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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) The following Management's Discussion and Analysis is intended to help the reader understand the results of operations and financial condition of the business of DecisionPoint Systems, Inc. ("DecisionPoint", the "Company", "we" or "us"). Management's Discussion and Analysis is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the related notes thereto included elsewhere in this Form 10-Q. Forward Looking Statements Some of the statements contained in this Quarterly Report on 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 of such terms, or by discussions of strategy that involve risks and uncertainties. We urge you to be cautious of forward-looking statements. Such statements 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 otherwise, and actual events may differ from the assumptions underlying the statements that have been made as a result of the risks we face and otherwise. 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, the risk factors discussed in the "Risk Factors" section of our Annual Report on Form 10-K filed with the SEC on March 31, 2014 and the following: • 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 and management information systems. All forward-looking statements made in connection with this Quarterly Report on Form 10-Q and 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. Non-GAAP Financial Measures In the following discussion and analysis of results of operations and financial condition, certain financial measures may be considered "non-GAAP financial measures" under SEC rules. These rules require supplemental explanation and reconciliation, which is provided in this Quarterly Report on Form 10-Q as applicable. DecisionPoint's management uses the non-GAAP financial measure, "Adjusted Working Capital"; in their evaluation of business cash flow and financial condition. We consider this measure to reflect our 'cash' working capital position. It is the equivalent of our U.S. GAAP working capital position, after removing the accrual effect of current deferred assets and liabilities. We believe this non-GAAP financial measure provides us, and investors with a better understanding of the operating results and financial condition of our company. Non-GAAP disclosures have limitations as analytical tools, should not be viewed as a substitute for measures of cash flow, operating earnings or financial condition determined in accordance with U.S. GAAP, and should not be considered in isolation from or as a substitute for analysis of our results as reported under U.S. GAAP, nor are they necessarily comparable to non-GAAP financial measures that may be presented by other companies. Our supplemental presentation of Non-GAAP financial measures should not be construed as an inference that our future operating results or financial condition will be unaffected by any adjustments necessary to reconcile our Non-GAAP financial measures to measures determined in accordance with U.S. GAAP. Overview Business Overview DecisionPoint enables its clients to "move decisions closer to the customer" by "empowering the mobile worker". We define mobile workers as those individuals who 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 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 information and report it back to the organization. 23 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. 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 necessary for businesses to improve hundreds of the individual decisions made each day. Historically, critical information has remained locked away in the organization's enterprise computing systems, accessible only when employees are at their desks. Our solutions are designed to 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. Mobile computing capabilities and usage continue to grow. With choice comes complexity so helping our customers navigate the myriad of options is what we aim to 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 help our customers make the right choices, and then to deliver to those customers the hardware, software, connectivity and follow-up maintenance and other services that they need. We address the mobile application needs of customers in the retail, manufacturing, transportation, warehousing, distribution, logistics and other 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 substantially 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 well 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. In 2013 we consolidated our East Coast depot facility into our larger facility in Irvine, CA in order to provide our East Coast customers with later service hours and to gain some economies of scale. We also continue to invest in our "MobileCare EMM" enterprise mobility management offering. We are continuing to extend our mobile device management ("MDM") offering from our historically ruggedized mobile computer customer base to address the growing use of consumer devices by clients and others and to support the Bring Your Own Device ("BYOD") and Bring Your Own Application ("BYOA") movements affecting commerce and our industry in general. Recognizing that we cannot build every business application, we have developed an 'ecosystem' of partners to support the assembly and manufacturing provisions of our custom and off-the-shelf solutions. These partners include suppliers of mobile devices (Apple, Intermec and Motorola among others), wireless carriers (AT&T, Sprint, T-Mobile, Verizon), mobile peripheral manufactures (Zebra Technologies Corporation, Datamax - O'Neil) and a large number of specialized independent software vendors such as AirWatch, VeriFone GlobalBay, XRS and Wavelink. We have several offices throughout North America allowing us to serve multi-location clients and their mobile workforces. Additionally, we keep aware of potential acquisition candidates that could provide us with complementary products and service offerings, and make acquisitions when we identify sufficiently valuable opportunities. Recent Events On July 2, 2014, the Company received a written "Wells Notice" from the staff of the Securities Exchange Commission (the "SEC") indicating that the staff has made a preliminary determination to recommend that the SEC bring an administrative proceeding against the Company. On the same day Nicholas R. Toms, the Company's President and Chief Executive Officer and a member of the Board of Directors, also received a Wells Notice. The SEC staff has informed the Company that both Wells Notices relate to allegations that, from late 2009 to early 2011, Mr. Toms was the beneficial owner of shares of common stock of the Company that were held and traded by a Delaware corporation in which Mr. Toms was a 10% owner; that Mr. Toms exercised control over the corporation's securities account; and that the corporation's shareholding and trades should have been reflected at the relevant times in public disclosures of Mr. Toms' other holdings of the Company's common stock. On August 8, 2014, the Company submitted to the SEC a response to the Wells Notice setting forth why no action should be commenced against it. As of the date of this filing, there have been no further developments. 24 On August 15, 2014, Nicholas Toms, a director of the Company and the Chief Executive Officer, who has been on leave from his duties as an officer since July 2014 (see the Company's Form 8-K dated July 10, 2014), resigned from his positions as Chief Executive Officer, President and member of the board of directors, effective immediately. The directors have commenced a search for a new, permanent Chief Executive Officer. On September 10, 2014, the Board of Directors of Company caused the Company to file a proxy statement with the SEC in preparation for notifying its shareholders of, and conducting, an annual meeting of shareholders. The Company's proxy statement proposed the reelection of the incumbent members of the Board and the election of a new, additional director, James F. DeSocio. On September 16, 2014, shareholders Michael N. Taglich and Robert F. Taglich filed a preliminary proxy statement contesting the Company's director slate and proposing an alternative slate of directors to be elected at the October 15, 2014 meeting. Effective as of the close of business on October 3, 2014, the Company's incumbent directors and Messrs. Michael and Robert Taglich reached a settlement of their differences. Pursuant to the settlement, five of the incumbent directors, Board Chairman Lawrence Yelin and Board members Jay B. Sheehy, David M. Rifkin, Marc Ferland and Donald Dalicandro, resigned from the Board; James F. DeSocio was appointed to the Board; and Donald Dalicandro was authorized to serve as a Board observer until the end of the term during which he is eligible, under his employment agreement with the Company, to remain as a member of the Board. Thereafter, remaining incumbent director Robert Schroeder and new director Mr. DeSocio appointed the following four additional individuals as directors (all of whom were members of the alternative director slate proposed by Messrs. Michael and Robert Taglich): Michael N. Taglich, John Guttilla, Stanley P. Jaworski and Paul A. Seid. The Company's annual shareholders meeting was held on October 28, 2014. At the meeting, the sitting directors, Messrs. Schroeder, DeSocio, Michael N. Taglich, Guttilla, Jaworski and Seid, were elected to serve as the Company's directors until the next annual meeting. Results of Operations For comparison purposes, all dollar amounts have been rounded to nearest million while all percentages are actual. Due to rounding, column entries in the tables presented may not sum to the totals presented in the table. Three Months Ended Nine Months Ended September 30, Increase September 30, Increase 2014 203 (Decrease) 2014 2013 (Decrease) Net sales $ 14.1 $ 17.6 (19.5 %) $ 47.4 $ 46.1 2.8 % Gross profit 3.0 3.5 (12.8 %) 10.4 9.9 5.3 % Total operating expenses 3.0 3.7 (17.4 %) 10.2 13.2 (22.8 %) Operating income (loss) (0.0 ) (0.2 ) (96.2 %) 0.2 (3.3 ) (106.5 %) Net loss before income taxes (0.2 ) (0.3 ) (39.7 %) (0.2 ) (3.9 ) (95.4 %) Net Sales Net sales for the three and nine months ended September 30, 2014 and 2013 is summarized below: Three Months Ended Nine Months Ended September 30, Increase September 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) Hardware $ 8.8 $ 11.9 (26.1 %) $ 30.7 $ 28.8 6.4 % Professional services 4.3 4.3 (1.5 %) 12.9 12.7 1.9 % Software 0.8 0.9 (18.6 %) 2.7 3.5 (22.0 %) Other 0.3 0.4 (20.2 %) 1.1 1.1 (1.5 %) $ 14.1 $ 17.6 (19.5 %) $ 47.4 $ 46.1 2.8 % Net sales were $14.1 million for the three months ended September 30, 2014, compared to $17.6 million for the same period ended September 30, 2013, a decrease of $3.5 million or 19.5%. The decrease was driven principally by our hardware category, where net sales declined by $3.1 million, or 26.1% over the comparable period. The decrease in hardware revenue was partially due to significant orders by several large retail customers in the first and second quarters of 2014 not being repeated at the same level in the third quarterof 2014. 25 Net sales were $47.4 million for the nine months ended September 30, 2014, compared to $46.1 million for the same period ended September 30, 2013, an increase of $1.3 million or 2.8%. The increase was driven principally by our hardware category, which grew by $1.9 million, or 6.4% over the comparable period. The increase in hardware revenue was partially due to significant orders by several large retail customers in the first and second quarters of 2014. The increase in revenue was also due to the increased field mobility solution sales and increased professional services revenue from our CMAC subsidiary for the nine months ended September 30, 2014, compared to the period ended September 30, 2013. We also recognized higher revenues through the expansion of our customer base and continued ordering from customers acquired after the first quarter of 2013. The decrease in software revenue of $0.8 million, or 22.0% for the nine months ended September 30, 2014 was primarily attributable to the decrease of $0.4 million associated with the Apex business. Software revenue for Apex in the nine months ended September 30, 2013 received the benefit of a new customer and additional business opportunities not recognized at the same level in the nine months ended September 30, 2014. Improved economic conditions in the U.S. have had a positive effect on our sales. In 2013, major retail chains 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. While the slowly improving economic conditions in the U.S. have had a positive effect generally, we have continued to experience greater competitive forces in the market place within our core traditional solutions business. Cost of Sales Cost of sales for the three and nine months ended September 30, 2014 and 2013 is summarized below: Three Months Ended Nine Months Ended September 30, Increase September 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) Hardware $ 7.2 $ 9.8 (26.1 %) $ 25.0 $ 23.4 6.8 % Professional services 2.8 2.9 (6.1 %) 8.4 8.6 (2.6 %) Software 0.9 1.1 (18.6 %) 2.8 3.4 (17.8 %) Other 0.3 0.3 (19.6 %) 0.9 0.9 (0.1 %) $ 11.1 $ 14.1 (21.2 %) $ 37.0 $ 36.2 2.1 % The cost of sales line includes 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 was $11.1 million for the three months ended September 30, 2014, compared to $14.1 million for the same period ended September 30, 2013, a decrease of $3.0 million or 21.2%. The decrease in cost of sales for hardware of 26.1% for the three months ended September 30, 2014 compared to the same period in 2013 was consistent with the hardware revenue decrease. The decrease in cost of sales for professional services from the three months ended September 30, 2014 compared to the three months ended September 30, 2013 was 6.1%, more than the professional services revenue decline of 1.5% for the same period, which was due to reductions in professional service personnel that we achieved as a component of our operational improvement efforts. The decrease in cost of sales for software of 18.6% for the three months ended September 30, 2014 compared to the similar period in 2013 was consistent with the decrease in software revenues for the same period and related to professional service personnel reductions. The decrease in other cost of sales was approximately in proportion to the decrease in the other revenues. Cost of sales was $37.0 million for the nine months ended September 30, 2014, compared to $36.2 million for the same period ended September 30, 2013, an increase of $0.8 million or 2.1%. The increase in cost of sales for hardware of 6.8% for the nine months ended September 30, 2014 compared to the same period in 2013 was slightly higher than the hardware revenue increase due to fewer large orders which usually have reduced pricing and product mix. The decrease in cost of sales for professional services from the nine months ended September 30, 2014 to the nine months ended September 30, 2013 was 2.6% compared to the revenue growth rate of 1.9%, and was due to reductions in professional service personnel that we achieved as a component of our operational improvement efforts.The decrease in cost of sales for software of 17.8% for the nine months ended September 30, 2014 compared to the same period in 2013 was also related to professional service personnel reductions. The increase in other cost of sales was approximately in proportion to the increase on other revenues. 26 Gross Profit Gross profit for the three and nine months ended September 30, 2014 and 2013 is summarized below: Three Months Ended Nine Months Ended September 30, Increase September 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) Hardware $ 1.6 $ 2.2 (26.4 %) $ 5.7 $ 5.4 4.5 % Professional services 1.5 1.4 8.4 % 4.5 4.1 11.3 % Software (0.1 ) (0.2 ) (19.0 %) (0.1 ) 0.1 (187.2 %) Other 0.1 0.1 (22.7 %) 0.2 0.3 (6.2 %) $ 3.0 $ 3.5 (12.8 %) $ 10.4 $ 9.9 5.3 % As a percentage of sales 21.4 % 19.7 % 1.7 % 21.9 % 21.4 % 0.5 % Our gross profit was $3.0 million for the three months ended September 30, 2014, compared to $3.5 million for the same period ended September 30, 2013, a decrease of $0.5 million or 12.6%. Our gross margin increased by 1,656 basis points to 21.4% in 2014, from 19.7% in the comparable period of 2013. Our gross profit was $10.4 million for the nine months ended September 30, 2014, compared to $9.9 million for the same period ended September 30, 2013, an increase of $0.5 million or 5.3%. Our gross margin increased by 524 basis points to 21.9% in 2014, from 21.4% in the comparable period of 2013. We believe that we would have realized even better gross margins had it not been for the very competitive environment for hardware sales across our entire customer base, hardware sales carry a lower gross margin. We realized higher gross margins on our professional services, due to our increased emphasis on cost control and reductions in professional services personnel. Selling, General and Administrative Expenses Three Months Ended Nine Months Ended September 30, Increase September 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) Selling, general and administrative expenses $ 3.0 $ 4.5 (32.5 %) $ 10.2 $ 14.0 (27.3 %) As a percentage of sales 21.4 % 25.5 % (4.1 %) 21.5 % 30.3 % (8.9 %) Adjustment to earn-out obligations $ - (0.8 ) $ - (0.8 ) Selling, general and administrative expenses were $3.0 million for the three months ended September 30, 2014, compared to $4.5 million for the same period in the prior year. This represents a decrease of $1.5 million, or 32.5%. Selling, general and administrative expenses were $10.2 million for the nine months ended September 30, 2014, compared to $14.0 million for the same period in the prior year. This represents a decrease of $3.8 million, or 27.3%. The decrease for the three and nine months ended September 30, 2014 compared to the similar periods in the prior year were due to significant efforts to streamline our business model. These efforts included, consolidation of our East Coast depot facility in to our larger California depot facility, reduction of outsourced consulting expertise where unnecessary and the replacement of certain service providers with lower cost providers. We have also consolidated administrative personnel and reduced total staffing levels by 29% from April 2013 through February 2014, constituting annual savings of $3 million. These cost reduction measures have reduced the expense structure of our business significantly. We are focused on continuing to improve processes and reducecosts. 27 Depreciation and Amortization We account for a portion of our depreciation and amortization expense as cost of sales, and the remainder as selling, general and administrative expense. Depreciation and amortization for the three and nine month periods ended September 30, 2014 and 2013 is summarized below: Three Months Ended Nine Months Ended September 30, Increase September 30, Increase Depreciation and 2014 2013 (Decrease) 2014 2013 (Decrease) amortization In cost of sales $ 0.2 $ 0.2 5.5 % $ 0.6 $ 0.6 4.7 % In operating expenses 0.2 0.3 (23.9 %) 0.7 0.9 (21.3 %) Total depreciation and amortization $ 0.4 $ 0.5 (12.0 %) $ 1.3 $ 1.5 (10.6 %) As a percentage of sales 3.1 % 2.8 % 0.3 % 2.8 % 3.2 % (0.4 %) The reduction in depreciation and amortization accounted for as selling, general and administrative expense was principally as a result of a decrease in the amortization of intangible assets. Interest Expense Interest expense arises from our outstanding balances under our lines of credit and from our outstanding subordinated debt. Interest expense was $229,000 for the three months ended September 30, 2014, compared to $241,000 for the same period in the prior year. The $12,000 decrease in interest expense reflected a decrease in our average outstanding general debt obligations during the three months ended September 30, 2014 compared to the similar period in the prior year. Interest expense was $658,000 for the nine months ended September 30, 2014, compared to $723,000 for the same period in the prior year. The $65,000 decrease in interest expense reflected a decrease in our average outstanding general debt obligations during the nine months ended September 30, 2014 compared to the similar period in the prior year. Liquidity and Capital Resources Going Concern Matters Our consolidated financial statements were prepared on a going concern basis in accordance with U.S. GAAP. The going concern basis of presentation assumes that we will continue in operation for the next twelve months and will be able to realize our assets and discharge our liabilities and commitments in the normal course of business and does not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our inability to continue as a going concern. Our history of losses, working capital deficit, capital deficit, minimal liquidity and other factors raises substantial doubt about our ability to continue as a going concern. In order for us to continue operations beyond the next twelve months and be able to discharge our liabilities and commitments in the normal course of business, we must do some or all of the following: establish sustained positive operating results through increased sales, successfully implement cost cutting measures, avoid further unforeseen expenses, potentially raise additional equity or debt capital, and successfully refinance our current debt obligations when they come due in February of 2015. There can be no assurance that we will be able achieve sustained positive operating results or obtain additional funds when needed or that such funds, if available, will be obtainable on terms satisfactory to us. If we do not continue to achieve positive operating results and 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 inability to fully implement our current business plan and 3) continued defaults under our various loan agreements. There can be no assurances that we will be able to successfully improve our liquidity position. Our consolidated financial statements do not do not reflect any adjustments that might be required if our liquidity position does not improve. Cash and Capital Resources Although we have historically experienced losses, a material part of those losses have been from non-cash transactions. In connection with these losses, we have accumulated substantial net operating loss carry-forwards to set off against future taxable income. In order to maintain normal operations for the foreseeable future, generate taxable income and make use of our net operating loss carry-forwards, we must continue to have access to our lines of credit, establish sustained positive operating results and access additional equity or debt capital. There can be no assurance that we will be able to achieve sustainable positive operating results or cost reductions or that we can obtain additional funds when needed to continue our normal operations. Funds generated by operating activities and our credit facilities continue to be our most significant sources of liquidity. 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 general economic conditions continue to improve. 28 In the quarter ended September 30, 2014, we experienced a decrease in revenue of $3.4 million, or 19.5% compared to the quarter ended September 30, 2013, and a $1.3 million, or 2.8% increase in revenue for the nine months ended September 30, 2014 over the comparable nine months of 2013. In the quarter ended September 30, 2014, we experienced net loss of $563,000 compared to the net loss of $167,000 for the quarter ended September 30, 2013, and a $696,000 net loss for the nine months ended September 30, 2014 compared to a net loss of $3.4 million for the comparable period in 2013. At September 30, 2014 and December 31, 2013, we had a substantial working capital deficit totaling $9.9 million. Although a portion of this deficit is associated with deferred costs, unearned revenues and term debt that has been classified current due to expected future covenant violations (see further discussion at Note 8, Term Debt of the Notes to the Unaudited Condensed Consolidated Financial Statements), our liabilities that we expect will be satisfied in the foreseeable future in cash substantially exceed the operating assets that are expected to be satisfied in cash. As a result of our historical operations, the availability under our credit line has contracted and our liquidity has been constrained. To address liquidity constraints, we have reduced non-essential expenses. Such expense reductions have included, but have not been limited to, the consolidation of information technology environments, the consolidation of our East Coast depot facility in to our larger California depot facility, the reduction of outsourced consulting expertise where unnecessary and the replacement of certain service providers with lower cost providers. We have also consolidated administrative personnel and reduced total staffing levels by 29% from April 2013 through February 2014, constituting annual savings of approximately $3 million. These cost reduction measures have reduced the expense structure of our business significantly. We are focused on continuing to improve processes and reduce costs. Currently, we have no plans to seek additional outside funding through the sale of our securities unless deemed necessary. Should additional outside financing be needed, there is no assurance that such amounts 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 interests of our existing common stockholders will be diluted. During 2012, 2013 and the first nine months of 2014, all principal and interest payments on our term debt were made within payment terms. As a matter of course, we do not maintain significant cash balances on hand because we have availability under our lines 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 SVB line of credit to fund our normal working capital needs. Our line of credit has a borrowing capacity of up to $10 million and is due February 2015. As of September 30, 2014 and December 31, 2013, the outstanding balance on our SVB line of credit was approximately $3.8 and $3.9 million, respectively, and the interest rate for September 30, 2014 and December 31, 2013 was 6.5% and 7.0%, respectively. As of September 30, 2014, there was $0.7 million available under the SVB line of credit. The line of credit has a certain financial covenant and other non-financial covenants. The minimum Tangible Net Worth requirement of $8.7 million deficit is to be reduced 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). As of September 30, 2014 and December 31, 2013, we were in compliance with the Tangible Net Worth financial covenant and had available a $0.6 million and $0.8 million cushion over the requirement, respectively. We believe that at the time of this filing we are in compliance with the terms and provisions of its SVB lending agreement. Should our results fail to improve further or once more deteriorate in a manner consistent with its recent historical financial performance, we will violate the Tangible Net Worth financial covenant without additional net capital outside funding in amounts that are approximately twice the amount of the losses incurred. We have $0.6 million of term debt with the Royal Bank of Canada (the "RBC Term Loan"), $1.5 million of term debt with the BDC (the "BDC Term Loan") and $0.5 million of term debt with SVB (the "SVB Term Loan"). For more information regarding these Term Loans, please see our Annual Report on Form 10-K filed with the SEC on March, 31, 2014. All three Term Loans have financial covenants. We were in compliance with the covenants of these Term Loans except for the RBC Term Loan, for which we were not in compliance at September 30, 2014 and December 31, 2013. Although the Company believes it is not likely that RBC will exercise their rights up to, and including, acceleration of the outstanding debt, there can be no assurance that RBC will not exercise their rights pursuant to the provisions of the debt obligation. Accordingly, the Company has classified the term debt obligation as current at September 30, 2014 and December 31, 2013. As part of the Apex Purchase Agreement, from the Apex Closing Date up until the expiry of the bonus period, under that agreement we are obligated to escrow 25% of any Equity Capital raised in excess of $500,000. The funds in the escrow are to be used to pay the 2013 EBITDA Basic Earn-Out, the 2013 EBITDA Additional Earn-Out and the additional bonus consideration. In December 2012, the Company raised $7,042,000 as part of its Series D preferred stock offering. In August 2013, the Company raised $1,756,000 issuing common stock. In November 2013, the Company raised $4,090,000 as part of its Series E preferred stock offering. None of these funds have been placed into escrow pending agreement between the Company and the sellers of Apex regarding the financial institution that will escrow the funds, the amount of funds that are to be placed into escrow andthe escrow agreement itself. In the last five complete years of operations from 2009 through 2013, we have not experienced any significant effects of inflation on our product and service pricing, revenues or our income (loss) from continuing operations. 29 As referred to above under the heading "Non-GAAP Financial Measures," we monitor our 'cash' working capital position after removing the accrual effect of current deferred assets and liabilities. We refer to this non-GAAP financial measure as our "Adjusted Working Capital". We believe this non-GAAP financial measure provides us, and investors, with a better understanding of the operating results and financial condition of our company. Adjusted Working Capital at September 30, 2014 and December 31, 2013 are computed as follows (in thousands): September 30, December 31, 2014 2013 Current assets $ 13,150 $ 16,912 Current liabilities 23,107 26,787 Working capital - U.S. GAAP (9,957 ) (9,875 ) Deferred costs (3,667 ) (3,809 ) Deferred revenue 5,824 7,481 Adjusted working capital - Non-GAAP measure $ (7,800 ) $ (6,203 ) 2014 Financing We have not engaged in any securities issuances or other material capital raising in the first nine months of 2014. 2013 Financing and Common Stock Private Placement For information concerning the financing we undertook in 2012 and 2013, please see our Annual Report on Form 10-K filed with the SEC on March, 31, 2014. Cash Flows from Operating, Investing and Financing Activities Information about our cash flows, by category, is presented in the accompanying unaudited Condensed Consolidated Statements of Cash Flows. The following table summarizes our cash flows for the nine months ended September 30, 2014 and2013 (in millions): Nine Months Ended September 30, 2014 2013 Increase/(Decrease) Operating activities $ 2.2 $ (2.2 ) $ 4.4 202.8 % Investing activities (0.0 ) (0.0 ) 0.0 27.1 % Financing activities (1.3 ) 1.4 (2.7 ) (198.6 %) Net cash provided by operating activities during the first nine months of 2014 increased by $4.4 million over the same period in the prior year. The increase in cash from operations was primarily driven by a decrease in net loss in the first nine months of 2014 of $2.7 million. Our net loss was $696,000 in the first nine months of 2014, a portion of which was the result of non-cash transactions during the year. Specifically, we had a $0.1 million non-cash expense related to employee and non-employee stock based compensation and a net $1.4 million of other non-cash transactions such as depreciation and amortization. Additionally, the changes in net working capital and other balance sheet changes contributed to a $0.9 million increase in cash provided by operating activities, most notably from a $4.1 million decrease in accounts receivable due to timing of receivable collections, a $3.8 million decrease in accounts payable and a $1.0 million decrease in inventory. During the nine months ended September 30, 2013, net cash used in operating activities was $2.2 million. Our net loss was $3.5 million during the first nine months of 2013, most of which was the result of non-cash transactions during the quarter. Specifically, we had a $0.8 million non-cash expense including depreciation and amortization, employee and non-employee stock-based compensation. Net cash used in investing activities was negligible during the nine months ended September 30, 2014 and the comparable nine months of 2013. During the nine months ended September 30, 2014, net cash used in financing activities was $1.3 million, due to $0.1 million in paid financing costs, $0.8 million in repayments under our term loans, $0.5 million in payments for the Series D and Series E Preferred Stock dividends and $0.1 million for payment on contingent acquisition liability, offset by cash provided by an $0.2 million in net amounts borrowed under our lines of credit. During the nine months ended September 30, 2013, net cash provided by financing activities was $1.4 million, primarily due to $1.0 million in proceeds from the bank term loan, net of $1.6 million in payments for term loans, a net $0.8 million in borrowings under our lines of credit, payment of $0.3 million for the Series D Preferred Stock dividend and $1.5 million in net proceeds from a common stock private placement. 30 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. There have been no material changes to the Company's critical accounting policies during the nine months ended September 30, 2014. See Footnote 2 of the Company's consolidated financial statements included in the Company's 2013 Annual Report on Form 10-K filed on March 31, 2014 with the SEC, for a description of the Company's critical accounting policies. Recently Issued Accounting Pronouncements In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers" (Topic 606), which supersedes the revenue recognition requirements in ASC Topic 605, "Revenue Recognition" and most industry specific guidance. This ASU is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. This new guidance is effective for annual reporting periods beginning after December 15, 2016 and early adoption is not permitted. Accordingly, we will adopt this new guidance beginning in fiscal 2017. Companies may use either a full retrospective or a modified retrospective approach to adopt this new guidance and management is currently evaluating which transition approach to use and the impact of this new guidance on our consolidated financial position or results of operations. In August 2014, the FASB issued ASU No. 2014-15, "Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern" (Subtopic 205-40), which defines management's responsibility to evaluate whether there are conditions or events that raise substantial doubt about the entity's ability to continue as a going concern and to provide related disclosures. Currently, this evaluation has only been an auditor requirement. Specifically, the amendments (1) provide a definition of the term "substantial doubt," (2) require an evaluation every reporting period, (3) provide principles for considering the mitigating effect of management's plans, (4) require certain disclosures when substantial doubt is alleviated as a result of the consideration of management's plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that financial statements are issued. This amended guidance will be effective for us beginning January 1, 2016. We do not expect the adoption of this amended guidance to have a significant impact on our Consolidated Financial Statements. Off-Balance Sheet Arrangements There were no off-balance sheet arrangements as of September 30, 2014. Inflation We do not believe that inflation has had a material impact on our business or operating results during the periods presented. |