WIRELESS RONIN TECHNOLOGIES INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements The following discussion contains various forward-looking statements within the meaning of Section 21E of the Exchange Act. Although we believe that, in making any such statement, our expectations are based on reasonable assumptions, any such statement may be influenced by factors that could cause actual outcomes and results to be materially different from those projected. When used in the following discussion, the words "anticipates," "believes," "expects," "intends," "plans," "estimates" and similar expressions, as they relate to us or our management, are intended to identify such forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from those anticipated. Factors that could cause actual results to differ materially from those anticipated, certain of which are beyond our control, are set forth in Item 1A under the caption "Risk Factors." Our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking statements. Accordingly, we cannot be certain that any of the events anticipated by forward-looking statements will occur or, if any of them do occur, what impact they will have on us. We caution you to keep in mind the cautions and risks described in this document and to refrain from attributing undue certainty to any forward-looking statements, which speak only as of the date of the document in which they appear. We do not undertake to update any forward-looking statement.

Overview We provide marketing technology solutions, which include digital signage, interactive kiosks, mobile messaging, social networking and web development solutions, to customers who use our products and services in certain retail and service markets. Through our proprietary RoninCast® software, we provide enterprise, web-based and hosted content delivery systems that manage, schedule and deliver digital content over wireless and wired networks. We also provide custom interactive software solutions, content engineering and creative services to our customers.

While our marketing technology solutions have application in a wide variety of industries, we focus on three primary markets: (1) automotive, (2) food service (including QSR, fast casual and managed food services markets), and (3) branded retail. The industries in which we sell goods and services are not new but their application of marketing technology solutions is relatively new and participants in these industries only recently started considering adopting these types of technologies as part of their overall marketing strategies. As a result, we remain an early stage company without an established history of profitability, or substantial or steady revenue. We believe this characterization applies to our competitors as well, which are working to promote broader adoption of marketing technology solutions and to develop profitable, substantial and steady sources of revenue.

We believe that the adoption of marketing technology solutions will increase substantially in years to come both in industries on which we currently focus and in other industries. We also believe that adoption of our marketing technology solutions, which includes digital signage, depends not only upon the software and services that we provide but upon the cost of hardware used to process and display content in digital signage systems. Digital media players and flat panel displays constitute a large portion of the expenditure customers make relative to the entire cost of digital signage systems. Costs of these digital media players and flat panel displays have historically decreased and we believe will continue to do so, though we do not manufacture either product and do not substantially affect the overall markets for these products. In addition, we have been developing our next generation of RoninCast® software in such a way as to allow it to function on significantly lower cost media players than the ones in use today. We anticipate the launch of our next generation RoninCast® will be in the first quarter of 2013. If we are successful in deploying our next generation software on lower cost media players and continue to experience a further decline in costs for flat panel displays, we believe that adoption of digital signage and other marketing technology solutions is likely to increase, though we cannot predict the rate at which such adoption will occur.

28-------------------------------------------------------------------------------- Table of Contents Management focuses on a wide variety of financial measurements to assess our financial health and prospects but principally upon (1) sales, to measure the adoption of our marketing technology solutions by our customers, (2) cost of sales and gross profit, particularly expressed as gross profit percentage, to determine if sales have been made at levels of profit necessary to cover operating expenses on a long-term basis (based upon assumptions regarding adoption), (3) sales of hardware relative to software and services, understanding that hardware typically provides a lower gross profit margin than do software license fees and services, (4) operating expenses so that management can appropriately match those expenses with sales, and (5) current assets, especially cash and cash equivalents used to fund operating losses thus far incurred.

Our wholly-owned subsidiary, Wireless Ronin Technologies (Canada), Inc. ("RNIN Canada"), an Ontario, Canada provincial corporation located in Windsor, Ontario, maintains a vertical specific focus in the automotive industry and houses our content engineering operation. RNIN Canada develops digital content and sales support systems to help retailers train their sales staff and educate their customers at the point of sale. Today, the capabilities of this operation are integrated with our historical business to provide content solutions to all of our clients.

Our company and our subsidiary sell products and services primarily throughout North America.

In November 2012, our board of directors approved a one-for-five reverse stock split of all outstanding common shares, which became effective on December 14, 2012. A proportionate adjustment also was made to our outstanding derivative securities. All share and per share information set forth in this report has been adjusted to reflect such reverse stock split.

Our Sources of Revenue We generate revenues through system sales, license fees and separate service fees, including consulting, content development and implementation services, as well as ongoing customer support and maintenance, including product upgrades. We market and sell our software and service solutions primarily through our direct sales force, but we also utilize strategic partnerships and business alliances.

Our Expenses Our expenses are primarily comprised of three categories: sales and marketing, research and development and general and administrative. Sales and marketing expenses include salaries and benefits for our sales associates and commissions paid on sales. This category also includes amounts spent on the hardware and software we use to prospect new customers, including those expenses incurred in trade shows and product demonstrations. Our research and development expenses represent the salaries and benefits of those individuals who develop and maintain our software products including RoninCast® and other software applications we design and sell to our customers. Our general and administrative expenses consist of corporate overhead, including administrative salaries, real property lease payments, salaries and benefits for our corporate officers and other expenses such as legal and accounting fees.

Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the U.S., or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In recording transactions and balances resulting from business operations, we use estimates based on the best information available. We use estimates for such items as depreciable lives, volatility factors in determining fair value of options and warrants, tax provisions, recognition of revenue under fixed price contracts, provisions for uncollectible receivables and deferred revenue. We revise the recorded estimates when better information is available, facts change or we can determine actual amounts. These revisions can affect operating results. We have identified below the following accounting policies that we consider to be critical.

29 -------------------------------------------------------------------------------- Table of Contents Revenue Recognition We recognize revenue primarily from these sources: • Software and software license sales • System hardware sales • Professional service revenue • Software design and development services • Implementation services • Maintenance and hosting support contracts We apply the provisions of Accounting Standards Codification subtopic 605-985, Revenue Recognition: Software (or ASC 605-35) to all transactions involving the sale of software licenses. In the event of a multiple element arrangement, we evaluate if each element represents a separate unit of accounting, taking into account all factors following the guidelines set forth in "FASB ASC 605-985-25-5." We recognize revenue when (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred, which is when product title transfers to the customer, or services have been rendered; (iii) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (iv) collection is reasonably assured. We assess collectability based on a number of factors, including the customer's past payment history and its current creditworthiness. If it is determined that collection of a fee is not reasonably assured, we defer the revenue and recognize it at the time collection becomes reasonably assured, which is generally upon receipt of cash payment. If an acceptance period is required, revenue is recognized upon the earlier of customer acceptance or the expiration of the acceptance period. Sales and use taxes are reported on a net basis, excluding them from revenue and cost of revenue.

Multiple-Element Arrangements - We enter into arrangements with customers that include a combination of software products, system hardware, maintenance and support, or installation and training services. We allocate the total arrangement fee among the various elements of the arrangement based on the relative fair value of each of the undelivered elements determined by vendor-specific objective evidence (VSOE). In software arrangements for which we do not have VSOE of fair value for all elements, revenue is deferred until the earlier of when VSOE is determined for the undelivered elements (residual method) or when all elements for which we do not have VSOE of fair value have been delivered.

The VSOE for maintenance and support services is based upon the renewal rate for continued service arrangements. The VSOE of installation and training services is established based upon pricing for the services. The VSOE of software and licenses is based on the normal pricing and discounting for the product when sold separately.

Each element of our multiple element arrangements qualifies for separate accounting. However, when a sale includes both software and maintenance, we defer revenue under the residual method of accounting. Under this method, the undelivered maintenance and support fees included in the price of software is amortized ratably over the period the services are provided. We defer maintenance and support fees based upon the customer's renewal rate for these services.

Software and software license sales We recognize revenue when a fixed fee order has been received and delivery has occurred to the customer. We assess whether the fee is fixed or determinable and free of contingencies based upon signed agreements received from the customer confirming terms of the transaction. Software is delivered to customers electronically or on a CD-ROM, and license files are delivered electronically.

30 -------------------------------------------------------------------------------- Table of Contents System hardware sales We recognize revenue on system hardware sales generally upon shipment of the product or customer acceptance depending upon contractual arrangements with the customer. Shipping charges billed to customers are included in sales and the related shipping costs are included in cost of sales.

Professional service revenue Included in services and other revenues is revenue derived from implementation, maintenance and support contracts, content development, software development and training. The majority of consulting and implementation services and accompanying agreements qualify for separate accounting. Implementation and content development services are bid either on a fixed-fee basis or on a time-and-materials basis. For time-and-materials contracts, we recognize revenue as services are performed. For fixed-fee contracts, we recognize revenue upon completion of specific contractual milestones or by using the percentage-of-completion method.

Software design and development services Revenue from contracts for technology integration consulting services where we design/redesign, build and implement new or enhanced systems applications and related processes for clients are recognized on the percentage-of-completion method in accordance with "FASB ASC 605-985-25-88 through 107." Percentage-of-completion accounting involves calculating the percentage of services provided during the reporting period compared to the total estimated services to be provided over the duration of the contract. Estimated revenues for applying the percentage-of-completion method include estimated incentives for which achievement of defined goals is deemed probable. This method is followed where reasonably dependable estimates of revenues and costs can be made. We measure our progress for completion based on either the hours worked as a percentage of the total number of hours of the project or by delivery and customer acceptance of specific milestones as outlined per the terms of the agreement with the customer. Estimates of total contract revenue and costs are continuously monitored during the term of the contract, and recorded revenue and costs are subject to revision as the contract progresses. Such revisions may result in increases or decreases to revenue and income and are reflected in the financial statements in the periods in which they are first identified. If estimates indicate that a contract loss will occur, a loss provision is recorded in the period in which the loss first becomes probable and reasonably estimable.

Contract losses are determined to be the amount by which the estimated direct and indirect costs of the contract exceed the estimated total revenue that will be generated by the contract and are included in cost of sales and classified in accrued expenses in the balance sheet. Our presentation of revenue recognized on a contract completion basis has been consistently applied for all periods presented.

We classify the revenue and associated cost on the "Services and Other" line within the "Sales" and "Cost of Sales" sections of the Consolidated Statement of Operations. In all cases where we apply the contract method of accounting, our only deliverable is professional services, thus, we believe presenting the revenue on a single line is appropriate.

Costs and estimated earnings recognized in excess of billings on uncompleted contracts are recorded as unbilled services and are included in accounts receivable on the balance sheet. Billings in excess of costs and estimated earnings on uncompleted contracts are recorded as deferred revenue until revenue recognition criteria are met.

Implementation services Implementation services revenue is recognized when installation is completed.

Maintenance and hosting support contracts Maintenance and hosting support consists of software updates and support.

Software updates provide customers with rights to unspecified software product upgrades and maintenance releases and patches released during the term of the support period. Support includes access to technical support personnel for software and hardware issues. We also offer a hosting service through our network operations center, or NOC, allowing the ability to monitor and support our customers' networks 7 days a week, 24 hours a day.

31-------------------------------------------------------------------------------- Table of Contents Maintenance and hosting support revenue is recognized ratably over the term of the maintenance contract, which is typically one to three years. Maintenance and support is renewable by the customer. Rates for maintenance and support, including subsequent renewal rates, are typically established based upon a specified percentage of net license fees as set forth in the arrangement. Our hosting support agreement fees are based on the level of service we provide to our customers, which can range from monitoring the health of our customer's network to supporting a sophisticated web portal.

Basic and Diluted Loss per Common Share Basic and diluted loss per common share for all periods presented is computed using the weighted average number of common shares outstanding. Basic weighted average shares outstanding include only outstanding common shares. Diluted net loss per common share is computed by dividing net loss by the weighted average common and potential dilutive common shares outstanding computed in accordance with the treasury stock method. Shares reserved for outstanding stock warrants and options totaling 0.5 million, 0.5 million and 0.8 million for 2012, 2011 and 2010, respectively, were excluded from the computation of loss per share as their effect was antidilutive due to our net loss in each of those years.

Deferred Income Taxes Deferred income taxes are recognized in the financial statements for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts based on enacted tax laws and statutory tax rates. Temporary differences arise from net operating losses, reserves for uncollectible accounts receivables and inventory, differences in depreciation methods, and accrued expenses. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

Accounting for Stock-Based Compensation We account for stock-based compensation in accordance with "FASB ASC 718-10." Stock-based compensation expense recognized during the period is based on the value of the portion of share-based awards that are ultimately expected to vest during the period. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. The fair value of restricted stock is determined based on the number of shares granted and the closing price of our common stock on the date of grant. Compensation expense for all share-based payment awards is recognized using the straight-line amortization method over the vesting period. Stock-based compensation expense, including the amortization of warrants issued for debt issuance costs, of $0.5 million, $0.8 million and $0.9 million, or a basic and diluted loss per share of $0.10, $0.19 and $0.22, was charged to operating expenses during 2012, 2011 and 2010, respectively. No tax benefit has been recorded due to the full valuation allowance on deferred tax assets that we have recorded.

We apply the guidance of FASB 718-10-S99-1 for purposes of determining the expected term for stock options. We calculate the estimated expected life based upon historical exercise data. We calculate expected volatility for stock options and awards using historical volatility. The dividend yield assumption is based on our history and expectation of no future dividend payouts.

Stock-based compensation expense is based on awards ultimately expected to vest and is reduced for estimated forfeitures. FASB 718-10-55 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We applied a pre-vesting forfeiture rate of 18.3% to 24.4% based upon actual historical experience for all employee option awards. We continue to apply a zero forfeiture rate to those options granted to members of our board of directors.

32 -------------------------------------------------------------------------------- Table of Contents We account for equity instruments issued for services and goods to non-employees under "FASB ASC 505-50-1" Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services and "FASB ASC 505-50-25" Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other Than Employees.

Generally, the equity instruments issued for services and goods are shares of our common stock, or warrants or options to purchase shares of our common stock.

These shares, warrants or options are either fully-vested and exercisable at the date of grant or vest over a certain period during which services are provided.

We expense the fair market value of these securities over the period in which the related services are received. During 2012, we recognized $189,000, or a basic and diluted loss per share of $0.04, of stock-based compensation expense related to the fair market value of stock and warrants that were issued to outside vendors for professional services. We did not issue equity instruments to non-employees during the years ended 2011 or 2010.

See Note 7 in the Consolidated Financial Statements in this Form 10-K for further information regarding the impact of FASB ASC 718-10 and the assumptions we use to calculate the fair value of stock-based compensation.

33-------------------------------------------------------------------------------- Table of Contents Results of Operations Our results of operations for the years ended December 31, 2012, 2011 and 2010 were as follows: For the Years Ended December 31, (in thousands) 2012 2011 2010 Sales $ 6,704 $ 9,274 $ 8,567 Cost of sales (exclusive of depreciation and amortization shown separately below) 3,029 5,208 4,582 Gross profit 3,675 4,066 3,985 Sales and marketing expenses 1,550 2,090 2,329 Research and development expenses 1,795 2,116 2,864 General and administrative expenses 5,443 6,105 5,963 Depreciation and amortization expense 286 467 684 Total operating expenses 9,074 10,778 11,840 Operating loss (5,399 ) (6,712 ) (7,855 ) Other income (expenses): Interest expense (8 ) (30 ) (58 ) Interest income 1 4 30 Total other expense (7 ) (26 ) (28 ) Net loss $ (5,406 ) $ (6,738 ) $ (7,883 ) Our results of operations as a percentage of sales for the years ended December 31, 2012, 2011 and 2010 were as follows: For the Years Ended December 31, 2012 2011 2010 Sales 100.0 % 100.0 % 100.0 % Cost of sales (exclusive of depreciation andamortization shown separately below) 45.2 % 56.2 % 53.5 % Gross profit 54.8 % 43.8 % 46.5 % Sales and marketing expenses 23.1 % 22.6 % 27.2 % Research and development expenses 26.8 % 22.8 % 33.4 % General and administrative expenses 81.2 % 65.8 % 69.6 % Depreciation and amortization expense 4.3 % 5.0 % 8.0 % Total operating expenses 135.4 % 116.2 % 138.2 % Operating loss (80.6 %) (72.4 %) (91.7 %) Other income (expenses): Interest expense (0.1 %) (0.3 %) (0.7 %) Interest income - - 0.4 % Total other expense (0.1 %) (0.3 %) (0.3 %) Net loss (80.7 %) (72.7 %) (92.0 %) 34 -------------------------------------------------------------------------------- Table of Contents 2012 compared to 2011 Sales Our sales decreased 28% to $6.7 million in 2012 from $9.3 million in 2011. The year-over-year decrease in revenue was primarily attributable to revenue related to the prior year deployments of Chrysler's iShowroom-branded tower application into Chrysler and Fiat dealerships. Revenue generated from Chrysler and the associated Fiat dealerships totaled $3.4 million in 2012, which was down 34% from $5.1 million recognized for the prior year. In addition to assisting Chrysler with its ongoing development needs related to the iShowroom initiative during 2012, we continued to receive additional orders for interactive kiosks from Fiat dealerships utilizing the iShowroom application. During 2012, we received a total of 83 kiosks orders for Fiat dealerships, compared to 178 in 2011. Chrysler continues to require that all Fiat Dealerships adopt the iShowroom interactive application, which is being featured in the Fiat Style Center of the new Fiat Studio Facilities. We received no orders for kiosks for Chrysler dealerships during 2012 compared to kiosk orders for 400 Chrysler dealerships in 2011. Although we have not received any additional iShowroom branded tower orders from Chrysler dealers since the second quarter of 2011, we believe Chrysler will further expand the program with further dealership adoption once the inventory we have already delivered and recognized as revenue is deployed from the purchase made in May 2011. However, since we do not have a contract with Chrysler requiring it to source all the various components of the solution through us and the purchase of the iShowroom branded towers will remain within the discretion of individual dealerships, we are unable to predict or forecast the timing or value of any future orders. Since the start of this program in September 2010, we have received orders for a total of 661 Chrysler and Fiat dealerships, substantially all of which has been filled as of December 31, 2012.

The remaining decrease in sales when comparing 2012 to 2011 was due to a decrease in orders from ARAMARK. Total sales to ARAMARK in 2012 totaled $1.1 million, representing a decrease of 34% from 2011. Although we continued to expand the various ARAMARK branded food concepts to several colleges and universities during 2012, ARAMARK deployed fewer new food concepts which incorporate our digital menu board solutions in 2012 than in 2011. Upon completing the installation for orders received through December 31, 2012, the total number of ARAMARK locations being managed through our NOC will increase to approximately 299 sites, compared to 250 sites at the end of 2011.

Partially offsetting the decrease in our revenue when comparing 2012 to 2011 was an increase in revenue generated in 2012 with a new customer, Buffalo Wild Wings. In March 2012, we rolled out an initial five store deployment of our marketing technology solutions and subsequently received an order for 54 additional stores. The initial five store solution deployed had an emphasis on creating a new guest experience through the interaction of a touchscreen photo booth application, which displays both consumer-generated and client-branded content. Additionally, the solution uses unique QR codes and email to allow customers to share their photos with their social networks, extending the content beyond the restaurant's locations to further promote its brand. In 2012, we recognized revenue from this customer totaling $387,000 which includes the development of various customer-engagement applications featuring our RoninCast® software installed at a total of 59 Buffalo Wild Wings stores as of December 31, 2012.

We continued to provide ongoing support to YUM!'s QSR brands in 2012, which includes KFC and KFC/Taco Bell combination stores. Although we did not roll out new menu board deployments during 2012, we did receive an order from KFC to upgrade the existing stores to our latest version of RoninCast® software. We continue to believe KFC will expand the number of locations which features our digital menu board solution, but currently do not have a commitment on timing.

The total number of YUM! brand stores we fully host and support through our NOC was 188 at the end of 2012.

We continue to support through our NOC a network of approximately 300 sites we have deployed for Thomson Reuters, which feature its InfoPoint news service. In addition, during 2012, we announced a new partnership under which we are the exclusive provider of a Thomson Reuter branded offering, Thomson Reuters Digital Signage Knowledge Direct. Thomson Reuters is presently selling this offering through its sales team to the financial services industry, including many existing news service customers of Thomson Reuters.

35-------------------------------------------------------------------------------- Table of Contents We continue to work for, and receive orders from, various customers in the QSR and fast casual restaurant industry as they come to realize the benefits of deploying digital signage for an array of different types of menu boards for both inside and outside applications.

In addition, since 2011 we have successfully deployed other marketing technology solutions within our three primary verticals, QSR, automotive and branded retail, as a way of creating unique customer experiences. These technologies include interactive kiosks, iPad applications, mobile messaging, QR codes, SMS marketing, near field communications and the integration of social networks into our product offerings. We believe these new technologies greatly expand the marketing solutions we are able to provide our existing and prospective customers and represent an opportunity to increase our revenue beyond traditional digital signage.

As of December 31, 2012, we had a total of $0.9 million of purchase orders for which we had not recognized revenue.

Lastly, our recurring hosting and support revenue increased 22% in 2012 to $2.0 million when compared to 2011 as a result of the expansion of our customer base from the deployments referenced above.

Due to the current economic environment and the lengthy sales cycle associated with deploying large scale marketing technology solutions, including digital signage, we are not able to predict or forecast our future revenue with any degree of precision at this time.

Cost of Sales Our cost of sales decreased 42% to $3.0 million in 2012 from $5.2 million in 2011. The decrease in cost of sales was primarily due to the year-over-year decrease in hardware sales, which was primarily associated with the lack of kiosk sales to Chrysler and the decrease in kiosk sales to Fiat dealerships. On a percentage basis, our overall gross margin increased to 55% in 2012 compared to 44% for the prior year. The primary reason for this increase was that sales of hardware, which traditionally carry a lower gross margin percentage, accounted for a lower percentage of our overall sales in 2012 when compared to 2011. Additionally, our services gross margin on a percentage basis continues to improve to 58% in 2012, which was up 13 percentage points from 45% in 2011 as a result of the increase in recurring hosting and support fees. Partially offsetting these increases was a decline in our RoninCast ® software gross margin as a result of fewer seat licenses sold when comparing 2012 to 2011.

During 2012 our software margin on a percentage basis was 80%, compared to 88% in 2011. Our ability to maintain these levels of gross margin on a percentage basis can be impacted in any given quarter by shifts in our sales mix. However, we believe over the long-term our gross margins on a percentage basis will continue to increase as our recurring revenue grows.

Operating Expenses Sales and marketing expense includes the salaries, employee benefits, commissions, stock compensation expense, travel and overhead costs of our sales and marketing personnel, as well as trade show activities and other marketing costs. Total sales and marketing expenses declined 26% to $1.6 million in 2012 from $2.1 million in 2011. The decline in sales and marketing expense when comparing 2012 to 2011 was primarily due to a decrease in tradeshow costs and related advertising expenses by $0.2 million as a result of concentrating our marketing dollars on more forums and user groups instead of the larger national tradeshows such as Digital Signage Expo. In addition, compensation and employee-related expenses were $0.2 million lower than in 2011 as a result of personnel changes made during first quarter of 2012 and lower commission expense as a result of lower revenue when comparing 2012 to 2011. We traditionally incur higher levels of tradeshow expenditures in the first quarter of our fiscal year compared to the remaining three quarters. Total stock compensation expense included in sales and marketing expense was approximately $0.1 million for both 2012 and 2011. Any significant increase in our sales and marketing expenses in 2013 relative to 2012 would be the result of higher levels of commission expense resulting from an increase in our revenue, as we do not anticipate higher costs associated with tradeshows or marketing initiatives.

36-------------------------------------------------------------------------------- Table of Contents Research and development expense includes salaries, employee benefits, stock compensation expense, related overhead costs and consulting fees associated with product development, enhancements, upgrades, testing, quality assurance and documentation. Total research and development expenses for 2012 decreased 15% to $1.8 million from $2.1 million in 2011. The decrease when comparing 2012 to 2011 was primarily related to lower employee compensation costs due to personnel changes made during the first quarter of 2012 and a decrease in consulting costs. Although we experienced lower employee-related expenses for 2012 compared to 2011, the decrease was primarily attributable to a higher level of research and development costs being allocated to cost of goods sold related to billable development work performed for our customers and lower outside consultant expense. Overall we had 13 developer employees and contractors as of December 31, 2012 compared to 16 as of the end of 2011. Total stock compensation expense included in research and development expense was approximately $0.1 million for both 2012 and 2011. Although we currently have no intention of increasing our staff levels in 2013, we have engaged outside providers to assist in augmenting our development efforts as we continue to make further enhancements to our RoninCast® software. We believe these enhancements are critical for our success as the requirements for a more sophisticated multi-marketing technology platform continue to evolve.

General and administrative expense includes the salaries, employee benefits, stock compensation expense and related overhead cost of our finance, information technology, human resources and administrative employees, as well as legal and accounting expenses, consulting and contractor fees and bad debt expense. Total general and administrative expenses for 2012 decreased 11% to $5.4 million from $6.1 million in 2011. The decrease when comparing 2012 to 2011 was the result of lower employee-related stock-based compensation expense of $0.2 million, a reduction in employee compensation and related travel expenses of $0.1 million and a decline in fees paid for professional services and other public company related expenses of $0.2 million and $0.1 million, respectively. Partially offsetting these declines was a $0.2 million increase in stock-based compensation expense attributable to the stock and warrants issued to outside vendors for professional services during the year ended 2012. Additionally, we recognized stock based-compensation expense associated with stock awards and options to our employees and six non-employee board members as part of their compensation for board service during 2012 and 2011 of $0.4 million and $0.6 million, respectively. We currently believe our general and administrative costs will remain at a similar level to that experienced during 2012 for 2013.

Depreciation and amortization expense. Our depreciation and amortization expense consists primarily of depreciation of computer equipment and office furniture and the amortization of purchased software and leasehold improvements made to our leased facilities. Depreciation and amortization expense decreased 39% to $0.3 million in 2012 from $0.5 million in 2011. The decrease was primarily due to the limited number of capital acquisitions made from 2010 through 2012.

Interest Expense Interest expense decreased to $8,000 in 2012 from $30,000 in 2011. The decrease was primarily the result of lower expense recognized related to the fair value of the warrant issued to Silicon Valley Bank as additional consideration for the loan and security agreement we originally entered into in March 2010. During 2012, we included in interest expense a charge of $3,000 for the fair value of the warrants, compared to $21,000 in 2011. The warrant vested 100% on date of grant and we began recognizing the fair value, as determined using the Black-Scholes model, of $66,000 over the original life of the agreement on a straight-line basis. The loan and security agreement modification in January 2011 included a provision to reduce the exercise price of the warrant, resulting in an incremental increase in fair value of approximately $8,000. The fair value remaining as of the date of the modification totaled $19,000 and was amortized on a straight-line basis through the then renewed expiration date of March 2012. See Note 6 to our consolidated financial statements regarding the assumptions used in determining the fair value of this warrant. Also included in interest expense for 2012 and 2011 was $3,000 and $9,000, respectively, associated with the capital lease we entered into in July 2010.

37-------------------------------------------------------------------------------- Table of Contents 2011 compared to 2010 Sales Our sales increased 8% to $9.3 million in 2011 from $8.6 million in 2010. The year-over-year increase in revenue was primarily attributable to revenue related to the deployments of Chrysler's iShowroom-branded tower application into Chrysler and Fiat dealerships. Revenue generated from Chrysler and the associated Fiat dealerships totaled $5.1 million in 2011, which was up 28% from $4.0 million recognized for the prior year. In addition to assisting Chrysler with its ongoing development needs related to the iShowroom initiative during 2011, $3.1 million of our 2011 revenue from Chrysler and the associated Fiat dealerships came from orders for over 1,100 interactive kiosks as part of its branded tower salon to be installed at approximately 400 dealers.

The remaining increase in sales when comparing 2011 to 2010 was due to an increase in orders from ARAMARK. Total sales to ARAMARK in 2011 totaled $1.7 million, representing an increase of 48% from 2010. We continued to expand the number of Grille Works installations to several colleges and universities during the past year.

We continued to provide traditional digital menu boards to YUM!'s QSR brands in 2011, which includes KFC and KFC/Taco Bell combination stores.

During 2011, we increased the total number of sites deploying Thomson Reuters InfoPoint digital signage to 440 locations, which we support through our NOC.

This includes the expansion from 50 to 62 in the number of InfoPoint installed sites for a financial services institution with over 3,000 locations. We continued to partner with Thomson Reuters in providing a digital signage subscription news service to the financial services industry.

We continued to work for, and receive orders from, various customers in the QSR and fast casual restaurant industry as they come to realize the benefits of deploying digital signage for an array of different types of menu boards for both inside and outside applications. Additionally, starting in 2011, we began to deploy other marketing technology solutions within our three primary verticals, QSR, automotive and branded retail, as a way of creating unique customer experiences. These technologies include interactive kiosks, iPad applications, mobile messaging, QR codes, SMS marketing, near field communications and the integration of social networks into our product offerings.

As of December 31, 2011, we had a total of $1.3 million of purchase orders for which we had not recognized revenue.

Lastly, our recurring hosting and support revenue increased 23% in 2011 to $1.6 million when compared to 2010 as a result of the expansion of our customer base from the deployments referenced above.

Cost of Sales Our cost of sales increased 14% to $5.2 million in 2011 from $4.6 million in 2010. The increase in cost of sales was primarily due to the year-over-year increase in hardware sales. On a percentage basis, our overall gross margin declined to 44% in 2011 compared to 47% for the prior year. The primary reason for this decline was that sales of hardware, which traditionally carries a lower gross margin percentage, accounted for a larger percentage of our overall sales in 2011 when compared to 2010. Additionally, our RoninCast® software gross margin of 88% for 2011 was lower by 4 percentage points when compared to 2010 as a result of higher costs associated with third-party software. Partially offsetting these declines was a continued improvement in our services gross margin percentage to 45% in 2011, which was up 3 percentage points from 42% in 2010 as a result of the increase in recurring hosting and support fees.

Operating Expenses Sales and marketing expense includes the salaries, employee benefits, commissions, stock compensation expense, travel and overhead costs of our sales and marketing personnel, as well as trade show activities and other marketing costs. Total sales and marketing expenses declined 10% to $2.1 million in 2011 from $2.3 million in 2010. The decline in sales and marketing expenses was primarily due to lower compensation expense of $0.3 million, partially offset by an increase in trade shows and other consulting services of $0.1 million. We continued to focus our efforts to maximize the return on investment by attending many of the leading industry digital signage tradeshows, as we believe our presence is necessary to attract and retain new customers. We traditionally incur higher levels of tradeshows expenditures in the first quarter of our fiscal year compared to the remaining three quarters. Total stock compensation expense included in sales and marketing expense was approximately $0.1 million for both 2011 and 2010.

38 -------------------------------------------------------------------------------- Table of Contents Research and development expense includes salaries, employee benefits, stock compensation expense, related overhead costs and consulting fees associated with product development, enhancements, upgrades, testing, quality assurance and documentation. Total research and development expenses for 2011 decreased 26% to $2.1 million from $2.9 million in 2010. The year-over-year decrease was primarily due to lower levels of contractor and other engineering consultants expense incurred. The additional contractor costs incurred in 2010 were primarily associated with the first release of our next generation of digital signage software, RoninCast®, which became generally available during the fourth quarter of 2010. Overall we had 16 developer employees and contractors as of December 31, 2011 compared to 20 as of the end of 2010.

General and administrative expense includes the salaries, employee benefits, stock compensation expense and related overhead cost of our finance, information technology, human resources and administrative employees, as well as legal and accounting expenses, consulting and contractor fees and bad debt expense. Total general and administrative expenses for 2011 increased 2% to $6.1 million from $6.0 million in 2010. The increase was primarily the result of higher levels of fees paid to outside consultants of $0.3 million, along with additional professional fees for investor relations and costs associated with complying with the new XBRL filing requirements with the SEC in 2011 of $0.1 million.

Offsetting these costs was a decrease in compensation and benefits which was primarily the result of our former CEO retiring at the end of December 2010 and other reductions to our general and administrative headcount made during 2011 totaling $0.3 million. Stock-based compensation expense included in general and administrative costs for 2011 totaled $0.6 million, compared to $0.7 million in 2010.

Depreciation and amortization expense. Our depreciation and amortization expense consists primarily of depreciation of computer equipment and office furniture and the amortization of purchased software and leasehold improvements made to our leased facilities. Depreciation and amortization expense decreased 32% to $0.5 million in 2011 from $0.7 million in 2010. The decrease was primarily due to the limited number of capital acquisitions made from 2009 through 2011.

Interest Expense Interest expense decreased to $30,000 in 2011 from $58,000 in 2010. The decrease was primarily the result of lower expense recognized related to the fair value of the warrant issued to Silicon Valley Bank as additional consideration for the loan and security agreement we entered into in March 2010. During 2010, we included in interest expense a charge of $50,000 for the fair value of the warrant compared to $21,000 for the same period in 2011. The warrant vested 100% on date of grant and we began recognizing the fair value, as determined using the Black-Scholes model, of $66,000 over the original life of the agreement on a straight-line basis. The loan and security agreement modification in January 2011 included a provision to reduce the exercise price of the warrant, resulting in an incremental increase in fair value of approximately $8,000. The fair value remaining as of the date of the modification totaled $19,000 and was amortized on a straight-line basis through the then renewed expiration date of March 2012. See Note 6 to our consolidated financial statements regarding the assumptions used in determining the fair value of this warrant. Also included in interest expense for 2011 and 2010 was $9,000 and $3,000, respectively, associated with the capital lease we entered into in July 2010.

Liquidity and Capital Resources Going Concern We incurred net losses and negative cash flows from operating activities for the years ended December 31, 2012, 2011 and 2010. At December 31, 2012 we had cash and cash equivalents of $2.3 million and working capital of $1.8 million. The cash used in operating activities for the year ended December 31, 2012 was $4.8 million. At December 31, 2012, we had an outstanding balance of $0.4 million on our line of credit with Silicon Valley Bank; additionally, Silicon Valley Bank has issued a letter of credit in the amount of $0.2 million as collateral to the landlord of our corporate office. We can not assure you that funds would be available or sufficient under our loan and security agreement with Silicon Valley Bank, and we may not be able to successfully obtain additional financing on favorable terms, or at all. Although we were not in compliance with the minimum tangible net worth requirement under the loan and security agreement as of December 31, 2012, we obtained a waiver from Silicon Valley Bank for the default. From time to time we have failed to satisfy such covenant, which must be satisfied in order for us to borrow under such agreement. Furthermore, as a result of the contractually imposed limits on our borrowing base, the amount available to us under the loan and security agreement, based on calculations as of January 31, 2013 was approximately $0.2 million. The line of credit, which is secured by all of our assets, matures on March 13, 2013. We are currently seeking to negotiate its extension with Silicon Valley Bank; however, we cannot assure you we will be successful in this effort.

39-------------------------------------------------------------------------------- Table of Contents The financial statements accompanying this report for the fiscal year ended December 31, 2012 have been prepared on a going concern basis, meaning that they do not include any adjustments to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should our company be unable to continue as a going concern. However, our auditor also expressed substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is an issue raised as a result of losses suffered from operations. We do not currently have sufficient capital resources to fund operations beyond May 2013. We continue to experience operating losses. Management continues to seek financing on favorable terms; however, there can be no assurance that any such financing can be obtained on favorable terms, if at all. At present, we have no commitments for any additional financing. Because we have received an opinion from our auditor that substantial doubt exists as to whether our company can continue as a going concern, it may be more difficult for our company to attract investors, secure debt financing or bank loans, or a combination of the foregoing, on favorable terms, if at all. Our future depends upon our ability to obtain financing and upon future profitable operations. If we are unable to generate sufficient revenue, find financing, or adjust our operating expenses so as to maintain positive working capital, then we likely will be forced to cease operations and investors will likely lose their entire investment. We can give no assurance as to our ability to generate adequate revenue, raise sufficient capital, sufficiently reduce operating expenses or continue as a going concern.

In light of our financial condition and potential for continued net losses, we are evaluating strategic and financial alternatives and have engaged Roth Capital Partners, LLC to assist us in that process. Such alternatives may include licensing our product for use in one or more specific industries, acquiring other entities to enable us to gain sufficient mass to regain meaningful access to the capital markets and/or become a more attractive acquisition candidate, and/or selling substantially all of our assets or engaging in some other business combination transaction. However, there can be no assurance that any of these efforts will be successful or resolve our short-term liquidity issues.

Operating Activities We do not currently generate positive cash flow. Our investments in infrastructure have been greater than sales generated to date. As of December 31, 2012, we had an accumulated deficit of $94.4 million. The cash flow used in operating activities was $4.8 million, $4.6 million and $7.1 million for the years ended December 31, 2012, 2011 and 2010, respectively. In 2012, net cash used by operating activities was attributable to our net loss, along with an overall increase in changes to our operating assets and liability accounts of $0.3 million, partially offset by depreciation and amortization and stock compensation expense. Included in the changes to our operating accounts were decreases in inventory, prepaid expenses, accounts payable, deferred revenue and accrued liabilities, all of which were primarily due to lower operating costs incurred during the fourth quarter of 2012 when compared to the same period in the prior year. The accounts receivable balance at the end of 2012 increased from the prior year balance as a result of an increase in sales during the fourth quarter of 2012 when compared to the same period in the prior year. The days sales outstanding were 73, 76 and 78 at December 31, 2012, 2011 and 2010, respectively.

In 2011, net cash used by operating activities was attributable to our net loss and an increase in accounts receivables, inventory, prepaid expenses and other current assets. The decreases in accounts receivable, inventory, prepaid expenses and accounts payable were due to our sales being $1.4 million lower during the fourth quarter of 2011 when compared to the same period in the prior year-end. The deferred revenue balance at the end of 2011 increased from the prior year balance as a result of an increase in installations for which we bill an annual hosting and support fee and amortize on a straightline basis over the service period provided.

Disruptions in the economy and constraints in the credit markets have caused companies to reduce or delay capital investment. Some of our prospective customers may cancel or delay spending on the development or roll-out of capital and technology projects with us due to continuing economic uncertainty. Difficult economic conditions have adversely affected certain industries in particular, including the automotive and restaurant industries, in which we have major customers. We could also experience lower than anticipated order levels from current customers, cancellations of existing but unfulfilled orders, and extended payment or delivery terms. Economic conditions could also materially impact us through insolvency of our suppliers or current customers.

As of December 31, 2012, Chrysler and Buffalo Wild Wings accounted for 40.5% and 16.7%, respectively, of our total receivables. In the case of insolvency by one of our significant customers, an account receivable with respect to that customer might not be collectible, might not be fully collectible, or might be collectible over longer than normal terms, each of which could adversely affect our financial position. There can be no assurance that we will not suffer credit losses in the future.

40 -------------------------------------------------------------------------------- Table of Contents In addition, our financial condition and potential for continued net losses could cause current and prospective customers to defer placing orders with us, to require terms that are unfavorable to us, or to place their orders with marketing technology suppliers other than ourselves, which could adversely affect our business, financial condition and results of operations. On the same basis, third-party suppliers may refuse to do business with us, or may do so only on terms that are unfavorable to us, which also could cause our revenue to decline.

Investing Activities Net cash used in investing activities was $47,000, $149,000 and $189,000 for the years ended December 31, 2012, 2011 and 2010, respectively. Net cash used in investing activities for the periods presented was attributable to the purchases of property and equipment. We believe capital investments for 2013 will be similar to 2012 as our current infrastructure has the capacity to service additional deployments.

Financing Activities We have financed our operations primarily through sales of common stock and the issuance of notes payable to vendors, shareholders and investors. For the years ended December 31, 2012, 2011 and 2010, we generated a net $1.6 million, $3.2 million and $2.2 million from financing activities, respectively.

In September 2012, we sold approximately 348,000 shares of our common stock at $4.05 per share pursuant to a registration statement on Form S-3 which was declared effective by the SEC in September 2009. We obtained approximately $1.2 million in net proceeds as a result of this registered direct offering. During 2012, we also received $51,000 from the sale of approximately 12,000 shares of common stock to our associates (employees) through our 2007 Associate Stock Purchase Plan. We also received a $0.4 million advance on our line of credit with Silicon Valley Bank in 2012.

In December 2011, we sold approximately 664,000 shares of our common stock at $5.00 per share pursuant to a registration statement on Form S-3 which was declared effective by the SEC in September 2009. We obtained approximately $2.9 million in net proceeds as a result of this registered direct offering. During 2011, we received $68,000 from the sale of approximately 14,000 shares of common stock to our associates (employees) through our 2007 Associate Stock Purchase Plan and we received approximately $0.2 million from the exercise of outstanding stock options. We used $36,000 for the payment of capital leases during 2011.

In November 2010, we sold approximately 285,000 shares of our common stock at $6.25 per share and issued warrants to purchase up to 57,000 shares of our common stock at $7.1875 per share pursuant to a registration statement on Form S-3 which was declared effective by the SEC in September 2009. We obtained approximately $1.6 million in net proceeds as a result of this registered direct offering. During 2010, we received $30,000 from the sale of approximately 6,000 shares of common stock to our associates (employees) through our 2007 Associate Stock Purchase Plan and we received approximately $0.2 million from the exercise of outstanding stock options and warrants. Our restricted cash balance was reduced by $0.3 million in 2010 related to the cancellation of a letter of credit which was collateralized by an equal amount of cash held at the issuing bank. We used $11,000 for the payment of capital leases during 2010.

We will likely be required to raise additional funding through public or private financings, including equity financings. Any additional equity financings may be dilutive to shareholders and may be completed at a discount to market price.

Debt financing, if available, would likely involve restrictive covenants similar to or more restrictive than those contained in the security and loan agreement we currently have with Silicon Valley Bank. Those covenants include maintaining minimum tangible net worth, which we may not satisfy. There can be no assurance we will successfully complete any future equity or debt financing. Adequate funds for our operations, whether from financial markets, collaborative or other arrangements, may not be available when needed or on terms attractive to us, especially from markets which continue to be risk averse. If adequate funds are not available, our plans to operate our business may be adversely affected and we could be required to curtail our activities significantly and/or cease operating.

41 -------------------------------------------------------------------------------- Table of Contents Due to losses suffered from operations, in its report in the attached financial statements for the year ended December 31, 2012, our independent registered public accounting firm expressed substantial doubt about our ability to continue as a going concern. We do not currently have sufficient capital resources to fund our operations beyond May 2013. We continue to experience operating losses.

Management continues to seek financing on favorable terms; however, there can be no assurance that any such financing can be obtained on favorable terms, if at all. At present, we have no commitments for any additional financing. If we are unable to generate sufficient revenue, find financing, or adjust our operating expenses so as to maintain positive working capital, then we likely will be forced to cease operations and investors will likely lose their entire investment.

Line of Credit In March 2010, we entered into a loan and security agreement with Silicon Valley Bank, which was most recently amended effective September 2012. The loan and security agreement provides us with a revolving line-of-credit at an annual interest rate of prime plus 1.5%. The availability of which is the lesser of (a) $2.5 million or (b) the amount available under our borrowing base (75% of our eligible accounts receivable plus 50% of our eligible inventory) minus (1) the dollar equivalent amount of all outstanding letters of credit, (2) 10% of each outstanding foreign exchange contract, (3) any amounts used for cash management services, and (4) the outstanding principal balance of any advances.

In connection with the July 2010 lease agreement for our corporate office, Silicon Valley Bank issued a letter of credit which as of December 31, 2012 was in the amount of $0.2 million, which effectively reduced the capacity amount under the loan and security agreement to $2.3 million, subject to the borrowing base availability and continued compliance with restrictive covenants. We had a $0.4 million outstanding balance under this loan agreement, in addition to our lease letter of credit, as of December 31, 2012. Although we were not in compliance with the minimum tangible net worth requirement under the loan and security agreement as of December 31, 2012, we obtained a waiver from Silicon Valley Bank for the default. From time to time we have failed to satisfy such covenant, which must be satisfied in order for us to borrow under such agreement. Furthermore, as a result of the contractually-imposed limits on our borrowing base, the amount available to us under the agreement, based on calculations as of January 31, 2013, was approximately $193,000. The line of credit, which is secured by all of our assets, matures on March 13, 2013. We are currently seeking to negotiate its extension with Silicon Valley Bank; however, we cannot assure you we will be successful in this effort.

The amendment which became effective September 2012 adjusted the minimum tangible net worth requirement to $3.0 million for the month ending September 30, 2012, to $2.5 million for the months ending October 31, 2012, November 30, 2012 and December 31, 2012, and to $1.4 million for the months ending January 31, 2013, February 28, 2013, and through the maturity date of March 13, 2013. It further established that the minimum tangible net worth requirement increases (a) by 75% of our net income for each month starting with the month ending September 30, 2012 and (b) by 75% of the gross proceeds received from our issuances of equity during such month and/or the principal amount of subordinated debt we incur during such month, but excluding the gross proceeds from our September 2012 registered direct offering of equity securities. We must comply with this tangible net worth minimum in order to draw on such line of credit and also while there are outstanding credit extensions (other than our existing lease letter of credit). The maximum permitted amount of outstanding letters of credit is $300,000.

Under the loan and security agreement we also are generally required to obtain the prior written consent of Silicon Valley Bank to, among other things, (a) dispose of assets, (b) change our business, (c) liquidate or dissolve, (d) change CEO or COO (replacements must be satisfactory to the lender), (e) enter into any transaction in which our shareholders who were not shareholders immediately prior to such transaction own more than 40% of our voting stock (subject to limited exceptions) after the transaction, (f) merge or consolidate with any other person, (g) acquire all or substantially all of the capital stock or property of another person, or (h) become liable for any indebtedness (other than permitted indebtedness).

Off Balance Sheet Arrangements It is not our business practice to enter into off-balance sheet arrangements.

Contractual Obligations We have no material commitments for capital expenditures. Unless we experience a significant increase in our revenue, we expect our 2013 operating expenses will remain at levels similar to 2012 as we continue to control expenses in the current economic environment.

42 -------------------------------------------------------------------------------- Table of Contents Operating and Capital Leases At December 31, 2012, our principal commitments consisted of long-term obligations under operating leases. We conduct our U.S. operations from a leased facility located at 5929 Baker Road in Minnetonka, Minnesota. We lease approximately 19,000 square feet of office and warehouse space under a lease that extends through January 31, 2018. In addition, we lease office space of approximately 10,000 square feet to support our Canadian operations at a facility located at 4510 Rhodes Drive, Suite 800, Windsor, Ontario, Canada under a lease, as amended, that extends through June 30, 2014.

The following table summarizes our obligations under contractual agreements as of December 31, 2012 and the time frame within which payments on such obligations are due (in thousands): Payment Due by Period Less Than More Than Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years Operating Lease Obligations $ 1,098 $ 259 $ 445 $ 394 $ - Our internal source of liquidity solely consists of our cash balance, which as of December 31, 2012 was $2.3 million. Of this amount, $2.0 million is invested in a daily sweep commercial paper account with Silicon Valley Bank. We monitor the credit rating of this financial institution and have determined there is a low level of risk of the funds not settling on a daily basis. Although we were not in compliance with the minimum tangible net worth requirement under the loan and security agreement as of December 31, 2012, we obtained a waiver from Silicon Valley Bank for the default. From time to time we have failed to satisfy such covenant, which must be satisfied in order for us to borrow under such agreement. Furthermore, as a result of the contractually-imposed limits on our borrowing base, the amount available to us under the agreement, based on calculations as of January 31, 2013, was approximately $193,000. This amount represents our external source of liquidty. The line of credit, which is secured by all of our assets, matures on March 13, 2013. We are currently seeking to negotiate its extension with Silicon Valley Bank; however, we cannot assure you we will be successful in this effort.

Based on our working capital position at December 31, 2012, we believe we have sufficient working capital to meet our current obligations through May 2013.

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