a decrease in travel and office related expenses of $32,000. Product Research, Development and Engineering Expenses. Product research, development and engineering expenses for the three months ended December 31, 2012 were $695,000, an increase of $208,000, or approximately 43%, compared to $487,000 for the three months ended December 31, 2011. The increase was due primarily to an increase in product development costs of $170,000 associated with three new products and an increase in headcount related expenses of $69,000 for new engineering personnel as well as incentive compensation paid to engineering personnel for meeting performance objectives, offset by a decrease in patent filing expenses of $33,000, in comparison to the prior year that included new patent filings associated with the C5 feature set. Product research, development and engineering expenses for the nine months ended December 31, 2012 were $1,609,000, an increase of $189,000, or approximately 13%, compared to $1,420,000 for the nine months ended December 31, 2011. The increase was primarily due to an increase in headcount related expenses of $146,000 and an increase in product development expenses of $133,000, offset by a decrease in patent filing expenses of $87,000. The reasons for the fluctuations for the nine months ended December 31, 2012 are the same as those described for the three months ended December 31, 2012. For our fiscal year ending March 31, 2013, we expect our product research, development and engineering expenses to increase primarily due to the development of the additional products and, to a lesser extent, the non-recurrence of a $398,000 reduction in fiscal year 2012 engineering expenses arising from the elimination of an accrual in the fourth quarter. 18 -------------------------------------------------------------------------------- General Administration Expenses. General administration expenses for the three months ended December 31, 2012 were $965,000, compared to $914,000 for the three months ended December 31, 2011, an increase of $51,000, or approximately 6%. The increase primarily consists of an increase in incentive compensation of $122,000 paid to administrative personnel for meeting performance objectives, an increase in investor and public relations related expenses of $47,000, primarily associated with the up-listing of our common stock to NASDAQ, an increase in our professional fees of $21,000, primarily legal, and an increase in depreciation of $14,000, partially offset by the non-recurrence of a prior year charge of $100,000 for patent infringement claims, reductions in stock compensation of $17,000 and the general allowance for doubtful accounts of $17,000 associated with the decrease in accounts receivable and a decrease in business personal property tax of $11,000. General administration expenses for the nine months ended December 31, 2012 were $2,655,000, compared to $2,377,000 for the nine months ended December 31, 2011, an increase of $278,000, or approximately 12%. The increase was primarily due to an increase in headcount related expenses of $205,000, consisting primarily of incentive compensation paid to administrative personnel for meeting revenue and cash flow performance objectives, as compared to the prior year period in which all incentive compensation was accrued in the fourth quarter, an increase in investor and public relations related expenses of $69,000, an increase in information systems of $34,000 due to a system upgrade and an increase in depreciation of $11,000, partially offset by a decrease in business personal property tax of $23,000 and a decrease in the general allowance for doubtful accounts of $11,000. For the three months ended December 31, 2012 and 2011, the fair value of employee stock-based compensation expense was $164,000 and $222,000, respectively. For the nine months ended December 31, 2012 and 2011, the recorded employee stock-based compensation expense was $531,000 and $641,000, respectively. The fluctuation in expense is attributable to the timing of the granting of new awards and employee turnover. Stock compensation expense was recorded in the employee related functional classification. Depreciation and amortization expenses for the three months ended December 31, 2012 and 2011 were $129,000 and $156,000, respectively. Depreciation and amortization expenses for the nine months ended December 31, 2012 and 2011 were $380,000 and $524,000, respectively. The decrease in depreciation expense is principally due to the aforementioned reduction of demonstration units of $53,000 and $190,000, respectively, partially offset by the tooling amortization associated with the C5 of approximately $12,000 and $34,000, and depreciation of internal units and office equipment of $14,000 and $12,000, respectively, for the three and nine months ended December 31, 2012. Depreciation and amortization is recorded in the related functional classification. Interest Expense. Interest expense for the three months ended December 31, 2012 was $1,000 compared to $64,000 for the three months ended December 31, 2011, a decrease of $63,000. Interest expense for the nine months ended December 31, 2012 was $65,000, compared to $155,000 for the nine months ended December, 2011, a decrease of $90,000. The decreases in both periods are attributable primarily to no outstanding borrowings under our credit facility for the three months ended December, 2012 and a reduction in outstanding borrowings under that facility for the nine months ended December 31, 2012. Other Expenses. Other expenses for the three months ended December 31, 2012 were $6,000, compared to $11,000 for the three months ended December 31, 2011. Other expenses for the nine months ended December 31, 2012 were $35,000, compared to $43,000 for the nine months ended December 31, 2011. Net Income (Loss). Our net loss for the three months ended December 31, 2012 was $626,000, as compared to a net income of $284,000 for the three months ended December 31, 2011, a decrease in income of $910,000. The decrease was due to a decrease in revenue and an increase in operating expenses. The net income for the nine months ended December 31, 2012 was $470,000 as compared to a net loss of $1,848,000 for the nine months ended December 31, 2011, an increase in income of $2,318,000. The increase was due to increases in revenue, partially offset by an increase in operating expenses. Net Loss Attributable to Common Stockholders. Net loss attributable to common stockholders for the three months ended December 31, 2012 was $907,000, compared to $1,088,000 for the three months ended December 31, 2011, a decrease of $181,000, due primarily to the decrease of $1,091,000 in the dividends attributable to Preferred Stock, as the Preferred Stock was outstanding for one month in the current year as compared to three months in the prior year, partially offset by the decrease in net income of $910,000. In connection with the closing of the public offering on October 31, 2012, each series of our outstanding preferred stock was automatically converted into common stock. Net loss attributable to common stockholders for the nine months ended December 31, 2012 was $1,822,000, compared to $5,201,000 for the nine months ended December 31, 2011, a decrease of $3,379,000, attributable to a decrease in the net loss of $2,318,000 and a decrease in dividends attributable to preferred stock of $1,061,000, as the preferred stock was outstanding only through October 31, 2012. The outstanding shares of preferred stock accrued cumulative dividends that were paid in shares of stock quarterly on the first day of June, September, December and March, with the exception of the last dividends, which were paid upon conversion on October 31, 2012. The dividends attributable to these shares for the three months ended December 31, 2012 and 2011 were $281,000 and $1,372,000, respectively. The dividends attributable to these shares for the nine months ended December 31, 2012 and 2011 were $2,292,000 and $3,353,000, respectively. The dividend rate for the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock was 7.5% per annum, and were paid in shares of common stock determined by dividing (i) the aggregate amount of the dividend then payable by (ii) the volume weighted average trading price of the common stock over the 10 trading days ending on the third trading day immediately preceding the dividend payment date, less a discount of 25% of the volume weighted average trading price of the common stock. The dividend rate for the Series D Preferred Stock was 10% per annum, payable in additional shares of Series D Preferred Stock valued at $1.00 per share. The values for dividends paid and dividends accrued and unpaid were determined based on the market prices of our common stock as of the dates of share issuances or accrual multiplied by the equivalent common shares. 19 -------------------------------------------------------------------------------- A summary of paid dividends for the three months ended December 31, 2012 and 2011 and accrued and unpaid dividends as of December 31, 2012 and 2011 is as follows: Dividends Accrued and Unpaid as Paid For Qtr Ended Paid For Nine Months of December 31, Ended December 31, December 31, 2012 2011 2012 2011 2012 2011 Series A Preferred Stock $ 350,000 $ 511,000 $ 1,365,000 $ 1,498,000 $ - $ 148,000 Series B Preferred Stock 43,000 63,000 168,000 189,000 - 18,000 Series C Preferred Stock 140,000 204,000 545,000 598,000 - 59,000 Series D Preferred Stock 184,000 509,000 698,000 1,296,000 - 119,000 Liquidity and Capital Resources We have incurred net losses in each fiscal year since our inception and we may report a net loss for our fiscal year ending March 31, 2013. As of December 31, 2012, our working capital was $14,895,000 and our cash and cash equivalents were $10,318,000. From inception, we have financed our operations and met our capital expenditure requirements primarily from the gross proceeds of private and public sales of debt and equity securities totaling approximately $112.8 million. Sources of capital available to us are a credit facility with a specialty finance company. On December 10, 2009, we entered into an Accounts Receivable Purchasing Agreement (as amended, the "ARPA") with DSCH Capital Partners, LLC d/b/a Far West Capital ("FWC"). Pursuant to the ARPA, FWC may purchase, in its sole discretion, our eligible accounts receivable on a revolving basis, up to a maximum of $8,500,000. Under the terms of the ARPA, FWC purchases eligible receivables from our subsidiary with full recourse for the face amount of such eligible receivables. FWC retains 15% of the purchase price of the purchased receivables as a reserve amount. We are required to pay FWC a monthly cost of funds fee equal to the net funds employed by FWC (i.e., the daily balance of the purchase price of all purchased receivables less the reserve amount, plus any unpaid fees and expenses due to FWC under the ARPA) multiplied by the annual prime lending rate reported in The Wall Street Journal plus 10.00%, which fees accrue daily. In June 2012, in connection with the reduction of our cost of funds rate and the elimination of the discount to FWC in connection with its purchase of eligible receivables, we agreed to a net worth financial covenant requiring, as of the last day of each fiscal quarter, our subsidiary to have a net worth (defined as assets minus liabilities) of not less than $4,000,000. In the event we are unable to maintain the minimum net worth requirement, the monthly cost of funds fee required to be paid to FWC will be increased to equal the net funds employed by FWC multiplied by the lesser of (a) the maximum rate allowed under applicable law and (b) the annual prime lending rate reported in The Wall Street Journal plus 16.0%, which fees accrue daily. On August 26, 2011, we entered into an amendment to the ARPA to provide for advances up to $700,000 based upon eligible finished goods Tablet PC inventory, provided that total funds advanced on such inventory does not exceed 30% of all eligible inventory and provided further that the advances will at no time exceed 40% of the sum of (1) total funds advanced by FWC under the ARPA and (2) products scheduled to be shipped in satisfaction of customer purchase orders within 90 days. Eligible inventory is valued at the lower of cost or market value. The ARPA also provides that FWC has the right to require the subsidiary to repurchase any purchased accounts receivable: (a) if there is a dispute as to the validity of such receivable by the account debtor, (b) if certain covenants, warranties or representations made by the subsidiary with respect to such receivables are breached, (c) upon and during the continuance of an event of default under the ARPA or upon the termination of the ARPA, or (d) if such receivable remains unpaid 90 days after the invoice date. The ARPA has an initial term of one year with automatic renewals for successive one-year periods. Notwithstanding that, FWC may terminate the ARPA at any time upon 150 days prior written notice or without prior notice upon and during the continuance of an event of default. The ARPA contains standard representations, warranties, covenants, indemnities and releases for agreements governing financing arrangements of this type. We have guaranteed the obligations of our subsidiary under the ARPA pursuant to a corporate guaranty and suretyship. In addition, pursuant to the ARPA, our obligations under the ARPA are secured by a first priority security interest on all our assets. 20--------------------------------------------------------------------------------As of February 6, 2013, there were no borrowings outstanding under the ARPA. On October 31, 2012, we completed the closing of the public offering of 2,000,000 shares of common stock at an offering price of $5.00 per share and received gross proceeds of $10,000,000, before deducting the underwriting discount and offering expenses of $2,144,000. In connection with the closing of the public offering, each series of our outstanding preferred stock was automatically converted into common stock in accordance with the terms and provisions of our amended and restated certificate of incorporation. We believe that our current cash and cash flow from operations, including proceeds from our recent public offering, together with borrowings under the ARPA, will be sufficient to fund our anticipated operations, working capital and capital spending for the next 12 months. Cash Flow Results The table set forth below provides a summary statement of cash flows for the periods indicated: Three Months Ended Nine Months Ended December 31, December 31, 2012 2011 2012 2011 (in thousands of dollars) Net cash provided by (used in) operating activities $ 229,000 $ (268,000 ) $ 2,886,000 $ (422,000 ) Net cash used in investing activities (238,000 ) (111,000 ) (649,000 ) (469,000 ) Net cash provided by financing activities 7,856,000 1,182,000 7,882,000 1,640,000 Cash and cash equivalents, end of period 10,318,000 917,000 10,318,000 917,000 Our operating activities provided $229,000 of net cash for the three months ended December 31, 2012, as compared to $268,000 of net cash used by operating activities for the three months ended December 31, 2011, a favorable improvement of $497,000. The increase in net cash provided by operating activities was primarily due to a favorable variance resulting from the timing of accounts receivable billings and collections of $4,346,000 and a favorable decrease in the prepaid expenses of $947,000, partially offset by an unfavorable increase in the use of cash arising from the timing of payables of $3,709,000 and an increase in net loss and the reduction in net income, net of items not affecting cash, of $1,063,000. Our operating activities provided $2,886,000 of net cash for the nine months ended December 31, 2012, as compared to $422,000 of net cash used in operating activities for the nine months ended December 31, 2011, a favorable improvement of $3,308,000. The increase in net cash provided by operating activities was primarily due to an increase from favorable timing of accounts receivable billings and collections of $9,241,000, and an increase from our net income and the reduction in net loss, net of items not affecting cash, of $1,897,000, partially offset by an unfavorable increase in the use of cash arising from the timing of accounts payable of $6,695,000, an unfavorable decrease in the net cash provided by inventory of $938,000 and an unfavorable increase in prepaid expenses and other current assets of $197,000. Net cash used in investment activities for the three months ended December 31, 2012 consists primarily of investments in tooling costs related to new products being developed. Net cash used in investment activities for the nine months ended December 31, 2012 consists of tooling costs of $472,000, investments in demonstration units of $150,000 and $27,000 for a new phone system and other assets. For the three and nine months ended December 31, 2011, the net cash used in investment activities consisted primarily of investments in demonstration units of our newly launched C5 tablet PCs of $111, 000 and $469,000, respectively. Our financing activities provided $7,856,000 of net cash for the three months ended December 31, 2012, as compared to $1,182,000 of net cash provided in financing activities for the three months ended December 31, 2011. For the nine months ended December 31, 2012 our financing activities provided $7,882,000 of net cash, compared to $1,640,000 of net cash for the nine months ended December 31, 2011. Net cash provided by financing activities for the three and nine months ended December 31, 2012, consisted of net proceeds from the public offering of our common stock of $7,856,000 and the issuance of capital stock by the employee stock purchase plan of $0 and $26,000, respectively. For the three and nine months ended December 31, 2011, net cash provided by financing activities consisted of the net proceeds of $2,182,000 from the issuance of our Series D Preferred Stock in a private placement and proceeds from the issuance of capital stock by the employee stock purchase plan of $12,000 and $24,000, respectively, partially offset by net repayments of our working capital facility of $1,012,000 and $566,000, respectively. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements. 21-------------------------------------------------------------------------------- |