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COMARCO INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8 of this report as well as our risk factors included in Item 1A of this report. The following discussion contains forward-looking statements. See "Cautionary Note Regarding Forward-Looking Statements" included in Item 1 of this report. Overview Comarco, Inc. was incorporated in California in 1960 and its common stock has been publicly traded since 1971, when it was spun-off from Genge Industries, Inc. Comarco Inc.'s wholly-owned subsidiary Comarco Wireless Technologies, Inc. ("CWT") was incorporated in the state of Delaware in September 1993. Comarco and CWT are collectively referred to as "we," "us," "our," "Comarco," or the "Company". Our operations consist solely of the operations of Comarco Wireless Technologies, Inc. ("CWT"). Going Concern Qualification The Company has experienced pre-tax losses from continuing operations for fiscal 2014 and fiscal 2013 totaling $2.1 million and $5.6 million, respectively. The Company also has negative working capital and uncertainties surrounding the Company's future ability to obtain borrowings and raise additional capital. 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 begin to monetize our intellectual property; manage operating expenses; prevail in our ongoing litigation; and raise additional funds, through either debt and/or equity financing to meet our working capital needs. We cannot guarantee that we will be able to monetize our intellectual property, manage expenses, prevail in our ongoing litigation, or obtain additional funds through either debt or equity financing transactions or that such funds, if available, will be obtainable on satisfactory terms. If we are unable to monetize our intellectual property, manage expenses, prevail in our ongoing litigation, or raise additional capital through debt or equity financings, we may be unable to continue to fund our operations, or realize value from our assets and discharge our liabilities in the normal course of business. These uncertainties raise substantial doubt about our ability to continue as a going concern. 12 --------------------------------------------------------------------------------Business Strategy and Future Plans Through the third quarter of fiscal year 2014, we developed and designed innovative technologies and intellectual property that was used in power adapters to power and charge battery powered devices such as laptop computers, tablets, smart phones and readers. On August 19, 2013, Lenovo Information Products Co., Ltd. ("Lenovo"), our only material customer, informed us that it intended to cease offering our Constellation product, the power adapter we designed and developed for Lenovo. Sales of the Constellation product to Lenovo accounted for materially all of our revenue for the fiscal years 2014 and 2013. We anticipate that we will generate de minimus revenue in future periods from the development, design, distribution or sale of any products. We have effectively suspended traditional operations and are now primarily focused on potentially realizing value from our ongoing litigation as well as exploring opportunities to expand, protect, and monetize our patent portfolio, including through the potential sale or licensing of our patent portfolio. In the future, we may resume our traditional operations, if and when possible. Company Trends and Uncertainties Management currently considers the following additional trends, events, and uncertainties to be important to an understanding of our business: ? We are currently analyzing and will continue to analyze a range of alternatives to preserve value and/or build for our stakeholders, including, but not limited to, exploring additional investment and incremental financing from current and/or new investors, the engagement of advisors to assist in exploring strategic options for us as well as identifying potential partnerships for the purpose of monetizing some or all of our patent portfolio and past, present, and future infringement claims. There can be no assurances that we will be successful in implementing any of these alternatives, or if implemented, that any of these alternatives will successfully preserve or increase shareholder value. ? Revenue for fiscal 2014 decreased to $4.4 million compared to $6.3 million for fiscal 2013. The decrease is attributable to decreased sales to our principal customer Lenovo. In the third quarter of fiscal 2014, Lenovo terminated its relationship with us. We completed our final shipment of product to Lenovo during the third quarter ended October 31, 2013 and we generated de minimus revenue in our fourth quarter ending January 31, 2014. We anticipate that we will generate de minimus revenue from the development, design, distribution or sale of any products until we settle our current litigation and are able to resume traditional operations. ? On March 10, 2014, we filed a lawsuit against Targus Group International, Inc. ("Targus") for patent infringement, breach of contract, intentional interference with contract, violation of business and professional codes, misrepresentation and fraudulent concealment. We are seeking damages of $17 million. ? We have been party to litigation with Chicony Power Technology, Co. Ltd. ("Chicony"). On February 4, 2014, a jury returned a verdict in our favor and awarded us damages of approximately $10.8 million, offset by previously accrued liabilities of $1.1 million for a net award of approximately $9.7 million. Because the award is subject to entry of final judgment and may be appealed, we will not recognize the award in our financial statements until the award is realized per applicable accounting standards. If and once realized, a portion of our award may be payable to our attorneys pursuant to an alternative professional fee arrangement. In addition, we may be entitled to reimbursement of attorney's and other fees pending final judgment. Together, these matters may increase or decrease the net financial impact of this verdict on us. ? We have been party to litigation with ACCO Brands USA LLC and its Kensington Computer Products Group division (collectively "Kensington"). On February 4, 2014, Kensington entered into a settlement and licensing agreement with us with an effective date of February 1, 2014 that dismisses all claims between the two parties arising from this matter. 13-------------------------------------------------------------------------------- ? On September 23, 2013, we entered into an alternative fee agreement with our legal counsel representing us in the Chicony matter, which we believe will provide us legal counsel through the conclusion of the Chicony proceedings. Similarly on August 6, 2013, we changed our legal representation with respect to our ongoing intellectual infringement and enforcement litigation and entered an alternative fee arrangement in order to reduce our legal expenses. ? On August 26, 2013, we entered into an agreement with our insurance carrier and received a one-time, lump-sum payment in exchange for a mutual release and the assumption of sole financial responsibility for any expenses related to the Chicony matter subsequent to August 31, 2013. Previously, in October 2012, our insurance carrier agreed to defend certain claims brought against us by Chicony, but did not agree to prosecute or pay for any claims we brought against Chicony. As a result, the defense of claims brought against us by Chicony were previously handled by counsel appointed by our insurance carrier at their cost, with any claims we brought against Chicony handled by counsel appointed by us at our cost. In July 2013, in response to our stated desire to have counsel appointed by us representing our consolidated interests across the entirety of our litigation with Chicony, we entered into discussions with our insurance carrier and subsequently entered into the agreement as a means to achieve our desired representation goal. ? On February 11, 2013, we entered into a Secured Loan Agreement (the "Loan Agreement") with Elkhorn Partners Limited Partnership ("Elkhorn"). Pursuant to the Loan Agreement, on February 11, 2013, Elkhorn made a $1,500,000 senior secured term loan (the "Loan") to us. The Loan bears interest at 7% per annum for the first year; increasing to 8.5% per annum thereafter, ranks senior in right of payment to all of our other indebtedness, is secured by a first priority security interest in all of the assets of Comarco and CWT, and is due and payable in full on November 30, 2014. See Note 7 to our consolidated financial statements contained elsewhere in this report for additional information regarding the Loan Agreement, the Loan and certain related agreements. ? Concurrent with the execution of the Loan Agreement, Elkhorn entered into a Stock Purchase Agreement with us (the "Stock Purchase Agreement"). Pursuant to that Stock Purchase Agreement, we sold 6,250,000 shares of our common stock to Elkhorn at a price of $0.16 per share, resulting in an aggregate purchase price of $1.0 million. The purchase price of $0.16 per share paid by Elkhorn for those shares was determined by arms-length negotiations between Elkhorn and the members of a special committee of our Board of Directors, comprised of three of the directors who have no affiliation with Elkhorn and no financial interest, other than their interests solely as our shareholders, in either the loan or share transactions with Elkhorn. See Note 7 to our consolidated financial statements contained elsewhere in this report for additional information regarding the Stock Purchase Agreement and certain related agreements. ? As a result of our sale of the 6,250,000 shares of common stock to Elkhorn pursuant to the Elkhorn Stock Purchase Agreement, Elkhorn's beneficial ownership has increased from approximately 9% to approximately 49% of our outstanding voting stock, making Elkhorn our largest shareholder. Critical Accounting Policies The preparation of our consolidated financial statements requires us to apply accounting policies and make certain estimates and judgments. All of our significant accounting policies are presented in Note 2 of the notes to the consolidated financial statements in Item 8 of this report. Of our significant accounting policies, we believe the following are the most significant and involve a higher degree of uncertainty, subjectivity, and judgments. These policies involve estimates and judgments that are inherently uncertain. Changes in these estimates and judgments may significantly impact our annual and quarterly operating results. Revenue Recognition We recognized product revenue upon shipment provided there were no uncertainties regarding customer acceptance, persuasive evidence of an arrangement exists, the sales price was fixed or determinable, and collectability was probable. Generally, our products were shipped FOB named point of shipment, whether it is Lake Forest, which is the location of our corporate headquarters, or China, the shipping point for most of our contract manufacturers. Subsequent to October 1, 2013 and the termination of the Lenovo relationship, we had minimal revenue activities. 14-------------------------------------------------------------------------------- Stock-based Compensation We recognize compensation costs for all stock-based awards made to employees, consultants, and directors. The fair value of stock based awards is estimated on the date of grant, and is recognized as expense ratably over the requisite service period. We currently use either a Lattice Binomial or the Black-Scholes option-pricing model to estimate the fair value of our share-based payments. Both the Lattice Binomial and the Black-Scholes option-pricing model are based on a number of assumptions, including expected volatility, expected forfeiture rates, expected life, risk-free interest rate and expected dividends. The prevailing difference between the two models is the Lattice Binomial model's ability to enhance the simple assumptions that underlie the Black-Sholes model. The Lattice Binomial model allows for assumptions such as risk-free rate of interest, volatility and exercise rate to vary over time reflecting a more realistic pattern of economic and behavioral occurrences. If the assumptions change under either model, stock-based compensation may differ significantly from what we have recorded in the past. Derivative Liabilities A derivative is an instrument whose value is "derived" from an underlying instrument or index such as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded in other contracts and for hedging activities. As a matter of policy, we do not invest in separable financial derivatives or engage in hedging transactions. However, we have entered into certain financing transactions in fiscal 2013 that involve financial equity instruments containing certain features that have resulted in the instruments being deemed derivatives. We may engage in other similar complex financing transactions in the future, but not with the intention to enter into derivative instruments. Derivatives are measured at fair value using the Monte Carlo simulation pricing model and marked to market through earnings. However, such new and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation of derivatives often incorporate significant estimates and assumptions. Changes in these subjective assumptions can materially affect the estimate of the fair value of derivative liabilities and, consequently, the related amount recognized as loss due to change in fair value of derivative liabilities on the consolidated statement of operations. Furthermore, depending on the terms of a derivative, the valuation of derivatives may be removed from the financial statements upon exercise or conversion of the underlying instrument into some other security. Accounts Receivable We perform ongoing credit evaluations of our customers and adjust credit limits and related terms based upon payment history and the customer's current credit worthiness. We continually monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Because our accounts receivable are concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse effect on the collectability of our accounts receivable and our future operating results. Specifically, our management must make estimates of the collectability of our accounts receivable. Management analyzes specific customer accounts and establishes reserves for uncollectible receivables based upon specific identification of account balances that have indications of uncertainty of collection. Indications of uncertainty of collections may include the customer's inability to pay, customer dissatisfaction, or other factors. Significant management judgments and estimates must be made and used in connection with establishing the allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of our losses for any period if management made different judgments or utilized different estimates. Income Taxes We are required to estimate our provision for income taxes in each of the tax jurisdictions in which we conduct business. This process involves estimating our actual current tax expense in conjunction with the evaluation and measurement of temporary differences resulting from differing treatment of certain items for tax and accounting purposes. These temporary timing differences result in the establishment of deferred tax assets and liabilities, which are recorded on a net basis and included in our consolidated balance sheets. We then assess on a periodic basis the probability that our net deferred tax assets, if any, will be recovered. If after evaluating all of the positive and negative evidence, a conclusion is made that it is more likely than not that some portion or all of the net deferred tax assets will not be recovered, a valuation allowance is provided with a corresponding charge to tax expense to reserve the portion of the deferred tax assets which are estimated to be more likely than not to be realized. 15-------------------------------------------------------------------------------- Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any required valuation allowance. We continue to maintain a full valuation allowance on the entire deferred tax asset balance. This valuation allowance was established based on management's overall assessment of risks and uncertainties related to our future ability to realize, and hence, utilize certain deferred tax assets, primarily consisting of net operating loss carry forwards and temporary differences. Due to the current and prior years' operating losses, the adjusted net deferred tax assets remained fully reserved as of January 31, 2014. We have a net operating loss carryforward of $40.7 million for federal and $33.6 million for state, which expire through 2033 We are reviewing whether a Section 382 ownership change may have occurred as a result of the Elkhorn transaction in fiscal 2014 (Part II, Item 8, Note 7). If this transaction results in an ownership change, it would substantially limit our research and experimentation credits and net operating loss carryforwards. Valuation of Long-Lived Assets We evaluate long-lived assets used in operations when indicators of impairment, such as reductions in demand or significant economic slowdowns that negatively impact our customers or markets, are present. Reviews are performed to determine whether the carrying value of assets is impaired based on comparison to the undiscounted expected future cash flows. If the comparison indicates that there is impairment, the impaired asset is written down to fair value, which is typically calculated using a weighted average of the market approach and the discounted expected future cash flows using a discount rate based upon our cost of capital. Impairment is based on the excess of the carrying amount over the fair value of those assets. Significant management judgment is required in the forecast of future operating results that is used in the preparation of expected discounted cash flows. It is reasonably possible that the estimates of anticipated future net revenue, the remaining estimated economic life of the products and technologies, or both, could differ from those used to assess the recoverability of these assets. In that event, additional impairment charges or shortened useful lives of certain long-lived assets could be required. Results of Operations-Continuing Operations The following tables set forth certain items as a percentage of revenue from our audited consolidated statements of operations for fiscal 2014 and fiscal 2013: Revenue Revenue for fiscal 2014 decreased to $4.4 million compared to $6.3 million for fiscal 2013. The decrease is attributable to by decreased sales to our only material customer Lenovo. In the third quarter of fiscal 2014, Lenovo terminated its relationship with us. We completed our final shipment of product to Lenovo during the third quarter ended October 31, 2013 and we generated de minimus revenue in our fourth quarter ending January 31, 2014. (in thousands) Years Ended January 31, 2014 2013 % Change Revenue $ 4,429 $ 6,338 -30 % Operating loss $ (2,233 ) $ (3,008 ) -26 % Net loss $ (2,058 ) $ (5,592 ) -63 % (in thousands) Years Ended January 31, 2014 2013 % Change Revenue: Asia-Pacific $ 4,319 $ 6,238 -31 % North America 73 78 -6 % Europe 37 22 68 % $ 4,429 $ 6,338 -30 % 16-------------------------------------------------------------------------------- (in thousands) Years Ended January 31, 2014 2013 % Change Revenue: Lenovo $ 4,319 $ 6,203 -30 % Dell - 67 -100 % Other 110 68 62 % $ 4,429 $ 6,338 -30 % Cost of Revenue and Gross Margin (in thousands) Years Ended January 31, 2014 2013 % Change % of Total % of Total Cost of Revenue: Product costs $ 2,994 76 % $ 4,375 105 % -32 % Supplier settlement - 0 % (1,443 ) -35 % -100 % Supply chain overhead 534 14 % 812 20 % -34 % Inventory reserve and scrap charges 402 10 % 406 10 % -1 % $ 3,930 100 % $ 4,150 100 % -5 % Years Ended January 31, 2014 2013 % Change Gross profit percent 11 % 35 % -68 % Gross profit percent, excluding supplier settlement 11 % 12 % -6 % Fiscal 2014 gross profit percent was comparable to the fiscal 2013 levels, excluding supplier settlement. In fiscal 2013, we recorded a benefit of $1.4 million in cost of revenue as a result of a settlement agreement with our supplier, EDAC Power Electronics, Co. Ltd. ("EDAC"). We reversed previously incurred product and freight costs and discharged $1.4 million in net liabilities due to EDAC. Our supply chain overhead expenses decreased $0.28 million or 34 percent in fiscal 2014 compared to fiscal 2013. The decrease is due to reductions in personnel and related costs as well as other expenses as a result of continued cost cutting measures. The inventory reserve and scrap charges of $0.4 million recorded in fiscal 2014 relates primarily to reserves established for excess Constellation components and other slow-moving inventory. The inventory reserve and scrap charges of $0.4 million recorded in fiscal 2013 relates primarily to reserves established for excess ChargeSource components as well as slow-moving inventory. Operating Costs and Expenses (in thousands) Years Ended January 31, 2014 2013 % Change % of Total % of Total Operating expenses: Selling, general and administrative expenses, excluding corporate overhead $ 32 1 % $ 256 4 % -88 % Corporate overhead 1,967 44 % 2,505 40 % -21 % Engineering and support expenses 733 17 % 2,435 38 % -70 % $ 2,732 62 % $ 5,196 82 % -47 % 17--------------------------------------------------------------------------------The fiscal 2014 decrease in selling, general and administrative expenses of $2.5 million compared to fiscal 2013 relates primarily to decreased legal expenses and personnel and related costs. Corporate overhead consists of salaries and other personnel-related expenses of our accounting and finance, human resources and benefits, and other administrative personnel, as well as professional fees, directors' fees, and other costs and expenses attributable to being a public company. The decrease of $0.5 million for the year ended January 31, 2014 relates primarily to decreased personnel and related costs and consulting expenses offset by increases in rent expense, insurance and other expenses. Engineering and support expenses generally consist of salaries, employer paid benefits, and other personnel related costs of our engineers and testing personnel, as well as facility and IT costs, professional and consulting fees, lab costs, material usages, and travel and related costs incurred in the development and support of our products. The fiscal 2014 decrease in engineering and support costs includes approximately $1.2 million in decreased legal fees primarily as result of alternative fee agreements we entered into with our legal counsel in the Chicony litigation and our other intellectual infringement and enforcement litigation matters and $0.4 million in decreased personnel and related expenses (due primarily to a reduction in overall headcount). Interest Expense, Net Interest expense, net, consists primarily of amortization expense related to the loan discount and interest expense offset by interest income, if any. During fiscal 2014, we incurred approximately $0.3 million in amortization of the loan discount. Additionally, interest expense of $0.1 million related to our Loan Agreement with Elkhorn was expensed as incurred. During fiscal 2013, we incurred approximately $1.4 million in amortization of the loan discount. Additionally, loan fees totaling $55,000 related to our Loan Agreement with Broadwood were expensed as incurred. Change in Fair Value of Derivative Liabilities For fiscal 2014, the change in fair value of derivative liabilities is a result decrease in the fair value of our derivative liabilities of $0.6 million. Our derivative liabilities consist of conversion features embedded in the Elkhorn Loan Agreement entered into in the first quarter of fiscal 2014 and warrants issued to Broadwood in the second quarter of fiscal 2013. (See Note 8 of Part II, Item 8 of this report) For fiscal 2013, we reported an increase in the fair value of our derivative liabilities of approximately $1.1 million. Our derivative liabilities consist solely of the warrants issued to Broadwood in the second quarter of fiscal 2013. Income Taxes Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any required valuation allowance. We continue to maintain a full valuation allowance on the entire deferred tax asset balance. This valuation allowance was established based on management's overall assessment of risks and uncertainties related to our future ability to realize, and hence, utilize certain deferred tax assets, primarily consisting of net operating loss carry forwards and temporary differences. Due to the current and prior years' operating losses, the adjusted net deferred tax assets remained fully reserved as of January 31, 2014. During fiscal 2014, we recorded a net loss of $2.1 million and recorded income tax expense of $1,600, which represents the minimum tax due in the state of California. The net deferred tax asset of $16.7 million, all of which is fully reserved. During fiscal 2013, we recorded a net loss of $5.6 million and recorded income tax expense of $1,600, which represents the minimum tax due in the state of California. The net deferred tax asset of $17.7 million, all of which is fully reserved. 18--------------------------------------------------------------------------------Liquidity and Capital Resources The following table is a summary of our Consolidated Statements of Cash Flows: (in thousands) Years Ended January 31, 2014 2013 Cash provided by (used in): Operating activities $ 443 $ (2,712 ) Investing activites $ 19 $ (92 ) Financing activities $ 530 $ 2,000 Cash Flows from Operating Activities The cash provided in operating activities during fiscal 2014 of $0.4 million is a result of cash collected from customers and suppliers of $1.8 million, net of operating expenses paid of $1.4 million. The cash used in operating activities during fiscal 2013 of $2.7 million related to $1.3 million decrease from accounts receivable from customers and suppliers and of $1.4 million in operating expenses paid in fiscal 2013. In the fiscal 2014 and 2013, we initiated a reduction in force across all departments in order to reduce our cash burn. While we anticipate that our cost cutting measures will reduce our cash burn during fiscal 2015, we may require further cost cutting measures and/or additional capital from debt or equity financing to fund our operations. We cannot be certain that such financing will be available to us on acceptable terms, or at all. Cash Flows from Investing Activities During fiscal 2014, we spent $9,000 in capital equipment purchases and received $28,000 in proceeds from the sale of equipment. During fiscal 2013, we spent $0.1 million in capital equipment purchases, which primarily related to purchases of tooling and other equipment used by our contract manufacturers and engineers for the manufacture and design of our products. Our restricted cash balance declined by $10,000 in fiscal 2013 as we reduced the collateral requirement for our chargebacks related to our merchant services account, which we opened in the third quarter of fiscal 2012 in anticipation of the launch of our retail website www.chargesource.com. Cash Flows from Financing Activities; Loan Agreement & Credit Facility On February 11, 2013, we and Elkhorn, entered into a Secured Loan Agreement (the "Elkhorn Loan Agreement") and a Stock Purchase Agreement (the "Elkhorn SPA"), and certain related agreements (collectively, the "Elkhorn Agreements"). Pursuant to those agreements, Elkhorn made a $1.5 million senior secured loan to us with a maturity date of November 30, 2014 (the "Elkhorn Loan") and purchased a total of 6,250,000 shares of our common stock at a cash purchase price of $0.16 per share, generating an additional $1.0 million of cash for the Company. On February 11, 2013, we used approximately $2.1 million of the proceeds of $2.5 million from the Elkhorn Loan and the sale of the shares to Elkhorn to pay the entire principal amount of and all accrued interest on the Broadwood Loan. On July 27, 2012, we entered into a Senior Secured Six Month Term Loan Agreement (the "Broadwood Loan Agreement") with Broadwood. Pursuant to the Broadwood Loan Agreement, on July 27, 2012, Broadwood made a $2,000,000 senior secured six month loan (the "Broadwood Loan") to us. The Broadwood Loan bore interest at 5% per annum, ranked senior in right of payment to all of our other indebtedness, was secured by a first priority security interest granted to Broadwood in all of our assets, and was due and payable in full on January 28, 2013. The Broadwood Loan was paid in full on February 11, 2013 with debt and equity financing secured from Elkhorn Partners Limited Partnership ("Elkhorn"). (See Notes 7 and 14 of Part II, Item 8 of this report). In conjunction with the Broadwood Loan Agreement, we incurred $55,000 in loan fees that are reported in interest expense, net in our consolidated statement of operations for fiscal 2013. 19 --------------------------------------------------------------------------------Uncertainties Regarding Future Operations and the Funding of Liquidity Requirements for the Next 12 Months As of January 31, 2014, we had negative working capital of approximately $7.8 million, of which $2.5 million relates to the fair value of derivative liabilities. During our third fiscal quarter of fiscal 2014, Lenovo notified us of its intention to cease offering our Constellation product. We completed the delivery of all remaining units to Lenovo during that quarter. In order for us to continue our operations for the next twelve months and to be able to discharge our liabilities and commitments in the normal course of business, it will be necessary for us to successfully conclude and/or prevail in our ongoing litigation and raise additional funds through the sale or licensing of our patent portfolio, or through additional debt and/or equity financing, to meet our cash requirements during the next twelve months. No assurance can be given, however, that we will be successful in meeting those operating objectives or cash requirements. These uncertainties raise substantial doubt about our ability to continue as a going concern. If we become unable to continue as a going concern, we may have to liquidate our assets, and might realize significantly less than the values at which they are carried on our financial statements, and shareholders may lose all or part of their investment in our common stock. The consolidated financial statements do not reflect any adjustments related to the outcome of this uncertainty. There are several factors and events that could significantly affect our cash flows from operations, including, without limitation the following: ? Our ability to raise additional debt or equity financing; ? Our ability to sell or license some or all or our patents; ? Our patent enforcement efforts; and ? The outcome of our dispute with Broadwood. We are currently analyzing and will continue to analyze a range of alternatives to build and preserve value for our stakeholders, including, but not limited to exploring additional investment and incremental financing from current and/or new investors, entering litigation partnerships with outside entities with regard to certain current previously disclosed and/or future litigation matters, the engagement of advisors to assist in exploring strategic options for us as well as identifying potential partnerships for the purpose of monetizing some or all of the our patent portfolio and past, present, and future infringement claims. There can be no assurances that we will be successful in implementing any of these alternatives, or if implemented, that any of these alternatives will successfully preserve or increase shareholder value. If we become unable to continue as a going concern, we may have to liquidate our assets, and might realize significantly less than the values at which they are carried on our financial statements, and shareholders may lose all or part of their investment in our common stock. The consolidated financial statements included in this report do not reflect any adjustments related to the outcome of this uncertainty. Contractual Obligations In the course of our business operations, we incur certain commitments to make future payments under contracts such as operating leases and purchase orders. Payments under these contracts are summarized as follows as of January 31, 2014 (in thousands): Payments due by Period Long Term Debt Obligations Less than 1 year 1 to 3 years 3 to 5 years Total Operating lease obligations $ 248 408 - $ 656 20-------------------------------------------------------------------------------- In addition to the amounts shown in the table above, we have unrecognized tax benefits in the amount of $0.8 million, which we are uncertain as to if or when such amounts may be settled. We have a severance compensation agreement with a key executive. This agreement requires us to pay this executive, in the event of a termination of employment following a change of control of the Company or other circumstances, their then current annual base salary and the amount of any bonus amount the executive would have achieved for the current year. We have not recorded any liability in the consolidated financial statements for these agreements. Although the contemplated sale of shares of common stock and the issuance of the warrants and possible issuance of additional warrant shares by us to Broadwood could result in a "Change of Control" for purposes of the severance compensation agreements, each of the then executives who were parties to those agreements waived their rights to receive payments under those agreements in the event that a "Change of Control" occurs as a result of the sale of shares and the issuance of warrants and additional warrants to Broadwood. Additionally, as a result of our sale of the 6,250,000 shares of common stock to Elkhorn, as discussed above, Elkhorn's beneficial ownership of our common stock has increased from approximately 9% to approximately 49%, making Elkhorn our largest shareholder. Each of the executives who were parties to severance compensation agreements waived their rights to receive payments under those agreements as a result of the issuance of shares to Elkhorn. Recent Accounting Pronouncements In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"). ASU 2013-11 amends Accounting Standards Codification ("ASC") 740, Income Taxes, by providing guidance on the financial statement presentation of an unrecognized benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The ASU does not affect the recognition or measurement of uncertain tax positions under ASC 740. ASU 2013-11 will be effective for the Company for interim and annual periods beginning after December 15, 2013, with early adoption permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements. In February 2013, the FASB issued ASU 2013-02 ("ASU 2013-02"), "Reporting of Amounts Reclassified Out of Other Comprehensive Income". ASU 2013-02 finalized the reporting for reclassifications out of accumulated other comprehensive income, which was previously deferred, as discussed below. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, they do require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. An entity is also required to present on the face of the financials where net income is reported or in the footnotes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. Other amounts need only be cross-referenced to other disclosures required that provide additional detail of these amounts. The amendments in this update are effective for reporting periods beginning after December 15, 2012, and early adoption is permitted. The adoption of this standard did not have a material impact on the Company's financial position and results of operations. The FASB, the Emerging Issues Task Force and the SEC have issued certain other accounting standards updates and regulations as of December 31, 2013 that will become effective in subsequent periods; however, management of the Company does not believe that any of those updates would have significantly affected the Company's financial accounting measures or disclosures had they been in effect during 2013 or 2012, and it does not believe that any of those pronouncements will have a significant impact on the Company's consolidated financial statements at the time they become effective. 21-------------------------------------------------------------------------------- |