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DECISIONPOINT SYSTEMS, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Forward Looking Statements Some of the statements contained in this Form 10-Q that are not historical facts are "forward-looking statements" which can be identified by the use of terminology such as "estimates," "projects," "plans," "believes," "expects," "anticipates," "intends," or the negative or other variations, or by discussions of strategy that involve risks and uncertainties. We urge you to be cautious of the forward-looking statements, that such statements, which are contained in this Form 10-Q, reflect our current beliefs with respect to future events and involve known and unknown risks, uncertainties and other factors affecting our operations, market growth, services, products and licenses. No assurances can be given regarding the achievement of future results, as actual results may differ materially as a result of the risks we face, and actual events may differ from the assumptions underlying the statements that have been made regarding anticipated events. Factors that may cause actual results, our performance or achievements, or industry results, to differ materially from those contemplated by such forward-looking statements include, without limitation: Our ability to raise capital when needed and on acceptable terms and conditions; Our ability to manage the growth of our business through internal growth and acquisitions; The intensity of competition; General economic conditions and, Our ability to attract and retain management, and to integrate and maintain technical information and management information systems. All written and oral forward-looking statements made in connection with this Form 10-Q are attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Given the uncertainties that surround such statements, you are cautioned not to place undue reliance on such forward-looking statements. Except as may be required under applicable securities laws, we undertake no obligation to publicly update or revise any forward-looking statements whether as a result more information, future events or occurrences. In the following discussion and analysis of results of operations and financial condition, certain financial measures may be considered "non-GAAP financial measures" under Securities and Exchange Commission rules. These rules require supplemental explanation and reconciliation, which is provided in this Quarterly Report on Form 10-Q. DecisionPoint's management uses the non-GAAP measure, Adjusted Working Capital, in their evaluation of business cash flow and financial position performance. We believe this non-GAAP measure provides investors with a better understanding of operating financial position of our company. Non-GAAP disclosures have limitations as analytical tools, should not be viewed as a substitute for cash flow or operating earnings determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. This supplemental presentation should not be construed as an inference that our future results will be unaffected by similar adjustments to operating earnings determined in accordance with GAAP. Overview DecisionPoint enables our clients to "move decisions closer to the customer" by "empowering the mobile worker". We define the mobile worker as those individuals that are on the front line in direct contact with customers. These workers include field repair technicians, sales associates, couriers, public safety employees and millions of other workers that deliver goods and or services throughout the country. Whether they are blue or white collar, mobile workers have many characteristics in common. Mobile workers need information, access to corporate resources, decision support tools and the ability to capture and report information back to the organization. DecisionPoint empowers these mobile workers through the implementation of various mobile technologies including specialized mobile business applications, wireless networks, mobile computers (for example, rugged, tablets, and smartphones) and a comprehensive suite of consulting, integration, deployment and support services. Mobile computing capabilities and usage continue to grow. With choice comes complexity so helping our customers navigate the myriad of options is what we do best. The right choice may be an off-the-shelf application or a custom business application to fit a very specific business process. DecisionPoint has the specialized resources and support structure to address the needs of mobile applications in the retail, transportation, field workforce sales/service and the warehousing market segments. We continue to invest in building out our capabilities to support these markets and business needs. For example, in July 2012, we invested in the expansion of our custom software development capabilities through the acquisition of Illume Mobile in Tulsa, OK, which specializes in the custom development of specialized mobile business applications for Apple, Android and Windows Mobile devices. Additionally, through the acquisition of Illume Mobile we acquired a cloud-based, horizontal software application "ContentSentral" which manages and distributes multiple types of corporate content (for example, PDF, video, images, and spreadsheets) on mobile tablets used by field workers. We also dramatically increased our software products expertise with the acquisition in June 2012 of APEX in Canada. The APEXWare™ software suite significantly expanded our field sales/service software offerings. APEXWare™ is a purpose-built mobile application suite ideally suited to the automation of field sales/service and warehouse workers. Additionally, we continue to expand our deployment and MobileCare support offerings. In 2012 we moved our headquarters location to a larger facility in Irvine, CA in order to accommodate the expansion of our express depot and technical support organizations. We also continue to invest in our "MobileCare EMM" enterprise mobility management offering. In 2008, we recognized the need for customers to outsource their mobile device management ("MDM") needs, thus we invested in building out a MDM practice that offers these services under a comprehensive managed service model. We have extended this offering from our historically ruggedized mobile computer customer base to address the growth of consumer devices in the enterprise and support the Bring Your Own Device (BYOD) and Bring Your Own Application (BYOA) movement. 16-------------------------------------------------------------------------------- Table of Contents Recognizing that we cannot build every business application, we have developed an 'ecosystem' of partners which support our custom and off-the-shelf solutions. These partners include suppliers of mobile devices (Apple, Intermec, Motorola, among others), wireless carriers (AT&T, Sprint, T-Mobile, Verizon), mobile peripheral manufactures (Zebra Technologies Corporation, Datamax - O'Neil), in addition to a host of specialized independent software vendors such as AirWatch, VeriFone GlobalBay, XRS and Wavelink. We are focused on several commercial enterprise markets. These include retail, field sales/service, warehousing and distribution and transportation. With the continued growth of the mobile internet, we expect to see growth in our current markets in addition to the emergence of new markets. In order to identify these new markets we recently created a new internal organization whose sole purpose is to identify and nurture new market opportunities. We expect our customers to continue to embrace and deploy new technology to better enhance their own customers' experiences and improve their own operations while lowering their operating costs. Our expertise and understanding of our customers' operations and business operations in general, coupled with our expertise and understanding of mobile technology equipment and software offerings enables us to identify new trends and opportunities and provide these new solutions to our existing and potential customers. At DecisionPoint, we deliver to our customers the ability to make better, faster and more accurate business decisions by implementing industry-specific, enterprise wireless and mobile computing systems for their front-line mobile workers, inside and outside of the traditional workplace. It is these systems that provide the information to improve the hundreds of individual business decisions made each day. Historically, critical information has remained locked away in the organization's enterprise computing systems, accessible only when employees were at their desks. Our solutions unlock this information and deliver it to employees when needed regardless of their location. As a result, our customers are able to move their business decision points closer to their customers which we believe in turn improves customer service levels, reduces cost and accelerates business growth. We have several offices throughout North America which allows us to serve our multi-location clients and their mobile workforces. We provide depot services through our West and East coast facilities. Additionally, we are always keenly aware of potential acquisition candidates that can provide complementary products and service offerings to our customer base. Business Combinations Illume Mobile Acquisition On July 31, 2012 ("Illume Closing Date"), we consummated an asset purchase agreement ("Asset Purchase Agreement") with MacroSolve, Inc. Pursuant to the Asset Purchase Agreement, we purchased the business (including substantially all the related assets) of the seller's Illume Mobile division ("Illume Mobile"), based in Tulsa, Oklahoma. Founded in 1996, Illume Mobile is a mobile business solutions provider that services mobile products and platforms. Illume Mobile's initial core business is the development and integration of business applications for mobile environments. Today, Illume Mobile serves the mobile application development needs of a wide range of customers, from Fortune 500s to small and medium-sized businesses. It delivers advanced, mobile apps for many device platforms including iPad, iPhone and Android with functionality including 3D animation, mobile video, augmented reality, GPS, and more. Illume Mobile seeks to leverage its combination of creativity, technical savvy, years of mobile experience, and market insight to enable customers to envision their mobile applications and bring them to reality, providing the most value in the shortest amount of time. Apex Systems Integrators Acquisition On June 4, 2012 ("Closing Date"), pursuant to a Stock Purchase Agreement ("Purchase Agreement"), we acquired all of the issued and outstanding shares of Apex Systems Integrators Inc. ("Apex"), a corporation organized under the laws of the Province of Ontario, Canada. Apex is a provider of wireless mobile work force software solutions. Its suite of products utilizes the latest technologies to empower the mobile worker in many areas including merchandising, sales and delivery; field service; logistics and transportation; and, warehouse management. Its clients are North American companies that are household names whose products and services are used daily to feed, transport, entertain and care for people throughout the world. 17-------------------------------------------------------------------------------- Table of Contents The operating results of Illume Mobile have been included in our results of operations beginning August 1, 2012 and operating results of Apex have been included in our results of operations beginning June 5, 2012. Pro Forma Disclosure of Financial Information (unaudited) The following table summarizes our unaudited consolidated results of operations for the three months ended March 31, 2012 as if the Apex and Illume acquisitions had occurred on January 1, 2012 (in thousands except per share data): Three Months Ended March 31, 2012 As Reported Pro Forma Net sales $ 17,810 $ 19,810 Net loss attributable to common shareholders (459 ) (1,541 ) Net loss per share - basic and diluted (0.06 ) (0.18 ) Included in the pro forma combined results of operations for the three months ended March 31, 2012 are the following adjustments for Apex: (i) amortization of intangible assets of $343,000, (ii) a net increase in interest expense of $175,000. Included in the pro forma combined results of operations for the three months ended March 31, 2012 are the following adjustments for Illume Mobile: (i) amortization of intangible assets of $53,000. Net loss per share assumes the 325,000 shares issued in connection with the Apex acquisition and the 617,284 shares issued in connection with the Illume Mobile acquisition are outstanding for each period presented (see "Note 4 - Business Combinations" in the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements). The historical financial information of Apex has been extracted for the periods required from the historical financial statements of Apex Systems Integrators, Inc. which were prepared in accordance with U.S. generally accepted accounting principles. The historical financial information of Illume Mobile has been derived from using internally generated management reports for the periods required. The unaudited pro forma financial information is not intended to represent or be indicative of our consolidated results of operations that would have been reported had the Apex and Illume Mobile acquisitions been completed as of the beginning of the period presented, nor should it be taken as indicative of our future consolidated results of operations. Company History DecisionPoint Systems, Inc., formerly known as Comamtech, Inc. (the "Company", "DecisionPoint", "we", "our" or "us"), was incorporated on August 16, 2010, in Canada under the laws of the Ontario Business Corporations Act ("OCBA"). On June 15, 2011, we entered into a Plan of Merger ("Merger Agreement") among the Company, its wholly-owned subsidiary, 2259736 Ontario Inc., incorporated under the laws of the Province of Ontario, Canada ("Purchaser") and DecisionPoint Systems, Inc., ("Old DecisionPoint"). Pursuant to the Merger Agreement, under Section 182 of the OCBA, on June 15, 2011 ("Effective Date"), Old DecisionPoint merged ("Merger") into the Purchaser and became a wholly-owned subsidiary of the Company. Prior to the Merger, Comamtech was a "shell company" (as such term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended ("Exchange Act")). In connection with the Merger, we changed our name to DecisionPoint Systems, Inc., and the Purchaser changed its name to DecisionPoint Systems International, Inc. ("DecisionPoint Systems International"). On June 15, 2011, both companies were reincorporated in the State of Delaware. Since the Merger, the business conducted by us has been the business conducted by Old DecisionPoint prior to the Merger. The accompanying unaudited condensed consolidated financial statements present the previously issued shares of Comamtech common stock as having been issued pursuant to the Merger on June 15, 2011, in exchange for the net assets of Comamtech totaling approximately $3.9 million as consideration received. The shares of common stock of the Company issued to Old DecisionPoint's stockholders in the Merger are presented as having been outstanding since the original issuance of the shares. Further, the exchange ratio has been retroactively applied to all shares, weighted-average share, loss per share, and stock option and warrant disclosures. 18-------------------------------------------------------------------------------- Table of Contents We have two wholly-owned subsidiaries, Apex and DecisionPoint Systems International. Apex was acquired on June 4, 2012. DecisionPoint Systems International has two wholly-owned subsidiaries, DecisionPoint Systems Group Inc. ("DPS Group") and CMAC, Inc. DecisionPoint Systems International acquired CMAC on December 31, 2010. CMAC was founded and incorporated in March 1996, and is a logistics consulting and systems integration provider focused on delivering operational and technical supply chain solutions, headquartered in Alpharetta, Georgia. DPS Group has two wholly-owned subsidiaries, DecisionPoint Systems CA, Inc. and DecisionPoint Systems CT, Inc. DecisionPoint Systems CA, Inc., formerly known as Creative Concepts Software, Inc. was founded in 1995 and is a leading provider of Enterprise Mobility Solutions. Enterprise Mobility Solutions are those computer systems that give an enterprise the ability to connect to people, control assets, and transact business from any location by using mobile computers, tablet computers, and smartphones to securely connect the mobile worker to the back office software systems that run the enterprise. Technologies that support Enterprise Mobility Solutions include national wireless carrier networks, Wi-Fi, local area networks, mobile computers, smartphones and tablets, mobile software applications, middleware and device security and management software. DecisionPoint Systems CT, Inc. formerly known as Sentinel Business Systems, Inc. was founded in 1976, and has developed over time a family of powerful enterprise data collection software solutions, products and services. The combined company is a data collection systems integrator that sells and installs mobile devices, software, and related bar coding equipment, radio frequency identification systems technology and provides custom solutions and other professional services. Results of Operations For comparison purposes, all dollar amounts have been rounded to nearest million while all percentages are actual. Due to rounding, totals in the tables presented may not sum to the total presented in the table. Three Months Ended March 31, 2013 2012 Increase/(Decrease) Total revenue $ 13.8 $ 17.8 $ (4.0 ) (22.7 %) Gross profit $ 2.8 $ 3.8 $ (0.9 ) (24.8 %) Total operating expenses $ 5.0 $ 3.8 $ 1.2 31.0 % Loss from operations $ (2.2 ) $ (0.1 ) $ 2.1 2581.7 % Loss before provision for income taxes $ (2.4 ) $ (0.2 ) $ 2.2 1145.6 % Total Revenue Revenues for the three months ended March 31, 2013 and 2012 is summarized below: Increase Three Months Ended March 31, (Decrease) 2013 2012 Hardware $ 8.4 $ 12.8 (34.6 %) Professional services 3.9 3.7 5.2 % Software 1.1 0.8 32.1 % Other 0.4 0.5 (11.6 %) $ 13.8 $ 17.8 (22.7 %) Revenues were $13.8 million for the three months ended March 31, 2013, compared to $17.8 million for the same period ended March 31, 2012, a decrease of $4.0 million or 22.7%. The decrease in revenue was partially offset due to the inclusion of the operating results of our Apex and Illume Mobile acquisitions in mid-2012. Revenues for Apex were $0.5 million and revenues for Illume Mobile were $0.2 million in the three months ended March 31, 2013. Excluding the impact of Apex and Illume Mobile acquisitions in mid-2012, revenues decreased by $4.7 million, or 26.4% over the same quarter in the prior year with the largest decrease occurring in hardware sales where sales decreased by 35.1%. 19-------------------------------------------------------------------------------- Table of Contents The improved economic conditions in the U.S. which had begun in the first half of 2010, and continued improvement throughout 2011 and 2012 had a positive effect on our sales in those years. Prior to 2010, major retail chains had deferred new technology implementation and delayed systems' refresh. Conversely, the economic environment in 2012 stabilized whereupon we benefitted from renewed interest and more importantly, fundamental need to implement new cost saving technology. In the first quarter of 2013, we did not have the same level of customers with new technology implementation and systems' refresh. As a result, the 34.6% decrease in hardware revenues for the three months ended March 31, 2013 compared to the same period in 2012 was due to the decrease in system upgrades of mobile computing at the retail level. The slight increase in professional services for the three months ended March 31, 2013 compared to the same period in 2012 of 5.2% relates to deployment and staging services to support our customers' prior technology upgrades. Our increase in software revenues for the three months ended March 31, 2013 compared to the same period in 2012 is attributable to contributions of software revenues from the Apex and Illume Mobile acquisitions. The slight decrease in other revenues relates to a reallocation of our corporate resources away from the lower volume for consumables and towards the professional services business. Cost of Sales Cost of sales for the three months ended March 31, 2013 and 2012 is summarized below: Three Months Ended March 31, Increase 2013 2012 (Decrease) Hardware $ 6.7 $ 10.5 (36.0 %) Professional services 2.8 2.5 13.9 % Software 1.1 0.7 62.9 % Other 0.3 0.4 (15.0 %) $ 10.9 $ 14.1 (22.2 %) The types of expenses included in the cost of sales line are hardware costs, third party licenses, costs associated with third party professional services, salaries and benefits for project managers and software engineers, freight, consumables and accessories. Cost of sales were $10.9 million for the three months ended March 31, 2013, compared to $14.1 million for the same period ended March 31, 2012, a decrease of $3.2 million or 22.2%. The decrease in cost of sales for hardware of 36.0% for the three months ended March 31, 2013 compared to the same period in 2012 was slightly higher than the hardware revenue decrease due to fewer large hardware orders which usually have reduced pricing. The increase in cost of sales for professional services from the three months ended March 31, 2012 to the three months ended March 31, 2013 was 13.9%, much higher than the revenue growth rate of 5.2% and was due to an increase in professional service personnel. The increase in cost of sales for software of 62.9% for the three months ended March 31, 2013 compared to the same period in 2012 was approximately equal to the software revenue increase, except for the impact of intangible software amortization. The decrease in other cost of sales relates to the decrease in the other revenues of approximately the same percentage. Gross Profit Our gross profit was $2.8 million for the three months ended March 31, 2013, compared to $3.8 million for the same period ended March 31, 2012, a decrease of $0.9 million or 24.8%. Our gross margin percentage decreased by 570 basis points to 20.5% in 2013, from 21.1% in the comparable period of 2012. The decrease in gross profit percentage is directly due to amortization of intangible software assets, offset by the lower volume of hardware sales which carry a lower gross margin, combined with a higher proportion of sales from professional services. Additionally, we have continued to implement increased cost control for the products and services which we resell, and our professional service costs were positively impacted by our better utilization associated with greater recognized revenue from these services in the current three months and therefore, we realized higher margins on those services. 20-------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expenses Three Months Ended March 31, 2013 2012 Increase/(Decrease) Selling, general and administrative expenses $ 5.0 $ 3.8 $ 1.2 31.0 % As a percentage of sales 36.5 % 21.5 % 15.0 % Selling, general and administrative expenses were $5.0 million for the three months ended March 31, 2013, compared to $3.8 million for the same period in the prior year. This represents an increase of $1.2 million, or 31.0%. The increase was partially due to the addition of the Apex and Illume Mobile businesses which added $0.3 million in selling, general and administrative costs to operate those businesses. Additionally, there was an increase in sales salary related expenses of $0.4 million which, in part relates to the expansion of the sales force in the U.S. tasked with bringing the APEXWare™ product to the U.S. market. Additional increases relate to professional service fees, mainly accounting, tax and capital raising costs of $0.3 million. Three Months Ended March 31, 2013 2012 Increase/(Decrease) Depreciation and amortization $ 0.3 $ 0.2 $ 0.1 85.5 % In addition to the differences above, selling, general and administrative costs were higher due to amortization of intangible assets as a result of the Apex and Illume acquisitions in 2012. Interest Expense Interest expense, which is related to our line of credit, subordinated debt, was $0.2 million for the three months ended March 31, 2013, compared to $0.1 million for the same period in the prior year. The $0.1 million increase in interest expense was the result of increased debt obligations relating to the Apex acquisition. On June 4, 2012 Apex entered in to the RBC Credit Agreement, borrowing CDN $2,500,000 at an interest rate of RBP plus 4%. The RBC Credit Agreement also includes a revolving demand facility with an authorized limit of CDN $200,000 at an interest rate of RBP plus 1.5%. On June 4, 2012 Apex also entered in to the BDC Loan Agreement, borrowing CDN $1,700,000 at the rate of 12% per annum. Due to these additional borrowings, interest expense was higher during the first quarter of 2013. Liquidity and Capital Resources Cash and Cash Flow Although we have historically experienced losses, a material part of those losses were from non-cash transactions (refer to the unaudited accompanying Consolidated Statements of Cash Flows.) In connection with these losses, we have accumulated substantial net operating loss carry-forwards to off-set future taxable income. In order to maintain normal operations for the foreseeable future, we must continue to have access to our line of credit, become profitable and/or access additional equity capital. There can be no assurance that we will become profitable or that we can continue to raise additional funds required to continue our normal operations. The accompanying consolidated financial statements do not include any adjustments that would be required should we not be successful with these activities. Funds generated by operating activities and our credit facilities continue to be our most significant sources of liquidity. For the three months ended March 31, 2013, our revenue decreased approximately 22.7%, compared to the three months ended March 31, 2012, partially due to the lower level of retail customers' system refreshes and system implementations. We also had an increased level of selling, general and administrative expenses in the first three months of 2013 compared to the same period in 2012 due to inclusion of the results from Apex and Illume Mobile along with increased selling expenses, professional expenses and investor relations expenses related to being a public company along with an increase in amortization expense of intangible assets, all resulted in higher operating loss for the first three months of 2013. We believe that our strategic shift to higher margin field mobility solutions with additional APEXWare™ software and professional service revenues will improve our results as economic conditions continue to improve. In the quarter ended March 31, 2013, we experienced a decrease in revenue of $4.0 million compared to the quarter ended March 31, 2012, and a $3.6 million decrease in revenue compared to the previous sequential quarter ended December 31, 2012. Additionally, in the first three months ended March 31, 2013, we incurred approximately $0.6 million in increased largely one-time expenses due to professional fees relating to the capital raising activities, the registration of common shares as a result of the Series D Preferred Stock offering and the associated audit fees. As a result, the availability under our credit line contracted significantly and our overall liquidity has become constrained. 21-------------------------------------------------------------------------------- Table of Contents To address this, we have plans to seek additional capital through sales of our common stock. There is no assurance additional funding will be available on terms acceptable to us, or at all. If we raise additional funds by selling additional shares of our capital stock, or securities convertible into shares of our capital stock, the ownership interest of our existing shareholders may be diluted. We are also reducing non-essential expenses and completing the integration of our acquisitions of Apex and Illume Mobile, which is expected to result in further cost savings. If we continue to incur operating losses and/or do not raise sufficient additional capital, material adverse events may occur including, but not limited to, 1) a reduction in the nature and scope of our operations, 2) our ability to fully implement our current business plan and/or 3) a default on the financial covenants under the SVB line of credit. A covenant default would give the bank the right to demand immediate payment of all outstanding amounts which we would not be able to repay out of normal operations. There are no assurances that we will successfully implement our plans with respect to these liquidity matters. The accompanying unaudited condensed consolidated financial statements do not reflect any adjustment that may be required resulting from the adverse outcome relating to this uncertainty. As a matter of course, we do not maintain significant cash balances on hand since we are financed by a line of credit. Typically, we use any excess cash to repay the then outstanding line of credit balance. As long as we continue to generate revenues and meet our financial covenants, we are permitted to draw down on our line of credit to fund our normal working capital needs. As of March 31, 2013, the outstanding balance on our SVB line of credit was approximately $3.0 million and the interest rate is 7.0%. As of March 31, 2013, there was $4.1 million available under the line of credit. As of April 30, 2013, the outstanding balance under the line of credit was $4.2 million and there was $1.4 million available under the line of credit. On February 27, 2013, we obtained an additional $1.0 million term loan from SVB (see below under "2013 Financing" for terms of the line of credit and the term loan.) In connection with our Preferred Series D Private Placement in December 2012, 25% of the net proceeds are to be restricted for the Apex payment of the contingent consideration and the additional bonus consideration (see below under "2012 Financing.") These funds have not been placed into escrow pending agreement between the Company and former owners of Apex regarding the financial institution that will escrow the funds, the amount of funds to be escrowed and the terms of the escrow agreement itself. In the last four complete years of operations from 2009 through 2012, we have not experienced any significant effects of inflation on our product and service pricing, revenues or our income from continuing operations. As of March 31, 2013 and December 31, 2012, we had cash of approximately $0.3 million and $1.1 million, respectively. We have used, and plan to use, such cash for general corporate purposes, including working capital. As of March 31, 2013, we had negative working capital of $10.3 million and total stockholders' deficit of ($1.3) million. As of December 31, 2012, we had negative working capital of $9.1 million and total stockholders' equity of $0.9 million. At March 31, 2013, included in current liabilities is unearned revenue of $7.6 million, which reflects services that are to be performed in future periods but that have been paid and/or accrued for and therefore, would not represent additional future cash outflows. At March 31, 2013, included in current assets are deferred costs of $4.0 million which reflect costs paid for third party extended maintenance services that are being amortized over their respective service periods, which do not generally represent future cash inflows. The increase in the unearned revenue, offset by the deferred costs, continues to provide a benefit in future periods as the amounts convert to net realized revenue. As explained above in the discussion of our use of "non-GAAP financial measures," we monitor our 'cash' working capital position after removing the accrual effect of the current deferred assets and liabilities. For the reasons set forth above, we believe this non-GAAP measure provides investors with a better understanding of operating financial position of our company. 22-------------------------------------------------------------------------------- Table of Contents Adjusted Working Capital at March 31, 2013 and December 31, 2012 are computed as follows (in thousands): March 31, December 31, 2013 2012 Current assets $ 17,288 $ 18,708 Current liabilities 27,614 27,801 Working capital - GAAP (10,326 ) (9,093 ) Deferred cost (4,028 ) (3,955 ) Deferred revenue 7,664 7,409 Adjusted working capital - non-GAAP measure $ (6,690 ) $ (5,639 ) 2013 Financing Silicon Valley Bank Financing On February 27, 2013, we and Silicon Valley Bank ("SVB"), entered into an Amendment (the "Amendment") to Loan and Security Agreement, which amended the terms of the Loan and Security Agreement dated as of December 15, 2006 (as amended, the "Loan Agreement"). Pursuant to the Amendment, SVB made a new term loan to us on February 27, 2013, of $1,000,000 ("Term Loan II"). Repayment of Term Loan II, together with accrued interest thereon, is due in 36 monthly installments commencing on the first day of the month following the month in which the funding date of Term Loan II occurred. Pursuant to the Amendment, the Loan Agreement was amended to provide that the revolving credit line thereunder will accrue interest at an annual rate equal to 3.75 percentage points above the Prime Rate, which may be further reduced to 3.25 percentage points above the Prime Rate after we achieve two consecutive fiscal quarters (beginning with any fiscal quarter ending on or after March 31, 2013) of profitability. In addition, the maturity date of the revolving credit line under the Loan Agreement was extended to February 28, 2015, the principal amount outstanding under the Term Loan under the Loan Agreement will accrue interest at a fixed annual rate equal to 9.0%, the principal amount outstanding under the Term Loan II will accrue interest at a fixed annual rate equal to 7.5%, and we agreed to pay an anniversary fee of $100,000 on February 28, 2014. The Loan Agreement includes customary covenants, limitations and events of default. Financial covenants which may materially impact our liquidity, include minimum liquidity and fixed charge coverage ratios (1.5 to 1), minimum tangible net worth requirements ($9.7 million) and limitations on indebtedness. Additionally, the Agreement has customary cross-default covenants which will cause us to be in default if we are in default in other loan agreements. As of March 31, 2013 and December 31, 2012, we were in compliance with all of our SVB covenants. At March 31, 2013 we were in compliance with our financial covenants with SVB, however, had we incurred another $400,000 in net losses, tangible net worth would have been reduced and could have caused us to not be in compliance with our tangible net worth financial covenant at March 31, 2013. This cushion of $400,000 will be further enhanced by one half of any funds raised through sales of common stock (as only 50% of additional capital raises are given credit in the tangible net worth calculation). In contrast, this cushion will be further eroded by any losses we incur subsequent to March 31, 2013. 2012 Financing and Preferred Series D Private Placement Royal Bank of Canada and BDC Capital, Inc. Financing On June 4, 2012, Apex entered into a Credit Agreement ("RBC Credit Agreement") with Royal Bank of Canada ("RBC"), pursuant to which RBC made available certain credit facilities in the aggregate amount of up to CDN$2,750,000 (US$2,641,000 at the Closing Date), including a revolving demand facility with an authorized limit of CDN$200,000 (US$192,000 at the Closing Date). The RBC Term Loan accrues interest at RBP plus 4% (7% at December 31, 2012). Principal and interest is payable over a three year period at a fixed principal amount of CDN$69,444 a month beginning in July 2012 and continuing through June 2015. Apex paid approximately $120,000 in financing costs, which has been recorded as deferred financing costs and is being amortized to interest expense over the term of the loan. In addition, the RBC Term Loan calls for mandatory repayments based on 20% of Apex's free cash flow as defined in the RBC Credit Agreement, before discretionary bonuses based on the annual year end audited financial statements of Apex, beginning with the fiscal year ended December 31, 2012, and payable within 30 days of the delivery of the annual audited financial statements, and continuing every six months through December 31, 2014. As of March 31, 2013 and December 31, 2012, the Company estimates that the mandatory repayment based on 20% of Apex's free cash flow will be $0. 23-------------------------------------------------------------------------------- Table of Contents The RBC Term Loan has certain financial covenants and other non-financial covenants. As of March 31, 2013 and December 31, 2012, Apex was not in compliance with the Fixed Charge Coverage ratio (as defined by the RBC Credit Agreement). The Fixed Charge Coverage ratio of not less than 1.25:1 is calculated as the ratio of the trailing twelve months of earnings before interest, taxes, depreciation and amortization ("EBITDA") to loan payments and interest charges for the RBC Credit Agreement and the BDC Term Loan. Our calculation of the Fixed Charge Coverage ratio at March 31, 2013 and December 31, 2012 is 0.78:1 and 0.86:1, respectively. Additionally, at March 31, 2013 we were not in compliance with the Maximum Funded Debt to EBITDA ratio. In order to be in compliance with this covenant, we need a ratio of not less than 2.25:1. At March 31, 2013 our maximum funded debt to EBITDA ratio was 2.07:1. Under the RBC Credit Agreement, violation of this covenant is an Event of Default which grants RBC the right to demand immediate payment of outstanding balances. In May 2013 and March 2013, we received waivers for non-compliance of these covenants at December 31, 2012, March 31, 2013 and through June 30, 2013, and have received a non-binding communication from the bank that it will continue to work with us to reset the covenants, however there are no assurances that this will occur. On June 4, 2012, Apex also entered into the BDC Loan Agreement with BDC Capital Inc. ("BDC"), a wholly-owned subsidiary of Business Development Bank of Canada, pursuant to which BDC made available to Apex a term credit facility ("BDC Credit Facility") in the aggregate amount of CDN $1,700,000 (USD $1,632,340 at the Closing Date). The BDC Term Loan accrues interest at the rate of 12% per annum, and matures on June 23, 2016, with an available one year extension for a fee of 2%, payable at the time of extension. In addition to the interest payable, consecutive quarterly payments of CDN$20,000 as additional interest are due beginning on June 23, 2012, and subject to compliance with bank covenants, Apex will make a mandatory annual principal payment in the form of a cash flow sweep which will be equal to 50% of the Excess Available Funds (as defined by the BDC Loan Agreement) before discretionary bonuses based on the annual year end audited financial statements of Apex. The maximum annual cash flow sweep in any year will be CDN$425,000. As of March 31, 2013 and December 31, 2012, the Company estimated the cash sweep will be approximately $0. Such payments will be applied to reduce the outstanding principal payment due on the maturity date. In the event that Apex's annual audited financial statements are not received within 120 days of its fiscal year end, the full CDN$425,000 becomes due and payable on the next payment date. Apex paid approximately $70,000 in financing costs which has been recorded as deferred financing costs and is being amortized to interest expense over the term of the loan. The BDC Loan Agreement contains certain financial and non-financial covenants which may materially impact our liquidity, including minimum working capital requirements, tangible net worth requirements and limitations on additional indebtedness. As of March 31, 2013 and December 31, 2012, Apex was not in compliance with the minimum working capital financial covenant. In order to be in compliance with the minimum working capital requirement at March 31, 2013 and December 31, 2012, we would have needed an additional $0.8 and $0.5 million in working capital, respectively. Under the BDC Loan Agreement, violation of this covenant is an Event of Default which grants BDC the right to demand immediate payment of outstanding balances. In May 2013 and March 2013, we received waivers for non-compliance of these covenants at December 31, 2012, March 31, 2013 and through June 30, 2013, and have received a non-binding communication from the bank that it will continue to work with us to reset the covenants, however there are no assurances that this will occur. In connection with the BDC Loan Agreement, BDC executed a subordination agreement in favor of Silicon Valley Bank, pursuant to which BDC agreed to subordinate any security interest in assets of the Company granted in connection with the BDC Loan Agreement to Silicon Valley Bank's existing security interest in assets of the Company. The subordination agreement contains cross-default provisions which may materially impact our liquidity. Preferred Series D Private Placement On December 20, 2012, we entered into and closed a securities purchase agreement (the "Series D Purchase Agreement") with accredited investors (the "Investors"), pursuant to which we sold an aggregate of 633,600 shares of Series D Convertible Preferred Stock (the "Series D Preferred Shares") for a purchase price of $10.00 per share, for aggregate gross proceeds of $6,336,000 (the "Series D First Closing"). We retained Taglich Brothers, Inc. (the "Placement Agent") as the placement agent for the Series D First Closing. We paid the Placement Agent $506,880 in commissions (equal to 8% of the gross proceeds), and issued to the Placement Agent five-year warrants (the "Placement Agent Warrants") to purchase 633,600 shares of our common stock (equal to 10% of the number of shares of common stock underlying the Series D Preferred Shares sold under the Purchase Agreement) at an exercise price of $1.10 per share, in connection with the Series D First Closing. The Investors included certain of our officers, directors and employees, who purchased an aggregate of 20,700 Series D Preferred Shares. We used $4.7 million of the proceeds from the Series D Closing to redeem all of our outstanding shares of Series C Preferred Stock. 24-------------------------------------------------------------------------------- Table of Contents On December 31, 2012, we sold an additional 70,600 shares of Series D Preferred Stock for a purchase price of $10.00 per share, for aggregate gross proceeds of $706,000 (the "Series D Second Closing", and together with the Series D First Closing, the "Series D Closings") pursuant to the Series D Purchase Agreement for an aggregate of 704,200 shares of Series D Preferred Stock sold. The Placement Agent acted as the placement agent for the Series D Second Closing as well. We paid the Placement Agent $56,480 in commissions (equal to 8% of the gross proceeds), and issued to the Placement Agent Placement Agent Warrants to purchase 70,600 shares of common stock (equal to 10% of the number of shares of common stock underlying the Series D Preferred Shares sold under the Series D Purchase Agreement) at an exercise price of $1.10 per share, in connection with the Series D Second Closing for an aggregate of 704,200 such Placement Agent Warrants. The Investors included one of our officers who purchased an aggregate of 2,500 Series D Preferred Shares. The table below presents the use of proceeds from the Series D Preferred Shares: Gross Proceeds $ 7,042,000 Less: Redemption of Preferred Series C Shares 4,732,567 Payment of placement agent fees, including other estimated costs 1,019,682 5,752,249 Funds available for general corporate purposes $ 1,289,751 Our proceeds from the Series D Closings, before deducting placement agent fees and other expenses, were approximately $7.0 million. We used $4.7 million for redemption of all of our outstanding shares of Series C Preferred Stock. Approximately $1.0 million was used to pay fees and expenses of the offering, and $1.3 million are funds are available for general corporate purposes. Pursuant to the Stock Purchase Agreement, we are required to place 25% of net offering proceeds, as defined, in an escrow account to satisfy our payment obligations of certain earn-out provisions. These funds have not been placed into escrow pending agreement between the Company and the sellers under the stock purchase agreement regarding the financial institution that will escrow the funds, the amount of funds that are to be placed in escrow and the escrow agreement itself. In connection with the Series D First Closing, on December 20, 2012, we filed a Certificate of Designation of Series D Preferred Stock (the "Series D Certificate of Designation") with the Secretary of State of Delaware. Pursuant to the Series D Certificate of Designation, we designated 4,000,000 shares of our preferred stock as Series D Preferred Stock. The Series D Preferred Stock has a Stated Value of $10.00 per share, votes on an as-converted basis with the common stock, and is convertible, at the option of the holder, into such number of shares of our common stock equal to the number of shares of Series D Preferred Stock to be converted, multiplied by the Stated Value, divided by the Conversion Price in effect at the time of the conversion. The initial Conversion Price is $1.00, subject to adjustment in the event of stock splits, stock dividends and similar transactions, and in the event of subsequent equity sales at a lower price per share, subject to certain exceptions. The Series D Preferred Stock entitles the holder to cumulative dividends, payable quarterly, at an annual rate of (i) 8% of the Stated Value during the three year period commencing on the date of issue, and (ii) 12% of the Stated Value commencing three years after the date of issue. We may, at our option, pay dividends in PIK Shares, in which event the applicable dividend rate will be 12% and the number of such PIK Shares issuable will be equal to the aggregate dividend payable divided by the lesser of (x) the then effective Conversion Price or (y) the average volume weighted average price of the Company's common stock for the five prior consecutive trading days. Upon any liquidation, dissolution or winding-up of our Company, holders of Series D Preferred Stock will be entitled to receive, for each share of Series D Preferred Stock, an amount equal to the Stated Value of $10.00 per share plus any accrued but unpaid dividends thereon before any distribution or payment may be made to the holders of any common stock, Series A Preferred Stock, Series B Preferred Stock, or subsequently issued preferred stock. In addition, commencing on the trading day on which the closing price of the common stock is greater than $2.00 for thirty consecutive trading days with a minimum average daily trading volume of at least 5,000 shares for such period, and at any time thereafter, we may, in our sole discretion, effect the conversion of all of the outstanding shares of Series D Preferred Stock to common stock (subject to the condition that, all of the shares issuable upon such conversion may be re-sold without limitation under an effective registration statement or pursuant to Rule 144 under the Securities Act). The Series D Preferred Stock also contains registration rights which compel the Company to file a registration statement with the SEC within 60 days of the final closing date (December 31, 2012), and requires the registration statement to become effective within 90 days thereafter. The initial registration statement was filed on February 12, 2013. If the registration statement is not declared effective by May 12, 2013, a partial liquidated damage equal to 0.1% of the purchase price paid by each investor shall be payable on each monthly anniversary until the registration statement becomes effective. In no event shall the partial liquidated damage exceed 0.6% of the purchase price paid by each investor. 25-------------------------------------------------------------------------------- Table of Contents Cash Flows from Operating, Investing and Financing Activities Information about our cash flows, by category, is presented in the accompanying Consolidated Statements of Cash Flows. The following table summarizes our cash flows for the three months ended March 31, 2013 and 2012 (in millions): Three Months Ended March 31, 2013 2012 Increase/(Decrease) Operating activities $ (0.8 ) $ 3.0 $ (3.8 ) 126.7 % Investing activities - - - N/A Financing activities 0.1 (2.9 ) 3.0 (103.4 %) Cash provided by operating activities during the first three months of 2013 decreased by $3.8 million over the prior year. The decrease in cash from operations was primarily driven by increase in net loss in the first quarter of 2013 of $1.9 million. Additionally, the changes in net working capital and other balance sheet changes contributed to a $2.4 million decrease in cash used in operating activities, most notably from $1.7 million decrease in accounts receivable due to timing of receivable collections. During the three months ended March 31, 2013, net cash used in operating activities was $0.8 million. Our net loss was $2.1 million in the first three months of 2013, a portion of which was the result of non-cash transactions during the year. Specifically, we had a $0.6 million non-cash expense related to employee and non-employee stock based compensation and $1.5 million of other non-cash transactions such as depreciation and amortization. For the three months ended March 31, 2012, net cash provided by operating activities was $3.0 million. Our net loss was $0.2 million during the first quarter of 2012, most of which was the result of non-cash transactions during the quarter. Specifically, we had a $0.2 million non-cash expense such as depreciation and amortization, employee and non-employee stock-based compensation, and deferred taxes. Net cash used in investing activities was negligible during the three months ended March 31, 2013 and during the comparable three months of 2012. During the three months ended March 31, 2013, net cash provided by financing activities was $0.1 million, primarily due to $1.0 million in proceeds from the bank term loan, net of $0.5 million in payments for term loans and a net $0.4 million in net payments under our lines of credit. During the three months ended March 31, 2012, net cash used in financing activities was $2.9 million, primarily due to the $2.4 million in net repayments on the line of credit, $0.3 million in debt repayments, payment of $0.1 million for the Series C Preferred Stock dividend and $0.1 million of financing costs. Critical Accounting Policies Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Critical accounting policies are those that require the application of management's most difficult, subjective, or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods. In preparing the consolidated financial statements, management has utilized available information, including our past history, industry standards and the current economic environment, among other factors, in forming its estimates and judgments, giving due consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different estimates, which may impact the comparability of our results of operations to those of companies in similar businesses. We believe that the following critical accounting policies involve a high degree of judgment and estimation: Accounts Receivable and Allowance for Doubtful Accounts We have policies and procedures for reviewing and granting credit to all customer accounts, including: Credit reviews of all new customer accounts, Ongoing credit evaluations of current customers, 26-------------------------------------------------------------------------------- Table of Contents Credit limits and payment terms based on available credit information, Adjustments to credit limits based upon payment history and the customer's current credit worthiness, and An active collection effort by regional credit functions, reporting directly to the corporate financial officers. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. These allowances are highly judgmental and require assumptions based on both recent trends of certain customers estimated to be a greater credit risk, as well as historical trends of the entire customer pool. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. To mitigate this credit risk we perform periodic credit evaluations of our customers. Inventory Inventory is stated at the lower of cost or market. Cost is determined under the first-in, first-out (FIFO) method. We periodically review our inventory and make provisions as necessary for estimated obsolete and slow-moving goods. We mark down inventory by an amount equal to the difference between cost of inventory and the estimated market value based upon assumptions about future demands, selling prices and market conditions. The creation of such provisions results in a write-down of inventory to net realizable value and a charge to cost of sales. Goodwill and Long-Lived Assets Goodwill represents the excess purchase price paid over the fair value of the net assets of acquired companies. Goodwill is subject to impairment testing as necessary, (at least once annually at December 31) if changes in circumstances or the occurrence of certain events indicate potential impairment. In assessing the recoverability of our goodwill, identified intangibles, and other long-lived assets, significant assumptions regarding the estimated future cash flows and other factors to determine the fair value of the respective assets must be made, as well as the related estimated useful lives. The fair value of goodwill and long-lived assets is estimated using a discounted cash flow valuation model and observed earnings and revenue trading multiples of identified peer companies. If these estimates or their related assumptions change in the future as a result of changes in strategy or market conditions, we may be required to record impairment charges for these assets in the period such determination was made. Intangible Assets We make judgments about the recoverability of purchased finite-lived intangible assets whenever events or changes in circumstances indicate that impairment may exist. Recoverability of finite-lived intangible assets is measured by comparing the carrying amount of the asset to the future undiscounted cash flows that the asset is expected to generate. If it is determined that an individual asset is impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. The assumptions and estimates used to determine future values and remaining useful lives of our intangible are complex and subjective. They can be affected by various factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our forecasts. Comprehensive Loss Comprehensive loss consists of net loss and accumulated other comprehensive loss, which includes certain changes in equity that are excluded from net income. Comprehensive loss for the three months ended March 31, 2013 is equal to the net loss plus other comprehensive loss totaling $3,000 (relating to exchange translation adjustments arising from the consolidation of our Canadian Apex subsidiary). Comprehensive loss for the comparable three months ended 2012 is equal to the reported net loss for that period. Income Taxes We account for income taxes in accordance with the Financial Accounting Standards Board ("FASB") guidance, which requires deferred tax assets and liabilities, be recognized using enacted tax rates to measure the effect of temporary differences between book and tax bases on recorded assets and liabilities. FASB guidance also requires that deferred tax assets be reduced by a valuation allowance, if it is more likely than not some portion or all of the deferred tax assets will not be recognized. We evaluate on an annual basis its ability to realize deferred tax assets by assessing its valuation allowance and by adjusting the amount of such allowance, if necessary. The factors used to assess the likelihood of realization are forecasts of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. 27-------------------------------------------------------------------------------- Table of Contents In accordance with FASB guidance on accounting for uncertainty in income taxes, we evaluate tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, we recognize the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement. For tax positions that are not more likely than not of being sustained upon audit, we do not recognize any portion of the benefit. If the more likely than not threshold is not met in the period for which a tax position is taken, we may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period. Translation of Foreign Currencies The Company's functional currency is the U.S. dollar. The financial statements of the Company's foreign subsidiary is measured using the local currency, in this case the Canadian dollar (CDN$), as its functional currency and is translated to U.S. dollars for reporting purposes. Assets and liabilities of the subsidiary are translated at exchange rates as of the balance sheet dates. Revenues and expenses of the subsidiary are translated at the rates of exchange in effect during the year. Revenue recognition Revenues are generated through product sales, warranty and maintenance agreements, software customization, and professional services. Product sales are recognized when the following criteria are met (1) there is persuasive evidence that an arrangement exists; (2) delivery has occurred and title has passed to the customer, which generally happens at the point of shipment provided that no significant obligations remain; (3) the price is fixed and determinable; and (4) collectability is reasonably assured. We generate revenues from the sale of extended warranties on wireless and mobile hardware and systems. Revenue related to extended warranty and service contracts is recorded as unearned revenue and is recognized over the life of the contract and we may be liable to refund a customer for amounts paid in certain circumstances. This has not been an issue for us historically. We also generate revenue from software customization and professional services on either a fee-for-service or fixed fee basis. Revenue from software customization and professional services that is contracted as fee-for-service, also referred to as per-diem billing, is recognized in the period in which the services are performed or delivered. Adjustments to contract price and estimated labor costs are made periodically, and losses expected to be incurred on contracts in progress are charged to operations in the period such losses are determined. We enter into revenue arrangements that contain multiple deliverables. Judgment is required to properly identify the accounting units of the multiple deliverable transactions and to determine the manner in which revenue should be allocated among the accounting units. Moreover, judgment is used in interpreting the commercial terms and determining when all criteria of revenue recognition have been met for each deliverable in order for revenue recognition to occur in the appropriate accounting period. While changes in the allocation of the arrangement consideration between the units of accounting will not affect the amount of total revenue recognized for a particular sales arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could affect the Company's results of operations. When we enter into an arrangement that includes multiple elements, the allocation of value to each element is derived based on management's best estimate of selling price when vendor specific objective evidence or third party evidence is unavailable. Revenue from software licenses is recognized when all of the software revenue recognition criteria are met and, if applicable, when vendor specific objective evidence, or VSOE, exists to allocate the total license fee to each element of multiple-element software arrangements, including post-contract customer support. Post-contract support is recognized ratably over the support period. When a contract contains multiple elements wherein the only undelivered element is post-contract customer support and VSOE of the fair value of post-contract customer support does not exist, revenue from the entire arrangement is recognized ratably over the support period. Software royalty revenue is recognized in arrears on a quarterly basis, based upon reports received from licensees during the period, unless collectability is not reasonably assured, in which case revenue is recognized when payment is received from the licensee. Stock-based compensation We record the fair value of stock-based payments as an expense in our consolidated financial statements. We determine the fair value of stock options using the Black-Scholes option-pricing model. This valuation model requires us to make assumptions and judgments about the variables used in the calculation. These variables and assumptions include the weighted-average period of time that the options granted are expected to be outstanding, the volatility of our common stock, the risk-free interest rate and the estimated rate of forfeitures of unvested stock options. Additional information on the variables and assumptions used in our stock-based compensation are described in Note 10 of the accompanying notes to our unaudited condensed consolidated financial statements. 28-------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements There were no off-balance sheet arrangements as of March 31, 2013. Inflation We do not believe that inflation has had a material impact on our business or operating results during the periods presented. |