XRS CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Risk Factors in this Annual Report on Form 10-K (Annual Report). This Annual Report contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those in such forward-looking statements as a result of many factors, including those discussed in Risk Factors and elsewhere in this Annual Report.

Overview XRS Corporation delivers fleet management and compliance software solutions to the commercial trucking industry to assist in maintaining regulatory compliance and controlling the operating costs associated with running a fleet using traditional on-board computers and mobile applications that run on smartphones, tablets and rugged handheld devices. XRS Corporation is a leader in the commercial trucking industry's migration to mobile solutions for collecting and analyzing DOT compliance data.

The Company's solutions include: • XataNet: a fleet optimization and compliance solution focused on addressing the needs of fleets to manage compliance risks and maximize the performance of their fleet.

• Turnpike: a mobile fleet optimization and compliance solution that uses a monthly subscription model with no upfront hardware fees.

• MobileMax: a mobile communication platform for the for-hire market with integrated back-end systems.

The Company's strong foundation with electronic driver logs, being a leading company to introduce fully DOT-compliant AOBRD solutions for the tracking of HOS, has allowed us to establish a customer base consisting of over 1,400 customers and 114,000 subscribers who utilize compliance, fleet performance, and driver workflow solutions. In 2012, we changed our name from Xata Corporation to XRS Corporation (Xata Road Science), reflecting our commitment to the mobile market, our next generation of products and addressing the compliance and performance needs of our customers.

The acquisition of Turnpike in 2009 brought a customer base using mobile devices with the operating systems provided by Android, Blackberry, and Windows Mobile.

As nationwide adoption of mobile devices, and the overall growth of smartphone ownership increases, fleet owners and operators are looking to better leverage their mobile investments, including using them for driver-specific tasks. The Turnpike solution allowed XRS Corporation to add fleet management to the overall power of the mobile solution with no upfront hardware costs. This also enabled the Company's Turnpike solution to be sold as a bill-on-behalf-of relationship with communication service providers including AT&T, Sprint and Verizon.

Critical Accounting Policies Accounting policies, methods and estimates are an integral part of the Company's consolidated financial statements and are based upon management's current judgments. Certain accounting policies, methods and estimates are particularly important because of their significance to the consolidated financial statements. Note 1 of the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used by the Company. The following is a discussion of what the Company believes to be the most critical of these policies and methods.

Revenue Recognition The Company derives its revenue from sales of (i) software, which includes monthly subscriptions from the XataNet and Turnpike solutions, monthly fees from the MobileMax solution and activation fees; (ii) hardware systems, which includes hardware with embedded software and software that can be hosted by a customer, warranty 18 -------------------------------------------------------------------------------- Table of Contents and repair revenue; and (iii) services, which includes installation, implementation, training and professional services revenue.

The Company sells its solutions using two methods: direct sales and channel sales. The Company's direct sales include sales of the Company's solutions primarily to fleet operators and logistics providers. The Company's channel sales are driven by Company personnel working in tandem with communication service providers to sell the Company's Turnpike solution to a variety of fleet sizes and types.

The Company's XataNet and MobileMax customers enter into multi-year agreements with automatic renewal features, however, in certain circumstances operate under month-to-month contracts. Historically, Turnpike customers have operated under month-to-month contracts, allowing them the ability to terminate the agreement upon providing 30-days notice.

The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collection is probable. A solution is considered delivered to the customer once it has been shipped and title and risk of loss has been transferred. For most of the Company's hardware systems and services sales, these criteria are met at the time the hardware system is shipped and/or the services are provided. For the Company's software subscriptions, these criteria are met over the term of the customer's agreement, and therefore revenue is recognized accordingly.

The Company recognizes revenue from the sale of a hardware system, which includes embedded software essential to the functionality of the hardware system and software that can be hosted by the customer, a software subscription and certain services requested by the customer, in accordance with revenue recognition accounting guidance for arrangements with multiple deliverables. In addition, the Company recognizes revenue from sales of software and software-related components, as well as add-on product offerings bundled with a hardware system not essential to the functionality of the hardware system, in accordance with industry specific software accounting guidance. Finally, the Company recognizes revenue from sales of software components and nonsoftware components that function together to deliver the solution's essential functionality in accordance with general revenue recognition accounting guidance.

Revenue Recognition for Arrangements with Multiple Deliverables For multi-element arrangements including hardware systems, which include embedded software essential to the functionality of the hardware system, a software subscription and services requested by the customer, the Company allocates revenue to all deliverables based on their relative selling prices. In such circumstances, the Company uses a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor specific evidence (VSOE) of fair value, if available, (ii) third-party evidence (TPE) of selling price if VSOE is not available, and (iii) best estimate of the selling price (ESP) if neither VSOE nor TPE is available (a description as to how the Company determined VSOE, TPE and ESPs is provided below). The Company limits the amount of revenue recognized for delivered elements to an amount that is not contingent upon future delivery of additional products or services or the meeting of any specified performance conditions.

The Company has identified three deliverables in arrangements involving the sale of its XataNet, MobileMax and Turnpike solutions. The first deliverable is the hardware system, which includes embedded software that is essential to the functionality of the hardware system and software that can be hosted by the customer. The second deliverable is the software subscription, which covers hosting fees, continued support and communication charges for XataNet and MobileMax solutions. The final deliverable includes certain services that may be requested by the customer and are deemed essential to the functionality of the hardware, such as installation, implementation and/or training.

The Company has determined that each deliverable included in the sale of its XataNet solution has standalone value and the deliverables can be separated into multiple units of accounting. The Company has allocated revenue between the three deliverables using the relative selling price method based on the Company's VSOE and ESPs. Amounts allocated to the delivered hardware system are recognized at the time of sale provided the other conditions for revenue recognition have been met. Amounts allocated to the software subscription are recognized on a straight- 19 -------------------------------------------------------------------------------- Table of Contents line basis over the term of the agreement with the customer. Finally, amounts allocated to services are recognized upon performance.

In response to changes in the Company's market strategy relative to the Turnpike solution, beginning in fiscal 2012, the Company concluded that the value provided by the Turnpike solution, relative to the optimization of its fleet operations, was derived from the use of the hardware system in conjunction with the software subscription. Therefore, the Company concluded that each deliverable included in the sale of its Turnpike solution, regardless of the method used to acquire the Turnpike hardware system, does not have standalone value, rather the deliverables must function together to have standalone value.

Therefore, revenue generated from sale of this solution is recognized ratably over the term of the agreement.

Finally, the Company has determined that revenue generated from sale of its MobileMax solution should be recognized ratably over the term of the agreement as the deliverables must function together to have standalone value.

The Company's process for determining its ESPs considers multiple factors that may vary depending upon the unique facts and circumstances related to each deliverable. Key factors considered by the Company in developing the ESPs include prices charged by the Company for similar offerings; historical pricing practices; pricing of competitive alternatives if they exist, adjusted for differences in product specifications; product-specific business objectives and the life cycle of the solution. The Company may modify its pricing practices in the future, which could result in changes to the determination of VSOE, TPE and ESPs. As a result, the Company's future revenue recognition for multiple-element arrangements could differ materially from its results in the current period.

ESPs are analyzed on an annual basis or more frequently if circumstances warrant.

Revenue Recognition for Software Products The Company accounts for multiple-element arrangements that consist only of software or software-related products, including certain of the Company's add-on product offerings, in accordance with industry specific accounting guidance for software and software-related transactions, ASC 985-605, Software - Revenue Recognition (ASC 985-605). Revenue generated from the sale of add-on product offerings is recognized ratably over the agreement as it is delivered to the customer.

Other Revenue Recognition Policies Applicable to Software and Nonsoftware Elements Many of the Company's customers engage the Company to perform installation, implementation, training and professional services. In certain instances, services revenues are accounted for separately from software revenues because they qualify as services transactions as defined in ASC 985-605. The significant factors considered in determining whether the revenues should be accounted for separately include the nature of services (i.e. consideration of whether the services are essential to the functionality of the hardware system or software subscription), degree of risk, availability of services from other vendors, timing of payments and impact of milestones. Revenues generated from services are recognized after the services are performed. If there is a significant uncertainty about the project completion or receipt of payment for the services performed, revenues are deferred until the uncertainty is sufficiently resolved.

Finally, the Company has entered into agreements with third-party providers to extend the benefits of solutions throughout the customer's supply chain. The Company recognizes revenue generated under the aforementioned agreements in accordance with ASC 605-45, Revenue Recognition - Principal Agent Considerations (ASC 605-45), based upon the terms of each partnership agreement.

Allowance for Doubtful Accounts Accounts receivable are stated at amounts net of an allowance for doubtful accounts. The Company grants credit to customers in the normal course of business based on an evaluation of a customer's financial condition, and amounts are typically due within 30 days. Balances outstanding for a period longer than contractual payment terms are 20 -------------------------------------------------------------------------------- Table of Contents considered past due. Estimates used in determining the allowance for doubtful accounts are based on historical collection experience, current trends, aging of accounts receivable and periodic credit evaluations of the customers' financial condition. The Company reserves for accounts receivable when they are determined to be uncollectible by increasing the allowance for doubtful accounts and bad debt expense, which is included in selling, general and administrative expense in the accompanying consolidated statements of operations. Payments subsequently received, or otherwise determined to be collectible, are treated as recoveries that reduce bad debt expense.

Goodwill and Identifiable Intangible Assets As of September 30, 2012, the carrying value of the Company's goodwill and identifiable intangible assets was $23.8 million and represented 45.0 percent of total assets. If the Company experiences revenue declines, continuing operating losses or does not meet operating forecasts, the Company may be subject to future impairments. Additionally, changes in assumptions regarding the future performance of the Company's business or significant declines in the stock price or the market as a whole could result in additional impairment indicators.

Because of the significance of the Company's goodwill and identifiable intangible assets, any future impairment of these assets could have a material and adverse effect on the Company's financial results.

Goodwill Goodwill represents the excess of the cost of acquired businesses over the fair value of identifiable tangible net assets and identifiable intangible assets purchased, in accordance with ASC 350-20, Intangibles - Goodwill and Others (ASC 350-20).

In accordance with ASC 350-20, Goodwill is tested at least annually for impairment and is tested for impairment more frequently if events or changes in circumstances indicate the asset might be impaired. The impairment test is performed using a two-step process. In the first step, the fair value of the reporting unit is compared with the carrying amount of the reporting unit, including goodwill. If the estimated fair value is less than the carrying amount of the reporting unit, an indicator of goodwill impairment exists, and the second step must be completed in order to determine the amount of the goodwill impairment, if any, that should be recorded. In the second step, an impairment loss is recognized for any excess of the carrying amount of the reporting unit's goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation.

The fair value of the Company's single reporting unit was determined using a review of our market capitalization and a discounted cash flow analysis. Use of the market capitalization approach consisted of a comparison of the value of the ownership interest that the shareholders maintain in the Company to the recorded value of equity.

In developing the discounted cash flow analysis, assumptions about future revenues and expenses, capital expenditures and changes in working capital are based on the annual operating plan and long-term business plan for the Company's single reporting unit. These plans take into consideration numerous factors including historical experience, anticipated future economic conditions, changes in raw material prices and growth expectations for the industries and end markets in which XRS Corporation participates. These assumptions are determined over a five-year long-term planning period. Revenues and operating profit beyond fiscal 2017 are projected to grow at a perpetual growth rate of 3.0 percent.

Discount rate assumptions considered the Company's assessment of risks inherent in the future cash flows of the reporting unit and its weighted average cost of capital. A discount rate of 16.5 percent was used in determining the discounted cash flows in the fair value analysis. Actual results may differ from those used in our valuations.

The Company completed its annual impairment test on the first day of the fourth quarter of fiscal 2012 and concluded no impairment existed.

21 -------------------------------------------------------------------------------- Table of Contents Identifiable Intangible Assets The Company's identifiable intangible assets include customer and reseller relationships, acquired technology and a trademark. The Company amortizes its identifiable intangibles with finite lives on a straight-line basis over their expected lives.

In accordance with ASC 360-10, identifiable intangible assets that are subject to amortization are evaluated for impairment whenever events or changes in circumstances occur that indicate that the carrying value of the asset or asset group may not be recoverable. An impairment loss is recognized whenever events or changes in circumstances indicate the carrying amount of an asset is not recoverable. Recoverability of these assets is measured by comparison of their carrying amounts to future undiscounted cash flows the assets are expected to generate. If certain identifiable intangibles are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds their fair market value as determined using an income approach.

The inputs used in the income approach include the use of Level 2 (discount rate) and Level 3 (forecasted cash flows) inputs as discussed in the fair value hierarchy below.

The Company reviewed its definite-lived intangible assets for impairment during the third quarter of fiscal 2012. As a result, the Company recorded an impairment charge of $3.5 million in the third quarter of fiscal 2012. The impairment charge was driven by a decline in the estimated fair value of acquired customer contracts originally recorded in conjunction with the acquisition of Geologic Solutions, Inc. (Geologic) as a result of reductions in expected future cash flows. The fair value for the acquired customer contracts for which the carrying amount was not deemed to be recoverable was determined using the future discounted cash flows the assets were expected to generate.

Warranties The Company provides warranty on its solutions. Liability under the warranty policies is based upon a review of the number of units sold, historical and anticipated claim experience and cost per claim. Adjustments are made to accruals for warranties as claim data and historical experience warrant.

As of September 30, 2012 and 2011, the Company had accruals for warranties of $0.9 million and $0.8 million respectively. These amounts are included in accrued expenses in the accompanying consolidated balance sheets.

Income Taxes The Company accounts for income taxes in accordance with the guidance provided by ASC 740-10, Income Taxes - Overall (ASC 740-10). ASC 740-10 requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the carrying amounts of assets and liabilities and their respective tax basis using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statements of operations in the period when the change is enacted. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Changes in valuation allowances from period to period are included in income tax benefit in the accompanying consolidated statements of operations in the period of change.

The Company recognizes the effect of income tax positions only if those positions are more likely than not to be sustained. Recognized income tax positions are measured at the largest amount that is greater than 50 percent likely of being realized. Changes in recognition or measurement are reflected in income tax benefit in the accompanying consolidated statements of operations in the period in which the change in judgment occurs. Interest and penalties related to income tax matters are recognized in net interest and other expense and income tax benefit, respectively, in the accompanying consolidated statements of operations.

22 -------------------------------------------------------------------------------- Table of Contents Operating Results XRS Corporation operates as a single business segment and believes the information presented in its Management's Discussion and Analysis of Financial Condition and Results of Operations provides an understanding of its business, operations and financial condition. The following table sets forth detail related to revenue, cost of goods sold and gross margins (in thousands, except percentage data): For the Year Ended September 30, 2012 2011 Software Revenue $ 47,455 $ 45,800 Cost of goods sold 13,043 11,575 Gross margin $ 34,412 $ 34,225 Gross margin % 72.5% 74.7% Hardware systems Revenue $ 13,893 $ 14,635 Cost of goods sold 15,287 15,774 Gross margin $ (1,394 ) $ (1,139 ) Gross deficit % (10.0)% (7.8)% Services Revenue $ 1,741 $ 2,596 Cost of goods sold 2,327 3,385 Gross margin $ (586 ) $ (789 ) Gross deficit % (33.7)% (30.4)% Other Revenue $ - $ - Cost of goods sold - (21 ) Gross margin $ - $ 21 Gross margin % -% -% Total Revenue $ 63,089 $ 63,031 Cost of goods sold 30,657 30,713 Gross margin $ 32,432 $ 32,318 Gross margin % 51.4% 51.3% In the above chart the revenue and cost of goods sold detail for categories listed are defined as follows: • Software revenue includes monthly subscriptions from the XataNet and Turnpike solutions, monthly fees from the MobileMax solution and activation fees.

• Hardware systems revenue includes hardware with embedded software and software that can be hosted by the customer, warranty and repair revenue.

• Services revenue includes installation, implementation, training and professional services revenue.

• Software cost of goods sold consists of communication costs, hosting costs, depreciation of Turnpike RouteTracker units (where the customer selected the no upfront hardware cost option) and direct personnel costs related to network, infrastructure, as well as Turnpike technical support.

• Hardware systems cost of goods sold consists of the direct product costs, warranty costs, product repair costs and direct personnel costs related to XataNet and MobileMax technical support.

23-------------------------------------------------------------------------------- Table of Contents • Services cost of goods sold consists of third-party vendor costs and direct costs related to services personnel.

Comparison of Fiscal 2012 Operating Results to Fiscal 2011 Impairment and Business Realignment Charges During fiscal 2012, the Company recorded $6.0 million of impairment and business realignment charges as it transitions to providing mobile-based solutions. The fiscal 2012 business realignment charges included $0.9 million in personnel expenses from a workforce reduction, $0.4 million in accelerated depreciation of fixed assets, $0.8 million to write off excess and obsolete inventory and $0.4 million in estimated costs to terminate inventory purchase commitments. The Company also recorded a non-cash impairment charge of $3.5 million associated with intangible assets that were originally recorded in conjunction with the 2008 acquisition of Geologic.

Revenue Fiscal 2012 overall revenue of $63.1 million increased 0.1 percent compared to $63.0 million for fiscal 2011 reflecting decreased hardware systems, services and other revenue partially offset by increased software revenue. Software revenue for fiscal 2012 increased 3.6 percent to $47.5 million from $45.8 million in fiscal 2011. Software revenue comprised 75.2 percent of total revenue for fiscal 2012 compared to 72.7 percent for fiscal 2011. The increase in software revenue for fiscal 2012 was driven by a 7.1 percent and 35.3 percent increase in XataNet and Turnpike revenue, respectively.. The increase in Turnpike software revenue was driven by new customers continuing to select a mobile-based solution, as well as an increase in the Turnpike average rate per unit.

Hardware systems revenue decreased 5.1 percent to comprise 22.0 percent of total revenue in fiscal 2012 compared to 23.2 percent in fiscal 2011. This decline is attributable to a combination of a decrease in the average sale prices of the Company's hardware systems as new technology and competition continue to drive a decline in hardware system prices and an increase in the number of customers adopting the no upfront hardware cost Turnpike solution, which does not require the customer to purchase hardware.

Services revenue decreased 32.9 percent and represented 2.8 percent of total revenue in fiscal 2012 compared to 4.1 percent in fiscal 2011. The continued shift in the customer base to the Turnpike solution, which provides for self installation, coupled with a trend in which customers are electing to become certified in the installation of the XataNet solution has driven the decrease in services revenue.

Cost of Goods Sold and Gross Margin Overall cost of goods sold remained relatively consistent at $30.7 million in fiscal 2012 and 2011, respectively.

Software cost of goods sold of $13.0 million increased 12.7 percent in fiscal 2012 compared to $11.6 million in fiscal 2011. Software gross margin decreased 2.2 percentage points from 74.7 percent of revenue for fiscal 2011 to 72.5 percent for fiscal 2012. Software margins were impacted by $0.4 million of the business realignment charges, as well as increased depreciation of equipment used in connection with the Turnpike solution as the number of Turnpike subscribers who have selected the no upfront cost hardware option continues to grow.

Hardware systems cost of goods sold of $15.3 million decreased 3.1 percent in fiscal 2012 compared to $15.8 million in fiscal 2011. Hardware systems gross margins decreased 2.2 percentage points to negative 10.0 percent in fiscal 2012 compared to negative 7.8 percent in fiscal 2011. Hardware systems gross margins were negatively impacted by the recording of $0.8 million to write off excess and obsolete inventory and $0.4 million in estimated costs to terminate inventory purchase commitments. Hardware margins were further impacted by competitive pressures to reduce prices coupled with the inherent difficulty in lowering hardware systems costs and other hardware systems-related charges at the same rate. Favorability in the Company's warranty activity has served as the primary driver of the offset to the impact of the realignment charges and negative competitive pressures.

24 -------------------------------------------------------------------------------- Table of Contents Services cost of goods sold of $2.3 million decreased 31.3 percent in fiscal 2012 compared to $3.4 million in fiscal 2011. Service gross margins declined 3.3 percentage points in fiscal 2012 to negative 33.7 percent compared to negative 30.4 percent in fiscal 2011. This decrease was primarily the result of the decline in higher margin installation revenue and lower utilization of services personnel as compared to the same period in fiscal 2011.

Selling, General and Administrative Expenses Selling, general and administrative expenses consist of personnel costs for the Company's sales, client management and administration functions; sales commissions, marketing and promotional expenses; executive and administrative costs; and accounting and professional fees. Selling, general and administrative expenses were $24.7 million or 39.2 percent of revenue for both fiscal 2012 and 2011. The recording of realignment charges of $0.8 million served to offset operational efficiencies realized in fiscal 2012.

Research and Development Expenses Research and development expenses consist of personnel costs and expenses related to development of new solutions and added functionality on existing solutions. Research and development expenses were $14.8 million or 23.5 percent of revenue for fiscal 2012 compared to $11.1 million or 17.6 percent of revenue for fiscal 2011. The increase in research and development expense in fiscal 2012 was driven by the Company's significant investment in its new mobile solution, XRS. The Company's new mobile solution, XRS, will use the business model of Turnpike, with its simplified installation, no upfront hardware cost model and ease of use, paired with the enterprise reporting and operational metrics of XataNet. The Company's new mobile solution will increase functionality of current offerings with dispatch management and workflow forms and integration to third-party systems, thereby addressing the needs of all sized fleets including owner/operators, small, medium and enterprise sized fleets.

Net Interest and Other Expense Net interest and other expense increased $0.1 million to $0.3 million in fiscal 2012, compared to net interest and other expense of $0.2 million in fiscal 2011.

The increase in net interest expense reflects the cost associated with the early extinguishment of the Company's capital lease facility previously used to finance certain equipment used in the Turnpike solution, offset in part by lower interest expense driven by a combination of lower average outstanding debt balances, as well as lower interest rates on the Company's revolving line of credit, compared to the capital lease facility previously used to finance certain equipment used in the Turnpike solution.

Income Taxes An income tax benefit of $0.6 million was recorded in fiscal 2012 to recognize of tax benefits relating to Canadian operations resulting from the use of net operating losses and tax credits to offset the deferred tax liability. The domestic operations recorded an income tax expense of $58,000 for fiscal 2012 related to certain states and municipalities.

Domestically the Company does not have objectively verifiable positive evidence of future taxable income as prescribed by ASC 740-10, Income Taxes - Overall.

Accordingly, the Company concluded that the recording of a valuation allowance equal to the value of the domestic deferred tax assets is appropriate. The realization of the domestic deferred tax assets is dependent on future taxable income during the periods when deductible temporary differences and carryforwards are expected to be available to reduce taxable income. The amount of the net deferred tax asset considered realizable could be increased in the future if the Company returns to profitability and it becomes more likely than not that these amounts would be realized. As of September 30, 2012, the Company had federal net operating loss carryforwards and tax credit carryforwards available for use of $42.2 million and $2.8 million, respectively.

Net Loss to Common Shareholders The Company incurred net losses to common shareholders of $10.5 million and $3.0 million for fiscal 2012 and 25 -------------------------------------------------------------------------------- Table of Contents 2011, respectively. Fiscal 2012 net loss to common shareholders reflects $6.0 million of impairment and business realignment charges. Net loss to common shareholders also reflects preferred stock dividends and preferred stock deemed dividends of $0.2 million for both fiscal 2012 and 2011.

Liquidity and Capital Resources Effective February 24, 2012, the Company entered into a two-year Loan and Security Agreement with Silicon Valley Bank (SVB) consisting of a $8.0 million revolving line of credit bearing interest at a floating rate equal to either 1.0 percent over the prime rate, provided certain liquidity conditions are met, or 1.5 percent over the prime rate. Interest is paid monthly, and the entire amount of any outstanding principal is due at maturity on February 24, 2014. Amounts borrowed under the revolving line of credit are secured by substantially all of the personal property of the Company and generally may be repaid and reborrowed at any time before maturity. In conjunction with the signing of the Loan and Security Agreement, the Company was required to repay all outstanding capital lease obligations under the Master Lease Agreements with BCCL and retire the Master Lease Agreements.

The Loan and Security Agreement contains customary representations, warranties, covenants and events of default including, without limitation, covenants restricting the Company's ability to incur indebtedness and liens, to declare and pay cash dividends and to merge or consolidate with another entity, and also contains a lockbox arrangement and subjective acceleration clause. The Loan and Security Agreement also includes financial covenants requiring the Company to maintain a minimum tangible net worth and adjusted quick ratio. The Company was in compliance with these covenants as of September 30, 2012.

Operating activities used $0.9 million of cash for fiscal 2012 compared to $4.4 million in cash provided by operating activities in fiscal 2011. The increase in cash used by operating activities in fiscal 2012 was driven by an increase in research and development expenditures associated with development of a new mobile solution in addition to the payment of certain business realignment charges.

Cash used in investing activities was $2.9 million for fiscal 2012 compared to $4.1 million for fiscal 2011. During fiscal 2012, the transition to purchase certain equipment used in the Turnpike solution rather than financing through a capital lease facility represented a $0.9 million usage of cash, with the remaining expenditures relating to the Company's continued capital investment in its SaaS infrastructure.

Cash used in financing activities was $1.4 million in fiscal 2012 compared to $1.2 million for fiscal 2011. The increase reflects the early extinguishment of the capital lease facility previously used to finance certain equipment used in the Turnpike solution and the payment of financing costs associated with initiating the revolving line of credit, which were offset, in part, by the Company drawing on the revolving line of credit.

Non-GAAP Financial Measures As of September 30, 2012, XRS Corporation held $7.1 million in cash and cash equivalents and had $9.6 million of working capital. These balances compared to $12.4 million in cash and cash equivalents and working capital of $14.1 million as of September 30, 2011. The following table is a reconciliation of working capital from current assets and current liabilities, which are the most directly comparable financial measures calculated in accordance with GAAP (in thousands): September 30, 2012 2011 Current assets $ 20,942 $ 26,491 Current liabilities (12,882 ) (14,724 ) Net current assets 8,060 11,767Current portion of deferred revenue net of deferred costs 1,544 2,294 Working capital $ 9,604 $ 14,061 The Company recorded negative free cash flow from operations of $3.8 million in fiscal 2012. Free cash flow in 26 -------------------------------------------------------------------------------- Table of Contents fiscal 2012 decreased $4.1 million as compared to free cash flow of $0.3 million in fiscal 2011. Fiscal 2012 cash flows were impacted by increased research and development expenditures, as well as the payment of certain business realignment charges. The negative free cash flow also reflects the transition to purchasing certain equipment used in the Turnpike solution rather than financing through a capital lease facility.

The following table is a reconciliation of free cash flow from net cash provided by operating and investing activities, which are the most directly comparable financial measures calculated in accordance with GAAP (in thousands): For the Year Ended September 30, 2012 2011 Net cash (used in) provided by operating activities $ (906 ) $ 4,408 Purchase of equipment and leasehold improvements (2,012 ) (4,161 ) Purchase of RouteTracker hardware units leased to customers (931 ) - Proceeds from the sale of fixed assets 2 12 Free cash flow $ (3,847 ) $ 259 Working capital and free cash flow are non-GAAP financial measures that management uses to assess the Company's performance. Management believes working capital and free cash flow provide useful information to management and investors by presenting measurements of cash generated from operations that are available to fund operations, invest in product and infrastructure development and repay debt. Our calculations of working capital and free cash flow may not be comparable to similarly titled measures reported by other companies.

The Company believes that based on our current level of operations, cash flow from operations, existing funds, revolving line of credit and vendor terms will provide adequate cash to fund operating needs for the foreseeable future. If we do not generate anticipated cash flow levels, our predictions regarding cash needs may prove inaccurate, and we may require additional financing.

XRS Corporation Series B Preferred Stock prohibits payment of dividends to the holders of any other capital stock unless and until the Company has paid dividends accrued on the Series B Preferred Stock, which pays a cumulative dividend of 4.0 percent per annum of the original issue price (payable semi-annually). At the option of the Series B Preferred Stockholders, such dividends are payable in additional shares of Series B Preferred Stock or cash.

In fiscal 2012 and 2011, the Company issued 81,227 and 84,216 shares, respectively, of Series B Preferred Stock for payment of accrued dividends.

In connection with the acquisition of Turnpike, the Company committed to pay total earn-outs up to an additional 2,500,000 shares of common stock upon the achievement of certain performance goals for the 2010, 2011 and 2012 fiscal years. The Company determined that the fiscal 2010 performance goals were achieved; and, therefore, in December 2010, the Company issued 809,993 shares of common stock to the former shareholders of Turnpike with the value of the remaining 23,340 shares being settled in cash of $70,000 paid to non-accredited U.S. holders.

The Company has determined that the fiscal 2011 and 2012 performance goals were not achieved. As a result, the value of the 809,993 shares of common stock that were to be issued each year were reclassified within shareholders' equity. In addition, the portion scheduled to be settled in cash of $51,000 and $68,000 for the fiscal years ended September 30, 2012 and 2011, respectively, were recorded as income and included in net interest and other expense.

Off-Balance Sheet Arrangements None Recently Issued Accounting Standards See Note 1 in the Notes to Consolidated Financial Statements located in Part II, Item 8 of this Report.

27 -------------------------------------------------------------------------------- Table of Contents

[ Back To Technology News's Homepage ]