10-Q 1 c80856e10vq.txt FORM 10-Q -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 000-22221 KONTRON MOBILE COMPUTING, INC. (Exact name of registrant as specified in its charter) Minnesota 41-1731723 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 7631 Anagram Drive Eden Prairie, Minnesota 55344 (Address of principal executive offices) (Zip Code) (952) 974-7000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The number of shares of the registrant's Common Stock, $.001 par value, outstanding as of November 5, 2003 was 14,952,926. -------------------------------------------------------------------------------- 1 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS KONTRON MOBILE COMPUTING, INC. BALANCE SHEETS

The accompanying notes are an integral part of these financial statements. 2 KONTRON MOBILE COMPUTING, INC. STATEMENTS OF OPERATIONS (UNAUDITED)

The accompanying notes are an integral part of these financial statements. 3 KONTRON MOBILE COMPUTING, INC. STATEMENTS OF CASH FLOWS (UNAUDITED)

The accompanying notes are an integral part of these financial statements. 4 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION: The accompanying unaudited financial statements of Kontron Mobile Computing, Inc. ("Kontron Mobile Computing" or "the Company") should be read in conjunction with the financial statements and notes thereto filed with the Securities and Exchange Commission in the Company's Annual Report on Form 10-K, for the fiscal year ended December 31, 2002. In the opinion of management, the accompanying financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary to present fairly the financial results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the entire fiscal year. 2. INVENTORIES: Inventories are stated at the lower of cost, as determined by the first-in, first-out cost method, or market value. The components of inventories were:

3. FINANCING: Kontron AG ("Kontron") has provided the Company with a written agreement to provide financial support to enable the Company to meet its cash flow needs and obligations as and when they become due through December 31, 2003, if necessary. The Company has a line of credit agreement with Kontron which allows for borrowings of up to 8.5 million Euros for operations ($9.7 million based on September 30, 2003 exchange rate.) As September 30, 2003, borrowings under this agreement bear interest at 8% per annum (payable monthly). Outstanding borrowings under this line of credit were approximately $6.5 million at September 30, 2003. In the first nine months of 2003, the Company repaid $2.0 million to Kontron, consisting of approximately $1,655,000 in principal and $345,000 in accrued interest. 4. FOREIGN CURRENCY TRANSACTIONS: The Company's credit agreements with Kontron allow for borrowings which are payable in Euros. In the second quarter of 2001, the Company began utilizing foreign currency forward contracts to protect against significant fluctuations in net income (loss) caused by changes in Euro exchange rates. The Company's practice is to enter into a forward contract at the beginning of each quarter and settle the contract at the end of the quarter. The Company records gains and losses on these derivative contracts (which are not designated as hedging instruments for accounting purposes) in net income (loss) in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 133, "Derivatives and Hedging Activities," as amended by SFAS No. 149 "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," and also marks the related debt instrument to market under SFAS No. 52, "Foreign Currency Translation." For the quarter ended September 30, 2003, the Company recorded a loss of $16,721. As of September 30, 2003, the Company entered into a new forward contract whereby the Company can hedge up to 5.8 million Euros. The Company currently has no other balances or transactions conducted in a foreign currency. 5 5. ACCOUNTING PRONOUNCEMENTS: In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 establishes accounting and disclosure requirements for a company's obligations under certain guarantees that it has issued. A guarantor is required to recognize a liability for the obligation it has undertaken in issuing a guarantee, including the ongoing obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. The objective of the initial measurement of that liability is the fair value of the guarantee at its inception. The initial recognition and measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. FIN 45 also requires expanded disclosure of information related to product warranty amounts recorded in the financial statements. The disclosure provisions are effective for interim and annual periods ending after December 15, 2002. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is applicable for contracts entered into or modified after June 30, 2003. The implementation of this statement does not have a significant impact on the financial statements. The Company warrants its products against defects in materials and workmanship under normal use and service for one year from the date of purchase with the exception of the ReVolution which has a three-year limited warranty on some components and a one-year warranty on some devices and accessories. Warranty costs for existing products, including parts and labor, are estimated based on actual historical experience. Management uses that historical data to accrue reserves to cover estimated costs based on units in the field. Management reviews the estimated warranty liability on a quarterly basis to determine its adequacy. As required under Financial Accounting Standards Board (FASB) Interpretation No. 45 (FIN 45), the following table presents the changes in the Company's warranty liability for the quarter ended September 30, 2003:

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition to the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure provisions of SFAS No. 123 to require prominent disclosures about an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. The Company has adopted the disclosure provisions of SFAS No. 148. Accordingly, under the provisions of SFAS No. 123, the Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations in accounting for its stock option plans. In accordance with APB 25, no compensation expense was recognized as the exercise price of the Company's stock options was equal to the market price of the underlying stock on the date of grant and the exercise price and number of shares subject to grant were fixed. If the Company had elected to recognize compensation expense based on the fair value of the options granted at the date of grant and in respect to shares issuable under the Company's equity compensation plans as prescribed by SFAS No. 123, net income and diluted earnings per share using the Black-Scholes option-pricing model would have been reduced to the pro forma amounts indicated in the table below: 6

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used in this Form 10-Q and in future filings by the Company with the Securities and Exchange Commission, in the Company's press releases and in oral statements made with the approval of an authorized executive officer, the words or phrases "believes," "anticipates," "expects," "intends," "estimates," "should," "may" or similar expressions are intended to identify such forward-looking statements, but are not the exclusive means of identifying such statements. These forward-looking statements involve risks and uncertainties that may cause the Company's actual results to differ materially from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, the following: risks associated with the development of new products, market acceptance of new products and services, technological obsolescence, dependence on third-party manufacturers and suppliers, risks associated with the Company's dependence on proprietary technology and the long customer sales cycle. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company undertakes no obligation to revise any forward-looking statements in order to reflect events or circumstances after the date of such statements. Readers are urged to carefully review and consider the various disclosures made by the Company in this report and in the Company's other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect the Company's business. The Company's forward-looking statements are qualified in their entirety by the cautions and risk factors set forth under the "Cautionary Statement" filed as Exhibit 99.1 to its Form 10-K for the year ended December 31, 2002. RESULTS OF OPERATIONS The following table sets forth certain financial data expressed as a percentage of net sales for the periods indicated:

7 Research and development ....................... 7 12 9 10 --- --- --- --- Total operating expenses ................ 32 55 38 42 --- --- --- --- Operating income (loss) ............................... 5 (15) 4 1 Loss on currency conversion ........................... -- (1) (1) (2) Interest expense, net ................................. (4) (7) (5) (7) --- --- --- --- Net income (loss) applicable to common shareholders ... 1% (23)% (2)% (8)% === === === ===

Net Sales. The Company's net sales increased $0.8 million, or 37%, to $3.2 million in the third quarter of 2003 from $2.4 million in the third quarter of 2002 and increased 5% to $8.2 million in the first nine months of 2003 from $7.9 million in the first nine months of 2002. The increase in third quarter 2003 was due to the shipments of two large orders, compared to one large shipment in third quarter 2002. The Company continues to target key vertical markets including government, military, public services, utilities and other field service organizations. Two customers, Visteon Corporation and Jackson County, Michigan, Sheriff's Department, accounted for 22% and 11%, respectively, of net sales in the third quarter of 2003, representing $0.7 million and $0.4 million, respectively, of the Company's net sales. In the third quarter of 2002, sales to Siemens Integrated represented 15%, or $0.4 million, of the Company's net sales. International sales increased to $0.4 million, or 12% of net sales, for the third quarter of 2003 from $40,000, or 2% of net sales, for the comparable period in 2002. 63% of the international sales in the third quarter of 2003 were in the Americas and 54% of the international sales for the comparable period in 2002 were in Canada. The Company believes that international sales as a percentage of net sales for the remainder of 2003 will be in the low- to mid-teen range with little impact on the Company's results of operations and liquidity. The Company records all sales in U.S. Dollars. Gross Margin. Gross margin increased to $1.2 million, or 37% of net sales, for the third quarter of 2003 from $0.9 million, or 40% of net sales for the third quarter of 2002. Gross margin increased to $3.5 million for the first nine months of year 2003 from $3.4 million for the first nine months of 2002. The gross margin percent decreased to 42% from 43% for the nine month periods ended 2003 and 2002, respectively. The increased gross margin dollars for third quarter 2003 is due to increased revenue, while the decreased gross margin percent is due to increased sales of a lower margin product. The Company's gross margin will fluctuate as a result of a number of factors, including mix of products sold, inventory obsolescence, the proportion of international sales, large customer contracts (with the associated volume discounts) and other manufacturing expenses. Sales and Marketing. Sales and marketing expenses include salaries, incentive compensation, commissions, travel, trade shows, technical support and professional services personnel and general advertising and promotion. These expenses also include the labor and material costs related to maintaining the Company's standard one-year warranty program on all products with the exception of the ReVolution which has a three-year limited warranty on some components and a one-year warranty on some devices and accessories. Sales and marketing expenses decreased to $0.5 million for the third quarter of 2003 from $0.6 million for the third quarter of 2002. This is due to an adjustment to the warranty reserve, in addition to reduced advertising costs due to timing. As a percentage of net sales, sales and marketing expenses decreased to 14% for the third quarter of 2003 from 26% for the third quarter of 2002 due to higher revenue over which to allocate the costs. In the first nine months of 2003, sales and marketing expenses were $1.4 million and 17% of net sales as compared to $1.7 million and 21% of net sales in the first nine months of 2002. General and Administrative. General and administrative expenses include the Company's executive, finance, information services and human resources departments. These expenses decreased to $0.3 million for the quarter ended September 30, 2003, from $0.4 million for the quarter ended September 30, 2002. As a percentage of net sales, general and administrative expenses decreased to 11% for the quarter ended September 30, 2003, from 17% for the quarter ended September 30, 2002. General and administrative expenses were $1.0 million, or 12% of net sales for the first nine months of 2003 as compared to $0.9 million, or 11% of net sales for the comparable period in 2002. Research and Development. Research and development expenses are incurred in the design, development and testing of new or enhanced products, services and customized computing platforms. All research and development costs are expensed 8 as incurred. Research and development expenses decreased to $0.2 million for the third quarter of 2003 from $0.3 million for the third quarter of 2002. As a percentage of net sales, research and development costs were 7% and 12% for the third quarter of 2003 and 2002, respectively. Research and development expenses remained consistent at $0.8 million for the first nine months of 2003 and 2002. As a percentage of net sales, research and development expenses decreased to 9% for the first nine months of 2003 from 10% for the first nine months of 2002. The reduced expenses for third quarter 2003 are due to allocating applicable engineering costs to cost of goods sold and offsetting them in gross margin for a current development project. The reduced percent is due to lower costs, in addition to higher revenue over which to allocate the costs. Loss on Currency Conversion. The Company's credit agreements with Kontron allow for borrowings which are payable in Euros. In the second quarter of 2001, the Company began utilizing foreign currency forward contracts to protect against significant fluctuations in net income (loss) caused by changes in Euro exchange rates. The Company's practice is to enter into a forward contract at the beginning of each quarter and settle the contract at the end of the quarter. The Company records gains and losses on these derivative contracts (which are not designated as hedging instruments for accounting purposes) in net income (loss) in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 133, "Derivatives and Hedging Activities," and also marks the related debt instrument to market under SFAS No. 52, "Foreign Currency Translation." For the quarter ended September 30, 2003, the Company recorded a loss on currency conversion of $16,721. As of September 30, 2003, the Company entered into a new forward contract whereby the Company can hedge up to 5.8 million Euros. The Company currently has no other balances or transactions conducted in a foreign currency. Interest Expense, Net. Net interest expense was approximately $126,100 for the third quarter of 2003 compared to net interest expense of $171,100 for the comparable period in 2002. Net interest expense for the first nine months of 2003 was $403,700 compared to net interest expense of $520,200 for the comparable period in 2002. The decrease in interest expense is due to the reduction of the interest rate of the Kontron note payable from 10% to 8%, effective March 1, 2003, in addition to a reduction of the principal balance, due to a $1,655,000 repayment made in February 2003. LIQUIDITY AND CAPITAL RESOURCES In 2003, one of the Company's focus areas is long-term growth by introducing new products that will further penetrate existing markets as well as new and growing markets. In the first quarter of 2003, the Company began shipping the ReVolution, marking the re-entry of the Company into the rugged notebook market. The Company continues to be focused on further cost reductions through on-going product re-design initiatives by Kontron worldwide mobile design teams. The Company realizes that continuous management of sales, gross margin and cash is necessary to improve liquidity. There can be no assurance that the Company will be successful in achieving these measures. Circumstances that are reasonably likely to affect liquidity include changes in technology, dependence on key customers, decrease in demand for the Company's products and reliance on Kontron for financing and research and development support. As in 2002, the Company intends to continue funding its own cash needs in 2003 without assistance from Kontron. To be successful, the Company will focus on increased sales and profitability, in addition to working capital management. The Company intends to reduce interest expense in 2003 by making partial repayments of the note payable to Kontron as funds are available, in addition to the reduction of the interest rate of the Kontron note payable from 10% to 8%, effective March 1, 2003. During the first nine months of 2003, the Company repaid $2.0 million to Kontron, consisting of approximately $1,655,000 in principal and $345,000 in accrued interest. However, there can be no assurance that additional repayments will be possible. Kontron has provided the Company with a written agreement to provide financial support to enable the Company to meet its cash flow needs and obligations as and when they become due through December 31, 2003, if necessary. As of September 30, 2003, Kontron controlled approximately 65% of the Company. The Company has a line of credit agreement with Kontron which allows for borrowings of up to 8.5 million Euros for operations ($9.7 million based on September 30, 2003 exchange rate.) As of September 30, 2003, borrowings under this agreement bear interest at 8% per annum (payable monthly). Outstanding borrowings under this line of credit were approximately $6.5 million at September 30, 2003. 9 After re-paying $2.0 million to Kontron in the first quarter, the Company's cash balance has stayed consistent at $1.3 to $1.4 million at the end of each of the quarters in 2003. The Company will continue to monitor its cash balance and cash flow needs through the year. Based in part upon the Company's current budget projections for the balance of 2003, the Company believes it will have sufficient cash to operate through the end of fiscal 2003; however, there can be no assurance that the Company will achieve its budgeted projections, and additional borrowings may be necessary. The Company has a $750,000 line of credit with a commercial bank and if necessary, intends to use this line of credit to fund potential cash requirements in excess of its current cash flow projection. The line of credit expires May 15, 2004. There were no borrowings outstanding on this line of credit at September 30, 2003. Cash provided by operating activities was $379,921 for the first nine months of 2003, compared to cash used for operating activities of $662,727 in the comparable period in 2002. Gross accounts receivable decreased to $2.3 million at September 30, 2003 from $3.3 million at December 31, 2002 due to collections and lower revenue levels compared to fourth quarter 2002. Inventories increased to $1.6 million at September 30, 2003 from $1.0 million at December 31, 2002 due to increased stock of new products. Accounts payable increased to $1.5 million at September 30, 2003 from $0.8 million at December 31, 2002 due to increased purchases for third quarter shipments and anticipated fourth quarter shipments. Cash used for investing activities was $8,383 relating to purchases of property and equipment. Cash used for financing activities was $997,553 relating to a partial repayment of the notes to Kontron of $1,655,349, offset by net proceeds from forward contracts of $657,796. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of September 30, 2003 the Company had $6.5 million outstanding on its line of credit from Kontron. This loan bears interest at 8% per annum, payable monthly. Both the principal amount borrowed under the line of credit and interest payable thereunder are payable in Euros. See the earlier discussion under "Foreign Currency Transactions" for a description of the foreign currency forward contract in effect. All remaining transactions of the Company are conducted and accounts are denominated in U.S. dollars. Based on its overall foreign currency rate exposure at September 30, 2003, and in light of the Company's currently effective foreign currency forward contract, the Company does not believe that a hypothetical 10% change in foreign currency rates would materially adversely affect its financial position or results of operations. The Company has no derivative financial instruments or derivative commodity instruments in its cash and cash equivalents. The Company had $1.4 million in cash and cash equivalents at September 30, 2003. Based on analysis, shifts in money market rates would have an immaterial impact on the Company. ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including the Company's Chief Executive Officer and President, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and President concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in timely alerting them to the material information relating to us (or our consolidated subsidiaries) required to be included in our periodic SEC filings. Changes in Internal Controls. During our third fiscal quarter, there were no significant changes made in our internal control over financial reporting (as defined in Rule 13(a) - 15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 10 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is involved in legal actions in the ordinary course of its business. Although the Company cannot predict the outcome of any such legal actions, management believes that there is no pending legal proceeding against or involving the Company for which the outcome is likely to have a material adverse effect upon the Company's financial position, results of operations or cash flows. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 3.1 Second Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement filed on Form S-1, File No. 333-18335) Exhibit 3.2 Second Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.4 to the Company's Registration Statement filed on Form S-1, File No. 333-18335) Exhibit 3.3 Articles of Merger amending the Company's Articles of Incorporation effective June 4, 2001 (incorporated by reference to the exhibit 3.1 filed with the Company's Report on Form 8-K filed June 4, 2001) Exhibit 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 31.2 Certification of President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 32.2 Certification of President pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 11 (b) Reports on Form 8-K: The Company filed an 8-K dated July 14, 2003 reporting under Item 4 ("Changes in Registrant's Certifying Accountants") and Item 7 ("Financial Statements and Exhibits"), announcing the dismissal of Deloitte & Touche LLP as the Company's independent auditors and the engagement of Boulay, Heutmaker, Zibell & Co. P.L.L.P. to serve as the Company's independent auditors for the year ending December 31, 2003. The Company filed an 8-K dated August 14, 2003 reporting under Item 7 ("Financial Statements and Exhibits") and Item 12 ("Results of Operations and Financial Condition"), a press release announcing the Company's financial results for the second quarter ended June 30, 2003. 12 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. KONTRON MOBILE COMPUTING, INC. Date: November 14, 2003 /s/ Thomas Sparrvik ---------------------------------------- Thomas Sparrvik, Chief Executive Officer (principal executive officer) 13

KONTRON MOBILE COMPUTING INC 10-Q