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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: • 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 are dependent on proprietary technology and communication networks owned and controlled by others, and accordingly, their problems may adversely impact us; • We have generated operating losses in the past and 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; and • 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, 2013, in this Form 10-Q and in subsequent filings we make with the Securities and Exchange Commission (SEC). 18 -------------------------------------------------------------------------------- Table of Contents Overview XRS Corporation and its wholly owned subsidiary, Turnpike Global Technologies, Inc. (collectively, XRS Corporation, the Company, we, our, us) delivers compliance and fleet management solutions to the commercial trucking industry. Our solutions enable customers to improve compliance with United States Department of Transportation (DOT) regulations, optimize the utilization of their assets and enhance the productivity of fleet operations across the entire supply chain resulting in decreased costs. We are leading the commercial trucking industry's migration to mobile devices for collecting and analyzing DOT compliance and management data through our continued focus on leveraging the latest technology with our solutions. Our mobile solutions include: • XRS - The XRS solution is a mobile fleet optimization and compliance solution built with the scalability of cloud-based infrastructure and the functionality to support North America's largest fleets down to an individual owner/operator. It harnesses the power of mobility, transforming driver and truck data into an easy to use dashboard of information which is shared in real-time between drivers, dispatchers and fleet owners. The XRS solution uses a monthly subscription model with no upfront hardware costs. • Turnpike - Turnpike is the Company's first generation mobile fleet optimization and compliance solution, which uses a monthly subscription model with no upfront hardware costs. Our legacy solutions include: • XataNet - A fleet optimization and compliance solution, utilizing a traditional on-board computer, integrated communications and a SaaS platform used by fleet managers, with broad functionality for enterprise customers seeking to maximize performance and minimize compliance risks. • MobileMax - A traditional on-board communication solution for the for-hire trucking market with integrated back-office systems. With over 1,300 customers representing over 109,000 active truck subscriptions, we have a strong foundation as an industry leader in delivering Federal Motor Carrier Safety Administration compliant electronic logging devices with a track record of empowering fleet owners to leverage truck data to radically reduce costs. We have sales and distribution partnerships with various third-party resellers supporting the U.S. and Canadian commercial trucking industries. 19 -------------------------------------------------------------------------------- Table of Contents Results of Operations For the Three Months Ended December 31, 2013 and 2012 We operate as a single business segment and believe the information presented in our Management's Discussion and Analysis of Financial Condition and Results of Operations provides an understanding of our business, operations and financial condition. The following table sets forth detail related to revenue, cost of goods sold and gross margins (in thousands, except percentage data): For the Three Months Ended December 31, 2013 2012 Software Revenue $ 10,908 $ 11,769 Cost of goods sold 3,269 3,051 Gross margin $ 7,639 $ 8,718 Gross margin % 70.0 % 74.1 % Hardware systems Revenue $ 2,131 $ 2,191 Cost of goods sold 1,604 1,733 Gross margin $ 527 $ 458 Gross margin % 24.7 % 20.9 % Services Revenue $ 258 $ 235 Cost of goods sold 546 522 Gross deficit $ (288 ) $ (287 ) Gross deficit % (111.6 )% (122.1 )% Total Revenue $ 13,297 $ 14,195 Cost of goods sold 5,419 5,306 Gross margin $ 7,878 $ 8,889 Gross margin % 59.2 % 62.6 % 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, XRS and Turnpike solutions; 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 for the XataNet and MobileMax solutions, hosting costs, depreciation of Relay and RouteTracker assets and direct personnel costs related to network infrastructure, as well as technical support for the XRS and Turnpike solutions. • Hardware systems cost of goods sold consists of direct product costs, warranty costs and product repair costs, as well as direct personnel costs and technical support for the XataNet and MobileMax solutions. • Services cost of goods sold consists of third-party vendor costs and direct costs related to services personnel. 20-------------------------------------------------------------------------------- Table of Contents Comparison of Fiscal 2014 Operating Results to Fiscal 2013 Revenue Total revenue was $13.3 million for the three months ended December 31, 2013 decreased 6.3 percent, compared to $14.2 million for the same period in fiscal 2013. Mobile software revenue grew 14.4 percent over the same period in fiscal 2013 as customers continued to respond to the increased use of mobile applications within the commercial trucking industry. Legacy software revenue was impacted by the shift in new customers selecting the Company's mobile solutions, as well as by attrition in the legacy subscription base. As a result, overall software revenue was $10.9 million for the three months ended December 31, 2013, compared to $11.8 million for the same period in fiscal 2013. Software revenue comprised 82.0 percent of total revenue for the three months ended December 31, 2013, compared to 82.9 percent for the same period in fiscal 2013. Hardware systems revenue decreased 2.7 percent to comprise 16.0 percent of total revenue for the three months ended December 31, 2013, compared to 15.4 percent of revenue for the same period in fiscal 2013. This decline is attributable to decreased sales of XataNet hardware systems as adoption of the Company's mobile solutions, with no upfront hardware costs to customers, continues to increase. Cost of Goods Sold and Gross Margins Total cost of goods sold increased 2.1 percent to $5.4 million for the three months ended December 31, 2013, compared to $5.3 million for the same period in fiscal 2013. The shift in sales mix between software and hardware systems and the decline in software gross margins were the primary contributors to the decrease of 3.4 percentage points in the overall gross margin percentage from 62.6 percent of revenue for the three months ended December 31, 2012 to 59.2 percent of revenue for the same period in fiscal 2014. Software cost of goods sold of $3.3 million increased 7.1 percent for the three months ended December 31, 2013, compared to $3.1 million for the same period in fiscal 2013. Software gross margins decreased 4.1 percentage points to 70.0 percent of revenue for the three months ended December 31, 2013, compared to 74.1 percent for the same period in fiscal 2013. The decline in margins is reflective of the Company's commitment to continue to support its legacy solutions while it transitions customers to its mobile solutions. Hardware systems cost of goods sold of $1.6 million decreased 7.4 percent for the three months ended December 31, 2013, compared to $1.7 million for the same period in fiscal 2013. Hardware systems gross margins improved by 3.8 percentage points to 24.7 percent of revenue for the three months ended December 31, 2013, compared to 20.9 percent for the same period in fiscal 2013. Hardware system margins for the three months ended December 31, 2013 improved as a result of favorability in inventory obsolescence and warranty activity and 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 $4.9 million for the three months ended December 31, 2013, compared to $5.5 million for the same period in fiscal 2013. The decrease in selling, general and administrative expenses reflects the Company's commitment to increased operational efficiencies. In addition, the current period reflects reduced legal expenses as the Company was involved in defending a patent litigation suit in the first quarter of fiscal 2013. 21 -------------------------------------------------------------------------------- Table of Contents 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 $2.9 million or 21.8 percent of revenue for the three months ended December 31, 2013, compared to $3.1 million or 21.5 percent of revenue for the same period in fiscal 2013. Continued investment in the development and enhancement of the XRS mobile solution's functionality to meet the operational needs of larger, more complex fleets resulted in research and development expense remaining consistent with the same period in fiscal 2013. Net Interest and Other Expense Net interest and other expense was $15,000 and $18,000 for the three months ended December 31, 2013 and 2012, respectively. As of December 31, 2013 and September 30, 2013, the Company utilized increased cash provided by operations to maintain a debt-free balance sheet. For the three months ended December 31, 2013, the decrease in net interest and other expense was attributable to lower interest expense resulting from lower average debt balances. Income Taxes The Company's effective tax rate was 17.3 percent and 1.6 percent for the three months ended December 31, 2013 and 2012, respectively. The higher tax rate for the three months ended December 31, 2013 was attributable to the impact of state income taxes. The Company does not have objectively verifiable positive evidence of future taxable income. Accordingly, the Company concluded that recording a valuation allowance to the extent 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, 2013, the Company had federal and state net operating loss carryforwards of $39.7 million, and $10.6 million, respectively, both which are scheduled to expire from 2014 through 2032. As of September 30, 2013, the Company also had tax credit carryforwards of $3.0 million. Net Income to Common Shareholders Net income to common shareholders was $0.03 million for the three months ended December 31, 2013, compared to a net income to common shareholders of $0.3 million for the same period in fiscal 2013. Net income to common shareholders reflects preferred stock dividends and preferred stock deemed dividends of $0.1 million for each of the three months ended December 31, 2013 and 2012. Liquidity and Capital Resources Operating activities provided $1.4 million of cash for the three months ended December 31, 2013, compared to $2.2 million for the same period in fiscal 2013. Improvements in working capital served as the primary contributor to the cash provided by operations for the three months ended December 31, 2013. Cash used in investing activities was $0.7 million for the three months ended December 31, 2013, compared to $0.6 million for the same period in fiscal 2013. Consistent with the Company's mobile strategy, purchases of equipment used in the Company's mobile solutions served as the primary investing activities for the three months ended December 31, 2013 and 2012 . 22 -------------------------------------------------------------------------------- Table of Contents Cash provided by financing activities was $0.1 million for the three months ended December 31, 2013 which reflects proceeds from the exercise of vested option awards. For the three months ended December 31, 2012 cash used in financing activities was $2.3 million, which reflects the Company's payoff of all outstanding debt facilities. The Company maintained a debt-free balance sheet as of December 31, 2013 and 2012. Non-GAAP Financial Measures The Company recorded free cash flow of $0.6 million for the three months ended December 31, 2013, a decrease of $0.9 million as compared to free cash flow of $1.6 million for the same period in fiscal 2013. The decrease in free cash flow was driven by net income of $0.1 million for the three months ended December 31, 2013, compared to a net income of $0.3 million for the same period in fiscal 2013 as well as a decrease in working capital components over the comparable periods. 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 Three Months Ended December 31, 2013 2013 2012 Net cash provided by operating activities $ 1,364 $ 2,182 Net cash used in investing activities: Purchase of equipment and leasehold improvements (183 ) (114 ) Purchase of Relay assets (formerly RouteTracker assets) (551 ) (499 ) Proceeds from the sale of equipment - 7 Net cash used in investing activities (734 ) (606 ) Free cash flow $ 630 $ 1,576 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): December 31, September 30, 2013 2013 Current assets $ 21,280 $ 21,061 Current liabilities (8,097 ) (9,331 ) Net current assets 13,183 11,730 Current portion of deferred revenue net of deferred costs 1,210 1,261 Working capital $ 14,393 $ 12,991 Free cash flow and working capital are non-GAAP financial measures that management uses to assess the Company's performance. Management believes free cash flow and working capital 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 the cash flow from operations, existing funds, availability on a 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. 23 -------------------------------------------------------------------------------- Table of Contents The Company's existing Loan and Security Agreement with Silicon Valley Bank is scheduled to expire on February 24, 2014. The Company anticipates having a similar revolving line of credit in place upon the expiration of the existing Loan and Security Agreement. 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 three months ended December 31, 2013 and the fiscal year ended September 30, 2013, the Company issued 47,000 and 97,000 shares, respectively, of Series B Preferred Stock for payment of accrued dividends. Critical Accounting Policies We describe our significant accounting policies in Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements included in our Form 10-K for the fiscal year ended September 30, 2013. There has been no significant change in our significant accounting policies or critical accounting estimates since the end of fiscal 2013. Recently Issued Accounting Standards There were no new accounting pronouncements issued or effective during the three months ended December 31, 2013 that have had or are expected to have a material impact on the consolidated financial statements. 24 -------------------------------------------------------------------------------- Table of Contents |