[April 30, 2013] COMARCO INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8 of this report as well as our risk factors included in Item 1A of this report. The following discussion contains forward-looking statements. See "Cautionary Note Regarding Forward-Looking Statements" included in Item 1 of this report. Overview Comarco, Inc., through its wholly-owned subsidiary Comarco Wireless Technologies, Inc. (collectively, "we," "us," "our," "Comarco," or the "Company"), is a developer and designer of innovative technologies and intellectual property currently used in power adapters to power and charge battery powered devices such as laptop computers, tablets, smart phones and readers. Our operations consist solely of the operations of Comarco Wireless Technologies, Inc. ("CWT"). 16 --------------------------------------------------------------------------------Going Concern Qualification The Company has experienced pre-tax losses from continuing operations for fiscal 2013 and fiscal 2012 totaling $5.6 million and $5.3 million, respectively. The Company also has negative working capital and uncertainties surrounding the Company's future ability to obtain borrowings and raise additional capital. These factors, among others, raise substantial doubt about our ability to continue as a going concern. Business Strategy and Future Plans Our business today is almost entirely driven by sales of our products to Lenovo (accounting for 98% of our fiscal 2013 revenue), and we continue to focus a significant percentage of our time and resources on providing outstanding products and service to Lenovo, our valued principal customer. In addition to contributing significantly to the value of our ChargeSource® products, our extensive patent portfolio covering key technical aspects of our products could potentially generate an additional revenue stream based upon royalties paid to us by others for the use of some or all of our patents in third party products. We believe that a favorable outcome in the Kensington matter described in Note 13 of Part II, Item 8 of this report, would likely ensure such a revenue stream. Such a favorable outcome cannot be guaranteed and based upon the existing trial date of January, 2014, we may not generate significant royalties, if any, until fiscal 2015. We are concurrently exploring opportunities to monetize our patent portfolio, including through enforcement. A positive outcome in our ongoing litigation with Chicony and Kensington, described in Note 13 of Part II, Item 8 of this report, if such an outcome were realized, could not only reduce our accumulated deficit, but could also provide us with a cash infusion. However, the outcome of our ongoing litigation matters is not determinable as of the date of filing this report. Simultaneously, we are working to build sales of our newest generation AC adapter, branded ChargeSource®. This product line is currently available exclusively on our retail website www.chargesource.com. We believe retail website sales during fiscal 2013 were constrained by our lack of financial resources to implement a marketing plan. Although our financial position has not materially improved, we continue to implement very low cost marketing trials in an attempt to generate retail sales. We are confident that our products can compete very effectively in the marketplace from a technology and value perspective. Our challenge is to ensure that our strategies are tightly aligned with our limited available assets and resources. In summary, our current objectives are focused primarily on maintaining our relationship with Lenovo, monetizing our existing patent portfolio, prevailing or otherwise successfully resolving our current litigation and implementing creative, low cost marketing trials in an attempt to generate sales from our ChargeSource® product line. However, there can be no assurance that we will be successful in any of these objectives. Company Trends and Uncertainties Our business targets the needs of today's mobile culture by providing innovative charging solutions for the myriad of battery powered devices used by nearly all consumers today. Our innovative technology allows the consumer to charge multiple devices from a single charger, eliminating the need to carry multiple chargers while traveling. This technology was developed by Comarco and we own an extensive patent portfolio related to this technology. Management currently considers the following additional trends, events, and uncertainties to be important to an understanding of our business: · Revenue for fiscal 2013 decreased to $6.3 million compared to $8.1 million for fiscal 2012. The decrease is attributable to our exit from the Dell business during the second quarter of fiscal 2013, due to low volumes and thin margins, as well as recording the final Targus sales in fiscal 2012 offset by increased sales to our principal customer Lenovo. 17-------------------------------------------------------------------------------- · On February 11, 2013, we entered into a Secured Loan Agreement (the "Loan Agreement") with Elkhorn Partners Limited Partnership ("Elkhorn"). Pursuant to the Loan Agreement, on February 11, 2013, Elkhorn made a $1,500,000 senior secured term loan (the "Loan") to us. The Loan bears interest at 7% per annum for the first year; increasing to 8.5% per annum thereafter, ranks senior in right of payment to all of our other indebtedness, is secured by a first priority security interest in all of the assets of Comarco and CWT, and is due and payable in full on November 30, 2014. See Note 14 to our consolidated financial statements contained elsewhere in this report for additional information regarding the Loan Agreement, the Loan and certain related agreements. · Concurrent with the execution of the Loan Agreement, Elkhorn entered into a Stock Purchase Agreement with us (the "Stock Purchase Agreement"). Pursuant to that Stock Purchase Agreement, we sold 6,250,000 shares of our common stock to Elkhorn at a price of $0.16 per share, resulting in an aggregate purchase price of $1.0 million. The purchase price of $0.16 per share paid by Elkhorn for those shares was determined by arms-length negotiations between Elkhorn and the members of a special committee of our Board of Directors, comprised of three of the directors who have no affiliation with Elkhorn and no financial interest, other than their interests solely as our shareholders, in either the loan or share transactions with Elkhorn. See Note 14 to our consolidated financial statements contained elsewhere in this report for additional information regarding the Stock Purchase Agreement and certain related agreements. · As a result of our sale of the 6,250,000 shares of common stock to Elkhorn pursuant to the Elkhorn Stock Purchase Agreement, Elkhorn's beneficial ownership has increased from approximately 9% to approximately 49% of our outstanding voting stock, making Elkhorn our largest shareholder. · On January 28, 2013, Broadwood Partners, L.P. ("Broadwood") informed us of its position that one or more of the conditions precedent to its obligation to purchase shares of our common stock pursuant to the SPA had not been satisfied and, as a result, Broadwood would not consummate that purchase. See Note 7 to our consolidated financial statements contained elsewhere in this report for additional information. · On July 28, 2012, our Board of Directors appointed Mr. Louis Silverman to the board and as Chairman of the Board. Mr. Silverman has a track record of turning business opportunities into successful companies with significant revenue and profit growth, resulting in substantial shareholder value creation. · On July 27, 2012, we entered into a Senior Secured Six Month Term Loan Agreement (the "Prior Loan Agreement") with Broadwood, a partnership managed by Broadwood Capital, Inc., the general partner of Broadwood. Broadwood is a significant shareholder of the Company. Pursuant to the Loan Agreement, on July 27, 2012, Broadwood made a $2,000,000 senior secured six month loan (the "Prior Loan") to us. The Prior Loan was repaid on February 11, 2013 from the proceeds received from the Elkhorn Loan and stock purchase described above. See Note 7 to our consolidated financial statements contained elsewhere in this report for additional information regarding the Prior Loan Agreement, the Prior Loan and certain related agreements. · As previously reported, on July 24, 2012, we entered a Settlement Agreement with EDAC Power Electronics, Co. Ltd. ("EDAC") ending the litigation among the parties. As a direct result of the settlement, we discharged $1.4 million in net liabilities due to EDAC. · In December 2011, we launched our direct-to-consumer retail sales channel through our website www.chargesource.com in an effort to increase retail sales and improve gross margins. Revenue generated from this sales channel in fiscal 2013 was not significant and we believe sales were constrained by our lack of financial resources to implement a marketing plan. We continue to implement very low cost marketing trials in an attempt to generate retail sales. · On January 25, 2011 we received written notification from Targus Group International, Inc. ("Targus") of its non-renewal of the Strategic Product Development and Supply Agreement (the "Targus Agreement"). Approximately 15 percent of our revenue for fiscal 2012 was from sales to Targus. We generated no revenue from sales to Targus in fiscal 2013 nor do we expect any future revenue from sales to Targus. · We are focused on preserving our cash balances by monitoring expenses, identifying costs savings, and investing only in those strategies and products that we believe will most likely contribute to our profitability. Additionally, during fiscal 2013 a significant portion of our cash used in operations reported as part of our net loss relates to funding the litigation described in Note 13 to our consolidated financial statements contained elsewhere in this report. 18--------------------------------------------------------------------------------Critical Accounting Policies The preparation of our consolidated financial statements requires us to apply accounting policies and make certain estimates and judgments. All of our significant accounting policies are presented in Note 2 of the notes to the consolidated financial statements in Item 8 of this report. Of our significant accounting policies, we believe the following are the most significant and involve a higher degree of uncertainty, subjectivity, and judgments. These policies involve estimates and judgments that are inherently uncertain. Changes in these estimates and judgments may significantly impact our annual and quarterly operating results. Revenue Recognition We recognize product revenue upon shipment provided there are no uncertainties regarding customer acceptance, persuasive evidence of an arrangement exists, the sales price is fixed or determinable, and collectability is probable. Generally, our products are shipped FOB named point of shipment, whether it is Lake Forest, which is the location of our corporate headquarters, or China, the shipping point for most of our contract manufacturers. Stock-based Compensation We recognize compensation costs for all stock-based awards made to employees, consultants, and directors. The fair value of stock based awards is estimated on the date of grant, and is recognized as expense ratably over the requisite service period. We currently use either a Lattice Binomial or the Black-Scholes option-pricing model to estimate the fair value of our share-based payments. Both the Lattice Binomial and the Black-Scholes option-pricing model are based on a number of assumptions, including expected volatility, expected forfeiture rates, expected life, risk-free interest rate and expected dividends. The prevailing difference between the two models is the Lattice Binomial model's ability to enhance the simple assumptions that underlie the Black-Sholes model. The Lattice Binomial model allows for assumptions such as risk-free rate of interest, volatility and exercise rate to vary over time reflecting a more realistic pattern of economic and behavioral occurrences. If the assumptions change under either model, stock-based compensation may differ significantly from what we have recorded in the past. Derivative Liabilities A derivative is an instrument whose value is "derived" from an underlying instrument or index such as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded in other contracts and for hedging activities. As a matter of policy, we do not invest in separable financial derivatives or engage in hedging transactions. However, we have entered into certain financing transactions in fiscal 2013 that involve financial equity instruments containing certain features that have resulted in the instruments being deemed derivatives. We may engage in other similar complex financing transactions in the future, but not with the intention to enter into derivative instruments. Derivatives are measured at fair value using the Monte Carlo simulation pricing model and marked to market through earnings. However, such new and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation of derivatives often incorporate significant estimates and assumptions. Changes in these subjective assumptions can materially affect the estimate of the fair value of derivative liabilities and, consequently, the related amount recognized as loss due to change in fair value of derivative liabilities on the consolidated statement of operations. Furthermore, depending on the terms of a derivative, the valuation of derivatives may be removed from the financial statements upon exercise or conversion of the underlying instrument into some other security. Accounts Receivable We perform ongoing credit evaluations of our customers and adjust credit limits and related terms based upon payment history and the customer's current credit worthiness. We continually monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Because our accounts receivable are concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse effect on the collectability of our accounts receivable and our future operating results. 19 -------------------------------------------------------------------------------- Specifically, our management must make estimates of the collectability of our accounts receivable. Management analyzes specific customer accounts and establishes reserves for uncollectible receivables based upon specific identification of account balances that have indications of uncertainty of collection. Indications of uncertainty of collections may include the customer's inability to pay, customer dissatisfaction, or other factors. Significant management judgments and estimates must be made and used in connection with establishing the allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of our losses for any period if management made different judgments or utilized different estimates. Valuation of Inventory We value inventory at the lower of the actual cost to purchase and/or manufacture the inventory (calculated on average costs, which approximates first-in, first-out basis) or market value. We regularly review inventory quantities on hand and record a write down of excess and obsolete inventory based primarily on excess quantities on hand based upon historical and forecasted component usage. As demonstrated during prior periods, demand for our products can fluctuate significantly. A significant increase in the demand for our products could result in a short-term increase in the cost of inventory purchases while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. In addition, our industry is characterized by rapid technological change, frequent new product development, and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. In the future, if our inventory were determined to be overvalued, we would be required to recognize such costs in our cost of revenue at the time of such determination. Therefore, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and our operating results. Income Taxes We are required to estimate our provision for income taxes in each of the tax jurisdictions in which we conduct business. This process involves estimating our actual current tax expense in conjunction with the evaluation and measurement of temporary differences resulting from differing treatment of certain items for tax and accounting purposes. These temporary timing differences result in the establishment of deferred tax assets and liabilities, which are recorded on a net basis and included in our consolidated balance sheets. We then assess on a periodic basis the probability that our net deferred tax assets, if any, will be recovered. If after evaluating all of the positive and negative evidence, a conclusion is made that it is more likely than not that some portion or all of the net deferred tax assets will not be recovered, a valuation allowance is provided with a corresponding charge to tax expense to reserve the portion of the deferred tax assets which are estimated to be more likely than not to be realized. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any required valuation allowance. We continue to maintain a full valuation allowance on the entire deferred tax asset balance. This valuation allowance was established based on management's overall assessment of risks and uncertainties related to our future ability to realize, and hence, utilize certain deferred tax assets, primarily consisting of net operating loss carry forwards and temporary differences. Due to the current and prior years' operating losses, the adjusted net deferred tax assets remained fully reserved as of January 31, 2013. Valuation of Long-Lived Assets We evaluate long-lived assets used in operations when indicators of impairment, such as reductions in demand or significant economic slowdowns that negatively impact our customers or markets, are present. Reviews are performed to determine whether the carrying value of assets is impaired based on comparison to the undiscounted expected future cash flows. If the comparison indicates that there is impairment, the impaired asset is written down to fair value, which is typically calculated using a weighted average of the market approach and the discounted expected future cash flows using a discount rate based upon our cost of capital. Impairment is based on the excess of the carrying amount over the fair value of those assets. Significant management judgment is required in the forecast of future operating results that is used in the preparation of expected discounted cash flows. It is reasonably possible that the estimates of anticipated future net revenue, the remaining estimated economic life of the products and technologies, or both, could differ from those used to assess the recoverability of these assets. In that event, additional impairment charges or shortened useful lives of certain long-lived assets could be required. 20 --------------------------------------------------------------------------------Warranty Costs We provide limited warranties for products for a period generally not to exceed 24 months. We accrue for the estimated cost of warranties at the time revenue is recognized. The accrual is a fixed rate which is consistent with our actual claims experience. Should actual warranty claim rates differ from our estimates, revisions to the liability would be required. We recorded an additional accrual of $0.2 million related to the recall during fiscal 2012. Significant management judgments and estimates have been made to determine the amount of the recall accrual. We believe we have accrued and paid for substantially all of our material financial obligations with respect to the recall. We are in on-going litigation with the manufacturer of the Bronx product that is the subject of the recall. Results of Operations-Continuing Operations The following tables set forth certain items as a percentage of revenue from our audited consolidated statements of operations for fiscal 2013 and fiscal 2012: Years Ended January 31, 2013 over 2013 2012 2012 (In thousands) % Change % of Revenue % of Revenue Revenue $ 6,338 100% $ 8,069 100% (21 %) Operating loss $ (3,008 ) $ (5,263 ) Net loss from continuing operations $ (5,592 ) $ (5,289 ) Years Ended January 31, 2013 over 2013 2012 2012 (In thousands) % Change Revenue: North America $ 78 $ 2,397 (97 %) Europe 22 26 (15 %) Asia - Pacific 6,238 5,646 10 % $ 6,338 $ 8,069 (21 %) Years Ended January 31, 2013 over 2013 2012 2012 (In thousands) % Change Revenue: Dell $ 67 $ 1,398 (95 %) Lenovo 6,203 5,345 16 % Targus - 1,174 (100 %) Other 68 152 (55 %) $ 6,338 $ 8,069 (21 %) 21--------------------------------------------------------------------------------Revenue The fiscal 2013 decrease in revenue of $1.7 million is attributable primarily to the loss of Targus as a customer during fiscal 2012. As previously discussed, on January 25, 2011, we received written notification from Targus of its non-renewal of the Targus Agreement. We expect no future revenue from Targus. Additionally, revenue to Lenovo increased $0.9 million or 16 percent. The increase was primarily due to a prior year disruption in our supply chain, which was remediated in fiscal 2013. We introduced a 90 watt DC adapter sold exclusively to Dell in May 2010. We exited the Dell business during fiscal 2013 due to low sales volumes and thin product margins, coupled with high administrative costs. We expect no future revenue from Dell. Cost of Revenue and Gross Margin Years Ended January 31, 2013 over 2013 2012 2012 (In thousands) % Change % of % of Total Total Cost of Revenue: Product costs $ 4,375 105 % $ 4,824 58 % (9 %) Accrued product recall costs - - 248 3 % (100 %) Supplier Settlement (1,443 ) (35 %) 383 5 % (477 %) Supply chain overhead 812 20 % 1,620 20 % (50 %) Inventory reserve and scrap charges 406 10 % 1,014 12 % (60 %) Freight, expedite, and other charges - - 172 2 % (100 %) $ 4,150 100 % $ 8,261 100 % (50 %) Years Ended January 31, 2013 over 2013 2012 2012 ppt Change Gross profit (loss) percent 35 % (2 %) 37 Gross profit percent, excluding supplier settlement 12 % 2 % 10 The fiscal 2013 decrease in the total cost of revenue of $4.1 million compared to fiscal 2012 is attributable to reduced product costs, freight, expedite and other costs, supply chain overhead, inventory reserve and scrap charges and recall accruals incurred during fiscal 2012 as well as a favorable settlement with a former supplier in fiscal 2013 compared to the fiscal 2012 supplier settlement. The product costs incurred in fiscal 2013 decreased by $0.4 million or 9 percent compared to fiscal 2012, which is generally consistent with our 21 percent decrease in revenue. However, approximately $0.9 million of the Targus revenue recorded in fiscal 2012 related to re-worked Bronx product, and it had no associated product costs as those costs, totaling approximately $0.6 million, had been recorded in the fiscal 2011, and the associated revenue had been deferred due to uncertainty of collection at the time. As previously discussed, in fiscal 2011 we announced a voluntary product safety recall of approximately 500,000 units of our Bronx 90-watt universal AC power adapter sold to our distributer, Targus. Included in the cost of revenue fiscal 2012 is an accrual for the estimated product costs associated with the recall of $0.2 million. During the second quarter of fiscal 2013, we entered a Settlement Agreement with EDAC Power Electronics, Co. Ltd. ("EDAC") ending the litigation among the parties. As a direct result of the settlement, we reversed previously incurred product and freight costs and discharged $1.4 million in net liabilities due to EDAC. During the second quarter of fiscal 2012, we accrued a charge of $0.4 million relating to a settlement reached with Anam Electronics ("Anam") relating to purchase commitments made to support the Targus business. Our supply chain overhead expenses decreased $0.8 million or 50 percent in fiscal 2013 compared to fiscal 2012. The decrease is due to reductions in personnel and related costs as well as other expenses as a result of continued cost cutting measures. The inventory reserve and scrap charges of $0.4 million recorded in fiscal 2013 relates primarily to reserves established for excess ChargeSource components as well as slow-moving inventory. The inventory reserve and scrap charges of $1.0 million recorded in fiscal 2012 relates primarily to Manhattan product components that we procured from Anam during fiscal 2012 as well as reserves established for excess tips located in many warehouses as well as increases in our reserves due to slow-moving inventory. 22 -------------------------------------------------------------------------------- The freight, expedite and other charges in fiscal 2012 relate primarily to Dell shipments. As Dell has worldwide inventory hubs, our shipping costs increased due to the lower per-shipment volume required by these various locations. Although we still incur freight expenses, the amounts are not material compared to the prior fiscal year amounts and the current year amounts are included in the supply chain overhead. Operating Costs and Expenses Years Ended January 31, 2013 over 2013 2012 2012 (In thousands) % Change % of Revenue % of Revenue Operating expenses: Selling, general, and administrative expenses, excluding corporate overhead $ 256 4 % $ 675 8 % (62 %) Corporate overhead 2,505 40 % 2,465 31 % 2 % Engineering and support expenses 2,435 38 % 1,931 24 % 26 % $ 5,196 82 % $ 5,071 63 % 2 % The fiscal 2013 decrease in selling, general and administrative expenses of $0.4 million compared to fiscal 2012 relates primarily to decreased personnel and related costs. During the third quarter of fiscal 2012, our former Vice President of Sales and Marketing and interim Chief Executive Officer was terminated and a settlement of $40,000 paid in the third fiscal quarter of fiscal 2012 is included in the amounts above. During fiscal 2013, the sales and marketing function was performed by various consultants who are focused on digital media and search engine optimization to assist with generation of sales on our website www.chargesource.com. Corporate overhead consists of salaries and other personnel-related expenses of our accounting and finance, human resources and benefits, and other administrative personnel, as well as professional fees, directors' fees, and other costs and expenses attributable to being a public company. The increase of $40,000 for the year ended January 31, 2013 relates primarily to increased legal expenses of approximately $0.3 million related primarily to the Chicony litigation offset by decreases in rent expense, insurance, travel and other expenses. Engineering and support expenses generally consist of salaries, employer paid benefits, and other personnel related costs of our engineers and testing personnel, as well as facility and IT costs, professional and consulting fees, lab costs, material usages, and travel and related costs incurred in the development and support of our products. The fiscal 2013 increase in engineering and support costs includes approximately $0.9 million in increased legal fees primarily due to the Kensington litigation offset by decreases of approximately $0.3 million and $0.1 million respectively, in personnel and related expenses (due primarily to a reduction in overall headcount) and decreased rent expense (pursuant to the amended lease we entered into in fiscal 2012). Interest Expense, Net Interest expense, net, consists primarily of amortization expense related to the loan discount and interest expense offset by interest income, if any. During fiscal 2013, we incurred approximately $1.4 million in amortization of the loan discount. Additionally, loan fees totaling $55,000 related to our Loan Agreement with Broadwood were expensed as incurred. During fiscal 2012, we earned $2,000 in interest income and incurred approximately $65,000 in interest expense and loan origination fees related to our former Silicon Valley Bank ("SVB") credit facility. Loss Due to Change in Fair Value of Derivative Liabilities For fiscal 2013, we reported an increase in the fair value of our derivative liabilities of approximately $1.1 million (See Note 8 of Part II, Item 8 of this report). Our derivative liabilities consist solely of the warrants issued to Broadwood in the second quarter of fiscal 2013. 23 --------------------------------------------------------------------------------Other Income (Loss), Net During fiscal 2012, we recorded other income of $35,000 related to a final distribution of the sale of our investment in SwissQual AG from fiscal 2006. Income Tax Benefit Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any required valuation allowance. We continue to maintain a full valuation allowance on the entire deferred tax asset balance. This valuation allowance was established based on management's overall assessment of risks and uncertainties related to our future ability to realize, and hence, utilize certain deferred tax assets, primarily consisting of net operating loss carry forwards and temporary differences. Due to the current and prior years' operating losses, the adjusted net deferred tax assets remained fully reserved as of January 31, 2012. During fiscal 2013, we recorded a net loss of $5.6 million and recorded income tax expense of $1,600, which represents the minimum tax due in the state of California. The net deferred tax asset of $17.7 million, $2.4 million of which relates to net operating losses created in fiscal 2013, at January 31, 2013 continues to be fully reserved. During fiscal 2012, we recorded a net loss of $5.3 million and recorded income tax expense of $1,600, which represents the minimum tax due in the state of California. The net deferred tax asset of $17.1 million at January 31, 2012 was fully reserved, and included $1.5 million of net operating loss carryforwards created in fiscal 2012. Discontinued Operations, net of income taxes Income from Discontinued Operations - Wireless Test Solutions The sale of our wireless test solutions ("WTS") business was completed on January 6, 2009, between us and Ascom Holding AG and its subsidiary Ascom Inc., (collectively, "Ascom"), which resulted in a pre-tax gain of $5.9 million. The fiscal 2012 year to date loss from WTS discontinued operations of $21,000 relates to a sales tax audit performed by the California State Board of Equalization during the second quarter of fiscal 2012. The expensed amount represents the portion of the assessment borne by us for the sale of our WTS business to Ascom. Liquidity and Capital Resources The following table is a summary of our Consolidated Statements of Cash Flows: Years Ended January 31, 2013 2012 (In thousands) Cash provided by (used in): Operating activities $ (2,712 ) $ (4,236 ) Investing activities (92 ) (184 ) Financing activities 2,000 (1,053 ) Cash Flows from Operating Activities The cash used in operating activities during fiscal 2013 of $2.7 million relates to our net loss of $5.6 million and is offset by non-cash amortization of the Broadwood loan discount of $1.4 million, an increase in the fair value of derivative liabilities of $1.1 million and stock-based compensation expense of $0.2 million. Additionally, we had a non-cash settlement with EDAC crediting our cost of revenue in the amount of $1.4 million and total receivable increases of $1.3 million, offset by increases totaling $2.2 million in accounts payable and accrued liabilities and a decrease in net inventory of $0.7 million. 24 -------------------------------------------------------------------------------- The cash used in operating activities during fiscal 2012 of $4.2 million relates to our net loss of $5.3 million and is offset by non-cash depreciation and stock-based compensation of $0.4 million and $0.2 million, respectively. Accounts receivable collections from customers totaled $2.6 million in fiscal 2012. This source of cash is offset by a combined net decrease in accrued liabilities and accounts payable of $2.7 million related primarily to supplier payments. Late in the fourth quarter of fiscal 2013, we initiated a reduction in force across all departments in order to reduce our cash burn. Our January 31, 2013 cash balance was approximately $100,000 which was increased by approximately $400,000 from the proceeds received from Elkhorn during the first quarter of fiscal 2014. While we anticipate that our cost cutting measures will reduce our cash burn during fiscal 2014, we may require further cost cutting measures and/or additional capital from debt or equity financing to fund our operations. We cannot be certain that such financing will be available to us on acceptable terms, or at all. Cash Flows from Investing Activities During fiscal 2013, we spent $0.1 million in capital equipment purchases, which primarily related to purchases of tooling and other equipment used by our contract manufacturers and engineers for the manufacture and design of our products. Our restricted cash balance declined by $10,000 in fiscal 2013 as we reduced the collateral requirement for our chargebacks related to our merchant services account, which we opened in the third quarter of fiscal 2012 in anticipation of the launch of our retail website www.chargesource.com. During fiscal 2012, we spent $0.1 million in capital equipment purchases, which primarily related to purchases of tooling and other equipment used by our contract manufacturers and engineers for the manufacture and design of our ChargeSource® products. Additionally, during fiscal 2012, we generated restricted cash of $92,000, of which $77,000 relates to the security deposit of for our corporate lease, which became collateralized by cash in a separate bank account. The remaining $15,000 of restricted cash relates to collateralized cash balances for chargebacks related to our merchant services account. Cash Flows from Financing Activities; Loan Agreement & Credit Facility On July 27, 2012, we entered into a Senior Secured Six Month Term Loan Agreement (the "Broadwood Loan Agreement") with Broadwood. Pursuant to the Broadwood Loan Agreement, on July 27, 2012, Broadwood made a $2,000,000 senior secured six month loan (the "Broadwood Loan") to us. The Broadwood Loan bore interest at 5% per annum, ranked senior in right of payment to all of our other indebtedness, was secured by a first priority security interest granted to Broadwood in all of our assets, and was due and payable in full on January 28, 2013. The Broadwood Loan was paid in full on February 11, 2013 with debt and equity financing secured from Elkhorn Partners Limited Partnership ("Elkhorn"). (See Notes 7 and 14 of Part II, Item 8 of this report). In conjunction with the Broadwood Loan Agreement, we incurred $55,000 in loan fees that are reported in interest expense, net in our consolidated statement of operations for fiscal 2013. On February 11, 2009, we entered into a Loan and Security Agreement (the "SVB Agreement") with SVB. The SVB Agreement was renewed on February 8, 2010 and again on February 9, 2011 and originally matured, on February 9, 2012, at which time, any outstanding principal balance was to be paid in full. During the first quarter of fiscal 2012, we repaid the $1.0 million that had been outstanding under the SVB Agreement and we incurred $53,000 in loan origination fees relating to its renewal. On September 15, 2011, we received a letter from SVB terminating the SVB Agreement effective September 22, 2011. Uncertainties Regarding Future Operations and the Funding of Liquidity Requirements for the Next 12 Months As of January 31, 2013, we had negative working capital of approximately $7.0 million, of which $2.5 million relates to the fair value of derivative liabilities. In order for us to continue our operations for the next twelve months and to be able to discharge our liabilities and commitments in the normal course of business, it will be necessary for us to increase sales, effectively manage operating expenses, and raise additional funds, through either debt and/or equity financing to meet our cash requirements during the next twelve months. No assurance can be given, however, that we will be successful in meeting those operating objectives or cash requirements. 25 -------------------------------------------------------------------------------- On February 11, 2013, we and Elkhorn, entered into a Secured Loan Agreement (the "Elkhorn Loan Agreement") and a Stock Purchase Agreement (the "Elkhorn SPA"), and certain related agreements (collectively, the "Elkhorn Agreements"). Pursuant to those agreements, Elkhorn made a $1.5 million senior secured loan to us with a maturity date of November 30, 2014 (the "Elkhorn Loan") and purchased a total of 6,250,000 shares of our common stock at a cash purchase price of $0.16 per share, generating an additional $1.0 million of cash for the Company. On February 11, 2013, we used approximately $2.1 million of the proceeds of $2.5 million from the Elkhorn Loan and the sale of the shares to Elkhorn to pay the entire principal amount of and all accrued interest on the Broadwood Loan. Concurrent with the execution of the Broadwood Loan Agreement, the Company and Broadwood entered into a Stock Purchase Agreement (the "SPA"). The SPA provided for the purchase by Broadwood of up to 3,000,000 shares of our common stock, at a price of $1.00 per share, subject to the following conditions: (i) during the six month term of the Broadwood Loan, we would use our best commercial efforts to raise at least $3.0 million from the sale of additional equity securities to other investors, which could include other shareholders of the Company, and (ii) we remain in compliance with our covenants under the Broadwood Loan Agreement. We were informed by Broadwood on January 28, 2013, that it was Broadwood's position that one or more of the conditions precedent to its obligation to purchase shares of our common stock pursuant to the SPA had not been satisfied and, as a result, Broadwood would not consummate that purchase. It is our position that, contrary to Broadwood's assertions, all of the conditions under the SPA had been satisfied, and Broadwood's refusal to purchase 3,000,000 shares of our common stock, at the price of $1.00 per share, constituted a material breach by Broadwood of its obligations under the SPA. As a result, as of the date of filing this report, we have not issued any additional stock purchase warrants to Broadwood and each party has reserved its rights under and with respect to the SPA and any stock purchase warrants that may be owed to Broadwood. As discussed above, there are several factors and events that could significantly affect our future cash flows from operations, including, without limitation the following: · Our continued relationship with our primary customer Lenovo (representing 98% of our total revenues for fiscal 2013); · Our patent enforcement efforts; · Our future retail sales of our ChargeSource® products generated from our website www.chargesource.com; · The cost and outcome of ongoing litigation with our former contract manufacturer of the Bronx product, the subject of a product recall, and with Kensington, the maker of competitive power adapters; · The outcome of our dispute with Broadwood; · Our ability to raise additional debt or equity financing; and · The ability of our contract manufacturers to manufacture our products at the level currently anticipated, and the ability of our products to meet any required specifications. As we execute our current strategy, however, we may require further debt and/or equity capital to fund our working capital needs. In particular, we have experienced, and anticipate that we may again experience, a negative operating cash flow. However, there can be no assurance that the additional financing we may need will be available on terms acceptable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of opportunities, enforce our intellectual property, develop new revenue streams or otherwise respond to competitive pressures, our operating results and financial condition could be adversely affected and we may not be able to continue as a going concern. 26 -------------------------------------------------------------------------------- If we become unable to continue as a going concern, we may have to liquidate our assets, and might realize significantly less than the values at which they are carried on our financial statements, and stockholders may lose all or part of their investment in our common stock. The consolidated financial statements included in this report do not reflect any adjustments related to the outcome of this uncertainty. Contractual Obligations In the course of our business operations, we incur certain commitments to make future payments under contracts such as operating leases and purchase orders. Payments under these contracts are summarized as follows as of January 31, 2013 (in thousands): Payments due by Period Less than 1 to 3 3 to 5Long Term Debt Obligations 1 year years years More than 5 years Total Operating lease obligations $ 239 $ 504 $ 152 $ - $ 895 Purchase obligations 1,509 - - - 1,509 $ 1,748 $ 504 $ 152 $ - $ 2,404 We generally issue purchase orders to our suppliers with delivery dates from four to six weeks from the purchase order date. In addition, we regularly provide significant suppliers with rolling six-month forecasts of material and finished goods requirements for planning and long-lead time parts procurement purposes only. We are committed to accepting delivery of materials pursuant to our purchase orders subject to various contract provisions that allow us to delay receipt of such order or allow us to cancel orders beyond certain agreed lead times. Such cancellations may or may not include cancellation costs payable by us. In the past, we have been required to take delivery of materials from our suppliers that were in excess of our requirements and we have previously recognized charges and expenses related to such excess material. During fiscal 2012, we incurred expenses relating to cancellation of purchase orders to Anam in the amount of $0.4 million, which amount was recorded in cost of revenue in our consolidated statement of operations. If we are unable to adequately manage our suppliers and adjust such commitments for changes in demand, we may incur additional inventory expenses related to excess and obsolete inventory. Such expenses could have a material adverse effect on our business, results of operations, and financial position. Our fixed purchase commitments at January 31, 2013 totaled $1.5 million, of which approximately $0.3 million was cancelable as of January 31, 2013. In addition to the amounts shown in the table above, we have unrecognized tax benefits in the amount of $0.8 million, which we are uncertain as to if or when such amounts may be settled. We have severance compensation agreements with key executives. These agreements require us to pay these executives, in the event of a termination of employment following a change of control of the Company or other circumstances, their then current annual base salary and the amount of any bonus amount the executive would have achieved for the current year. We have not recorded any liability in the consolidated financial statements for these agreements. Although the contemplated sale of shares of common stock and the issuance of the warrants and possible issuance of additional warrant shares by us to Broadwood could result in a "Change of Control" for purposes of the severance compensation agreements, each of the executives who are parties to those agreements has waived their rights to receive payments under those agreements in the event that a "Change of Control" occurs as a result of the sale of shares and the issuance of warrants and additional warrants to Broadwood. Additionally, as a result of our sale of the 6,250,000 shares of common stock to Elkhorn, as discussed above, Elkhorn's beneficial ownership of our common stock has increased from approximately 9% to approximately 49%, making Elkhorn our largest shareholder. Each of the executives who are parties to severance compensation agreements has waived their rights to receive payments under those agreements as a result of the issuance of shares to Elkhorn. 27 --------------------------------------------------------------------------------Recent Accounting Pronouncements In May 2011, the FASB issued Accounting Standards Update ("ASU") 2011-04, "Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards ("IFRS")," which amends current fair value measurement and disclosure guidance to converge with International Financial Reporting Standards and provides increased transparency around valuation inputs and investment categorization. ASU 2011-04 also requires new disclosures about qualitative and quantitative information regarding the unobservable inputs used in a fair value measurement that is categorized within Level 3 of the fair value hierarchy. We adopted ASU 2011-04 in the second quarter of fiscal 2013, when it became applicable to us. In June 2011, the FASB issued ASU No. 2011-05, "Presentation of Comprehensive Income." ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in stockholders' equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU 2011-05 did not have a material impact on our consolidated balance sheet, results of operations or cash flow. [ Back To TMCnet.com's Homepage ]