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AXESSTEL INC - 10-Q/A - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements Statements in the following discussion and throughout this report that are not historical in nature are "forward-looking statements". You can identify forward-looking statements by the use of words such as "expect," "anticipate," "estimate," "may," "should," "intend," "believe," and similar expressions. Although we believe the expectations reflected in these forward-looking statements are reasonable, such statements are inherently subject to risk and we can give no assurances that our expectations will prove to be correct. Actual results could differ from those described in this report because of numerous factors, many of which are beyond our control. These factors include, without limitation, those described under Item 1A "Risk Factors." We undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this report or to reflect actual outcomes. Please see "Special Note Regarding Forward Looking Statements" at the beginning of this report. The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes and other financial information appearing elsewhere in this report. Overview We develop fixed wireless voice and broadband access solutions for the worldwide telecommunications market. Our product portfolio includes fixed wireless phones, wire-line replacement terminals, and 3G and 4G broadband gateway devices used to access voice calling and high-speed data services. Our fixed wireless phones and 3G and 4G gateway products have similar functionality to phones and modems that use traditional landline telecommunications networks; however, our products are wireless and can be substituted for wired phones and modems. Our wire-line replacement terminals act as communication devices in homes where conventional handsets and wireless handsets can be plugged into our wireless terminals and serviced on a wireless network, as opposed to connecting to the fixed line provided by the local telephone or cable operator. Our products are based on CDMA (Code Division Multiple Access), GSM (Global System for Mobile Communications), GPRS (General Packet Radio Service), WCDMA (Wideband Code Division Multiple Access), and HSPA (High-Speed Packet Access) technologies. We develop and manufacture our products with third party engineering and manufacturing suppliers, particularly in China. Our design team works with these manufacturers to develop and customize products to incorporate our design and functional requirements on their baseline designs. We strive to retain intellectual property rights in key areas, while outsourcing commoditized work. We use this approach to reduce research and development expenses, shorten time to market for new products, and leverage supply chains and economies of scale to reduce product costs. We sell our products to telecommunications operators worldwide. In developing countries, where large segments of the population do not have telephone or internet service, telecommunications operators deploy wireless networks as a more cost effective alternative to traditional wired communications. In developed countries, telecommunications operators are using wireless networks to augment or supplant existing wire-line infrastructure. Currently, our largest customers are located in the United States, Scandinavia, and Poland. Recent Developments We have reshaped our business, designing a more competitive product portfolio, increasing sales in markets that support better margins, and aggressively reducing operating costs. These initiatives began producing results in the second half of 2011, and we have since recorded five consecutive quarters of profitability. During the quarter ended September 30, 2012, we took advantage of that improved operating performance to restructure a significant portion of our liabilities, reduce our cost of borrowing and improve our working capital position. Sales of our 4G gateway with VoIP capability into the Europe region continued to be robust during the third quarter, making that device our number one selling product globally. Our gateways enable operators in this region to attract new subscribers and increase their revenue with broadband data and voice packages to both small office and residential users. We also continued to experience strong sales of our wireless terminal product in our North American region for the third quarter of 2012. Operators in the United States have initiated wire-line replacement efforts. Our wireless terminal is a communication hub in the home into which users can plug conventional handsets and wireless handsets, replacing traditional wire-line phone service. -14--------------------------------------------------------------------------------- Table of Contents We work very closely with our customers in the development of our products. Our 2012 research and development initiatives are focused on three product areas. First, we will be introducing a line of self-sustained, affordable wireless alert products that allow wireless operators to enter the security market with another 'cut the cord' solution for residential and small business use. Second, we will be launching a new dual-mode gateway supporting both GSM and CDMA technologies in one device, making it easier for operators to meet customer needs while optimizing network usage. This gateway complements our 4G gateway, which is our number one selling product globally. Finally, we are working with customers on the design of the next generation of our wire-line replacement terminal. We expect to begin initial shipments of these products in the late 2012, early 2013 timeframe. Revenues for the nine months ended September 30, 2012 were $43.9 million, an increase of 18% from the $37.2 million generated in the same period last year. The increased revenue was mainly attributable to increased revenue from Europe, North America and MEA offset by reduced revenue from Latin America. We saw strong sales of our gateway devices and our wire-line replacement terminals. We also had significant shipments to a new customer in MEA. Sales to Latin America declined compared to the same period last year, as a result of intense price competition from Chinese competitors. Revenues by geographic region based on customer locations were as follows: Three months ended Nine months ended September 30, September 30, September 30, September 30, 2012 2011 2012 2011 Revenues Europe $ 8,324,425 $ 4,593,700 $ 22,115,807 $ 17,997,081 North America (United States and Canada) 6,897,638 8,687,454 16,634,320 10,836,210 MEA (Middle East and Africa) 797,330 2,865,900 4,226,330 2,987,936 Latin America 308,250 914,810 780,550 5,224,565 Asia 0 0 134,415 192,988 Total revenues $ 16,327,643 $ 17,061,864 $ 43,891,422 $ 37,238,780 Gross margin was 26% in the first nine months of 2012 compared to 23% in the first nine months of 2011. Gross margin improved principally as a result of the introduction of our new products and a change in product mix. Operating expenses were $7.5 million for the nine months ended September 30, 2012, compared to $7.4 million in the same period last year. We generated net income of $3.5 million for the nine months ended September 30, 2012, compared to $81,000 for the same period last year. In addition to our continued profitable operations, we entered into two transactions during the quarter ended September 30, 2012, that resulted in a $5.3 million improvement in our working capital position and reduced the effective interest rates on advances under a new credit facility to 6% to 7% at current market rates, down from 16% to 24%. On September 7, 2012, we entered into a Payment Confirmation Agreement with Wistron Neweb Corporation ("WNC"), which settled all disputes with WNC arising out of our prior manufacturing relationship, including restructure of an $8.2 million account payable which was past due. In connection with the Payment Confirmation Agreement, we paid WNC $458,000 in cash and issued WNC a Promissory Note with a face value of $7.7 million and a discounted value of $6.9 million. The Promissory Note obligates us to make payments of $50,000 per month, plus an additional payment on or before March 31 each year in the amount, if any, that would make the total of all payments to WNC for the prior year equal to 50% of our net income for that year. The issuance of the Promissory Note had a $5.3 million positive impact on our working capital at September 30, 2012, as that amount was reclassified from a current liability to a long-term liability. This Note does not bear interest, and we recognized a one-time note payable discount of $791,000 which boosted our net income for the three and nine months ended September 30, 2012. The restructuring of the WNC account payable combined with our continued profitable operations has improved our working capital position from a negative $11.8 million at December 31, 2012 to a negative $2.8 million at September 30, 2012. On September 25, 2012, we entered into a one year $7.0 million credit facility with Silicon Valley Bank ("SVB"). The facility is a working capital based revolving line of credit where SVB, in its discretion, will make advances in the amount of up to 80% of the value of (i) eligible accounts receivable and (ii) eligible purchase orders for inventory in transit to a customer. For each account receivable or purchase order financed, we pay interest based on SVB's prime rate, plus a specified margin, multiplied by the face amount of the eligible account receivable or purchase order. For eligible accounts receivable, the specified margin is 1.0% and for eligible purchase orders the margin is 1.4%. However, if our EBITDA for any trailing six month period falls below $1.0 million, the specified margins increase to 3.0% and 3.2%, respectively. At September 30, 2012, we had borrowings of $3.4 million under this credit facility and the effective interest rate on the borrowed funds was 6% per annum. -15--------------------------------------------------------------------------------- Table of Contents Outlook In order to maintain profitability under our current business model, we need to generate revenues of approximately $50 to $60 million annually with gross margins in the mid to low twenty percent range. Our primary goal for 2012 is to achieve consistent quarterly profitability and year over year revenue growth. The economic and competitive climate remains challenging and price competition in our markets remains intense. We anticipate continued erosion in the average selling prices for our products in 2012. This will require us to sell more units in order to achieve revenue growth or introduce new products with higher margins. For the full year, we are targeting gross margins in the mid twenty percent range. Any significant reduction of average selling prices could push gross margins to the low end of that range. We expect our overall operating expenses to be consistent with the prior year, subject to fluctuating certification and test fees from the launch of new products and variable selling and operating expenses based on revenue levels and customer and product mix experienced during the year. We believe that our operations can support higher revenues, without significant increases to operating expenses and our goal is to scale our revenues and continue to reduce operating expenses as a percentage of revenue. Critical Accounting Policies and Estimates Management believes that the most critical accounting policies important to understanding our financial statements and financial condition are our policies concerning Revenue Recognition, Accounts Receivable, Inventories, and Warranty Costs. Revenue Recognition Our Revenue Recognition policy calls for us to recognize revenue on sales when ownership and title pass to the customer. We generally sell our products either FCA (Free Carrier) shipping port, or DDU (Delivery Duty Unpaid). When we ship FCA shipping port, title and risk of loss pass to the customer when the product is received by the customer's freight forwarder. When we ship DDU, title and risk of loss pass when the product is received at the customer's warehouse. Because our sales are characterized by large orders, the timing of when the revenue is recognized may have a significant impact on results of operations. Accounts Receivable-Allowance for Doubtful Accounts Under our Accounts Receivable policy, our management exercises judgment in establishing allowances for doubtful accounts based on information collected from individual customers. We have traditionally experienced high customer concentration, resulting in large accounts receivable from individual customers. The determination of the credit worthiness of these customers and whether or not an allowance is appropriate could have a significant impact on our results of operations. Inventories-Provision for Excess and Obsolete Inventories are stated at the lower of cost (first-in, first-out method) or market. We review the components of our inventory and our inventory purchase commitments on a regular basis for excess and obsolete inventory based on estimated future usage and sales. Write-downs in inventory value or losses on inventory purchase commitments depend on various items, including factors related to customer demand, economic and competitive conditions, and technological advances or new product introductions by us or our customers that vary from our current expectations. The determination of the provision for excess and obsolete inventories requires significant management judgment and can have a significant impact on our results of operations. Warranty Costs Our standard terms of sale provide a limited warranty, generally for a period of one to two years from purchase or initialization of the product. We establish a warranty reserve based on management's estimates of anticipated service and replacement costs over the term of outstanding warranties. Management's estimates are based on historical warranty experience. However, we frequently introduce new products to the market. In addition, our products are purchased from third party design and manufacturing firms, or are comprised of components acquired from third party suppliers, which are manufactured and assembled to our specifications by contract manufacturers. As a result, we may have limited experience from which to establish an estimate for an applicable warranty reserve for a specific product. Any significant change in warranty expense may have a substantial impact on our results of operations. -16--------------------------------------------------------------------------------- Table of Contents Accounting Policies and Estimates Please see "Note 3-Significant Accounting Policies" to our financial statements for a more complete discussion of the accounting policies we have identified as the most important to an understanding of our current financial condition and results of operations. The preparation of financial statements in conformity with United States generally accepted accounting principles, or "GAAP," requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increase, these judgments become even more subjective and complex. Quarterly Results of Operations The following table sets forth, for the periods indicated, the unaudited consolidated statements of operations data (in thousands) and the percentages of total revenues thereto. Three months ended Three months ended Nine months ended Nine months ended ($ in thousands) September 30, 2012 September 30, 2011 September 30, 2012 September 30, 2011 Revenues $ 16,327 100.00 % $ 17,062 100.00 % $ 43,891 100.00 % $ 37,239 100.00 % Cost of goods sold 11,802 72.28 12,888 75.53 32,559 74.18 28,650 76.94 Gross margin 4,525 27.72 4,174 24.47 11,332 25.82 8,589 23.06 Operating expenses: Research and development 706 4.32 513 3.00 1,777 4.05 1,518 4.08 Sales and marketing 880 5.39 987 5.79 2,266 5.16 2,981 8.00 General and administrative 1,292 7.91 945 5.54 3,476 7.92 2,893 7.77 Total operating expenses 2,878 17.62 2,445 14.33 7,519 17.13 7,392 19.85 Operating income 1,647 10.10 1,729 10.14 3,813 8.69 1,197 3.21 Other income (expense): Interest expense, net (204 ) (1.25 ) (422 ) (2.48 ) (930 ) (2.12 ) (1,116 ) (2.99 ) Note payable discount 791 4.84 0 0.00 791 1.80 0 0.00 Total other income (expense) 587 3.59 (422 ) (2.48 ) (139 ) (0.32 ) (1,116 ) (2.99 ) Income before income tax provision 2,234 13.69 1,307 7.66 3,674 8.37 81 0.22 Income tax provision 112 0.69 0 0.00 184 0.42 0 0.00 Net income $ 2,122 13.00 % $ 1,307 7.66 % $ 3,490 7.95 % $ 81 0.22 % Comparison of the Three and Nine months Ended September 30, 2012 to the Three and Nine months Ended September 30, 2011 Revenues We sell our products directly and through third party distributors to telecommunications operators worldwide. Revenues are recorded at the prices charged to the telecommunications operators or, in the case of sales to distributors, at the prices to the distributors. Our products are sold on a fixed price-per-unit basis. All of our sales are based on purchase orders or other short-term arrangements. We negotiate the pricing of our products based on the quantity and the length of the time for which deliveries are to be made. For orders involving a significant number of units, or which involve deliveries over a long period of time, we typically receive rolling forecasts or a predetermined quantity for a fixed period of time from our customers, which in turn allows us to forecast internal volume and component requirements for manufacturing. In order to minimize our collection risks, we attempt to sell to our international customers under guaranteed letters of credit or open terms secured by credit insurance. At times, we extend credit based on our evaluation of the customer's financial condition and payment history. In order to minimize foreign exchange risk, we have made all sales to date in United States dollars. For the three months ended September 30, 2012, which we refer to as Q3 2012, revenues were $16.3 million compared to $17.1 million for the three months ended September 30, 2011, which we refer to as Q3 2011, representing a 4% decrease. This decrease is mainly attributable to the general nature of quarterly revenue activity in our business, as revenue can often fluctuate from quarter to quarter based on our current reliance on large-volume orders from only a few customers. -17- -------------------------------------------------------------------------------- Table of Contents For the nine months ended September 30, 2012, revenues were $43.9 million compared to $37.2 million for the nine months ended September 30, 2011, representing an 18% increase. The year over year increase is mainly attributable to overall strong demand for our gateway products and wire-line replacement terminals in our Europe, North America, and MEA markets. These increases were partially offset by a decrease in sales from our Latin America region where we have lost market share due to intense price competition from larger Chinese competitors. In Q3 2012, our revenues were derived principally from three customers, which together represented 86% of revenues, and individually represented 39%, 37% and 10% of revenues. In Q3 2011, our revenues were derived principally from four customers, which together represented 90% of revenues, and individually represented 47%,16%,16% and 11% of revenues. Our revenues for Q3 2012 consisted of 45% for voice products and 55% for data products. For Q3 2011, our revenues consisted of 56% for voice products and 44% for data products. For the nine months ended September 30, 2012, our revenues were derived principally from three customers, which together represented 79% of revenues, and individually represented 32%, 32% and 15% of revenues. For the nine months ended September 30, 2011, our revenues were derived principally from four customers, which together represented 72% of revenues, and individually represented 22%, 21%, 19% and 10% of revenues. Our revenues for the nine months ended September 30, 2012, consisted of 40% for voice products and 60% for data products. For the nine months ended September 30, 2011, our revenues consisted of 40% for voice products and 60% for data products. Our objective is to increase revenues through maintaining close relationships with our core customers and helping them expand their markets. At the same time, we are actively seeking new customer opportunities where we have the ability to deliver products that address unique customer requirements with the potential to lead to significant sales. Cost of Goods Sold Cost of goods sold consists of direct materials, manufacturing expense, freight expense, warranty expense, royalty fees, and the cost of obsolete inventory. The wireless communications industry has been characterized by declining average selling prices. We expect this trend to continue. We actively manage our costs of goods sold through the following initiatives: outsourcing manufacturing to larger contract manufacturers who can achieve economies of scale; increasing our purchasing power through increased volume; using standardized parts across our product lines; contracting with manufacturing partners in low cost regions; engineering our products with new technologies and expertise to decrease the number of components; and increasing reliance on software based applications rather than hardware. For Q3 2012, cost of goods sold was $11.8 million compared to $12.9 million for Q3 2011, a decrease of 8%. The decrease is primarily attributable to the 4% revenue decrease from the comparative period and improved gross margins. For the nine months ended September 30, 2012, cost of goods sold was $32.6 million compared to $28.7 million for the nine months ended September 30, 2011, an increase of 14%. The increase is primarily attributable to the 18% revenue increase from the comparative period partially offset by improved gross margins. Gross Margin For Q3 2012, gross margin as a percentage of revenues was 28% compared to 24% for Q3 2011. For the nine months ended September 30, 2012, gross margin as a percentage of revenues was 26% compared to 23% for the nine months ended September 30, 2011. These margin differences are mainly reflective of product and customer mix in the comparable periods. We are targeting gross margins in the mid-twenties for the full year 2012. However, intense price competition and aggressive new product releases by our competitors could put additional pressure on gross margins. Research and Development Research and development expenses consist primarily of salaries and related payroll expenses for engineering personnel, facility expenses, employee travel, contract engineering fees, prototype development costs, test fees and depreciation of developmental test equipment for software, mechanical and hardware product development. We expense research and development costs as they are incurred. We conduct our research and development activities through a combination of internal and external development initiatives. Our third party development agreements generally provide for one of two types of payments. In some agreements we pay a non-recurring engineering fee for the development services against performance of specified milestones. Under these agreements, we expense the non-recurring engineering fee to research and development expense as it is incurred. In other agreements, we pay a royalty to the third party developer in connection with product sales. This may be in addition to, or in lieu of, any non-recurring engineering fee. In these cases, the royalty payments are charged to cost of goods sold in the period in which the revenue from the sale of the product is recognized. -18- -------------------------------------------------------------------------------- Table of Contents For Q3 2012, research and development was $706,000 compared to $513,000 for Q3 2011, an increase of 38%. As a percentage of revenues, research and development for Q3 2012 increased to 4% from 3% in Q3 2011. For the nine months ended September 30, 2012, research and development was $1.8 million compared to $1.5 million for the nine months ended September 30, 2011, an increase of 17%. As a percentage of revenues, research and development was 4% for the nine months ended September 30, 2012 and 2011. The increases from both periods were mainly attributable to increased bonus expense. For the three and nine months ended September 31, 2012, we accrued bonus expense of $121,000 and $252,000, respectively. For the three and nine months ended September 31, 2011, we did not accrue any bonus expense since we had not achieved our internal milestone goals on profitability. We anticipate that 2012 research and development expenses will remain at current levels, with the exception of fluctuating certification and test fees from the launch of new products. For 2012, we are developing a new product line of security alert devices, a dual-mode gateway product for our Europe market, and the next generation of our wire-line replacement terminals. Sales and Marketing Sales and marketing expenses consist primarily of salaries and related payroll expenses for sales, marketing, and technical sales personnel. Other costs include facility expenses, employee travel, internal and external commissions, and trade show expense. For Q3 2012, sales and marketing expenses were $880,000 compared to $987,000 for Q3 2011, a decrease of 11%. As a percentage of revenue, sales and marketing expenses were 5% in Q3 2012 compared to 6% in Q3 2011. For the nine months ended September 30, 2012, sales and marketing expenses were $2.3 million compared to $3.0 million for the nine months ended September 30, 2011, a decrease of 24%. As a percentage of revenue, sales and marketing expenses were 5% for the nine months ended September 30, 2012 compared to 8% for the nine months ended September 30, 2011. These decreases were mainly attributable to decreased revenues from our Latin America region where we paid third party sales commissions on our sales in Venezuela in 2011. We expect sales and marketing expenses to remain stable in 2012, with the exception of fluctuating selling expenses based on the revenue levels and the customer mix experienced during the year. General and Administrative General and administrative expenses consist primarily of salaries and related payroll expenses for executive and operational management, finance, human resources, information technology, and administrative personnel. Other costs include facility expenses, employee travel, bank and financing fees, insurance, legal expense, collection fees, accounting, consulting and professional service providers, board of director expense, stockholder relations, amortization of intangible assets, depreciation expense of software and other fixed assets, and bad debt expense. For Q3 2012, general and administration expenses were $1.3 million compared to $1.0 million for Q3 2011, an increase of 37%. For the nine months ended September 30, 2012, general and administration expenses were $3.5 million compared to $2.9 million for the nine months ended September 30, 2011, an increase of 20%. The increases from both periods were mainly attributable to increased bonus expense. For the three and nine months ended September 31, 2012, we accrued bonus expense of $235,000 and $602,000, respectively. For the three and nine months ended September 31, 2011, we did not accrue any bonus expenses since we had not achieved our internal milestone goals on profitability. As a percentage of revenue, general and administration expenses for Q3 2012 were 8% compared to 6% for Q3 2011. As a percentage of revenue, general and administration expenses for the nine months ended September 30, 2012 were 8% compared to 8% for the nine months ended September 30, 2011. We expect selling, general and administrative expenses to remain stable at the current 2012 levels. Interest Expense, net For Q3 2012, net interest expense was $204,000 compared to $422,000 for Q3 2011. For the nine months ended September 30, 2012, net interest expense was $930,000 compared to $1.1 million for the nine months ended September 30, 2011. Substantially all of the expense resulted from interest expense associated with borrowings under our credit facilities and financing activities. We expect our outstanding loan balances to fluctuate over the next several quarters based on volume and timing of customer orders, but at greatly reduced interest rates. Under our new credit facility, effective interest rates on borrowed funds are 6% to 7% at current market rates, a substantial reduction from the 16% to 24% we were paying under our prior factoring arrangement. Note Payable Discount On September 7, 2012, we issued a $7,714,000 Promissory Note to Wistron Neweb Corporation (WNC) in connection with a payment and settlement agreement. This Note does not bear interest, and we have discounted the Note based on an imputed interest rate of 6.25% over an estimated repayment term of approximately four years resulting in a note payable discount of $791,000. For the three and nine months ended September 30, 2012, we recorded a gain of $791,000 to other income. For the three or nine months ended September 30, 2011, there was no activity in other income. -19--------------------------------------------------------------------------------- Table of Contents Provision for Income Taxes For the three and nine months ended September 30, 2012, we recorded income tax provisions of $112,000 and $184,000, respectively. No income tax provisions were recorded for the three or nine months ended September 30, 2011. Currently, we have established a full reserve against all deferred tax assets. Net Income For Q3 2012, net income was $2.1 million compared to net income of $1.3 million for Q3 2011. For the nine months ended September 30, 2012, net income was $3.5 million compared to net income of $81,000 for the nine months ended September 30, 2011. Liquidity and Capital Resources Liquidity At September 30, 2012, cash and cash equivalents was $1.6 million compared to $850,000 at December 31, 2011. In addition, at September 30, 2012, accounts receivable were $11.7 million compared to $8.9 million at December 31, 2011. At September 30, 2012, we had negative working capital of $2.8 million compared to negative working capital of $11.8 million at December 31, 2011. At September 30, 2012, we had bank financings of $5.0 million compared to $6.1 million at December 31, 2011. At September 30, 2012, we had a note payable with a face value of $7.7 million and a discounted value of $6.9 million compared to no note payable at December 31, 2011. For the nine month period ended September 30, 2012, we generated $2.1 million of cash from operations which was derived from the cash net income of $2.9 million (net income adjusted for depreciation and amortization expense, stock based compensation, recoveries from losses on accounts receivable, and gain from note discount based on imputed interest) less changes in operating assets and liabilities of $774,000. During the nine months ended September 30, 2012, we consumed $201,000 of cash from investing activities, and as of September 30, 2012, we did not have any significant commitments for capital expenditures. Financing activities consumed $1.1 million of cash during the nine months ended September 30, 2012, from the net financings of accounts receivable. Bank Financing We have two bank financing arrangements. In September 2012, we entered into a one year $7.0 million credit facility with Silicon Valley Bank ("SVB"). The facility is a working capital based revolving line of credit where SVB, in its discretion, will make advances in the amount of up to 80% of the value of (i) eligible accounts receivable and (ii) eligible purchase orders for inventory in transit to a customer. For each account receivable or purchase order financed, we pay interest based on SVB's prime rate, plus a specified margin, multiplied by the face amount of the eligible account receivable or purchase order. For eligible accounts receivable, the specified margin is 1.0% and for eligible purchase orders the margin is 1.4%. However, if our EBITDA for any trailing six month period falls below $1.0 million, the specified margins increase to 3.0% and 3.2%, respectively. At September 30, 2012, we had borrowings of $3.4 million under this credit facility and the effective interest rate on the borrowed funds was 6% per annum. In April 2012, we entered into a one year term loan with a commercial bank in China, totaling 10,000,000 Chinese Yuan (equivalent to $1.6 million at September 30, 2012). This loan bears interest based on the People's Bank of China twelve month adjustable rate, which was 7% per annum at September 30, 2012. Credit Terms with Manufacturers In addition to credit facilities, we rely on open credit terms with our manufacturing partners to help fund our working capital requirements. Generally, we order products from our contract manufacturers only upon receipt of a purchase order from a customer. Often, we can finance our accounts receivable and use the proceeds from that borrowing to pay our manufacturers. However, our contract manufacturers order certain parts with long lead times based on rolling sales forecasts that we provide. If our forecasts are inaccurate and our contract manufacturers do not use the long lead time parts, or if we have a customer notify us of their cancellation or inability to pay for a purchase order, our contract manufacturers have the right, after a specified period of time, to deliver the parts or finished goods inventory to us and demand payment. New manufacturers generally require partial or full payments on initial orders before extending substantial credit to us. Once we establish a payment history with a manufacturer, we request open credit terms. We rely on those open credit terms to support our working capital requirements and reduce our borrowing costs. If our contract manufacturers restrict their credit terms with us, we may need to identify alternative manufacturers or secure additional capital in order to finance the production of our products. Based on our current operating projections, we expect to generate positive cash from operations over the next twelve month period, and believe that our existing capital resources will be sufficient to fund our working capital needs during that time. However, if we experience a substantial decline in product sales or our bank lenders or contract manufacturers refuse to extent us credit under their current terms, we may not generate sufficient cash to cover our operating expenses. If needed, we intend to secure additional working capital through the sale of debt or equity securities. No arrangements or commitments for any such financings are in place at this time, and we cannot give any assurances about the availability or terms of any future financing. -20--------------------------------------------------------------------------------- Table of Contents Recent Accounting Pronouncements Please see the section entitled "Recent Accounting Pronouncements" contained in "Note 3 - Significant Accounting Policies" to our financial statements included in Part I-Item 1. Financial Statements of this report Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements. |