Forward-looking Statements

Except for the historical information contained herein, the matters discussed in this Report on Form 10-Q are forward-looking statements involving risks and uncertainties that could cause actual results to differ materially from those in such forward-looking statements. Numerous factors, risks and uncertainties affect the Company's operating results and could cause the Company's actual results to differ materially from forecasts and estimates or from any other forward-looking statements made by, or on behalf of, the Company, and there can be no assurance that future results will meet expectations, estimates or projections. Risks and uncertainties include, but are not limited to, the following:

•         As we have generated operating losses recently, additional operating
          losses may occur in the future and may be in excess of amounts that
          could be funded from operations, thus, we may be dependent upon
          external investment to support our operations during these periods;


•         Our growth and profitability depend on our timely introduction and
          market acceptance of new products, our ability to continue to fund
          research and development activities and our ability to establish and
          maintain strategic partner relationships;


•         We will have dependence on proprietary technology and communication
          networks owned and controlled by others, and accordingly, their
          problems may adversely impact us; and


•         For the foreseeable future, we are dependent upon existing customers
          continuing to utilize our solutions.

Further information regarding these and other risks is included in "Risk Factors" in Part 1, Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2012, in this Form 10-Q and in our other filings we make with the Securities and Exchange Commission.

Overview

XRS Corporation, formerly Xata Corporation, and its wholly owned subsidiary, Turnpike Global Technologies, Inc. (collectively, XRS Corporation, the Company, we, our or us) delivers fleet management and compliance software solutions to the commercial trucking industry to assist in maintaining regulatory compliance and controlling the operating costs associated with running a fleet using traditional on-board computers and mobile applications that run on smartphones, tablets and rugged handheld devices. XRS Corporation is a leader in the commercial trucking industry's migration to mobile solutions for collecting and analyzing fleet data, including U.S. Department of Transportation (DOT) compliance data.

The Company's solutions include:
• XataNet: a fleet optimization and compliance solution focused on addressing the needs of fleets to manage compliance risks and maximize the performance of their fleet.

• Turnpike: a mobile fleet optimization and compliance solution that uses a monthly subscription model with no upfront hardware fees.

• MobileMax: a mobile communication platform for the for-hire market with integrated back-office systems.

The Company's strong foundation with electronic driver logs, being a leading company to introduce fully DOT-compliant automated on-board recording device solutions for the tracking of hours of service, has allowed us to establish a customer base consisting of over 1,400 customers and 114,000 subscribers who utilize compliance, fleet performance and driver workflow solutions. In fiscal 2012, we changed our name from Xata Corporation to XRS Corporation (Xata Road Science), reflecting our commitment to the mobile market, our next generation of products and addressing the compliance and performance needs of our customers.

The acquisition of Turnpike Global Technologies, Inc. in 2009 brought a customer base using mobile devices with the operating systems provided by Android, Blackberry and Windows Mobile. As nationwide adoption of mobile devices, and the overall growth of smartphone ownership increases, fleet owners and operators are looking to better leverage their mobile investments, including using them for driver-specific tasks. The Turnpike solution allows XRS Corporation to add fleet management to the overall power of the mobile solution with no upfront hardware costs. This also enables the Company's Turnpike solution to be sold as a bill-on-behalf-of relationship with communication service providers including AT&T, Sprint and Verizon.

Next Generation Solution

In fiscal 2013, we expect to introduce our next generation mobile solution, XRS. This new solution has been designed to address the needs of all sized fleets including owner/operators and small, medium and enterprise-sized fleets. The XRS mobile solution will use the subscription delivery model of Turnpike, with its simplified installation, no upfront hardware cost model and ease of use, paired with the enterprise reporting and operational metrics of XataNet. It will increase functionality of current offerings with dispatch management, workflow forms and interfacing with third-party systems. It is built using cloud-based technology allowing XRS to scale our technology operations to meet anticipated market demand.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with the accounting principles generally accepted in the U.S. (GAAP) as set forth in the Financial Accounting Standards Board's Accounting Standards Codification (ASC) and consider the various staff accounting bulletins and other applicable guidance issued by the Securities and Exchange Commission. GAAP, as set forth within the ASC, requires us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our consolidated financial statements will be affected. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

• Revenue Recognition

• Allowance for Doubtful Accounts

• Goodwill and Intangible Assets

• Warranties

• Income Taxes

In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management's judgment in its application. There are also areas in which management's judgment in selecting among available alternatives would not produce a materially different result. Our senior management has reviewed these critical accounting policies and related disclosures with the Audit Committee of the Board of Directors. There were no changes to the Company's critical accounting policies during three months ended December 31, 2012. Please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended September 30, 2012 for a more complete discussion of our critical accounting policies and estimates.

Results of Operations for the Three Months Ended December 31, 2012 and 2011

The following table includes detail of revenue and cost of goods sold (in
thousands):
                          For the Three Months Ended December 31,
                                     2012                          2011
Revenue:
Software         $             11,769                            $ 11,686
Hardware systems                2,191                               4,464
Services                          235                                 451
Total revenue    $             14,195                            $ 16,601



                                  For the Three Months Ended December 31,
                                              2012                          2011
Cost of goods sold:
Software                 $             3,051                              $ 3,216
Hardware systems                       1,733                                4,766
Services                                 522                                  669
Total cost of goods sold $             5,306                              $ 8,651

In the above table, the revenue and cost of goods sold detail for categories listed are defined as follows:

•         Software revenue includes monthly subscriptions from the XataNet and
          Turnpike solutions, embedded leasing charges on the Turnpike solution
          (where the customer selected the no upfront hardware cost option),
          monthly fees from the MobileMax solution and activation fees.


•         Hardware systems revenue includes hardware with embedded firmware and,
          for the XataNet solution, software that can be hosted by the customer,
          warranty and repair revenue.


•         Services revenue includes installation, implementation, training and
          professional services revenue.


•         Software cost of goods sold consists of communication costs, hosting
          costs, depreciation of Relay assets (formerly RouteTracker assets,
          where the customer selected the no upfront hardware cost option) and
          direct personnel costs related to network infrastructure, as well as
          Turnpike technical support.


•         Hardware systems cost of goods sold consists of direct product costs,
          warranty costs and product repair costs, as well as direct personnel
          costs related to XataNet and MobileMax technical support.


•         Services cost of goods sold consists of third-party vendor costs and
          direct costs related to services personnel.

Revenue

Total revenue of $14.2 million for the three months ended December 31, 2012 decreased 14.5 percent, compared to $16.6 million for the same period in fiscal 2012, reflecting decreased hardware systems and services revenue partially offset by increased software revenue. Software revenue for the three months ended December 31, 2012 increased 0.7 percent to $11.8 million from $11.7 million for the same period in fiscal 2012. Growth of 19.2 percent and 1.7 percent in Turnpike and XataNet revenue, respectively, drove the increase in software revenue. The continued demand for a mobile-based solution, coupled with an increased average rate per unit, fueled the continued growth in Turnpike software revenue year-over-year. Software revenue comprised 82.9 percent of total revenue for the three months ended December 31, 2012 compared to 70.4 percent for the same period in fiscal 2012.

Hardware systems revenue decreased 50.9 percent to comprise 15.4 percent of total revenue for the three months ended December 31, 2012, compared to 26.9 percent for the same period in fiscal 2012. This decline is attributable to decreased sales of XataNet hardware systems as adoption of the Turnpike no upfront hardware cost solution increased, which does not require the customer to purchase hardware.

Services revenue decreased 47.9 percent and represented 1.7 percent of total revenue for the three months ended December 31, 2012, compared to 2.7 percent for the same period in fiscal 2012. The continued shift in the Company's customer base to the Turnpike solution, which provides for self installation, drove the decrease.

Cost of Goods Sold and Gross Margin

Total cost of goods sold decreased 38.7 percent to $5.3 million for the three months ended December 31, 2012, compared to $8.7 million for the same period in fiscal 2012 in conjunction with decreased hardware systems revenue.

Software cost of goods sold of $3.1 million decreased 5.1 percent for the three months ended December 31, 2012, compared to $3.2 million for the same period in fiscal 2012. Software gross margin increased 1.6 percentage points to 74.1 percent of revenue for the three months ended December 31, 2012 from 72.5 percent for the same period in fiscal 2012. The improvement in software margins reflects an increase in the Company's blended rate per unit and decreased infrastructure costs.

Hardware systems cost of goods sold of $1.7 million decreased 63.6 percent for the three months ended December 31, 2012, compared to $4.8 million for the same period in fiscal 2012. Hardware systems gross margins improved by 27.7 percentage points to 20.9 percent of revenue for the three months ended December 31, 2012, compared to negative 6.8 percent for the same period in fiscal 2012. The improvement in hardware margins can be attributed to favorability in warranty activity and an increased volume of higher margin parts sales.

Services cost of goods sold of $0.5 million decreased 22.0 percent for the three months ended December 31, 2012, compared to $0.7 million for the same period in fiscal 2012. Service gross margins declined 73.8 percentage points to negative 122.1 percent of revenue for the three months ended December 31, 2012, compared to negative 48.3 percent for the same period in fiscal 2012. This decrease was primarily the result of the decline in higher margin installation revenue and lower utilization of services personnel as compared to the same period in fiscal 2012.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist of personnel costs for the Company's sales, client management and administration functions; sales commissions, marketing and promotional expenses; executive and administrative costs; and accounting and professional fees. Selling, general and administrative expenses were $5.5 million for the three months ended December 31, 2012, compared to $6.1 million for for the same period in fiscal 2012. A decrease in amortization and personnel expenses resulting from the third quarter of fiscal 2012 intangible asset impairment and business realignment events, respectively, served as the primary drivers behind the fiscal 2013 favorability.

Research and Development Expenses

Research and development expenses consist of personnel costs and expenses related to development of new solutions and added functionality on existing solutions. Research and development expenses were $3.1 million or 21.5 percent of revenue for the three months ended December 31, 2012, compared to $3.5 million or 21.0 percent of revenue for the same period in fiscal 2012. The consistency in research and development expenses is reflective of the Company's continued investment in the successful development and roll out of the new XRS mobile solution.

Net Interest and Other Expense

Net interest and other expense was $18,000 for the three months ended December 31, 2012, compared $0.1 million for the same period in fiscal 2012. There was no debt outstanding at December 31, 2012 as the Company utilized increased cash flow provided by operations to pay off the balance of the revolving line of credit. The decrease in net interest and other expense reflects lower interest expense resulting from lower average outstanding debt balances in combination with lower interest rates on the Company's revolving line of credit, compared to the capital lease facility previously used to finance certain equipment used in the Turnpike solution.

Income Taxes

The Company's effective tax rate was 1.6 percent for the first quarter of fiscal 2013, compared to 6.6 percent for the same period in fiscal 2012. The lower tax rate for first quarter of fiscal 2013 was attributable to the Company's Canadian subsidiary qualifying for certain refundable credits coupled with the recording of a valuation allowance to the extent of the Company's Canadian deferred tax assets.

The Company does not have objectively verifiable positive evidence of future taxable income; accordingly, the Company concluded that a valuation allowance of the Company's deferred tax assets is appropriate. The realization of the deferred tax assets is dependent on future taxable income during the periods when deductible temporary differences and carryforwards are expected to be available to reduce taxable income. The amount of the net deferred tax asset considered realizable could be increased in the future if the Company maintains profitability and it becomes more likely than not that these amounts would be realized. As of September 30, 2012, the Company had federal net operating loss carryforwards and tax credit carryforwards available for use of $42.2 million and $2.8 million, respectively.

Net Income (Loss) to Common Shareholders

Net income to common shareholders was $0.3 million for for the three months ended December 31, 2012, compared to a net loss to common shareholders of $1.7 million for the same period in fiscal 2012. Net income (loss) to common shareholders reflects preferred stock dividends and preferred stock deemed dividends of $58,000 and $6,000 for the three months ended December 31, 2012 and 2011, respectively.

Liquidity and Capital Resources

Operating activities provided $2.2 million of cash for the three months ended December 31, 2012, compared to $0.2 million for the same period in fiscal 2012. Net income of $0.3 million for the three months ended December 31, 2012, compared to a net loss of $1.7 million for the same period in fiscal 2012, served as the primary contributor to the increase.

Cash used in investing activities was $0.6 million for the three months ended December 31, 2012, compared to $0.9 million for the same period in fiscal 2012. For the three months ended December 31, 2012, $0.5 million of cash was used to purchase certain equipment used in the Turnpike solution rather than financing through a capital lease facility as was done in the comparable period in the prior year. Cash used in investing activities for the three months ended December 31, 2011 reflected the Company's investment in the Company's SaaS infrastructure.

Cash used in financing activities was $2.3 million for the three months ended December 31, 2012, which reflects the Company's decision to pay down all outstanding debt facilities, resulting in a debt-free balance sheet as of December 31, 2012. The Company recorded $0.5 million in cash used in financing activities in the same period in fiscal 2012, which represented payments on its capital lease facility then used to finance certain equipment used in the Turnpike solution.

Non-GAAP Financial Measures

The Company recorded free cash flow of $1.6 million for the three months ended December 31, 2012, an increase of $2.3 million as compared to negative free cash flow of $0.7 million for the same period in fiscal 2012. The increase in free cash flow was driven by net income of $0.3 million for the three months ended December 31, 2012, compared to a net loss of $1.7 million for the same period in fiscal 2012.

The following table is a reconciliation of free cash flow from net cash provided by operating and investing activities, which are the most directly comparable financial measures calculated in accordance with GAAP (in thousands):

                                                           For the Three Months Ended December 31,
                                                                 2012                     2011
Net cash provided by operating activities               $            2,182         $            180
Net cash provided by investing activities:
Purchase of equipment and leasehold improvements                      (114 )                   (907 )
Purchase of Relay assets (formerly RouteTracker assets)               (499 )                      -
Proceeds from the sale of equipment                                      7                        2
Net cash provided by investing activities                             (606 )                   (905 )
Free cash flow                                          $            1,576         $           (725 )

The improvement in free cash flow contributed to an improvement of $0.7 million in working capital to $10.3 million as of December 31, 2012.

The following table is a reconciliation of working capital from current assets and current liabilities, which are the most directly comparable financial measures calculated in accordance with GAAP (in thousands):

                                                            December 31,      September 30,
                                                                2012               2012
Current assets                                            $       19,757     $       20,942
Current liabilities                                              (10,647 )          (12,882 )
Net current assets                                                 9,110              8,060
Current portion of deferred revenue net of deferred costs          1,211              1,544
Working capital                                           $       10,321     $        9,604

Working capital and free cash flow are non-GAAP financial measures that management uses to assess the Company's performance. Management believes working capital and free cash flow provide useful information to management and investors by presenting measurements of cash generated from operations that are available to fund operations, invest in product and infrastructure development and repay debt. Our calculations of working capital and free cash flow may not be comparable to similarly titled measures reported by other companies.

The Company believes that based on the current level of operations, cash flow from operations, existing funds, availability on its revolving line of credit and vendor terms will provide adequate cash to fund operating needs for the foreseeable future. If the Company does not generate anticipated cash flow levels, predictions regarding cash needs may prove inaccurate, and additional financing may be required.

XRS Corporation Series B Preferred Stock prohibits payment of dividends to the holders of any other capital stock unless and until the Company has paid dividends accrued on the Series B Preferred Stock, which pays a cumulative dividend of 4.0 percent per annum of the original issue price (payable semi-annually). At the option of the Series B Preferred Stockholders, such dividends are payable in additional shares of Series B Preferred Stock or cash. In fiscal 2012, the Company issued 81,000 shares of Series B Preferred Stock for payment of accrued dividends.

Recently Issued Accounting Standards

There were no new accounting pronouncements issued or effective during the three months ended December 31, 2012 that have had or are expected to have a material impact on the consolidated financial statements.