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  **U.S. SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549****Form 10-KSB**(Mark One)   þ **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934****For the fiscal year ended: September 30, 2006**   o **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934****For the transition period from                      to                     ****Commission file number: 0-27166****XATA CORPORATION**(Name of small business issuer in its charter)   Minnesota 41-1641815 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)   151 East Cliff Road, Suite 10, Burnsville, Minnesota 55337 (Address of principal executive offices) (Zip Code)Issuer’s telephone number: (952) 707-5600Securities registered under Section 12(g) of the Exchange Act:Common Stock, $.01 par value (Title of Class)Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes þ No oCheck if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not containedin this form, and no disclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB. þIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o No þState issuer’s revenues for its most recent fiscal year: $30,629,000The aggregate market value of the voting stock held by non-affiliates of the registrant was$28,146,000 as of December 13, 2006, based upon the closing sale price on the Nasdaq Capital Marketreported for such date. Shares of Common Stock held by each officer and director and by eachperson who owns 10% or more of the outstanding Common Stock have been excluded in that such personsmay be deemed to be affiliates. This determination of affiliate status is not necessarily aconclusive determination for other purposes.There were8,452,000 shares of the registrant’s Common Stock issued and outstanding as of December13, 2006.DOCUMENTS INCORPORATED BY REFERENCEPart III of this Form 10-KSB incorporates information by reference from the definitive ProxyStatement for the Annual Meeting of Shareholders to be held on February 7, 2007 to the extentstated herein. Except with respect to information specifically incorporated by reference in thisForm 10-KSB, the Proxy Statement is not deemed to be filed as a part of this Report. It isanticipated that the definitive Proxy Statement will be filed with the Commission not later thanJanuary 12, 2007. In addition, there are incorporated by reference in this Report certainpreviously filed exhibits identified in Part III, Item 13.  
 

 
**TABLE OF CONTENTS**           Page PART I           Item 1. Description of Business  3        Item 2. Description of Property  17        Item 3. Legal Proceedings  17        Item 4. Submission of Matters to a Vote of Security Holders  17        PART II           Item 5. Market for Common Equity, Related Stockholder Matters  18        Item 6. Management’s Discussion and Analysis or Plan of Operation  20        Item 7. Financial Statements  27        Item 8. Changes In and Disagreement with Accountants on Accounting and Financial Disclosure  28        Item 8A. Controls and Procedures  28        Item 8B. Other Information  28        PART III             Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act  29        Item 10. Executive Compensation  29        Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters  29        Item 12. Certain Relationships and Related Transactions  29        Item 13. Exhibits  29        Item 14. Principal Accountant Fees and Services  33        SIGNATURES           EXHIBIT INDEX     Business Agreement Reseller Agreement Second Amendment to Custom Service Agreement Consent of Grant Thornton LLP Section 302 Certification Section 302 Certification Section 906 Certification Section 302 Certification
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**Forward Looking Statements**This report includes forward-looking statements based on current expectations. Actual results maydiffer materially. These forward-looking statements involve a number of risks and uncertaintiesabout us, our business, our customers, and the economy and business environment in general. Risksand uncertainties about us include, for example, the following: **•** We incurred operating losses in our most recent fiscal year, and such losses are likelyto continue in the next fiscal year.  **•** We may be unable to adapt to technological change quickly enough to grow or to retainour customer base.  **•** We will continue to be dependent upon positioning systems and wireless communicationnetworks owned and controlled by others, and accordingly, their problems may adverselyimpact us.  **•** For the foreseeable future, we are dependent upon the continued receipt and fulfillmentof new orders for our current products.  **•** Our growth and profitability depend on our timely introduction and market acceptance ofnew products, our ability to continue to fund product development activities, and ourability to establish and maintain strategic partner relationships.**Trademark Notice**XATA®, OpCenter®, XATANET®, SmartComTM, and XATA MobileSyncTM areall trademarks of XATA Corporation. XATA®, XATANET® and OpCenter®are registered with the U.S. Patent and Trademark Office.**PART I****Item 1. Description of Business****About XATA**We are one of the leading providers of fleet management solutions to the truck transportationindustry. Our innovative technologies and value-added services enable customers to optimize theutilization of their assets and enhance the productivity of fleet operations across the entiresupply chain, resulting in decreased costs, improved compliance with U.S. Department ofTransportation regulations, improved customer service and overall business productivity.
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Founded in 1985, XATA has leveraged over 20 years of experience developing solutions for NorthAmerica’s premier private fleets. That knowledge has resulted in a clear understanding of thefeatures and functions that matter most to drivers and fleet operators.We were the first company to provide completely paperless electronic logs, exception-basedmanagement reporting and learned standards for accurate business intelligence. Our productsseamlessly combine enterprise software, onboard computing, real-time communications and globalpositioning systems (GPS) to provide an enterprise logistics management solution for private fleetoperators.Our first-generation products, introduced in the early 1990’s, included our revolutionarytouch-screen Driver Computer and PC based Fleet Management System software. Valuable data wasdownloaded from Driver Computers to the Fleet Management System host software in batch mode via ourpatented Driver Key for compliance reporting and analysis.In 1999 we introduced OpCenter, a Microsoft Windows-based customer-hosted system that can managemultiple operation centers and users over a wide area network. OpCenter continues to be a leadingFleet Management System for Fortune 1000 private trucking fleets.In 2004, we introduced XATANET, our next-generation Web-based system. Over the past several yearswe have invested heavily in product development to bring the XATANET system to market, as well asto develop additional software applications for managing trucks and fleet operations. We believethat XATANET enables us to significantly broaden our penetration of the 3.6 million medium andheavy duty vehicle private fleet transportation market.In 2000, we formed a strategic alliance with John Deere Special Technologies Group, Inc. (“JDSTG”),a subsidiary of Deere & Company, to enable us to accelerate our product development initiatives andmore effectively distribute our new products to both new and existing markets. Deere now ownsapproximately 16.2 % of our outstanding common stock on a fully diluted basis.In December 2003, Trident Capital invested approximately $4.1 million in the Company by acquiring1,613,000 shares of Series B Convertible Preferred Stock. In September 2005, Trident Capitalinvested an additional $5.0 million by acquiring 1,269,000 shares of Series C Convertible PreferredStock. On an as if-converted and fully diluted basis, Trident Capital now owns approximately 29.5%of our common stock. Trident Capital, a private equity firm with more than $1.5 billion undermanagement, focuses on investments in the information services and enterprise software sectors.The additional capital has allowed us to continue expanding our product development, distributionand marketing efforts, and provided a strong endorsement of our plans for future growth.**Trucking Industry Background and Trends**Private fleets and for-hire carriers comprise the two major fleet categories within the commercialtrucking industry. Private fleets (our current market focus) include manufacturers, wholesalers,retailers and other companies who transport their own goods using equipment they own or lease.For-hire carriers include truckload and less-than-truckload carriers whose primary business is thetrucking and transportation of freight that belongs to others.Commercial trucking fleets are characterized by considerable investment in equipment, highoperating costs, significant annual mileage per vehicle and extensive federal and state compliancereporting requirements. Costs for equipment, drivers, fuel, insurance, maintenance, and supportpersonnel make the
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efficient operation of each vehicle an essential and complex part of fleet management.Accordingly, accurate and timely data collection and analysis enables managers of truck fleets toreduce operating costs. We believe there is, and will continue to be, significant demand in thetrucking industry for onboard fleet management systems, principally because the use of thistechnology enables fleet operators to reduce expenses, respond to competitive pressures and improvecustomer service.We believe the following trends continue to impact the private fleet trucking industry, resultingin increasing competitive pressures and demand for mobile information technology: **•** New technologies: Historical barriers to purchase are diminishing with theaffordability, simplicity and acceptance of new wireless communication and internettechnologies.  **•** Increased operating costs: Driver salaries, fuel, insurance, and other operatingcosts continue to increase. These trends encourage operators to utilize onboardinformation systems to control costs and more effectively manage their fleets.  **•** Safety and security concerns: Since the terrorist attacks of September 11, 2001,public authorities and fleet operators have become more acutely interested intechnology solutions to increase the safety and security of their drivers and cargo.This is especially true for companies transporting petroleum products and otherhazardous loads.  **•** E-commerce: As companies increasingly rely on just-in-time inventory management andseek to control and monitor inventories throughout their entire supply chain, theydemand better service and increased capabilities from their trucking operators andvendors. In addition, as companies increasingly adopt Internet technologies to reducecommunication costs, paperwork and processing times, trucking operators are adoptingtechnology to comply with the operating processes and systems of their customers. Thistrend encourages integration of onboard computers with the host information systems oftrucking fleet operators.  **•** Government regulations: U.S. Department of Transportation (DOT) driver logrequirements have become more stringent. The Federal Motor Carrier SafetyAdministration (FMCSA), an administration within the DOT, implemented new driverhours-of-service rules in January 2004, tightening driver work rules. These rules werechallenged in federal court and the FMSCA issued revised rules effective October 1,2005. The revised regulations became enforceable after a period of transitionalcompliance on January 1, 2006. The FMCSA is currently evaluating the benefit ofElectronic Onboard Recorders (EOBR’s) to increase hours-of-service compliance, and inturn, highway safety. We believe computer generated driver logs may eventually bemandated by federal or state governments.The extensive hours-of-service regulations imposed by the FMCSA are compounded by additionalregulation in each of the 50 states. In general, states require trucks to pay state fuel taxesbased on the amount of fuel consumed in their state. To comply with these regulations, driversmust record state border crossing and fuel purchase information. Many long haul vehicles cross upto 25 state borders per week, resulting in significant paperwork for the driver, the clerical staffof the carrier and the processor of the carrier’s fuel tax returns. To complicate an already largepaperwork requirement, these records must be maintained at the fleet home base as well as at thecarrier’s headquarters. Records must also be readily available for federal regulators to reviewdriver log compliance. Our systems are designed to automate compliance with each of theseregulatory requirements.
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**Our Products and Services**XATA provides powerful, advanced, yet user-friendly computer systems used by manufacturing,distribution, petroleum and other operators of trucking fleets to reduce fuel costs, increaseoperational efficiencies, improve safety and enhance customer service.Our product offerings consist of OpCenter, our comprehensive Windows-based fleet management system,and XATANET, our Web-based fleet management system. Our products perform the following functionsto enable fleet operators to control costs and maximize vehicle and driver performance: **•** Mobile two-way messaging and real-time vehicle location.  **•** Automation of DOT driver log requirements and state fuel tax reporting.  **•** Comprehensive vehicle and driver performance reporting.  **•** Efficient routing, trip optimization and stop activity scheduling.  **•** Diagnostic and accident data capture.These systems integrate data generated within the truck as well as data received via GPS (GlobalPositioning System) into either a Windows- or Web-based user interface, enabling fleet managers tomeasure fleet performance, resolve exception conditions, monitor ongoing operations and performdetailed analysis.*XATANET Fleet Management System*A flexible and expandable fleet management solution, XATANET enables fleet operators to loweroperating costs, increase productivity, improve safety, and comply with regulatory requirements.XATANET integrates onboard computers, driver displays and cost-effective communications with asuite of powerful, Web-based applications delivered on-demand via the Internet.If organizations chose to have XATA host the service, we will manage the Web-based applications andmaintainthe customer databases associated with them. XATANET will provide asset tracking withreal-time visibilityof drivers, vehicles and deliveries. It delivers a low cost of entry and the freedom from customershaving to monitor and manage software. All applications are securely accessible via the internetwith a standard Web browser.XATANET is ideal for organizations that seek to eliminate the startup costs and lengthyimplementation times typically associated with fleet management solutions. XATANET allows fleetsof all sizes to install, utilize and pay for only those applications that benefit theirorganization today, gaining immediate value at a lower cost of entry, while retaining the abilityto expand their use as fleet operations evolve.A XATANET solution is comprised of four primary components as described below:Onboard HardwareXATA Application Modules (XAM) — Rugged, mobile computing platforms including GPS and wirelesscommunications hardware that collect, store and intelligently manage data communications. The XAMconnects to the engine gathering vehicle and diagnostic information onboard. In conjunction withinteractive driver displays, the XAM unifies communication between fleet management, vehicles, anddrivers. Using our powerful onboard applications, all of the vehicle information can be deliveredimmediately to the driver display or reported back to fleet management, based on user definedpreferences.
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Our latest-generation, multi-mode XATA Application Module utilizes both the ORBCOMM satellite andSprint digital cellular (CDMA 1xRTT) networks in a single unit to provide high-bandwidth, lowlatency, ubiquitous coverage. Our patent pending XATA MobileSyncover-the-airapplication management instantly makes new features available and reduces the cost of updatingsoftware in the vehicle. Designed for use with both XATANET and OpCenter, the XAM serves as amigration path for OpCenter customers who want to leverage web-based software.Driver DisplaysTouch-screen driver displays are mounted in the cab of the truck capturing and communicating fleetperformance information. With the ability to monitor fuel economy, estimated time of arrival(ETA), and regulatory compliance drivers can help ensure the fleet reaches optimum performancelevels.Wireless Communications XATA systems use patented technologies that utilize lowest cost communication methods synchronizingtrip and driver data with maximum efficiency. Our multi-mode systems combine CDMA 1xRTT, 802.11WiFi, and satellite wireless networks to provide “No Gap” coverage and high speed data download.Application Service PackagesXATANET’s applications are bundled into 4 Service Packages, conveniently designed to target thespecific operational needs of fleet operations. This modular approach enables customers to expandservices over time.*OpCenter Fleet Management System*Our OpCenter system enables managers to achieve measurable fleet performance and productivityimprovements by integrating onboard technology into the fleet management process. The OpCentersystem consists of a Driver Computer, Driver Key, Data Station and our OpCenter Fleet ManagementSoftware hosted and managed by the customer. Our XAM can also be used in various hardwareconfigurations in replacement of a Driver Key.The Driver Computer has a touch-sensitive, easy-to-read, user-friendly screen that provides instantfeedback to the driver. Each driver has an electronic Driver Key that stores his identity, log,dispatch, and trip data and is a means of electronically transferring information to and from theDriver Computer and Data Station. Data Stations are located where drivers begin and end theirtrips, and provide dispatch data on a Driver Key at the beginning of each trip and offload actualtrip data from the Driver Key at the end of each trip.Our OpCenter Fleet Management Software operates in a multi-user, Microsoft Windows environment andis capable of managing multiple fleets over a wide area network. The system collects, validatesand processes data recorded by a fleet’s network of Driver Computers and Data Stations. OpCenterprovides a decision support tool for the entire distribution team. This system reduces operatingcosts, improves safety, streamlines compliance reporting and automates data collection for othersystems. OpCenter helps users efficiently measure fleet performance, resolve exception conditions,monitor ongoing operations and perform detailed analysis.
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When integrated with optional satellite, digital cellular or 802.11b Wi-Fi wireless communicationsvia ourXAM, OpCenter provides immediate access to critical onboard information. Its real-time notificationis triggered by user-defined onboard conditions, ensuring that only critical information isreported to fleet management. Detecting and processing of exception conditions only improvesoperating efficiency while minimizing recurring communication charges.**Target Markets**There are approximately 8.1 million commercial trucks operating in the United States, of which 6.6million are operated by private fleets and 1.5 million are operated by for-hire carriers. Whilemost of our current customers fall into a portion of the private fleet category, we believe thatour new fleet management products will enable us to enter other segments of the commercial truckingindustry.*Private Fleets*Private fleets include the commercial trucks operated by manufacturers, wholesalers, retailers andother companies who transport their own goods using equipment they own or lease. Historically, thecosts associated with purchasing an integrated hardware and software system for onboard computing,including our OpCenter system, required a minimum fleet size in order to recover the fixed costs ofa host system implementation. As a result, we target our OpCenter system to private fleets thatoperate more than 30 heavy-duty trucks in select vertical markets.We believe our historic target market segment has comprised approximately 300,000 vehicles. Webelieve our introduction of XATANET will allow us to significantly expand our addressable market toa much larger portion of the private fleet sector, including smaller fleets, large decentralizedfleets and fleets in new vertical markets. Specifically, smaller fleets and decentralized fleetsare able to purchase individual XATANET software application packages that target their specificinformation needs and use our Internet-based host system to collect, process and present theirdata. We believe these fleets represent a significant new market opportunity. We view the total6.6 million commercial trucks in this segment as our target market going forward, with particularemphasis on fleets operating medium and heavy duty trucks, estimated at 3.6 million vehicles.*For-Hire Carriers*For-hire carriers include both truckload and less-than-truckload (LTL) carriers, whose primarybusiness is the trucking and transportation of freight that belongs to others. There areapproximately 1.3 million commercial trucks in the for-hire carrier market segment.*Other Markets*We believe our XATANET web-based system may ultimately be introduced into several other new marketsbecause of its open system architecture and the many potential applications for web-based,GPS-enabled tools.**Major Customers**In fiscal 2006, we had sales with customers (hereinafter referred to as “Customer A” and “CustomerB”) who each accounted for approximately 18% of fiscal 2006 revenue. No other customer accountedfor 10% or more of revenue in fiscal 2006 or 2005.
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Our systems have been installed in approximately 54,000 trucks at over 1,800 distribution centers.Our customers include Fortune 500 companies and other large organizations, including AllegianceHealthcare Corporation, Baxter Healthcare Corporation, Bi-Lo, LLC, The BOC Group plc, Core-MarkInternational, CVS Pharmacy, Eby-Brown Company, Foster Farms Dairy, Hannaford Trucking Co., TheKroger Co., McLane Company, Publix Super Markets, Inc., Penske Corporation, Perlman Rocque, RyderSystem Inc., Safeway, Inc., Supervalu, Inc., Toys “R” Us, Inc., Unisource Worldwide, Inc., UnitedNatural Foods, Inc., the United States Postal Service, Whirlpool Corporation and xpedx (a divisionof International Paper Company).**Sales and Marketing**We market our products to operators of trucking fleets through a multi-tiered sales strategyincluding a direct sales force and various strategic alliances in our indirect sales channel.*Direct Sales Channel*Our direct sales force sells our onboard fleet management systems primarily to private fleet truckoperators and logistics providers through national, regional and inside sales account executives.The efforts of our sales executives are supported by our systems sales consultants, projectmanagement and customer service organizations, which have a strong working knowledge of thehardware and software configurations and experience integrating our systems into fleets. Webelieve the level of service we provide to our customers is unique in the industry and a keycompetitive advantage in securing new customers and retaining existing accounts.We focus our direct sales and marketing efforts on companies operating fleets of all sizes withinvertical markets that have experienced significant benefits from our systems. These verticalmarkets include food distribution, petroleum production and marketing, manufacturing andprocessing, retail/wholesale delivery, and government.*Indirect Sales Channel*Distribution relationships with leading truck leasing companies such as Penske Truck Leasing Co.,L.P. (a partnership of Penske Corporation and GE Capital) and NationaLease Purchasing Corporation(an affiliate of National Truck Leasing System) are the basis of our indirect sales channel. Inour arrangement with Penske, Penske integrates our XATANET web-based system into its full-servicelease program through a private labeled offering named Fleet I.Q. NationaLease also offers XATANETto its large base of lease customers in a joint go-to-market strategy with us.As we continue to evolve the XATANET system, we anticipate offering our product through other newindirect sales channels such as sales agents, wireless carries and third party installers that willdrive substantial additional sales.We also use a combination of integrated marketing activities, including advertising, trade shows,the Internet and direct mail, to gain exposure within our target markets. We exhibit our productsat selected industry conferences to promote brand awareness. We actively pursue speakingopportunities at industry trade shows for our management staff, as well as for customers who havegained efficiencies in fleet operations using our technology.**Competition**Competition in the mobile resource management system industry continues to increase at a rapid paceas businesses and governments realize the number of benefits organizations can achieve. We facestrong
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competition for our solutions, and this competition is expected to continue to increase in thefuture. We compete primarily on the basis of functionality, ease of use, quality, price, serviceavailability and corporate financial strength. As the demand by businesses for mobile resourcemanagement solutions increases, the quality, functionality and breadth of competing products andservices will likely improve and new competitors will likely enter our market. In addition, thewidespread adoption of industry standards may make it easier for new market entrants or existingcompetitors to improve their existing products and services, to offer some or all of the productsand services we offer or may offer in the future, or to offer new products and services that we donot offer. We also do not know to what extent network infrastructure developers and wirelessnetwork operators will seek to provide integrated wireless communications, Global PositioningSystems, software applications, transaction processing, and Internet solutions, including accessdevices developed internally or through captive suppliers.Many of our existing and potential competitors have substantially greater financial, technical,marketing and distribution resources than we do. Additionally, many of these companies have greatername recognition and more established relationships with our target customers. Furthermore, thesecompetitors may be able to adopt more aggressive pricing policies and offer customers moreattractive terms than we can.**Key Alliances and Relationships**We continue to establish relationships with third parties with the intent to increase thedeployment of our solutions. We believe that establishing these strategic relationships willfacilitate our technological leadership and increase our access to new customers. Some of ourexisting relationships include:*Communication Providers*We have established relationships with Sprint/Nextel (Sprint) and Orbcomm LLC (Orbcomm) to providewireless connectivity between our subscribers and our host system. We contract directly withSprint and Orbcomm for the provision of wireless communications, which are bundled with oursolutions. We are continuing to expand this category and look to add additional partners in theupcoming 12 — 18 months.*Indirect Sales Channel Alliances*We have an agreement with Penske Truck Leasing Co., L.P. in which we provide Penske a privatelabeled version of our XATANET web-based fleet management system, wireless communication services,managed hosting services and technical support. Penske has integrated our XATANET web-based systemas an option for its full-service lease customers under the name Fleet I.Q. In total, Penske TruckLeasing has approximately 200,000 vehicles under management.We also have a relationship with NationaLease Purchasing Corporation, whereby NationaLease offersXATANET to its truck leasing customers in a joint go-to-market strategy with us. NationaLease is aconsortium of approximately 120 independent truck leasing companies with a total fleet of 65,000vehicles.*Manufacturers*We have established a relationship with Winland Electronics, Inc. (Winland) for the manufacture andtesting of our mobile hardware products pursuant to our detailed specifications and qualityrequirements. In fiscal 2005 our primary manufacturing vendor was Phoenix InternationalCorporation, a subsidiary of Deere & Company. Deere & Company, through its subsidiary JDSTG, is aprincipal shareholder of the Company. In the first quarter of fiscal 2006, we changed our primarymanufacturing vendor to Winlandas a result of increased production capabilities.
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We have relationships with other companies that manufacture components for our solutions as well.All of our suppliers have entered into confidentiality agreements with respect to our proprietarytechnology. We believe our current suppliers can provide production volumes to meet ouranticipated increases in product demand and we are not aware of any difficulty experienced by oursuppliers in obtaining raw materials for manufacture.**Patents, Trademarks, and Copyrights**XATA, XATANET, and OpCenter are trademarks registered with the United States Patent and Trademarkoffice. All computer programs, report formats, and screen formats are protected under UnitedStates copyright laws. In addition, we possess a design patent issued by the United States Patentand Trademark Office that covers the design of our Driver Computer display, and have patentapplications pending on other technologies. We also claim trademark and trade name protection forthe following: XATA MobileSync, and SmartCom. We have trademark applications pending with theUnited States Patent and Trademark Office for XATA MobileSync. We have patents pending for XATAData Conduit, Portable Storage Module, and Environmental Condition Monitoring of a Container. Weprotect and defend our intellectual property rights vigorously.**Research and Development**We concentrate our research and development activities on hardware and software solutions for ourcustomers. Our U.S. research and development activities are supplemented by third party resourceswe contract in Belarus. To enhance our existing solutions and to introduce new solutions to ourexisting and potential customers, we focus on the following key areas: **•** *Software.*We intend to continue to develop our software applications by offering newfeatures while enhancing existing features. For example, in August 2006, we announced theavailability of XATANET 3.2, the latest version of our on-demand fleet management systemthat offers a new automated dashboard for key performance metrics and point-and-clickscheduled reporting for information distribution.  **•** *Hardware.*We intend to continue to develop and release platform upgrades to add newfeatures as well as to enhance existing features. For example, in November 2004, weannounced the availability of our Multi-Mode communications platform. An integrated digitalcellular (CDMA 1xRTT) and satellite communications platform that delivers both high-speeddata download and ubiquitous coverage, eliminating the traditional bandwidth and gaplimitations facing fleets trying to efficiently operate in real-time.Research and development expenses were $3.3 million for fiscal 2006 compared to $3.6 million forfiscal 2005. The decrease of $0.3 million was mainly due to the increase in capitalized softwaredevelopment costs. In addition, we invested approximately $0.3 million in both fiscal 2006 and2005 on the enhancement of released products. In fiscal 2006 and 2005, we incurred totalresearch and development costs of $4.2 million and $3.9 million, respectively; of which $0.9million and $0.3 million of software development costs were capitalized in fiscal 2006 and 2005,respectively. These costs were capitalized after the establishment of technological feasibilityoccurred as required by FAS 86, *Accounting for the Costs of Computer Software to Be Sold, Leased,or Otherwise Marketed.*These costs will be amortized to cost of goods sold over the anticipateduseful life of the product which is determinedbased upon its anticipated future net revenues.
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**Employees**As of September 30, 2006, our staff included 101 employees and 21 independent contractors whoseprimary assignments are approximately as follows: 47 in research and development and informationservices; 16 in sales and marketing; 35 in customer support; 24 in administrative, finance,purchasing and warehousing.**Executive Officers**John J. Coughlan, Chairman of the Board & Chief Executive OfficerMr. Coughlan, age 47, has been Chairman and Chief Executive Officer since joining XATA in October2006. Prior to joining XATA, he was involved in a business consulting practice. He previouslyserved as president and CEO of Lawson Software, Minnesota’s largest software company. Mr. Coughlanjoined Lawson Software in 1987 and became CEO in February 2001 prior to the company’s initialpublic offering in December of 2001. In addition to his responsibilities at XATA, Mr. Coughlan isan active regional business advocate and serves on the board of directors for several localorganizations, including Securian Financial Group, Inc. He replaced Craig Fawcett who resigned inSeptember 2006.Mark E. Ties, Chief Financial Officer & TreasurerMr. Ties, age 41, joined XATA in April 2005 as Chief Financial Officer. He is responsible for theCompany’s finance, human resources, purchasing, and distribution functions. Before joining XATA,Mr. Ties was the chief financial officer and treasurer at Velocity Express Corporation, where heserved as a member of the Company’s executive leadership team and was responsible for the Company’sfinancial activities including; capital raising activities; SEC compliance; financial planning andanalysis; mergers and acquisitions; cash management; back-office process integration; corporategovernance practices; and investor relations. Prior to Velocity, he served as a Senior Manager forErnst & Young LLP in its entrepreneurial services and mergers and acquisitions departments and as asenior financial executive at a number of companies in varied industries. He has extensivefinancial management experience in the areas of financing, mergers and acquisitions, businessintegration and financial processes.Thomas L. Schlick, Chief Operating OfficerMr. Schlick, age, 56 joined XATA in April 2006 as Chief Operating Officer. As COO, Schlick isresponsible for the XATA’s service operations, project management, quality delivery, customertraining, and implementation. Prior to joining XATA, Schlick was senior vice president, globalservice, solutions and sales operations, for DataCard Corporation. At DataCard, Schlick served as amember of the executive leadership team and was responsible for global services activitiesincluding; field operations, technical product and software support, sales and service training,program management, depot repair, and call center operations. Prior to DataCard, he served as asenior executive at Rosemount, Inc., a division of Emerson Electric. Schlick has a B.S. inElectrical Engineering and an MBA from the University of Minnesota. He is a Six Sigma Green Belt, aBoard Member of Association of Service Management, International and a senior member of theInstrument Society of America.Thomas N. Flies, Vice President — Business DevelopmentMr. Flies, age 37, is responsible for the company’s business development, marketing and productmanagement efforts. Mr. Flies joined XATA in 1990 and has served in various roles in sales,marketing, and product development including Sr. Vice President of Product Development where he ledthe development and introduction of XATA’s OpCenter product line. He was named Vice President ofBusiness Development in 2002 to focus on developing and marketing XATANET to truck leasing
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companies. In his role, Mr. Flies is responsible for developing product and marketing strategiesand programs that drive revenue growth and establish strong brand awareness. Mr. Flies is a memberof the National Private Truck Council (NPTC), American Trucking Association (ATA), Truck Rental andLeasing Association (TRALA) and the Council of Supply Chain Management Professionals (CSCMP).**Investment Considerations and Risk Factors*****We do not have a long or stable history of profitable operations.***The Company’s net losses tocommon shareholders for the fiscal years 2006 and 2005 were $2.1 million and $6.7 million,respectively. The respective periods’ net losses were $1.8 million and $6.0 million. Additionalamounts of $0.3 million and $0.7 million, resulting from beneficial conversion charges andpreferred stock dividends increased such respective period losses to the aforementioned levels ofnet losses to common shareholders.***We are dependent on key customers.***We sell large orders to individual fleets and may be dependentupon a few major customers each year whose volume of purchases is significantly greater than thatof other customers. As we continue to grow our existing customer base this risk will lessen, butuntil such time we are still dependent on continued purchases by present customers who continue toequip and upgrade their fleets. Loss of any significant current customers or an inability tofurther expand our customer base would adversely affect us.***Our sales cycle is long.***The period required to complete a sale of our systems has historicallybeen up to a year or longer. The length of the sales cycle may result in quarter-to-quarterfluctuations in revenue. Our systems are technically complex, which means the customer has to makean advance budget decision. The availability of new and other technologies also complicates anddelays buying decisions.***We have competitors who are larger than we are.***Many of the companies who offer competitiveproducts have greater financial and other resources than our company. These competitors offerproducts ranging in sophistication and cost from basic onboard recorders to advanced mobilesatellite communication and information systems. Their products may offer better or more functionsthan ours or may be more effectively marketed. In addition, the nature and sources of competitionin our industry are rapidly evolving and increasingly depend on the ability to deliver integrationof multiple information systems. These systems must link trucking operations with other facets ofthe supply chain through a variety of sophisticated software and communications technologies.These changes reflect a trend toward integration of intra-company data with the larger externalsupply chain involving the flow of goods to markets. We must continue to adapt our existingproducts and develop new products that facilitate the collection, integration, communication andutilization of information throughout the entire supply chain. This may entail the development ofnew technologies and the adaptation of new and existing products to be compatible with products andservices provided by others in the industry. These trends may require us to establish strategicalliances with other companies who may be competitors.***We have a limited number of products and those products are concentrated in one industry.***Althoughour systems have potential applications in a number of industries, to date we have targeted onlythe private fleet trucking segment of the transportation industry. If this market segmentexperiences a downturn that decreases our sales, the development of new applications and marketscould take several months or longer, and could require substantial funding. In addition, ourfuture success is dependent in part on developing and marketing new software applications. Wecannot assure that new applications can be successfully developed or marketed in a timely manner.***Our target market is highly cyclical.***The fleet trucking segment of the transportation industry issubject to fluctuations and business cycles. We cannot predict to what extent these businesscycles may result inincreases or decreases in capital purchases by fleet managers. A significant downturn in theprospects of the fleet trucking segment of the transportation industry could have a material,adverse affect on us.
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***The effectiveness of our selling efforts depends on knowledgeable staff and effective marketingalliances.***Direct sales of our products are dependent in part upon the salesperson’s in-depthknowledge and understanding of our systems. This knowledge is attained through experience andtraining over a period of several months or longer. We must attract, train, and retain qualifiedpersonnel on a continuing basis. We may not be able to sustain or augment our sales and marketingefforts by retaining or adding personnel, and it is possible that increased sales and marketingefforts will not result in increased sales or profitability. We believe that marketing allianceswith truck leasing companies, truck manufacturers and others in the truck supply chain will becomeincreasingly important distribution channels for our products. We may not be able to establish orsustain effective alliances. Moreover, we may have limited control over the selling efforts of ouralliance partners.***We are dependent on proprietary technology.***Our success is heavily dependent upon proprietarytechnology. We have been issued a design patent by the United States Patent and Trademark Officethat covers our Driver Computer and have recently applied for several software-related patents, butwe have not yet been awarded patents on any of our software programs. We rely primarily on acombination of copyright, trademark and trade secret laws, confidentiality procedures, andcontractual provisions to protect our proprietary rights. These measures afford only limitedprotection. Our means of protecting our proprietary rights may prove inadequate, or ourcompetitors may independently develop similar technology, either of which could adversely affectus. In addition, despite our efforts to protect our proprietary rights, unauthorized parties mayattempt to copy aspects of our systems or obtain and use information that we regard as proprietary.***We depend on wireless communication networks owned and controlled by others.***If we are unable todeliver continued access to communication services with sufficient capacity, our revenues coulddecrease. Our ability to grow and achieve profitability depends on the ability of satellite anddigital cellular wireless carriers to provide sufficient network capacity, reliability and securityto our customers. Even where wireless carriers provide coverage to entire regions, there areoccasional lapses in coverage, for example due to man-made or natural obstructions blocking thetransmission of data. These effects could make our services less reliable and less useful, andcustomer satisfaction could suffer. Our financial condition could be seriously harmed if ourwireless carriers were to increase the prices of their services, or to suffer operational ortechnical failures.***Our products may quickly become obsolete.***Our systems utilize proprietary software and onboardtouch-screen computers. Although we believe our proprietary software is more important in thecapture and communication of operating data than the hardware on which the software operates,continued improvements in hardware may render our technology, including its software, obsolete.The field of software and hardware is constantly undergoing rapid technological change and we maynot be able to react and adapt to changes in this field. Moreover, development by our competitorscould make our systems and services less competitive or obsolete. We believe that advancements inhardware and communications technology provide opportunities for us to form alliances withcompanies offering products complementary to our systems and services, but we cannot assure that wecan form alliances with such companies or that any such alliance will be successful. Our successdepends, in large part, on our ability to anticipate changes in technology and industry standards,and develop and introduce new features and enhancements to our system on a timely basis. If we areunable to do so for technological or other reasons or if new features or enhancements do notachieve market acceptance, our business could be materially and adversely affected. We mayencounter technical or other difficulties that could in the future delay the introduction of newsystems or system features or enhancements.
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***JDSTG and Trident Capital, who are represented on our Board of Directors, individually and togetherown enough stock to exert significant influence over XATA.***As of December 13, 2006, JDSTG ownedapproximately 16.2% and Trident Capital owned approximately 29.5% of our common stock on anas-converted basis, and Trident has the ability to increase its ownership significantly throughexercising warrants. In addition, JDSTG is entitled to name up to three representatives to ourBoard of Directors and Trident is entitled to name up to two representatives. Trident is entitledto vote its Series B Preferred Stock and Series C Preferred Stock as if converted to common stockand to vote as a separate class (to the exclusion of the holders of common stock) on the electionof its two director nominees. Both JDSTG and Trident benefit from certain restrictive covenants ofXATA in connection with their equity investments in the Company. The combination of stock ownershipand Board of Director representation enables these shareholders, individually and together, to agreater degree, to exercise significant influence over the Company.***We are dependent on key personnel.***Our staff is small and our future success depends to asignificant extent on the efforts of key management, technical and sales personnel. The loss ofone of our key employees could adversely affect our ability to provide leading edge technology tothe transportation industry.***We may need additional capital.***Although we believe cash flow from operations and our $5 millionline of credit will be sufficient to meet capital requirements for the foreseeable future, our cashneeds may vary significantly from predictions. For example, if we do not generate anticipated cashflow, or if we grow at a rate faster than we anticipate, our predictions regarding cash needs mayprove inaccurate and we may require additional financing. Our inability to obtain needed financingcould have a material adverse effect on operating results. We cannot assure that we will be ableto secure additional financing when needed or that financing, if obtained, will be on termsfavorable or acceptable to us. Moreover, future financing may result in dilution to holders of ourcommon stock.***We may issue additional stock without shareholder consent.***We have authorized 25,000,000 shares ofcommon stock, of which 8,452,000 shares were issued and outstanding as of December 13, 2006. TheBoard of Directors has authority, without action or vote of the shareholders, to issue all or partof the authorized but unissued shares. Additional shares may be issued in connection with futurefinancing, acquisitions, employee stock plans, or otherwise. Any such issuance will dilute thepercentage ownership of existing shareholders. We are also currently authorized to issue up to5,000,000 shares of preferred stock. As of December 13, 2006, 1,815,000 shares of Series BConvertible Preferred Stock and 1,269,000 Series C Convertible Preferred Stock were issued andoutstanding. The Board of Directors can issue additional preferred stock in one or more series andfix the terms of such stock without shareholder approval. Preferred stock may include the right tovote as a series on particular matters, preferences as to dividends and liquidation, conversion andredemption rights and sinking fund provisions. The issuance of preferred stock could adverselyaffect the rights of the holders of common stock and reduce the value of the common stock. Inaddition, specific rights granted to holders of preferred stock could be used to restrict ourability to merge with or sell our assets to a third party.***Our common stock could be delisted due to failure to satisfy a continued listing rule or standard.***On August 26, 2005, the Company received a letter from The Nasdaq Listing Qualification Staff(“Nasdaq”), notifying the Company that it was not in compliance with Marketplace Rule 4310(c)(2)(B)(the “Rule”). This Rule requires the Company to have a minimum $35 million in market value oflisted securities, $2.5 million in shareholders’ equity, or $500,000 in net income from continuingoperations for the most recently completed fiscal year or two of the three most recently completedfiscal years. Nasdaq informed
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the Company that it had 30 calendar days, or until September 26, 2005, to regain compliance withthe Rule. By virtue of the Trident Capital investment in September 2005, we regained compliancewith the Nasdaq Marketplace listing requirements. However, Nasdaq has advised us that it willcontinue to monitor our compliance with the listing standards. If we fail to show compliance, wemay be subject to delisting.***We may be unable to manage rapid growth.***The Company’s continued growth will place an increasingstrain on our resources, and we could experience difficulties relating to a variety of operationalmatters, including hiring, training and managing an increasing number of employees, obtainingsufficient quantities of product from vendors, obtaining sufficient materials and contractmanufacturers to produce our products, expanding our distribution capabilities and enhancing ourcustomer service, financial, and operating systems. There can be no assurance that the Companywill be able to manage growth effectively. Any failure to manage growth could have a materialadverse effect on the Company’s business, financial condition and results of operations.***Our directors’ liability is limited under Minnesota law and under certain agreements.***Our Articlesof Incorporation, as amended and restated, state that our directors are not liable for monetarydamages for breach of fiduciary duty, except for a breach of the duty of loyalty, for acts oromissions not in good faith or which involve intentional misconduct or a knowing violation of law,for dividend payments or stock repurchases illegal under Minnesota law or for any transaction inwhich the director derived an improper personal benefit. In addition, our bylaws provide that weshall indemnify our officers and directors to the fullest extent permitted by Minnesota law for allexpenses incurred in the settlement of any actions against them in connection with their service asofficers or directors of the Company. In addition, we have entered into indemnification agreementswith the Trident investors, and its representatives who serve as directors on our Board, which maysupplement the indemnification provisions available to them under Minnesota law.***Anti-takeover provisions.***Minnesota law provides Minnesota corporations with anti-takeoverprotections. These protective provisions could delay or prevent a change in control of our companyby requiring shareholder approval of significant acquisitions of our voting stock. Theseprovisions operate even when many shareholders may think a takeover would be in their bestinterests.***We face burdens relating to the recent trend toward stricter corporate governance and financialreporting standards.***New legislation or regulations that follow the trend of imposing strictercorporate governance and financial reporting standards, including compliance with Section 404 ofthe Sarbanes-Oxley Act of 2002, continues to increase our costs of compliance. A failure to complywith these new laws and regulations may impact market perception of our financial condition andcould materially harm our business. Additionally, it is unclear what additional laws or regulationsmay develop, and we cannot predict the ultimate impact of any future changes.***Failure to achieve and maintain effective internal controls could have a material adverse effect onour business, operating results and stock price.***We are in the process of documenting and testingour internal control procedures in order to satisfy the requirements of Section 404 of theSarbanes-Oxley Act which will become effective for the Company beginning in fiscal 2008, whichrequires annual management assessments of the effectiveness of our internal controls over financialreporting and a report by our Independent Auditors in fiscal 2009 addressing these assessments.During the course of our testing we may identify deficiencies which we may not be able to remediatein time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirementsof Section 404. In addition, if we fail to achieve and maintain the adequacy of our internalcontrols, as such standards are modified, supplemented or amended from time to time, we may not beable to ensure that we can conclude on an ongoing basis that we have effective internal controlsover financial reporting in accordance with Section 404 of the
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Sarbanes-Oxley Act. Moreover, effective internal controls, particularly those related to revenuerecognition, are necessary for us to produce reliable financial reports and are important tohelping prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud,our business and operating results could be harmed, investors could lose confidence in our reportedfinancial information, and the trading price of our stock could drop significantly.**Item 2. Description of Property**On April 4, 1997, we leased 20,600 square feet of office and warehouse space at 151 East Cliff Roadin Burnsville, Minnesota. We signed a seven year, non-cancelable operating lease for this space,with initial rental payments of $12,000 per month, plus a pro rata share of the building operatingexpenses commencing June 1, 1997. The base rent increased to $15,000 on February 1, 1999, in partdue to occupancy of an additional 4,800 square feet of warehouse space adjacent to the originallyoccupied space. Base rent increased to $16,000 on June 1, 2002. In May 2003 we extended thislease through November 2006. Effective with this extension, our leased space was reduced to the20,600 square feet we initially occupied, and our base rent was reduced to $13,000 per month. InDecember 2006, we extended this lease through March 31, 2008.**Item 3. Legal Proceedings**None.**Item 4. Submission of Matters to a Vote of Security Holders**None.
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**PART II****Item 5. Market for Common Equity, Related Stockholder Matters and Small Business IssuerPurchases of Equity Securities**The following table sets forth the quarterly high and low sales prices for our common stock asreported by the NASDAQ Capital Market for fiscal years 2006 and 2005. There is no market for ourSeries B Preferred Stock or Series C Preferred Stock.           **Low** **High****Fiscal Year 2006**        First Quarter $3.29  $5.20 Second Quarter  4.01   5.25 Third Quarter  4.70   5.32 Fourth Quarter  4.35   5.50            **Low** **High****Fiscal Year 2005**        First Quarter $5.25  $6.10 Second Quarter  4.00   6.25 Third Quarter  3.80   5.18 Fourth Quarter  2.62   4.83 Our common stock is held by 89 registered holders of record. Registered ownership includesnominees who may hold securities on behalf of multiple beneficial owners. We estimate the numberof beneficial owners of our common stock to be approximately 1,500.**Dividend Policy**Except for dividends paid to the holders of Series A 8% Convertible Preferred Stock (from issuancein May 1999 until conversion in full in August 2000), we have never paid cash dividends on any ofour securities. We have retained any earnings for use in our operations. Our Board of Directorswill determine future dividend payments, if any, based upon our earnings, capital needs and otherrelevant factors.On December 6, 2003, we issued 1,613,000 shares of Series B Preferred Stock that pays an annualcumulative dividend of 4% of the original issue price (payable in additional shares of PreferredStock or cash, at the option of the holders). The Series B Preferred Stock provides that we cannotpay dividends to the holders of any other capital stock unless and until we have paid dividendsaccrued on the Series B Preferred Stock. The holders of the Series B Preferred Stock elected toreceive dividends due and payable on each of May 31 and November 30 in additional shares ofPreferred Stock rather than cash. Accordingly as of December 15, 2006, we had issued a total of70,000 and 68,000 shares of Series B Preferred Stock for payment of dividends in calendar 2006 and2005.
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**Sale of Unregistered Securities****Preferred Stock**In August 2005, the Company’s Board of Directors authorized the sale of up to 1,400,000 shares ofSeries C Preferred Stock through a private placement. Pursuant to a Stock Purchase Agreemententered into in September 2005 with Trident Capital, Inc. and its affiliates (collectively,“Trident”) the Company sold 1,269,000 shares of Series C Preferred Stock for $5,015,000, or $3.94per share. Each share of the Series C Preferred Stock is convertible into one share of theCompany’s common stock. The price per share of Series C Preferred Stock and the conversion pricefor the common stock is equal to the “market value” of the common stock (as defined in the rules ofthe Nasdaq Stock Market) on the date of execution of the definitive agreements. The Series CPreferred Stock does not pay a dividend unless we decline to redeem the stock upon demand of theholders after an Acceleration Event (as defined in the Certificate of Designation of the Series CPreferred Stock). In that case, it pays an annual cumulative dividend of 4% of the original issueprice (payable in cash). The Series C Preferred Stock has a non-participating liquidation rightequal to the original issue price, plus accrued unpaid dividends which are senior to our commonstock and junior to the Series B Convertible Preferred Stock. The Company may redeem the Series CPreferred Stock at its option after five (5) years from the date of issuance at the original issueprice, plus accrued unpaid dividends, if the market value of the common stock is at least three (3)times the then effective conversion price for a specified period.Additionally, the Company issued Trident 5-year warrants to purchase 375,000 shares of its commonstock at an exercise price of $3.94 per share. The aggregate purchase price of the warrants was$47,000. The warrants permit “cashless exercise.”In connection with this transaction, the Company recognized a one-time, non-cash deemed dividend of$419,000 relating to the beneficial conversion portion of the preferred stock. The beneficialconversion portion was determined by allocating the Trident proceeds on a fair value basis betweenthe preferred stock and the warrants. The amount of the deemed dividend was the differencebetween the deemed fair value of the Series C Preferred Stock and the purchase price on the date ofthe transaction. The deemed dividend was recorded as an addition to preferred stock with acorresponding increase to accumulated deficit. The addition was recognized at the date of issuanceof the preferred stock, the same date at which the shares were eligible for conversion.No broker or placement agent was involved and no commissions or other compensation was paid.In December 2003, the Company’s Board of Directors authorized the sale of up to 1,700,000 shares ofSeries B Preferred Stock through a private placement. Pursuant to a Stock Purchase Agreemententered into with Trident the Company sold 1,613,000 shares of Series B Preferred Stock for$4,097,000, or $2.54 per share. Each share of the Preferred Stock is convertible into one share ofthe Company’s common stock. The price per share of the Series B Preferred Stock and the conversionprice for the common stock were equal to the “market value” of the common stock (as defined in therules of the Nasdaq Stock Market) on the date of execution of the definitive agreements. TheSeries B Preferred Stock pays an annual cumulative dividend of 4% of the original issue price(payable semi-annually; payable in additional shares of Series B Preferred Stock or cash, at theoption of the holders) and has a non-participating preferred liquidation right equal to theoriginal issue price, plus accrued unpaid dividends.In the fiscal year ended September 30, 2006, the Company issued 69,000 shares of Series B PreferredStock to Trident for payment of accrued dividends. Based on the market value of the Company’scommon stock on the date of the dividend payment, the payment of the dividend in additional sharesof Preferred Stock resulted in a non-cash deemed dividend of $144,000.
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The Series B Preferred Stock is redeemable at the option of Trident at 100% of the originalpurchase price plus accrued and unpaid dividends at any time after five years from the date ofissuance, or at any time if there is a significant adverse judgment against the Company, theCompany defaults on its debts or files for bankruptcy, or in the event of a change of control.However, the Company may decline to redeem any or all of the Preferred Stock at its sole option anddiscretion, and in such case the annual cumulative dividend on the Series B Preferred Stock willincrease from 4% to 10%. The Company may redeem the Series B Preferred Stock at its option afterfive years from the date of issuance if the market price of its Common Stock is greater than threetimes the conversion price on each of the sixty consecutive days prior to the redemption date.Additionally, the Company issued Trident 5-year warrants for 451,000 shares of its common stock atan exercise price of $3.17 per share. The aggregate purchase price of the warrants was $56,000.The warrants permit “cashless exercise.”In connection with this transaction, the Company recognized a one-time, non-cash deemed dividend of$629,000 relating to the beneficial conversion portion of the preferred stock. The beneficialconversion portion was determined by allocating the Trident proceeds on a fair value basis betweenthe preferred stock and the warrants. The amount of the deemed dividend was the differencebetween the deemed fair value of the Series B Preferred Stock and the purchase price on the date ofthe transaction. The deemed dividend was recorded as an addition to preferred stock with acorresponding increase to accumulated deficit. The addition was recognized at the date of issuanceof the preferred stock, the same date at which the shares were eligible for conversion.The placement agent for the Trident investment received as consideration a $320,000 cash fee and7-year warrants for purchase of an aggregate of 163,000 shares of Common Stock (130,000 shares at$2.54 per share and 33,000 shares at $3.17 per share). These warrants permit “cashless exercise”and provide the holders with piggyback registration rights.**Warrants**In January and September 2006, we issued two warrants for the purchase of 8,000 shares of commonstock at $4.84 per share and 32,000 shares of common stock at $4.95 per share, to Williams Executive Search and BlackbirdPartners, respectively. These warrants were consideration for executive search services.In July 2006, the placement agent for the Trident investment exercised 16,000 warrants at $3.17 pershare. In September 2006, a director of the company exercised10,000 warrants at $3.69 per share. These warrants were issued in September2001 for service as chairman of the board of directors.**Exemptions**All of the securities discussed above were issued in reliance upon the exemption from registrationunder Section 4(2) and/or Section 4(6) of the Securities Act of 1933. Notices on Form D were filedwith respect to the Trident investments in our Preferred Stock.**Item 6. Management’s Discussion and Analysis or Plan of Operation**The following discussion should be read in conjunction with the financial statements and therelated notes included in this Report. This Report contains forward-looking statements thatinvolve risks and uncertainties. Our actual results could differ materially from those in suchforward-looking statements asa result of many factors, including those discussed in “Investment Considerations and Risk Factors”and elsewhere in this Report.
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**Critical Accounting Policies**Accounting policies, methods and estimates are an integral part of our financial statements and arebased upon management’s current judgments. Certain accounting policies, methods and estimates areparticularly important because of their significance to the financial statements. Note 2 of theNotes to Financial Statements includes a summary of the significant accounting policies and methodswe use. The following is a discussion of what we believe to be the most critical of these policiesand methods.*Revenue Recognition.*We derive our revenue from sales of hardware, software and related services,and from application service contracts. We recognize revenue in accordance with Statement ofPosition (SOP) 97-2, *Software Revenue Recognition*, as amended by SOP 98-9, Modification of SOP97-2, *Software Revenue Recognition with Respect to Certain Transactions*, and Securities andExchange Commission Staff Accounting Bulletin (SAB) 104, *Revenue Recognition in FinancialStatements*.Software revenue is recognized under SOP 97-2 and SAB 104 when (i) persuasive evidence of anarrangement exists (for example a signed agreement or purchase order), (ii) delivery has occurred,as evidenced by shipping documents or customer acceptance, (iii) the fee is fixed or determinableand payable within twelve months, and (iv) collectibility is probable and supported by creditchecks or past payment history. Pursuant to certain contractual arrangements, revenues arerecognized for completed systems held at our warehouse pending the receipt of delivery instructionsfrom the customer. As of September 30, 2006 and September 30, 2005, we had approximately $20,000of systems on hand that had been billed to those customers awaiting specific delivery instructions.With regard to software arrangements involving multiple elements, we allocate revenue to eachelement based on the relative fair value of each element. Our determination of fair value of eachelement in multiple-element arrangements is based on vendor-specific objective evidence (VSOE). Welimit our assessment of VSOE for each element to the price charged when the same element is soldseparately. We have analyzed all of the elements included in its multiple-element arrangements andhave determined that it has sufficient VSOE to allocate revenue to consulting services andpost-contract customer support (PCS) components of its license arrangements. We sell ourconsulting services separately, and have established VSOE on this basis. VSOE for PCS componentsare determined based upon the customer’s annual renewal rates for these elements. Accordingly,assuming all other revenue recognition criteria are met, revenue from licenses is recognized upondelivery, and revenue from PCS components are recognized ratably over the applicable term,typically one year.Prior to January 1, 2006, certain software sales included application service contracts. The termsof those contracts did not meet the delivery requirements of SOP 97-2 and SAB 104 and resulted inthe recognition of all revenue ratably over the term of the agreement. During the fiscal yearending September 30, 2006, we changed the terms of all new contracts, such that all therequirements of SOP 97-2 and SAB 104 are met, including delivery. For these new contracts, revenueis recognized based on the multiple element arrangement accounting described above.*Allowance for doubtful accounts and sales returns.*We grant credit to customers in the normalcourse of business. The majority of our accounts receivables are due from companies with fleettrucking operations in a variety of industries. Credit is extended based on an evaluation of acustomer’s financial condition and, generally, collateral is not required. Accounts receivable aretypically due from customers within 30 days and are stated at amounts due from customers net of anallowance for doubtful accounts and sales
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returns. Accounts outstanding longer than the contractual payment terms are considered past due.We determine the allowance for doubtful accounts by considering a number of factors, including thelength of time trade receivables are past due, our previous loss history, the customer’s currentability to pay its obligation, and the condition of the general economy and the industry as awhole. We reserve for these accounts receivable by increasing bad debt expense when they aredetermined to be uncollectible. Payments subsequently received, or otherwise determined to becollectible, are treated as recoveries that reduce bad debt expense. We determine our allowancefor sales returns by considering several factors, including history of prior sales credits issued.We regularly assess the allowance for sales returns and increase it as needed. When we accept aproduct return or issue a sales credit for which we had specifically increased the allowance, wewrite-off the associated accounts receivable and decrease the allowance for sales returns.*Capitalized software development costs*. Software development costs incurred after establishingtechnological feasibility are capitalized. These costs are amortized to cost of goods soldbeginning when the product is first released for sale to the general public. The dollar amountamortized is the greater of the amount computed using the ratio of current gross revenues for theproduct to the total of current and anticipated future gross revenues or the straight-line methodover the estimated economic life of the product (two to five years).*Research and development costs.*We charge expenditures for research and development activities toexpense as incurred. Such expenses include product development costs and costs related to theCompany’s internally developed software systems, which have not met the capitalization criteria ofStatement of Position 98-1, *Accounting for the Costs of Computer Software Developed or Obtained forInternal Use*(SOP 98-1).*Income taxes*. Deferred income taxes are provided on the liability method whereby deferred taxassets and deferred tax liabilities are recognized for the effects of taxable temporarydifferences. Temporary differences are the differences between the reported amounts of assets andliabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, inthe opinion of management, it is more likely than not that some portion or all of the deferred taxassets will not be realized. Deferred tax assets and liabilities are adjusted for the effects ofchanges in tax laws and rates on the date of enactment.**Results of Operations for the years ending September 30, 2006 and 2005**The following table sets forth certain Statements of Operations data as a percentage of net sales:
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           Fiscal Years Ended  September 30,  **2006** 2005Net sales  **100****%**  100%Gross profit  **42****%**  38%Selling, general and administrative  **37****%**  50%Research and development  **11****%**  19%Operating loss  **-6****%**  -31%Net loss  **-6****%**  -31%***Net Sales***Net sales increased 58.7% to $30.6 million in fiscal 2006 compared to $19.3 million in fiscal 2005.Net sales derived from our OpCenter product line increased 6.6% to $14.7 million for fiscal 2006compared to $13.8 million for fiscal 2005.Net sales of XATANET equipment and services increased 190% to $15.9 million for fiscal 2006compared to $5.5 million for fiscal 2005. XATANET system sales were 52 percent of total net salesfor fiscal 2006, compared to 28 percent for fiscal 2005. The 184% growth in XATANET equipmentsales in fiscal 2006 is associated with the following: (i) the increase in XATANET systems revenuein fiscal 2006 resulting from prior period deferred sales versus fiscal 2005 and (ii) the change inour XATANET contract terms, which now meets the revenue recognition requirements for immediaterevenue recognition related to the software and hardware components of a sale for most new systemsales. The effect of this change was additional revenue of $1.8 million for fiscal 2006. The 207%growth in recognized XATANET subscription sales is due to a larger subscriber base in fiscal 2006in comparison to fiscal 2005.We ended fiscal 2006 with $12.0 million of deferred revenue in comparison to $11.1 millionat the end of fiscal 2005. Revenue associated with XATANET systemsthat are not under our new contract format will continue to be recognized over the initial term of eachsubscription rather than at the time of delivery. XATANET subscription terms are a minimum oftwelve months.***Cost of Goods Sold***Cost of goods sold includes the direct product costs associated with fulfilling customer orders,warranty costs related to previously sold systems, communication and hosting costs, product repairand refurbishment costs, and expenses associated with the enhancement of released products. Totalcost of goods sold increased $5.8 million to $17.8 million for fiscal 2006 compared to $12.0million for fiscal 2005, driven by increased XATANET system and subscription sales. Overall grossmargins on sales increased 4.1 percentage points to 41.8 percent for fiscal 2006 versus 37.7percent for fiscal 2005. This improvement in overall margins for fiscal 2006 was driven by strongOpCenter systems margins and by the improvement in XATANET subscriptions margins from 17% in fiscal2005 to 40% in fiscal 2006. We expect cost of XATANET revenue to decrease as a percentage of salesduring the next 12 months, primarily resulting from product design, manufacturing improvements andlower communication and facility costs that are being implemented.
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***Selling, General and Administrative Expenses***Selling, general and administrative expenses consist of employee salaries in our support, sales andadministration functions, sales commissions, marketing and promotional expenses, executive andadministrative costs, accounting and professional fees, recruiting costs and provision for doubtfulaccounts. Selling, general and administrative expenses were $11.5 million for fiscal 2006 comparedto $9.7 million for fiscal 2005. The increase of $1.8 million was mainly due to the following: (i)an increase in employee related expenses of $1.3 million due to an increase in headcount whichoccurred in late fiscal 2005 to support the XATANET product line (ii) an increase in stock basedcompensation expense of $0.1 million associated with the Company’s long-term incentive program and(iii) an increase in recruiting costs of $0.3 million associated with new executive, sales, andoperations positions that were added in fiscal 2006.***Research & Development Expenses***Research and development expenses are charged to expense as incurred. Such expenses includeproduct development costs and costs related to the Company’s internally developed software systems,which have not met the capitalization criteria of Statement of Position 98-1, *Accounting for theCosts of Computer Software Developed or Obtained for Internal Use*(SOP 98-1). Research anddevelopment expenses consist of employee salaries and expenses related to development personnel andconsultants, as well as expenses associated with software and hardware development. Research anddevelopment expenses were $3.3 million for fiscal 2006 compared to $3.6 million for fiscal 2005.The decrease of $0.3 million was mainly due to the increase in capitalized software developmentcosts. In fiscal 2006 and 2005, the Company incurred total research and development costs of $4.2million and $3.9 million, respectively; of which $0.9 million and $0.3 million of softwaredevelopment costs were capitalized in fiscal 2006 and 2005, respectively. These costs werecapitalized after the establishment of technological feasibility occurred as required by FAS 86,*Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.*Thesecosts will be amortized to cost of goods sold over the anticipated useful life of the product whichis determined based upon its anticipated future net revenues.***Non-operating Income***Non-operating income increased $0.1 million to $0.2 million in fiscal 2006 from $0.1 million infiscal 2005. The increase was primarily associated with higher interest income due to larger cashbalances and improved interest rates in fiscal 2006.***Income Taxes***No income tax benefit or expense was recorded in fiscal 2006 or fiscal 2005. Because we have hadcontinued operating losses and do not have objectively verifiable positive evidence of futuretaxable income as prescribed by SFAS No. 109, we concluded that a full valuation allowance wasappropriate. Realization of deferred tax assets is dependent on future taxable income during theperiods when deductible temporary differences and carryforwards are expected to be available toreduce taxable income. The amount of the net deferred tax asset considered realizable could beincreased in the future if we return to profitability and actual future taxable income is higherthan currently estimated. At September 30, 2006, we had federal net operating loss carryforwardsof approximately $22.1 million.
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***Net Loss to Common Shareholders***We incurred net losses to common shareholders of $2.1 million and $6.7 million for fiscal 2006 and2005, respectively. For both periods the difference between net loss applicable to commonshareholders and net loss relates to paid and deemed dividends on the Series B Preferred Stock.**Liquidity and Capital Resources**As of September 30, 2006, we held $6.4 million in cash and cash equivalents, and working capitaltotaled $6.3 million.Cash provided by operating activities for fiscal 2006 was $2.1 million compared to cash used inoperating activities of $4.4 million for fiscal 2005. Cash provided by operating activities forfiscal 2006 resulted primarily from working capital changes of $2.7 million and non-cash expensesof $1.1 million offsetting our net loss of $1.7 million.Accounts receivable was $5.3 million at September 30, 2006, a decrease of approximately $2.5million from $7.8 million at September 30, 2005. This decrease was driven by strong cash receiptsin fiscal 2006. Deferred revenue was $12.0 million at September 30, 2006, an increase ofapproximately $0.9 million from $11.1 million at September 30, 2005. This increase was driven bystrong XATANET systems sales to customers that are not under our new contract format. Theseincreases in working capital were partially offset by a $1.0 million increase in inventories,resulting from inventory buildups in response to early fiscal 2007 sales commitments.Cash used in investing activities of $1.7 million for fiscal 2006 included $0.8 million forpurchases of equipment and $0.9 million for capitalized software development.Cash used in financing activities of $0.6 million for fiscal 2006 included $2.0 million paid on ourbank line of credit, partially offset by $0.2 million borrowedon the bank line of credit and $1.3 million received from the exercise of options and warrants.On December 17, 2004 we established a $2.0 million line of credit with Silicon Valley Bank.Advances under the line of credit accrue interest at the prime rate, which was 8.25% as ofSeptember 30, 2006. On December 16, 2005 we amended this debt facility and increased the size ofthe facility to $5.0 million. The line is subject to borrowing base requirements and iscollateralized by substantially all our assets. We are required to meet a quick ratio level of noless than 1:1 under this agreement. All amounts owed under this line of credit must be repaid nolater than December 15, 2007.We believe our current cash balance, line of credit and vendor terms will provide adequate cash tofund operating needs for the foreseeable future. However, a protracted decline in revenue,significant revenue growth or an increase in product development in the near term may require us toobtain external funding. No assurance can be given that we will be able to secure any requiredadditional financing when needed, or that such financing, if obtained at all, will be on termsfavorable or acceptable to us. If additional financing is required and we are unable to securesuch additional financing, we may need to implement measures to slow our growth or reduce operatingcosts, including reductions to product development, marketing and other operating activities.
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Our Series B Preferred Stock prohibits payment of dividends to the holders of any other capitalstockunless and until we have paid dividends accrued on the Series B Preferred Stock, which pays anannual cumulative dividend of 4% of the original issue price. At the option of the Series BPreferred Stock holders, such dividends are payable in additional shares of Preferred Stock orcash. In fiscal 2006 and 2005, we issued 69,000 and 67,000 shares, respectively, of Series BPreferred Stock for payment of accrued dividends. We are further restricted from dividend paymentsby our primary lender.**Subsequent Event**OnOctober 1, 2006, we named John J. Coughlan to replace Craig S. Fawcett as Chairman andChief Executive Officer. We filed a Form 8-K regarding this matter on October 4, 2006.**Off-Balance Sheet Arrangements**None**Recently Issued Accounting Pronouncements****Shared-Based Payment (Statement 123)**In December 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123(revised 2004), *Shared-Based Payment,*which is a revision of FASB Statement No. 123, *Accounting forStock-Based Compensation.*Statement 123(R) supersedes ABP Opinion No. 25, *Accounting for StockIssued to Employees,*and amends FASB No. 95, *Statement of Cash Flows.*Generally the approach inStatement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R)requires all share-based payments to employees, including grants of employee stock options, to berecognized in the income statement based on their fair values. Pro forma disclosure will no longerbe an alternative. The provisions in Statement 123(R) are effective for all stock options or otherequity-based awards to employees or directors that vest or become exercisable in the Company’sfirst quarter of fiscal 2007. The Company will adopt Statement 123(R) at that time and report itsfirst fiscal quarter of 2007 in accordance with the new standard. The Company anticipates theeffect of adopting this Statement will reduce its diluted earnings per shares by approximately $.04for the fiscal year ending September 30, 2007.**Accounting Changes and Error Corrections (Statement 154)**In May 2005, the FASB issued Statement 154, *Accounting Changes and Error Corrections — areplacement of APB Opinion No. 20 and FASB Statement No. 3*, as part of its short-term convergenceproject with the International Accounting Standards Board. Statement 154 requires that allvoluntary changes in accounting principles and changes required by a new accounting pronouncementthat do not include specific transition provisions be applied retrospectively to prior periods’financial statements, unless it is impractical to do so. Opinion 20, *Accounting Changes*, requiredthat most voluntary changes in accounting principle be recognized by including the cumulativeeffect of changing to the new accounting principle as a component of net income in the period ofthe change.Statement 154 is effective prospectively for accounting changes and corrections of errors made infiscal years beginning after December 15, 2005. Statement 154 does not change the transitionprovisions of any existing accounting pronouncements, including those that are in a transitionphase as of the effective date of the Statement. The Company does not believe the adoption of thispronouncement will have a materialeffect on the Company’s results of operations.
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**Accounting for Uncertainty in Income Taxes (FIN 48)**In July, 2006 the FASB issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes*(“FIN 48”). FIN 48, an interpretation of FASB Statement No. 109 “Accounting for Income Taxes,”prescribes a recognition threshold and measurement process for the financial statement recognitionand measurement of a tax position taken or expected to be taken in a tax return. FIN 48 alsoprovides guidance on the derecognition, classification, accounting in interim periods anddisclosure requirements for uncertain tax positions. The accounting provisions of FIN 48 will beeffective for the Company beginning October 1, 2007. The Company is determining what impact if anythis Statement will have on the financial statements.**Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statement (SAB 108)**In September 2006, the SEC issued Staff Accounting Bulletin No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements*(“SAB108”). SAB 108 provides guidance on how prior year misstatements should be considered whenquantifying misstatements in the current year financial statements. The SAB requires registrants toquantify misstatements using both a balance sheet and an income statement approach and evaluatewhether either approach results in quantifying a misstatement that, when all relevant quantitativeand qualitative factors are considered, is material. SAB 108 does not change the guidance in SAB99, “Materiality”, when evaluating the materiality of misstatements. SAB 108 is effective forfiscal years ending after November 15, 2006. Upon initial application, SAB 108 permits a one-timecumulative effect adjustment to beginning retained earnings. TheCompany does not believe the adoption of this pronouncement will havea material effect on the Company’s results of operations.**Fair Value Measurements (FAS 157)**In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair ValueMeasurements (“FAS 157”). FAS 157 defines fair value, establishes a framework for measuring fairvalue and expands disclosures about fair value measurements but does not require any new fair valuemeasurements. FAS 157 is effective for financial statements issued for fiscal years beginning afterNovember 15, 2007, and interim periods within those fiscal years. The Company is determining what impact if anythis Statement will have on the financial statements.**Item 7. Financial Statements**   Report of Independent Registered Public Accounting Firm F-1Balance Sheets F-2Statements of Operations F-3Statements of Changes in Shareholders’ Equity F-4Statements of Cash Flows F-5Notes to Financial Statements F-6 - F-21
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**Item 8. Changes In and Disagreements With Accountants on Accounting and FinancialDisclosure**None.**I****tem 8A. Controls and Procedures*****Evaluation of disclosure controls and procedures.***The Company’s Chief Executive Officer and ChiefFinancial Officer (collectively, the “Certifying Officers”) are responsible for establishing andmaintaining disclosure controls and procedures for the Company. Such officers have concluded thatthe Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) areeffective, based on an evaluation of such controls and procedures as of the end of the periodcovered by this report.***Changes in internal controls over financial reporting.***The Certifying Officers also have indicatedthat there have been no changes in the Company’s internal controls over financial reporting duringits fourth fiscal quarter ended September 30, 2006, that have materially affected or are reasonablylikely to materially affect such controls.**Item 8B. Other Information**None.
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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**Board of Directors and