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XRS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements Except for the historical information contained herein, the matters discussed in this Report on Form 10-Q are forward-looking statements involving risks and uncertainties that could cause actual results to differ materially from those in such forward-looking statements. Numerous factors, risks and uncertainties affect the Company's operating results and could cause the Company's actual results to differ materially from forecasts and estimates or from any other forward-looking statements made by, or on behalf of, the Company, and there can be no assurance that future results will meet expectations, estimates or projections. Risks and uncertainties include, but are not limited to, the following: • As we have generated operating losses recently, additional operating losses may occur in the future and may be in excess of amounts that could be funded from operations, thus, we may be dependent upon external investment to support our operations during these periods; • Our growth and profitability depend on our timely introduction and market acceptance of new solutions, our ability to continue to fund research and development activities and our ability to establish and maintain strategic partner relationships; • We will have dependence on proprietary technology and communication networks owned and controlled by others, and accordingly, their problems may adversely impact us; and • For the foreseeable future, we are dependent upon existing customers continuing to utilize our solutions. Further information regarding these and other risks is included in "Risk Factors" in Part 1, Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2012, in this Form 10-Q and in our other filings we make with the Securities and Exchange Commission. Overview XRS Corporation, formerly Xata Corporation, and its wholly owned subsidiary, Turnpike Global Technologies, Inc. (collectively, XRS Corporation, the Company, we, our or us) delivers fleet management and compliance software solutions to the trucking industry to help maintain regulatory compliance and reduce operating costs. XRS Corporation is leading the trucking industry's migration to mobile devices for collecting and analyzing compliance and management data. Our mobility-based solutions have no upfront hardware costs and run on smartphones, tablets and rugged handhelds. XRS Corporation has sales and distribution partnerships with the major wireless carriers supporting the U.S. and Canadian trucking industries. The Company's solutions include: • XataNet: a fleet optimization and compliance solution focused on addressing the needs of fleets from managing compliance risks to maximizing performance. • Turnpike: a mobile fleet optimization and compliance solution that uses a monthly subscription model with no upfront hardware fees. • MobileMax: a wireless communication solution for the for-hire market with integrated back-office systems. The Company's strong foundation with electronic driver logs, being a leading company in the introduction of fully U.S. Department of Transportation compliant automated on-board recording device (AOBRD) solutions for the tracking of hours of service, has allowed us to establish a customer base consisting of over 1,400 customers and 114,000 subscribers who utilize our compliance, fleet performance and driver workflow solutions. In fiscal 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. 21 -------------------------------------------------------------------------------- Table of Contents The acquisition of Turnpike Global Technologies, Inc. in 2010 brought a customer base using mobile devices with 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 allows XRS Corporation to add fleet management to the overall power of the mobile solution with no upfront hardware costs. This also enables 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. Next Generation Solution In the second quarter of 2013, we introduced our next generation mobile solution, XRS, was available for sale. More than just AOBRD software, the new XRS mobile communications solution combines all the features and benefits of the leading fleet management platforms in a single package. The XRS mobile solution uses the subscription delivery 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. It increases functionality of current offerings with dispatch management, customizable workflow forms and integration with third-party systems. It is built using cloud-based technology allowing XRS Corporation to scale our technology operations to meet anticipated market demand. Critical Accounting Policies Our consolidated financial statements are prepared in accordance with the accounting principles generally accepted in the U.S. (GAAP) as set forth in the Financial Accounting Standards Board's Accounting Standards Codification (ASC) and consider the various staff accounting bulletins and other applicable guidance issued by the Securities and Exchange Commission. GAAP, as set forth within the ASC, requires us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our consolidated financial statements will be affected. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following: • Revenue Recognition • Allowance for Doubtful Accounts • Goodwill and Intangible Assets • Warranties • Income Taxes In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management's judgment in its application. There are also areas in which management's judgment in selecting among available alternatives would not produce a materially different result. Our senior management has reviewed these critical accounting policies and related disclosures with the Audit Committee of the Board of Directors. There were no changes to the Company's critical accounting policies during the six months ended March 31, 2013. Please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended September 30, 2012 for a more complete discussion of our critical accounting policies and estimates. 22 -------------------------------------------------------------------------------- Table of Contents Results of Operations for the Three and Six Months Ended March 31, 2013 and 2012 The following table includes detail of revenue and cost of goods sold (in thousands): For the Three Months Ended For the Six Months Ended March 31, March 31, 2013 2012 2013 2012 Revenue: Software $ 11,578 $ 11,703 $ 23,347 $ 23,389 Hardware systems 2,580 3,624 4,771 8,088 Services 338 532 573 983 Total revenue $ 14,496 $ 15,859 $ 28,691 $ 32,460 Cost of goods sold: Software $ 3,083 $ 3,394 $ 6,134 $ 6,610 Hardware systems 2,425 3,778 4,158 8,544 Services 538 662 1,060 1,331 Total cost of goods sold $ 6,046 $ 7,834 $ 11,352 $ 16,485 In the above table, 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, embedded leasing charges on the Turnpike solution (where the customer selected the no upfront hardware cost option), monthly fees from the MobileMax solution and activation fees. • Hardware systems revenue includes hardware with embedded firmware and, for the XataNet solution, 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 Relay assets (formerly RouteTracker assets, where the customer selected the no upfront hardware cost option) and direct personnel costs related to network infrastructure, as well as technical support for the Turnpike solution. • Hardware systems cost of goods sold consists of direct product costs, warranty costs and product repair costs, as well as direct personnel costs related to the XataNet solution and technical support for the Mobilemax solution. • Services cost of goods sold consists of third-party vendor costs and direct costs related to services personnel. Revenue Total revenue of $14.5 million for the three months ended March 31, 2013 decreased 8.6 percent, compared to $15.9 million for the same period in fiscal 2012. Total revenue of $28.7 million for the six months ended March 31, 2013 decreased 11.6 percent, compared to $32.5 million for the same period in fiscal 2012. The decrease in revenue is a result of decreased hardware revenue as the Company's customers continue to shift to mobile-based solutions with no upfront hardware costs. Software revenue for the three months ended March 31, 2013 of $11.6 million remained relatively consistent with the same period in fiscal 2012. Turnpike mobile software revenue grew 26.6 percent over the same period in fiscal 2012 driven by the continued demand for mobile-based solutions. Software revenue comprised 79.9 percent of total revenue for the three months ended March 31, 2013, compared to 73.8 percent for the same period in fiscal 2012. 23 -------------------------------------------------------------------------------- Table of Contents Hardware systems revenue decreased 28.8 percent to comprise 17.8 percent of total revenue for the three months ended March 31, 2013, compared to 22.9 percent of revenue for the same period in fiscal 2012. This decline is attributable to decreased sales of XataNet hardware systems as adoption of the Turnpike no upfront hardware cost solution continues to increase, which does not require the customer to purchase hardware. Cost of Goods Sold and Gross Margin Total cost of goods sold decreased 22.8 percent to $6.0 million for the three months ended March 31, 2013, compared to $7.8 million for the same period in fiscal 2012. Total cost of goods sold decreased 31.1 percent to $11.4 million for the six months ended March 31, 2013, compared to $16.5 million for the same period in fiscal 2012 in conjunction with decreased hardware systems revenue. Overall gross margins increased 7.7 percentage points to 58.3 percent of revenue for the three months ended March 31, 2013, compared to 50.6 percent of revenue for the same period in fiscal 2012. Overall gross margins increased 11.2 percentage points to 60.4 percent of revenue for the six months ended March 31, 2013, compared to 49.2 percent of revenue for the same period in fiscal 2012. The improvement in overall gross margins reflects an increase in software revenue as a percentage of total revenue as well as improvements in both software and hardware systems gross margins. Software cost of goods sold of $3.1 million decreased 9.2 percent for the three months ended March 31, 2013, compared to $3.4 million for the same period in fiscal 2012. Software gross margin increased 2.4 percentage points to 73.4 percent of revenue for the three months ended March 31, 2013, compared to 71.0 percent for the same period in fiscal 2012. The improvement in software margins is attributable to decreased infrastructure and communication costs. Hardware systems cost of goods sold of $2.4 million decreased 35.8 percent for the three months ended March 31, 2013, compared to $3.8 million for the same period in fiscal 2012. Hardware systems gross margins improved by 10.2 percentage points to 6.0 percent of revenue for the three months ended March 31, 2013, compared to negative 4.2 percent for the same period in fiscal 2012. The improvement in hardware margins can be attributed to favorability in warranty activity and to higher margin parts sales representing a larger portion of total hardware systems revenue. Selling, General and Administrative Expenses Selling, general and administrative expenses consist of personnel costs for the Company's sales, marketing, 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 $5.3 million for the three months ended March 31, 2013, compared to $6.6 million for for the same period in fiscal 2012. Selling, general and administrative expenses were $10.8 million for the six months ended March 31, 2013, compared to $12.7 million for for the same period in fiscal 2012. A decrease in the Company's amortization and personnel expenses, which resulted from the fiscal 2012 third quarter intangible asset impairment and business realignment events, has driven the favorability realized in first half of fiscal 2013. Research and Development Expenses Research and development expenses consist of personnel costs and expenses related to development of new solutions and added functionality to existing solutions. Research and development expenses were $2.8 million or 19.3 percent of revenue for the three months ended March 31, 2013, compared to $3.5 million or 22.1 percent of revenue for the same period in fiscal 2012. Research and development expenses were $5.8 million or 20.4 percent of revenue for the six months ended March 31, 2013, compared to $7.0 million or 21.6 percent of revenue for the same period in fiscal 2012. The Company capitalized $0.3 million in software development costs associated with the XRS mobile solution during the three months ended March 31, 2013, representing approximately 8.9 percent of total research and development costs. 24 -------------------------------------------------------------------------------- Table of Contents Net Interest and Other Expense Net interest and other expense was $29,000 for the three months ended March 31, 2013, compared $0.2 million for the same period in fiscal 2012. Net interest and other expense was $47,000 for the six months ended March 31, 2013, compared $0.3 million for the same period in fiscal 2012. As of March 31, 2013, the Company utilized increased cash provided by operations to maintain a debt-free balance sheet, compared to debt of $2.3 million as of September 30, 2012. Lower average outstanding debt balances in combination with 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, resulted in lower interest expense, thereby contributing to the decrease in net interest and other expense. Income Taxes The Company's effective tax rate was 16.4 percent for the for the six months ended March 31, 2013, compared to 7.6 percent for the same period in fiscal 2012. The higher tax rate for the six months ended March 31, 2013 was attributable to improved results from operations coupled with the recording of a valuation allowance to the extent of the Company's Canadian deferred tax assets. The Company does not have objectively verifiable positive evidence of future taxable income; accordingly, the Company concluded that a valuation allowance of the Company's deferred tax assets is appropriate. The realization of the 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 maintains 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 Income (Loss) to Common Shareholders Net income to common shareholders was $0.1 million for for the three months ended March 31, 2013, compared to a net loss to common shareholders of $2.1 million for the same period in fiscal 2012. Net income to common shareholders was $0.4 million for for the six months ended March 31, 2013, compared to a net loss to common shareholders of $3.8 million for the same period in fiscal 2012. Net income (loss) to common shareholders reflects preferred stock dividends and preferred stock deemed dividends of $0.1 million for each of the three and six months ended March 31, 2013 and 2012. Liquidity and Capital Resources Operating activities provided $4.2 million of cash for the six months ended March 31, 2013, compared to $0.9 million in cash used by operating activities for the same period in fiscal 2012. Net income of $0.5 million for the six months ended March 31, 2013, compared to a net loss of $3.7 million for the same period in fiscal 2012, served as the primary contributor to the increase. Cash used in investing activities was $1.5 million for the six months ended March 31, 2013, compared to $2.0 million for the same period in fiscal 2012. For the six months ended March 31, 2013, $1.2 million of cash was used to purchase certain equipment used in the Turnpike solution rather than financing through a capital lease facility as was done in the comparable period in the prior year. Cash used in investing activities for the six months ended March 31, 2012 also reflected investment in the Company's SaaS infrastructure. Cash used in financing activities was $2.4 million for the six months ended March 31, 2013, which reflects the Company's payoff of all outstanding debt facilities, resulting in a debt-free balance sheet as of March 31, 2013. The Company recorded $0.8 million in cash used in financing activities in the comparable period in fiscal 2012, which 25 -------------------------------------------------------------------------------- Table of Contents represented payments on the capital lease facility then used to finance certain equipment used in the Turnpike solution. Non-GAAP Financial Measures The Company recorded free cash flow of $2.8 million for the six months ended March 31, 2013, an increase of $5.7 million as compared to negative free cash flow of $2.9 million for the same period in fiscal 2012. The increase in free cash flow was driven by net income of $0.5 million for the six months ended March 31, 2013, compared to a net loss of $3.7 million for the same period in fiscal 2012. The following table is a reconciliation of free cash flow from net cash provided by (used in) operating activities and net cash used in investing activities, which are the most directly comparable financial measures calculated in accordance with GAAP (in thousands): For the Six Months Ended March 31, 2013 2013 2012 Net cash provided by (used in) operating activities $ 4,247 $ (906 ) Net cash used in investing activities: Purchase of equipment and leasehold improvements (224 ) (1,915 ) Purchase of Relay assets (formerly RouteTracker assets) (1,162 ) (67 ) Capitalized software development (85 ) - Proceeds from the sale of equipment 16 2 Net cash used in investing activities (1,455 ) (1,980 ) Free cash flow $ 2,792 $ (2,886 ) The improvement in free cash flow contributed to an improvement of $1.5 million in working capital to $11.2 million as of March 31, 2013, compared to $9.6 million as of September 30, 2012. 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): March 31, September 30, 2013 2012 Current assets $ 19,517 $ 20,942 Current liabilities (9,533 ) (12,882 ) Net current assets 9,984 8,060 Current portion of deferred revenue net of deferred costs 1,168 1,544 Working capital $ 11,152 $ 9,604 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 solution and infrastructure development and repay debt. 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 the current level of operations, cash flow from operations, existing funds, availability on its revolving line of credit and vendor terms will provide adequate cash to fund operating needs for the foreseeable future. If the Company does not generate anticipated cash flow levels, predictions regarding cash needs may prove inaccurate and additional financing may be required. 26 -------------------------------------------------------------------------------- Table of Contents 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. During the six months ended March 31, 2013 and the fiscal year ended September 30, 2012, the Company issued 52,000 and 81,000 shares, respectively, of Series B Preferred Stock for payment of accrued dividends. Recently Issued Accounting Standards There were no new accounting pronouncements issued or effective during the six months ended March 31, 2013 that have had or are expected to have a material impact on the consolidated financial statements. 27 -------------------------------------------------------------------------------- Table of Contents |