UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, |
or
Or | |
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________ |
Commission file number: 000-22920
NUMEREX CORP.
(Exact name of registrant as specified in its charter)
Pennsylvania | 11-2948749 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
3330 Cumberland400 Interstate North Parkway, Suite 7001350
Atlanta, GA 30339-2119
(Address of principal executive offices) (Zip Code)
(770) 693-5950
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.
Yes þNo¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ | Accelerated filer þ | |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o¨ No þ
As of November 3, 2015,19,254,706October 28, 2016, 19,583,392 shares of the registrant's Class A common stock, no par value (being the registrant's only class of common stock outstanding) were outstanding.
NUMEREX CORP. AND SUBSIDIARIES
TABLE OF CONTENTS
2 |
NUMEREX CORP. AND SUBSIDIARIES
Item 1. | Financial Statements. |
3 |
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30, | December 31, | September 30, | December 31, | |||||||||||||
2015 | 2014 | 2016 | 2015 | |||||||||||||
ASSETS | ||||||||||||||||
CURRENT ASSETS | ||||||||||||||||
Cash and cash equivalents | $ | 12,482 | $ | 17,270 | $ | 9,824 | $ | 16,237 | ||||||||
Accounts receivable, less allowance for doubtful accounts of $2,052 and $1,106 | 14,092 | 12,287 | ||||||||||||||
Restricted cash | 221 | - | ||||||||||||||
Accounts receivable, less allowance for doubtful accounts of $743 and $618 | 9,353 | 9,237 | ||||||||||||||
Financing receivables, current | 1,789 | 1,595 | 1,877 | 1,780 | ||||||||||||
Inventory, net of reserves | 7,974 | 8,410 | 6,339 | 7,617 | ||||||||||||
Prepaid expenses and other current assets | 2,054 | 2,329 | 1,838 | 1,887 | ||||||||||||
Deferred tax assets, current | - | 3,161 | 603 | 603 | ||||||||||||
TOTAL CURRENT ASSETS | 38,391 | 45,052 | 30,055 | 37,361 | ||||||||||||
Financing receivables, less current portion | 2,687 | 2,984 | 2,090 | 2,330 | ||||||||||||
Property and equipment, net of accumulated depreciation and amortization | 4,492 | 4,889 | 6,136 | 4,795 | ||||||||||||
Software, net of accumulated amortization | 6,958 | 6,106 | 6,118 | 7,146 | ||||||||||||
Other intangible assets, net of accumulated amortization | 17,512 | 19,163 | 12,879 | 15,722 | ||||||||||||
Goodwill | 43,424 | 44,348 | 40,945 | 43,424 | ||||||||||||
Deferred tax assets, less current portion | - | 5,816 | ||||||||||||||
Other assets | 1,107 | 2,585 | 849 | 409 | ||||||||||||
TOTAL ASSETS | $ | 114,571 | $ | 130,943 | $ | 99,072 | $ | 111,187 | ||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||||||||||
CURRENT LIABILITIES | ||||||||||||||||
Accounts payable | $ | 12,011 | $ | 12,257 | $ | 11,572 | $ | 11,390 | ||||||||
Accrued expenses and other current liabilities | 3,062 | 2,471 | 3,777 | 2,864 | ||||||||||||
Deferred revenues | 2,026 | 2,258 | 1,563 | 1,942 | ||||||||||||
Current portion of long-term debt | 3,750 | 4,251 | ||||||||||||||
Obligations under capital lease | - | 148 | ||||||||||||||
Current maturities of long-term debt, net of debt issuance costs | 638 | 3,600 | ||||||||||||||
Current obligations under capital lease | 257 | - | ||||||||||||||
TOTAL CURRENT LIABILITIES | 20,849 | 21,385 | 17,807 | 19,796 | ||||||||||||
Long-term debt, less current portion | 16,537 | 19,350 | ||||||||||||||
Noncurrent deferred taxes | 1,170 | - | ||||||||||||||
Long-term debt, net of debt issuance costs, less current maturities | 15,456 | 15,309 | ||||||||||||||
Obligations under capital lease, noncurrent | 980 | - | ||||||||||||||
Deferred tax liabilities, noncurrent | 1,416 | 1,595 | ||||||||||||||
Other liabilities | 1,759 | 1,346 | 1,528 | 1,891 | ||||||||||||
TOTAL LIABILITIES | 40,315 | 42,081 | 37,187 | 38,591 | ||||||||||||
COMMITMENTS AND CONTINGENCIES | ||||||||||||||||
COMMITMENTS AND CONTINGENCIES (NOTE H) | ||||||||||||||||
SHAREHOLDERS’ EQUITY | ||||||||||||||||
Preferred stock, no par value; 3,000 authorized; none issued | - | - | - | - | ||||||||||||
Class A common stock, no par value; 30,000 authorized; 20,532 and 20,284 issued; 19,225 and 18,992 outstanding | - | - | ||||||||||||||
Class A common stock, no par value; 30,000 authorized; 20,910 and 20,652 issued; 19,583 and 19,177 outstanding | - | - | ||||||||||||||
Class B common stock, no par value; 5,000 authorized; none issued | - | - | - | - | ||||||||||||
Additional paid-in capital | 101,319 | 99,056 | 104,568 | 102,108 | ||||||||||||
Treasury stock, at cost; 1,307 and 1,292 shares | (5,444 | ) | (5,352 | ) | ||||||||||||
Treasury stock, at cost, 1,326 and 1,316 shares | (5,466 | ) | (5,444 | ) | ||||||||||||
Accumulated other comprehensive loss | (95 | ) | (48 | ) | (105 | ) | (117 | ) | ||||||||
Accumulated deficit | (21,524 | ) | (4,794 | ) | (37,112 | ) | (23,951 | ) | ||||||||
TOTAL SHAREHOLDERS' EQUITY | 74,256 | 88,862 | 61,885 | 72,596 | ||||||||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 114,571 | $ | 130,943 | $ | 99,072 | $ | 111,187 |
The accompanying notes are an integral part of these financial statements.
4 |
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE (LOSS) INCOMELOSS
(In thousands, except per share data)
Three Months Ended | Nine Months Ended | Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
September 30, | September 30, | September 30, | September 30, | |||||||||||||||||||||||||||||
2015 | 2014 | 2015 | 2014 | 2016 | 2015 | 2016 | 2015 | |||||||||||||||||||||||||
Net revenues: | ||||||||||||||||||||||||||||||||
Subscription and support revenues | $ | 15,624 | $ | 17,429 | $ | 48,874 | $ | 47,530 | $ | 14,388 | $ | 15,624 | $ | 44,183 | $ | 48,874 | ||||||||||||||||
Embedded devices and hardware | 7,710 | 8,234 | 21,791 | 21,483 | 3,024 | 7,710 | 8,886 | 21,791 | ||||||||||||||||||||||||
Total net revenues | 23,334 | 25,663 | 70,665 | 69,013 | 17,412 | 23,334 | 53,069 | 70,665 | ||||||||||||||||||||||||
Cost of sales, exclusive of a portion of depreciation and amortization shown below: | ||||||||||||||||||||||||||||||||
Subscription and support revenues | 6,538 | 7,011 | 19,728 | 18,647 | 5,828 | 6,538 | 17,242 | 19,728 | ||||||||||||||||||||||||
Embedded devices and hardware | 6,958 | 7,236 | 19,582 | 18,102 | 3,082 | 6,958 | 9,027 | 19,582 | ||||||||||||||||||||||||
Inventory reserves | 1,277 | 129 | 1,547 | 415 | 27 | 1,277 | 514 | 1,547 | ||||||||||||||||||||||||
Impairment of other asset | 1,275 | - | 1,275 | - | - | 1,275 | - | 1,275 | ||||||||||||||||||||||||
Gross profit | 7,286 | 11,287 | 28,533 | 31,849 | 8,475 | 7,286 | 26,286 | 28,533 | ||||||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||||||
Sales and marketing | 3,047 | 3,029 | 9,136 | 9,066 | 3,229 | 3,047 | 9,444 | 9,136 | ||||||||||||||||||||||||
General and administrative | 4,507 | 3,429 | 12,108 | 11,207 | 3,280 | 4,507 | 11,269 | 12,108 | ||||||||||||||||||||||||
Engineering and development | 2,201 | 2,430 | 6,695 | 5,794 | 2,229 | 2,201 | 6,920 | 6,695 | ||||||||||||||||||||||||
Depreciation and amortization | 2,100 | 1,597 | 5,411 | 4,570 | 1,658 | 2,100 | 4,992 | 5,411 | ||||||||||||||||||||||||
Impairment of goodwill and other intangible assets | 1,250 | - | 1,250 | - | - | 1,250 | 4,172 | 1,250 | ||||||||||||||||||||||||
Operating (loss) income | (5,819 | ) | 802 | (6,067 | ) | 1,212 | ||||||||||||||||||||||||||
Restructuring charges | 276 | - | 1,520 | - | ||||||||||||||||||||||||||||
Operating loss | (2,197 | ) | (5,819 | ) | (12,031 | ) | (6,067 | ) | ||||||||||||||||||||||||
Interest expense | 188 | 278 | 604 | 564 | 469 | 188 | 1,196 | 604 | ||||||||||||||||||||||||
Loss on extinguishment of debt | - | - | 290 | - | ||||||||||||||||||||||||||||
Other income, net | (31 | ) | (97 | ) | (100 | ) | (1,272 | ) | (33 | ) | (31 | ) | (99 | ) | (100 | ) | ||||||||||||||||
(Loss) income from continuing operations before income taxes | (5,976 | ) | 621 | (6,571 | ) | 1,920 | ||||||||||||||||||||||||||
Income tax expense | 10,404 | 358 | 10,159 | 283 | ||||||||||||||||||||||||||||
(Loss) income from continuing operations, net of income taxes | (16,380 | ) | 263 | (16,730 | ) | 1,637 | ||||||||||||||||||||||||||
Loss from discontinued operations, net of income taxes | - | - | - | (492 | ) | |||||||||||||||||||||||||||
Net (loss) income | (16,380 | ) | 263 | (16,730 | ) | 1,145 | ||||||||||||||||||||||||||
Other items of comprehensive income, net of income taxes: | ||||||||||||||||||||||||||||||||
Loss before income taxes | (2,633 | ) | (5,976 | ) | (13,418 | ) | (6,571 | ) | ||||||||||||||||||||||||
Income tax (benefit) expense | (87 | ) | 10,404 | (257 | ) | 10,159 | ||||||||||||||||||||||||||
Net loss | (2,546 | ) | (16,380 | ) | (13,161 | ) | (16,730 | ) | ||||||||||||||||||||||||
Other items of comprehensive income (loss), net of income taxes: | ||||||||||||||||||||||||||||||||
Foreign currency translation adjustment | 30 | (13 | ) | 47 | (10 | ) | 1 | 30 | 12 | 47 | ||||||||||||||||||||||
Comprehensive (loss) income | $ | (16,350 | ) | $ | 250 | $ | (16,683 | ) | $ | 1,135 | ||||||||||||||||||||||
Comprehensive loss | $ | (2,545 | ) | $ | (16,350 | ) | $ | (13,149 | ) | $ | (16,683 | ) | ||||||||||||||||||||
Basic (loss) earnings per share: | ||||||||||||||||||||||||||||||||
(Loss) income from continuing operations | $ | (0.86 | ) | $ | 0.01 | $ | (0.88 | ) | $ | 0.09 | ||||||||||||||||||||||
Loss from discontinued operations | - | - | - | (0.03 | ) | |||||||||||||||||||||||||||
Net (loss) income | $ | (0.86 | ) | $ | 0.01 | $ | (0.88 | ) | $ | 0.06 | ||||||||||||||||||||||
Diluted (loss) earnings per share: | ||||||||||||||||||||||||||||||||
(Loss) income from continuing operations | $ | (0.86 | ) | $ | 0.01 | $ | (0.88 | ) | $ | 0.09 | ||||||||||||||||||||||
Loss from discontinued operations | - | - | - | (0.03 | ) | |||||||||||||||||||||||||||
Net (loss) income | $ | (0.86 | ) | $ | 0.01 | $ | (0.88 | ) | $ | 0.06 | ||||||||||||||||||||||
Weighted average shares outstanding used in computing earnings per share: | ||||||||||||||||||||||||||||||||
Loss per share: | ||||||||||||||||||||||||||||||||
Basic | 19,137 | 18,956 | 19,053 | 18,900 | $ | (0.13 | ) | $ | (0.86 | ) | $ | (0.68 | ) | $ | (0.88 | ) | ||||||||||||||||
Diluted | 19,137 | 19,263 | 19,053 | 19,253 | $ | (0.13 | ) | $ | (0.86 | ) | $ | (0.68 | ) | $ | (0.88 | ) | ||||||||||||||||
Weighted average shares outstanding used in per share calculation | ||||||||||||||||||||||||||||||||
Basic | 19,542 | 19,137 | 19,456 | 19,053 | ||||||||||||||||||||||||||||
Diluted | 19,542 | 19,137 | 19,456 | 19,053 |
The accompanying notes are an integral part of these financial statements.
5 |
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENT
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(inIn thousands)
Accumulated Other | Total | |||||||||||||||||||||||
Common | Additional | Treasury | Comprehensive | Accumulated | Shareholders' | |||||||||||||||||||
Shares | Paid-in Capital | Stock | Loss | Deficit | Equity | |||||||||||||||||||
Balance at January 1, 2015 | 20,284 | $ | 99,056 | $ | (5,352 | ) | $ | (48 | ) | $ | (4,794 | ) | $ | 88,862 | ||||||||||
Equity-based compensation expense | 133 | 2,319 | - | - | - | 2,319 | ||||||||||||||||||
Equity-based compensation plan activity | 114 | 138 | - | - | - | 138 | ||||||||||||||||||
Value of shares retained to pay employee taxes | - | (199 | ) | (92 | ) | - | - | (291 | ) | |||||||||||||||
Translation adjustment | - | - | - | (47 | ) | - | (47 | ) | ||||||||||||||||
Other | 1 | 5 | - | - | - | 5 | ||||||||||||||||||
Net loss | - | - | - | - | (16,730 | ) | (16,730 | ) | ||||||||||||||||
Balance at September 30, 2015 | 20,532 | $ | 101,319 | $ | (5,444 | ) | $ | (95 | ) | $ | (21,524 | ) | $ | 74,256 |
Accumulated Other | Total | |||||||||||||||||||||||
Common | Additional | Treasury | Comprehensive | Accumulated | Shareholders' | |||||||||||||||||||
Shares | Paid-in Capital | Stock | Loss | Deficit | Equity | |||||||||||||||||||
Balance at January 1, 2016 | 20,652 | $ | 102,108 | $ | (5,444 | ) | $ | (117 | ) | $ | (23,951 | ) | $ | 72,596 | ||||||||||
Equity-based compensation expense | - | 2,202 | - | - | - | 2,202 | ||||||||||||||||||
Exercises, vesting and other equity-based compensation plan activity, net | 257 | 250 | (22 | ) | - | - | 228 | |||||||||||||||||
Issuance of common shares for services | 1 | 8 | - | - | - | 8 | ||||||||||||||||||
Translation adjustment | - | - | - | 12 | - | 12 | ||||||||||||||||||
Net loss | - | - | - | - | (13,161 | ) | (13,161 | ) | ||||||||||||||||
Balance at September 30, 2016 | 20,910 | $ | 104,568 | $ | (5,466 | ) | $ | (105 | ) | $ | (37,112 | ) | $ | 61,885 |
The accompanying notes are an integral part of these financial statements.
6 |
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended | ||||||||
September 30, | ||||||||
2015 | 2014 | |||||||
Cash flows from operating activities: | ||||||||
Net (loss) income | $ | (16,730 | ) | $ | 1,145 | |||
Less loss from discontinued operations, net of income taxes | - | (492 | ) | |||||
(Loss) income from continuing operations, net of income taxes | (16,730 | ) | 1,637 | |||||
Adjustments to reconcile net (loss) income from continuing operations to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 6,163 | 4,969 | ||||||
Impairment of goodwill, other intangible assets and other assets | 2,525 | - | ||||||
Equity-based compensation expense | 2,319 | 1,833 | ||||||
Deferred income taxes | 10,147 | 36 | ||||||
Bad debt expense | 400 | 364 | ||||||
Inventory reserves | 1,547 | 415 | ||||||
Gain on sale of cost method investment | - | (1,109 | ) | |||||
Other non-cash expense | 63 | 76 | ||||||
Changes in assets and liabilities, net of effects of acquisitions: | ||||||||
Accounts and financing receivables | (1,898 | ) | (1,638 | ) | ||||
Inventory, net | (861 | ) | 613 | |||||
Accounts payable | (31 | ) | 208 | |||||
Deferred revenue | 231 | (77 | ) | |||||
Other | 249 | (275 | ) | |||||
Net cash provided by operating activities | 4,124 | 7,052 | ||||||
Cash flows from investing activities: | ||||||||
Net cash paid for acquisition | - | (37,113 | ) | |||||
Purchases of property and equipment | (1,984 | ) | (1,335 | ) | ||||
Capitalized software development and purchases of software | (3,314 | ) | (2,709 | ) | ||||
Proceeds from sale of cost basis investment | - | 1,309 | ||||||
Net cash used in investing activities | (5,298 | ) | (39,848 | ) | ||||
Cash flows from financing activities: | ||||||||
Principal payments on debt | (3,313 | ) | (1,725 | ) | ||||
Principal payments on capital lease obligations | (148 | ) | (221 | ) | ||||
Proceeds from long-term debt | - | 25,000 | ||||||
Equity-based compensation plan activity | 138 | 935 | ||||||
Payment of taxes on equity-based awards | (291 | ) | (288 | ) | ||||
Deferred financing costs | - | (293 | ) | |||||
Net cash (used in) provided by financing activities | (3,614 | ) | 23,408 | |||||
Cash flows from discontinued operations: | ||||||||
Cash provided by operating activities | - | 142 | ||||||
Net decrease in cash and cash equivalents | (4,788 | ) | (9,246 | ) | ||||
Cash and cash equivalents at beginning of period | 17,270 | 25,603 | ||||||
Cash and cash equivalents at end of period | $ | 12,482 | $ | 16,357 |
Nine Months Ended | ||||||||
September 30, | ||||||||
2016 | 2015 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (13,161 | ) | $ | (16,730 | ) | ||
Adjustments to reconcile net loss to net cash (used in) provided by operating activities: | ||||||||
Depreciation and amortization | 5,997 | 6,163 | ||||||
Impairment of goodwill and other assets | 4,172 | 2,525 | ||||||
Non-cash restructuring charges | 345 | - | ||||||
Equity-based compensation expense | 2,202 | 2,319 | ||||||
Loss on extinguishment of debt | 290 | - | ||||||
Deferred income taxes | (268 | ) | 10,147 | |||||
Bad debt expense | 327 | 400 | ||||||
Inventory reserves | 514 | 1,547 | ||||||
Other non-cash expense | 138 | 63 | ||||||
Changes in assets and liabilities: | ||||||||
Accounts and financing receivables | (303 | ) | (1,898 | ) | ||||
Inventory, net | (1,323 | ) | (861 | ) | ||||
Accounts payable | 427 | (31 | ) | |||||
Deferred revenue | (554 | ) | 231 | |||||
Other | 394 | 249 | ||||||
Net cash (used in) provided by operating activities | (803 | ) | 4,124 | |||||
Cash flows from investing activities: | ||||||||
Purchases of property and equipment | (789 | ) | (1,984 | ) | ||||
Capitalized software development and purchases of software | (1,662 | ) | (3,314 | ) | ||||
Net cash used in investing activities | (2,451 | ) | (5,298 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from long-term debt | 17,000 | - | ||||||
Principal payments on debt | (19,349 | ) | (3,313 | ) | ||||
Principal payments on capital lease obligations | - | (148 | ) | |||||
Exercises, vesting and other equity-based compensation plan activity, net | 486 | 138 | ||||||
Payment of taxes on equity-based awards | (258 | ) | (291 | ) | ||||
Deferred financing costs paid | (1,038 | ) | - | |||||
Net cash used in financing activities | (3,159 | ) | (3,614 | ) | ||||
Net decrease in cash and cash equivalents | (6,413 | ) | (4,788 | ) | ||||
Cash and cash equivalents at beginning of period | 16,237 | 17,270 | ||||||
Cash and cash equivalents at end of period | $ | 9,824 | $ | 12,482 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid for interest | $ | 1,047 | $ | 513 | ||||
Net cash paid for income taxes | 6 | 70 | ||||||
Disclosure of non-cash operating, investing and financing activities: | ||||||||
Capital expenditures in accounts payable | 196 | 203 | ||||||
Fixed assets acquired under a capital lease | 1,237 | - | ||||||
Transfers of inventory to equipment for managed services | 2,087 | 1,064 | ||||||
The accompanying notes are an integral part of these financial statements.
7 |
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS — CONTINUED
(In thousands)
Nine Months Ended | ||||||||
September 30, | ||||||||
2015 | 2014 | |||||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid for interest | $ | 513 | $ | 488 | ||||
Cash paid for income taxes | 70 | 83 | ||||||
Disclosure of non-cash investing and financing activities: | ||||||||
Capital expenditures in accounts payable | 203 | 386 | ||||||
Note issued in conjunction with disposal of discontinued operations | - | 35 |
The accompanying notes are an integral part of these financial statements.
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SeptemberSEPTEMBER 30, 20152016
NOTE A – NATURESUMMARY OF OPERATIONS AND BASIS OF PRESENTATIONSIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Numerex Corp. (NASDAQ:NMRX) is a leading provider of managed machine-to-machine (M2M) enterprise solutions enabling the Internet of Things (IoT). The CompanyCompany's solutions produce new revenue streams or create operating efficiencies for its customers. Numerex provides its technology and services through its integrated M2M horizontal platforms, which are generally sold on a subscription basis. The Company offers Numerex DNA® that may include hardwarea portfolio of managed end-to-end IoT solutions including smart devices, network connectivity and smart Devices, cellularservice applications capable of addressing the needs of a wide spectrum of vertical markets and satellite Network services, and software applicationsindustrial customers. The Company's mission is to empower enterprise operations with world-class, managed IoT solutions that are delivered through our M2M platform. The Company also provides business services to enable the development of efficient, reliable,simple, innovative, scalable, and secure solutions while accelerating deployment.secure. Numerex is ISO 27001 information security-certified, highlighting the Company’sCompany's focus on M2M data security, service reliability and around-the-clock support of its customers’ M2M solutions.customers. Foreign operations were not significant to us for the three and nine months ended September 30, 2016 or 2015.
Basis of Presentation
We prepared the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, referred to as GAAP, for interim financial information and the Rules and Regulations issued by the Securities Exchange Commission, or SEC, as applicable. These financial statements include all of our accounts and those of our wholly-owned subsidiaries. We have eliminated intercompany transactions and balances in consolidation.
Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted, although we believe that the disclosures made are adequate to make the information not misleading. In the opinion of management, the accompanying financial statements reflect all adjustments, which consist of normal recurring adjustments unless otherwise disclosed, considered necessary for a fair presentation of our financial position as of September 30, 20152016 and our operating results and cash flows for the interim periods presented. The accompanying condensed consolidated balance sheet as of December 31, 20142015 was derived from our audited financial statements, but does not include all disclosures required by GAAP. The financial information presented herein should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 20142015 which includes information and disclosures not included in this quarterly report.
Estimates and Assumptions
The preparation of financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Actual results may differ materially from these estimates. Operating results for the three and nine months ended September 30, 2015,2016 may not be indicative of the results that may be expected for the year ending December 31, 20152016 or any future periods.
Restricted Cash
As of September 30, 2016, cash of $0.2 million was held in escrow related to certain vendor obligations as a result of entering into our new loan agreement. See Note G – Debt. There was no restricted cash at December 31, 2015.
8 |
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
Reclassifications
As a result of the adoption of a recent accounting pronouncement, see Note K – Recent Accounting Pronouncements, the balance sheet as of December 31, 2015 reflects the following reclassifications (dollars in thousands):
Historical | Reclassi- | |||||||||||
Presentation | fication | As Adjusted | ||||||||||
Prepaid expenses and other current assets | $ | 2,037 | $ | (150 | ) | $ | 1,887 | |||||
Other assets | 699 | (290 | ) | 409 | ||||||||
Current portion of long-term debt | 3,750 | (150 | ) | 3,600 | ||||||||
Long-term debt, less current portion | 15,599 | (290 | ) | 15,309 |
NOTE B – MERGERINVENTORY
On May 5, 2014, in accordance with the terms and conditionsInventory consisted of the merger agreement,following as of the dates below (in thousands):
September 30, | December 31, | |||||||
2016 | 2015 | |||||||
Raw materials | $ | 1,553 | $ | 1,903 | ||||
Finished goods | 7,206 | 8,420 | ||||||
Inventory reserves | (2,420 | ) | (2,706 | ) | ||||
$ | 6,339 | $ | 7,617 |
During the nine months ended September 30, 2016, we merged our wholly-owned subsidiary withtransferred $2.1 million of inventory to monitoring equipment within property and into Omnilink Systems Inc. (Omnilink) with Omnilink surviving the merger as a wholly-owned subsidiaryequipment and disposed of Numerex. The purchase price$0.8 million of $37.5 million was composed of a cash payment of $37.3 million and a working capital adjustment of $0.2 million.fully reserved inventory.
Omnilink provides trackingNOTE C – PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
September 30, | December 31, | |||||||
2016 | 2015 | |||||||
Computer, network and other equipment | $ | 8,759 | $ | 7,150 | ||||
Monitoring equipment | 5,102 | 3,015 | ||||||
Furniture and fixtures | 486 | 888 | ||||||
Leasehold improvements | 265 | 374 | ||||||
Total property and equipment | 14,612 | 11,427 | ||||||
Accumulated depreciation and amortization | (8,476 | ) | (6,632 | ) | ||||
$ | 6,136 | $ | 4,795 |
We entered into an agreement effective August 1, 2016 to sublease the office space formerly occupied by our corporate headquarters that included all furniture and fixtures. We recorded a $0.4 million non-cash charge for the estimated net book value of the furniture and fixtures as of August 1, 2016, the cease-use date. See Note F – Restructuring.
During the nine months ended September 30, 2016, we transferred $2.1 million of inventory to monitoring equipment as part of our managed services for people and valuable assets via Omnilink’s M2M platform that connects hardware, networks, software, and support services. Our combination with Omnilink has provided operating synergies and created growth opportunities through product enhancement and channel expansion. The assets, liabilities and operating results of Omnilink are included in our condensed consolidated financial statements commencing from the merger date.business.
9 |
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SeptemberSEPTEMBER 30, 2015
The following table summarizes the fair values of the assets acquired and liabilities assumed as of the closing date of the Omnilink merger (dollars in thousands):
Estimated | ||||||
Fair Value | Useful Lives | |||||
Cash | $ | 195 | n/a | |||
Accounts receivable | 2,677 | n/a | ||||
Inventory | 873 | n/a | ||||
Prepaid and other assets | 377 | n/a | ||||
Property and equipment | 1,613 | 4(a) | ||||
Deferred tax asset | 2,400 | n/a | ||||
Customer relationships | 6,056 | 11 | ||||
Technology | 4,998 | 14 | ||||
Trade names | 3,632 | Indefinite | ||||
Goodwill | 17,518 | Indefinite | ||||
Total identifiable assets acquired | 40,339 | |||||
Accounts payable | (1,756 | ) | n/a | |||
Accrued expenses | (1,037 | ) | n/a | |||
Deferred revenue | (64 | ) | n/a | |||
Total liabilities assumed | (2,857 | ) | ||||
Net assets acquired | $ | 37,482 |
________________
The total purchase consideration for the merger was allocated to identifiable assets purchased and liabilities assumed based on fair value. The estimated fair value attributed to intangible assets, other than goodwill, was based on common valuation techniques. The fair value of acquired software was estimated using a cost approach based on assumptions of our historical software development costs. The fair value of trade names was based on an income approach with key assumptions including estimated royalty rates to license the trade names from a third party. The valuation of customer relationships utilized an income approach and discounted cash flows taking into consideration the number of customer relationships acquired and estimated customer turnover.
The gross amount of accounts receivable in the table above is $2.9 million. Based on the nature and financial strength of the customers on the date of acquisition, we expected to collect amounts due for the accounts receivable of $2.7 million.
The value of the deferred tax asset and goodwill as disclosed above reflect a subsequent measurement period adjustment of $0.2 million recorded during the three months ended June 30, 2015 to record the final calculation of acquired deferred tax assets. The residual allocation to goodwill results from such factors as an assembled workforce, expected significant synergies for market growth and profitability as well as Omnilink’s service and product lines contributing to our becoming the market leader in select M2M vertical markets. The total amount of goodwill will not be deductible for income tax purposes.
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
The measurement period adjustment resulted in recasting the December 31, 2014 consolidated balance sheet, as follows (in thousands):
December 31, | Measurement | December 31, | ||||||||||
2014 | Period | 2014 | ||||||||||
As Reported | Adjustment | Recast | ||||||||||
Assets | ||||||||||||
Goodwill | $ | 44,548 | $ | (200 | ) | $ | 44,348 | |||||
Deferred tax assets, less current portion | 5,616 | 200 | 5,816 | |||||||||
$ | 50,164 | $ | - | $ | 50,164 |
The measurement period adjustment had no effect on the statements of operations and comprehensive (loss) income or cash flows.
NOTE C - INVENTORY
Inventory consisted of the following (in thousands):
September 30, | December 31, | |||||||
2015 | 2014 | |||||||
Raw materials | $ | 2,109 | $ | 2,228 | ||||
Finished goods | 8,559 | 7,579 | ||||||
Inventory reserves | (2,694 | ) | (1,397 | ) | ||||
$ | 7,974 | $ | 8,410 |
In September 2015, we entered into new and amended agreements with wireless carriers that make adding 2G devices to wireless networks financially unfavorable under most circumstances. As a result of these agreements, we performed a lower of cost or market analysis leading to a significant increase in the inventory reserve of $1.1 million related to older, second generation (2G) cellular telecommunication devices and older satellite devices as well as an accrual for a purchase commitment related to raw materials for the older satellite devices that we will not fulfill.2016
NOTE D – PROPERTYGOODWILL AND EQUIPMENTOTHER INTANGIBLE ASSETS
Property and equipment consisted of the following (in thousands):
September 30, | December 31, | |||||||
2015 | 2014 | |||||||
Computer, network and other equipment | $ | 6,394 | $ | 5,925 | ||||
Monitoring equipment | 2,834 | 1,705 | ||||||
Furniture and fixtures | 888 | 746 | ||||||
Leasehold improvements | 357 | 328 | ||||||
Total property and equipment | 10,473 | 8,704 | ||||||
Accumulated depreciation and amortization | (5,981 | ) | (3,815 | ) | ||||
$ | 4,492 | $ | 4,889 |
Monitoring equipment includes devices and hardware owned by us and used by customers under managed service arrangements. Depreciation expense for monitoring equipment included in cost of sales for subscription and support revenues in the accompanying condensed consolidated statements of operations and comprehensive (loss) income was $0.3 million and $0.2 million for the three months ended September 30, 2015 and 2014, respectively, and $0.8 million and $0.4 million for the nine months ended September 30, 2015 and 2014, respectively.
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015Impairment Charges
During the threesecond quarter of 2016, management evaluated and nine monthsdetermined that the Omnilink and Do-It-Yourself (DIY) product lines and reporting units should be tested for impairment as a result of lower operating results, which are related to strategic changes and delays associated with the launch of a new personal tracking product line. Management initiated a quantitative two-step goodwill impairment test by comparing the carrying value of the net assets of the respective units to its fair value based on a discounted cash flow analysis. Based on our assessment, we determined that the fair value of these reporting units were less than the respective carrying value and goodwill was impaired, and we recorded $4.2 million in impairment charges. Such charges related to trade names, technology and goodwill as of September 30, 2016, and are summarized as follows:
Changes in the effected carrying values are summarized as follows (in thousands):
Omnilink | DIY | Total | ||||||||||||||||||
Trade Names | Goodwill | Technology | Goodwill | Impairment | ||||||||||||||||
January 1, 2016 | $ | 2,972 | $ | 17,580 | $ | 245 | $ | 1,656 | ||||||||||||
Amortization | - | - | (27 | ) | - | |||||||||||||||
Impairment | (1,612 | ) | (2,264 | ) | (81 | ) | (215 | ) | $ | (4,172 | ) | |||||||||
September 30, 2016 | $ | 1,360 | $ | 15,316 | $ | 137 | $ | 1,441 |
There were no impairment charges recorded during the quarter ended September 30, 2015, we recognized additional depreciation expense of $0.4 million for managed service devices and hardware used by a financially troubled customer.2016.
NOTE E – INTANGIBLE ASSETS
Intangible Assets Other Than Goodwill
Intangible assets other than goodwill are summarized as follows (dollars in thousands):
As of September 30, 2015 | As of December 31, 2014 | As of September 30, 2016 | As of December 31, 2015 | |||||||||||||||||||||||||||||||||||||||||||||||||||
Gross | Gross | Gross | Gross | |||||||||||||||||||||||||||||||||||||||||||||||||||
Remaining | Carrying | Accumulated | Net Book | Carrying | Accumulated | Net Book | Remaining | Carrying | Accumulated | Net Book | Carrying | Accumulated | Net Book | |||||||||||||||||||||||||||||||||||||||||
Useful Lives | Amount | Amortization | Value | Amount | Amortization | Value | Useful Lives | Amount | Amortization | Value | Amount | Amortization | Value | |||||||||||||||||||||||||||||||||||||||||
Purchased and developed software | 1.2 | $ | 13,233 | $ | (8,658 | ) | $ | 4,575 | $ | 11,176 | $ | (6,409 | ) | $ | 4,767 | 1.8 | $ | 16,736 | $ | (12,051 | ) | $ | 4,685 | $ | 15,399 | $ | (9,503 | ) | $ | 5,896 | ||||||||||||||||||||||||
Software in development | n/a | 2,383 | - | 2,383 | 1,339 | - | 1,339 | n/a | 1,433 | - | 1,433 | 1,250 | - | 1,250 | ||||||||||||||||||||||||||||||||||||||||
Total software | 15,616 | �� | (8,658 | ) | 6,958 | 12,515 | (6,409 | ) | 6,106 | 18,169 | (12,051 | ) | 6,118 | 16,649 | (9,503 | ) | 7,146 | |||||||||||||||||||||||||||||||||||||
Licenses | 0.4 | 12,786 | (12,081 | ) | 705 | 12,763 | (11,886 | ) | 877 | 2.9 | 13,215 | (12,442 | ) | 773 | 13,215 | (12,167 | ) | 1,048 | ||||||||||||||||||||||||||||||||||||
Customer relationships | 7.8 | 8,287 | (2,064 | ) | 6,223 | 8,287 | (1,359 | ) | 6,928 | 7.7 | 8,167 | (2,852 | ) | 5,315 | 8,167 | (2,285 | ) | 5,882 | ||||||||||||||||||||||||||||||||||||
Technologies | 12.6 | 4,998 | (506 | ) | 4,492 | 4,998 | (237 | ) | 4,761 | 11.2 | 4,316 | (829 | ) | 3,487 | 4,316 | (595 | ) | 3,721 | ||||||||||||||||||||||||||||||||||||
Patents and trademarks | 3.6 | 4,018 | (2,027 | ) | 1,991 | 3,343 | (1,657 | ) | 1,686 | 1.9 | 4,296 | (2,352 | ) | 1,944 | 4,236 | (2,137 | ) | 2,099 | ||||||||||||||||||||||||||||||||||||
Trade names | Indefinite | 3,632 | - | 3,632 | 3,632 | - | 3,632 | Indefinite | 1,360 | - | 1,360 | 2,972 | - | 2,972 | ||||||||||||||||||||||||||||||||||||||||
Other | n/a | 469 | - | 469 | 1,279 | - | 1,279 | |||||||||||||||||||||||||||||||||||||||||||||||
Total other intangible assets | 34,190 | (16,678 | ) | 17,512 | 34,302 | (15,139 | ) | 19,163 | 31,354 | (18,475 | ) | 12,879 | 32,906 | (17,184 | ) | 15,722 | ||||||||||||||||||||||||||||||||||||||
$ | 49,806 | $ | (25,336 | ) | $ | 24,470 | $ | 46,817 | $ | (21,548 | ) | $ | 25,269 | $ | 49,523 | $ | (30,526 | ) | $ | 18,997 | $ | 49,555 | $ | (26,687 | ) | $ | 22,868 |
Remaining useful lives in the preceding table were calculated on a weighted average basis as of September 30, 2015.2016. We did not incur significant costs to renew or extend the term of acquired intangible assets during the three or nine months ending September 30, 2015.2016.
AmortizationIntangible asset amortization expense related to intangible assetsrecorded in operations was $1.3 million and $3.8 million, respectively, for the three month and nine months ended September 30, 2016 compared to $1.3 million and $3.8 million for the respective periods in 2015. Amortization and depreciation expense recorded in cost of subscription revenues was $0.4 million and $1.0 million, respectively, for the three and nine months ended September 30, 20152016, compared to $1.2 million and $3.4 million and for the respective periods in 2014. Amortization expense recorded in cost of subscription revenues in the accompanying condensed consolidated statements of operations and comprehensive (loss) income was $0.3 million and $0.8 million, respectively, for the three and nine months ended September 30, 2015, and $0.2 million and $0.4 million for the three and nine months ended September 30, 2014.2015. Additionally, we have capitalized approximately $0.6$0.5 million and $1.8$1.1 million of internally generated software development costs for the three and nine months ended September 30, 2015,2016, respectively, and $0.6 million and $1.6$1.8 million for the three and nine months ended September 30, 2014,2015, respectively.
Impairment of Goodwill and Patents and Trademarks
Our Do-It-Yourself (DIY) product line and reporting unit is not generating results of operations consistent with our expectations and previous forecasts and management is evaluating different strategic options for the reporting unit. These factors were triggering events that it was more likely than not that the fair value of the DIY reporting unit was less than its carrying amount. As a result, we performed our initial assessment of Goodwill for impairment of the DIY reporting unit, along with other intangible assets of the reporting unit, in the period ending September 30, 2015. The DIY reporting unit included $2.6 million in recorded goodwill and $0.6 million carrying value of patents along with an additional $1.3 million in other intangible assets.
We estimated the fair value of the reporting unit using a combination of market and income approaches and concluded that the estimated fair value of the reporting unit was less than its carrying value. We assessed the implied fair value of goodwill in the same manner as if we were acquiring the reporting unit in a business combination. Specifically, we allocated the estimated fair value of the reporting unit to all of the assets and liabilities of that unit, including any unrecognized intangible assets, in a hypothetical calculation, referred to as Step 2. We assessed the amortizing long-lived assets for impairment based on undiscounted cash flows and concluded that the carrying value of patents may not be recoverable. As a result, the fair value of patents was estimated using an income approach.
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SeptemberSEPTEMBER 30, 2015
Based on preliminary Step 2 calculations, we have recorded impairments of $0.9 million for goodwill and $0.3 million for patents during the period ending September 30, 2015. The amount of the impairments is an estimate that has not been finalized prior to filing this quarterly report. We expect to finalize Step 2 of the goodwill analysis and finalize the impairment of patents during the quarter ended December 31, 2015.
Activity for the carrying amount of goodwill for the nine months ended September 30, 2015 is summarized as follows (in thousands):
January 1, 2015 | $ | 44,348 | ||
DIY reporting unit impairment | (924 | ) | ||
September 30, 2015 | $ | 43,424 |
The January 1, 2015 goodwill balance of $44,348 reflects a final measurement period adjustment of $0.2 million related to deferred tax assets. See Note B – Merger.2016
NOTE F – OTHER ASSETS
Other noncurrent assets consisted of the following (in thousands):
September 30, | December 31, | |||||||
2015 | 2014 | |||||||
Deferred activation fees | $ | 414 | $ | 310 | ||||
Prepaid carrier fees | 375 | 1,860 | ||||||
Deferred financing fees | 201 | 260 | ||||||
Deposits | 117 | 155 | ||||||
$ | 1,107 | $ | 2,585 |
During 2011, we purchased and installed telecommunication infrastructure equipment and related equipment to improve the capacity and functionality of our devices operating on one of our carrier networks. To comply with the needs of one of our carriers and in exchange for more favorable carrier fees, we transferred the legal right to the equipment to the vendor. Thus, our existing agreement with this vendor was amended to provide for the new carrier fees and the legal transfer of the equipment. We accounted for this transaction as a non-monetary exchange. The $2.2 million cost of the equipment was determined to be its fair value and we recorded this transaction by transferring the equipment cost to prepaid carrier fees. During 2014, we made a prepayment of $0.4 million to the same carrier to license additional network access. Both prepaid expenses were being amortized in cost of sales for subscription and support revenue on a straight-line basis over the term of the agreement, which was to expire in 2021.
In September 2015, we entered into a mutual agreement with the vendor to (1) cancel the existing agreement, (2) purchase certain equipment from the vendor and (3) assume certain nationalcarrier and other agreements from the vendor. Our consideration included (1) $0.5 million in cash, (2) 30,000 shares of our common stock having a value of $0.3 million (3) the prepayment above to license additional network access having a carrying value of $0.4 million for a total of $1.2 million. Consummation of the transaction, which was contingent upon obtaining consents from certain of our vendor’s carriers, closed in October 2015. During negotiations with the vendor in the third quarter of fiscal year 2015, a triggering event was identified, for purposes of assessment of long-lived assets for impairment, as it was more likely than not that the aforementioned assets may be disposed of significantly before the end of their previously estimated useful life. As a result of this transaction and in conjunction with a separate agreement with a mutual nationalcarrier, we determined that the prepaid expenses had no continuing value. We recorded a charge of $1.3 million in cost of sales to write-off the carrying value of the prepaid carrier fees as a settlement of a pre-existing relationship with the vendor. The impairment charge affected multiple reporting units.
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
NOTE GE – INCOME TAXES
We calculate our interim income tax provision in accordance with the accounting guidance for income taxes in interim periods. At the end of each interim period, we make our best estimate of the annual expected effective tax rate and apply that rate to our ordinary year-to-date income or loss. In addition, we calculate a year-to-date adjustment to increase or decrease our income tax provision to take into account our current expected effective tax rate. The tax or benefit related to significant, unusual, or extraordinary items that will be separately reported or reported net of their related tax effect are individually computed and recognized in the interim period in which those items occur.
In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider projections of future taxable income, tax planning strategies and the reversal of temporary differences in making this assessment.
At September 30,During 2015, we determined that we would not meet the criteria of “more likely than not” that the cumulative federal net operating losses and certain other deferred tax assets would be recoverable. This determination was based on our cumulative loss over the past three years. Accordingly, we recorded a valuation allowance against these items. The deferred tax assets consist of federal net operating losses, state net operating losses, tax credits, and other deferred tax assets, most of which expire between 20152016 and 2035.2036. We will maintain the valuation allowance against the net deferred tax assets until sufficient positive evidence outweighs any negative evidence to support reversal. Future reversals or increases to the valuation allowance could have a significant impact on our future earnings.
As a resultWe recorded an income tax benefit of recording a valuation allowance as of September 30, 2015, we recognized deferred tax expense of $10.4$0.1 million representing an effective tax rate of (174.1%),and $0.3 million for the three and nine months endedending September 30, 2015 and deferred tax expense of $10.1 million,2016, respectively, representing an effective tax rates of 3.3% and 1.9%, respectively. The difference in the effective tax rates compared to the federal statutory rate of (154.6%),are due primarily to differences between the book and tax bases and accounting differences for the nine months ended September 30, 2015. The remaining difference of $0.3 million incertain long and indefinite lived intangible assets. We also recognized a provision for income tax expense for the three months ended September 30, 2015 is primarily reversing the previous year-to-date benefit. For the nine months ended September 30, 2015, the remaining difference of $0.1 million in income tax expense is forcertain state income taxes that cannot utilize offsetting net operating losses. Income tax expense recorded in the future will be reduced or increased to the extent of offsetting decreases or increases to the valuation allowance.
For the three and nine months ended September 30, 2014, weWe recorded income tax expense from continuing operations of $0.4 million and $0.3 million, respectively, representing effective tax rates of 57.6% and 14.7%, respectively. Oura provision for income tax expense of $0.4$10.4 million for the three months ended September 30, 2014 included a year-to-date adjustment2015 and income tax expense of $0.2$10.2 million or 31.3% of the quarter’s pre-tax income, to increase our tax provision for the sixnine months ended JuneSeptember 30, 2014 to the estimated annual2015. The effective tax rate. Our effective tax rates were 174.1% and 154.6% for the three and nine months ended September 30, 20142015, respectively. The effective tax rates for the three months and nine months ended September 30, 2015 differed from the federal statutory rate applied to income and losses before income taxes primarily as a result of a number of discrete items, including (1) the effect of expenses that are not deductible for income tax purposes including a portion of transaction costs incurred in the Omnilink merger and (2) state income taxes, including the tax effect of changes in effective state income tax rates, resulting from the merger with Omnilink. In addition, the effective tax rate for the nine months ended September 30, 2014, was reduced for thepartially offset by an income tax benefit from the capital loss on the disposaldisqualifying dispositions of BNI due to the ability to offset capital gains in our current tax year and to carry back for capital gains in prior tax years.incentive stock options.
We file U.S., state and foreign income tax returns in jurisdictions with varying statutes of limitation. The 20122013 through 20142015 tax years generally remain subject to examination by federal and most state tax authorities. However, certain returns from years in which net operating losses have arisen are still open for examination by the tax authorities.
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SeptemberSEPTEMBER 30, 20152016
NOTE HF – RESTRUCTURING
In 2016, we entered into agreements to relocate our corporate headquarters. One agreement is a sublease of the office space formerly occupied by our corporate headquarters and includes all furniture and fixtures. The sublease agreement is effective August 1, 2016 and is coterminous with the prime lease agreement expiring on September 29, 2022. We recorded a restructuring charge of $1.5 million, which includes $0.8 million related to facilities and $0.7 million in severance costs for the nine months ended September 30, 2016. Of this $1.5 million charge, $1.2 million was recorded during the three months ended June 30, 2016, related to severance and facility charges, and $0.3 million was recorded for the three months ended September 30, 2016, related to severance. The restructuring charge for facilities of $0.8 million is comprised of $0.4 million for broker and other related fees and $0.4 million non-cash charge for the estimated August 1, 2016 net book value of furniture, fixtures and leasehold improvements, as well as moving costs. Our temporary new corporate headquarters office space, effective July 15, 2016, is under a one-year lease agreement. We anticipate cash savings of $0.8 million under the new agreement over the next 12 months and are reviewing alternatives for longer-term office space.
NOTE G – DEBT
Debt consisted of the following (dollarsas of the dates below(dollars in thousands):
September 30, | December 31, | September 30, | December 31, | |||||||||||||
2015 | 2014 | 2016 | 2015 | |||||||||||||
Note payable to Silicon Valley Bank, with interest at our option of prime rate or LIBOR rate plus margin | $ | 20,287 | $ | 23,125 | ||||||||||||
Seller financed note payable, with interest at 4.25%, monthly payments of principal and interest, secured by equipment, due September 2015 | - | 476 | ||||||||||||||
Note payable to Crystal Financial LLC, with interest at LIBOR plus margin | $ | 17,000 | $ | - | ||||||||||||
Note payable to Silicon Valley Bank, repaid in 2016 | - | 19,349 | ||||||||||||||
Less long-term deferred financing costs | (906 | ) | (440 | ) | ||||||||||||
20,287 | 23,601 | 16,094 | 18,909 | |||||||||||||
Less current portion of long-term debt | 3,750 | 4,251 | (638 | ) | (3,600 | ) | ||||||||||
Noncurrent portion of long-term debt | $ | 16,537 | $ | 19,350 | $ | 15,456 | $ | 15,309 |
On May 5, 2014,March 9, 2016, we and certain of our wholly-owned, consolidated subsidiaries entered into a Second Amendednew term loan agreement with Crystal Financial LLC as Term Agent, and Restatedthe term lenders party thereto (the “Crystal Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank in orderpursuant to among other things, establishwhich the term lenders made a term loan to us in the amount of $25.0 million and a revolving line of credit of up to $5.0 million (collectively, the “Credit Facility”). As of September 30, 2015,we had no outstanding balance on the revolving line of credit.$17.0 million. The net proceeds from the term loan (after payment of the fees and expenses of the Term Agent), along with $2.9 million of cash on hand, were used to financerepay the Omnilink merger. See Note B –– Merger.$19.4 million outstanding debt under the Silicon Valley Bank (SVB) Loan Agreement and pay related transaction fees. We recorded a charge of $0.3 million to loss on extinguishment of debt for unamortized deferred financing costs related to the SVB Loan Agreement during the nine months ended September 30, 2016.
The maturity date of the term loan is May 5, 2019 withMarch 9, 2020. We are required to make regular required quarterly principal payments which began June 30, 2014. The scheduled outstanding principalof $0.6 million beginning September 1, 2017 with the balance of $5.0 million will be due aton the maturity date, if not otherwise repaid earlier by way of voluntary Permitted Prepaymentsprepayments, or by mandatoryupon the occurrence of certain Prepayment Events or Excess Cash Flow Recapture Payments (as defined in the Crystal Loan Agreement)., or as a result of acceleration of the loan as a result of an event of default. Prepayments of the loan are subject to a prepayment penalty of 3% of the amount prepaid if prepayment occurs prior to the first anniversary of the closing date and 2% of the amount prepaid if the prepayment occurs on or after the first anniversary of the closing date but prior to the second anniversary date of the closing date. There is no prepayment penalty for prepayments that occur on or after the second anniversary of the closing date. The interest rate applicable to amounts drawn pursuant topayable on the Loan Agreementoutstanding loan amount is currently 2.75% and is, at our option, determined by reference to the prime rate or LIBOR rate plus a margin established in the Loan Agreement.agreement. At September 30, 2016, the applicable interest rate was 9.35%.
Our obligations under the Credit FacilityCrystal Loan Agreement are secured by a first priority security interest in substantially all of our assets and the assets of our subsidiaries. In addition, we are required to meet certain financial and other restrictive covenants customary with this type of facility, including maintaining a senior leverage ratio, a fixed charge coverage ratiominimum Adjusted EBITDA, minimum Consolidated Fixed Charge Coverage Ratio, maximum Consolidated Total Net Leverage, maximum Subscriber Churn, and minimum liquidity availability.Liquidity, all of which are defined in the Crystal Loan Agreement. We are also prohibited from entering into any debt agreements senior toincurring indebtedness, disposing of or permitting liens on our assets and making restricted payments, including cash dividends on shares of our common stock, except as expressly permitted under the Credit Facility and paying dividends.Crystal Loan Agreement. The Amended Loan Agreementagreement contains customary events of default. If a default occurs and is not cured within the applicable cure period or is not waived, any outstanding obligations under the Credit Facilityagreement may be accelerated.
12 |
As of September
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015,2016
On July 29, 2016 and November 3, 2016, we did not meet the fixed charge coverage ratio covenant. We entered into the firstan amendment to the Crystal Loan Agreement on November 3, 2015 (the “Amendment”). The Amendment does not permit any subsequent advances underto modify the Credit Facility, waivedcovenant relating to the fixed charge coverage ratio formaximum subscriber Churn and update the three months ended September 30, 2015 and added a monthly liquidity ratio covenant.definition of Adjusted EBITDA. As a result of the waiver and our expectation of maintainingamendments, we were in compliance with all of the covenants in the future, we have continued to record scheduled principal payments due after twelve months as noncurrent.
In connection with our acquisition of a small technology business in October 2012, we entered into a Promissory Note of $1.9 million payable to the sellers of the business. The Promissory Note was paid in full as of September 30, 2015.2016.
NOTE IH – NET (LOSS) EARNINGS PER SHARE
Basic (loss) earnings per share is computed by dividing net (loss) income availableattributable to common shareholders byis based on the weighted averageweighted-average number of common shares outstanding during the period excluding the dilutive impact of common stock equivalents. Diluted earnings per share include the effect of all potentially dilutive securities on earnings per share. The dilutive effect of outstanding equity-based compensation awards is computed using the treasury stock method. The computation of diluted earnings per shareshares does not assume exercise of securities that would have an anti-dilutive effect on earnings.
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
Diluted (loss) per share is not presented separately because there are no adjustments to the numerator in calculating dilutive net loss per share and all potentially dilutive common stock equivalents would be antidilutive. The following table presents a reconciliation of the shares used in the calculation of basic and diluted net (loss) incomedilutive earnings per share from continuing operations containedand anti-dilutive equity based compensation awards (in thousands).
For the Three Months Ended | For the Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Weighted average common shares outstanding | ||||||||||||||||
Basic | 19,542 | 19,137 | 19,456 | 19,053 | ||||||||||||
Dilutive effect of common stock equivalents | - | - | - | - | ||||||||||||
Total | 19,542 | 19,137 | 19,456 | 19,053 | ||||||||||||
Anti-dilutive equity-based compensation awards | 1,571 | 2,294 | 1,576 | 2,294 |
NOTE I – LEASES, COMMITMENTS AND CONTINGENCIES
Capital Lease
We record leases in our condensed consolidated statementswhich we have substantially all the benefits and risks of operationsownership as capital leases and comprehensive (loss) incomeall other leases as operating leases. For leases determined to be capital leases, we record the assets held under capital lease and related obligations at lesser of the present value of aggregate future minimum lease payments or the fair value of the assets held under capital lease. We amortize the underlying assets over the expected life of the assets if we will retain title to the assets at the end of the lease term; otherwise we amortize the asset over the term of the lease.
In March 2016, we entered into a 60-month lease arrangement for computer and network equipment, software and related costs having a value of $1.2 million. The lease commenced in April 2016 and is accounted for as a capital lease. Future minimum capital lease payments and the present value of the net minimum lease payments for the capital leases as of September 30, 2016 are as follows (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
(Loss) income from continuing operations, net of income taxes | $ | (16,380 | ) | $ | 263 | $ | (16,730 | ) | $ | 1,637 | ||||||
Weighted average shares outstanding: | ||||||||||||||||
Basic | 19,137 | 18,956 | 19,053 | 18,900 | ||||||||||||
Dilutive effect of common stock equivalents | - | 307 | - | 353 | ||||||||||||
Total | 19,137 | 19,263 | 19,053 | 19,253 | ||||||||||||
Anti-dilutive equity-based compensation awards | 2,294 | 757 | 2,294 | 757 |
Total minimum lease payments | $ | 1,384 | ||
Less amounts representing interest | (147 | ) | ||
Present value of future minimum lease payments | 1,237 | |||
Less current portion | (257 | ) | ||
Amounts due after one year | $ | 980 |
13 |
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
Operating Leases
As disclosed in Note F – Restructuring, in June 2016, we entered into agreements to relocate our corporate headquarters. One agreement is a sublease of the office space formerly occupied by our corporate headquarters and includes all furniture and fixtures. The sublease agreement is effective August 1, 2016 and is coterminous with the prime lease agreement expiring on September 29, 2022. Rental income from the sublease will be $0.9 million annually plus 2.5% annual escalation, recorded as a reduction to rental expense in general and administrative expense. We also executed a one-year lease agreement for temporary new corporate headquarters office space effective July 15, 2016. Annual rent expense will be $0.1 million through July 2017, also recorded in general and administrative expense. We anticipate cash savings of $0.8 million under the new agreement over the next 12 months and are reviewing alternatives for longer-term and lower cost office space.
NOTE J - FAIR VALUE MEASUREMENTS
We account for certain assets at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:
Level 1– Valuations based on quoted prices for identical assets and liabilities in active markets.
Level 2– Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3– Valuations based on unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.
Assets measured at fair value on a recurring basis comprise only investments in short-term US Treasury Funds of $15.5 million as of December 31, 2015. The investments are classified as available for sale debt securities included in cash and cash equivalents in the consolidated balance sheets and are categorized as Level 1 measurements in the fair value hierarchy. We do not have any liabilities measured at fair value on a recurring basis.
The following table summarizes assets measured at fair value on a nonrecurring basis during the nine months ended September 30, 2016 (in thousands):
Fair | Total | |||||||||||
Value | Level 3 | Losses | ||||||||||
Omnilink Reporting Unit | ||||||||||||
Indefinite lived trade names | $ | 1,360 | $ | 1,360 | $ | 1,612 | ||||||
Goodwill | 15,316 | 15,316 | 2,264 | |||||||||
DIY Reporting Unit | ||||||||||||
Technology | 146 | 146 | 81 | |||||||||
Goodwill | 1,441 | 1,441 | 215 | |||||||||
Total nonrecurring fair value measurements | $ | 18,263 | $ | 18,263 | $ | 4,172 |
See Note D – Goodwill and Intangible Assets for additional information.
14 |
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE K – RECENT ACCOUNTING PRONOUNCEMENTS
Recently Adopted Accounting Guidance
In SeptemberMarch 2015, the Financial Accounting Standards Board (FASB) issued an accounting standards updateguidance about simplifying the presentation of deferred financing costs. The guidance was intended to help clarify deferred financing costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for deferred financing costs were not affected. The guidance was effective January 1, 2016 and, in accordance with the guidance,$0.9 million of deferred financing costs is included in long-term debt as of September 30, 2016 and $0.4 million of deferred financing costs was reclassified from current and noncurrent other assets to the current and noncurrent portions of long-term debt as of December 31, 2015. See Note A – Summary of Significant Account Policies.
In September 2015, the FASB issued guidance to simplify the accounting for measurement-period adjustments for an acquirer in a business combination. The update will requirerequires an acquirer to recognize any adjustments to provisional amounts of the initial accounting for a business combination with a corresponding adjustment to goodwill in the reporting period in which the adjustments are determined in the measurement period, as opposed to revising prior periods presented in financial statements. Thus, an acquirer shall adjust its financial statements as needed, including recognizing in its current-period earnings the full effect of changes in depreciation, amortization, or other income effects, by line item, if any, as a result of the change to the provisional amounts calculated as if the accounting had been completed at the acquisition date. This update iswas effective January 1, 2016 and the adoption of this guidance did not have a material impact on our financial statements.
Recently Issued Accounting Guidance
In August 2016, the FASB issued guidance to reduce diversity in practice related to eight specific cash flow issues. This standard will be effective for fiscal yearsannual periods beginning after December 15, 2015,2017, including interim periods within that reporting period. Early adoption of this standard is permitted. The Company is currently evaluating the impact this guidance may have on its statement of cash flows.
In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payments transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance is effective for annual and interim periods withinbeginning after December 31, 2016. Early adoption is permitted for any entity in any interim or annual period. We are currently evaluating the effect that the updated standard will have on our financial statements, but expect the guidance will add modest volatility in our equity-based compensation expense, provision for income taxes, and net income (loss) due to recording award forfeitures as they occur instead of on the basis of assumed averages.
In February 2016, the FASB issued guidance that requires lessees to recognize most leases as assets and liabilities on the balance sheet. Qualitative and quantitative disclosures will be enhanced to better understand the amount, timing and uncertainty of cash flows arising from leases. The guidance is effective for annual and interim periods beginning after December 31, 2018. The updated standard mandates a modified retrospective transition method with early adoption permitted. We are currently evaluating the effect that the updated standard will have on our financial statements.
In November 2015, the FASB issued guidance requiring all deferred tax assets and liabilities to be classified as non-current on the balance sheet instead of separating deferred taxes into current and non-current amounts. In addition, valuation allowance allocations between current and non-current deferred tax assets are no longer required because those fiscal years.allowances also will be classified as non-current. This standard is effective for public companies for annual periods beginning after December 15, 2016. We do not expect the adoption of this guidance to have a material impact on our financial statements.
In July 2015,the FASB issued guidance intended to simplify the presentation of applicable inventory at the lower of cost or net realizable value. The new guidance clarifies that net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The new guidance will be effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. We do not expect the adoption of this guidance to have a material impact on our financial position or results of operations.
In March 2015, the FASB issued guidance about simplifying the presentation of debt issuance costs. The guidance is intended to help clarify debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected. The amendments are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within fiscal years beginning after December 15, 2016. We do not expect the adoption of this guidance to have a material impact on our financial position or results of operations.
In August 2014, the FASB issued guidance about disclosing an entity’s ability to continue as a going concern. The guidance is intended to define management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The standard will be effective for annual periods ending after December 15, 2016, and for interim and annual periods thereafter, with early application permitted. We do not expect the adoption of this guidance to have a material impact on our financial position or results of operations.
In June 2014, the FASB issued guidance that applies to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. It requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition and follows existing accounting guidance for the treatment of performance conditions. The standard will be effective for us prospectively for fiscal years, and interim reporting periods within those years, beginning January 1, 2016, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our financial position or results of operations.
NUMEREX CORP. AND SUBSIDIARIES
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SeptemberSEPTEMBER 30, 20152016
In May 2014, the FASB issued new accounting guidance for revenue recognized from contracts with customers. The core principle of the guidance is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The guidance was set towill become effective for us for fiscal years, and interim reporting periods within those years, beginning January 1, 20172018 and will require retrospective application when adopted.On July 9, 2015,application. We are evaluating the FASB voted to defereffect that this amendment will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effective date by one year to December 15, 2017 for interim and annual reporting periods beginning after that date and permitted early adoptioneffect of the standard but not before the original effective date of December 15, 2016. We are currently evaluating how the adoption of this standard will impacton our Consolidated Financial Statements.ongoing financial reporting.
NOTE KL – SUBSEQUENT EVENTS
On October 8, 2015, we closed on a mutual agreement with a vendor to (1) cancel the existing agreement, (2) purchase certain equipment from the vendor and (3) assume certain nationalcarrier and other agreements from the vendor in exchange for $0.5 million in cash and 30,000 shares of our common stock having a value of $0.3 million. See Note F – Other Assets.Amended Debt Agreement
On November 3, 2015,2016, we entered into the firstan amendment to the Crystal Loan Agreement.Agreement to modify the covenant related to the maximum subscriber Churn defined in the agreement, and update the definition of Adjusted EBITDA. See Note HG – Debt.
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
Forward Looking Statements
This document contains, and other statements may contain, forward-looking statements with respect to ourNumerex future financial or business performance, conditions or strategies and other financial and business matters, including expectations regarding growth trends and activities. Forward-looking statements are typically identified by words or phrases such as "believe," "expect," "anticipate," "intend," "estimate," "assume," "strategy," "plan," "outlook," "outcome," "continue," "remain," "trend," and variations of such words and similar expressions, or future or conditional verbs such as "will," "would," "should," "could," "may," or similar expressions. We cautionNumerex cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. These forward-looking statements speak only as of the date of this filing, and we assumeNumerex assumes no duty to update forward-looking statements. Actual results could differ materially from those anticipated in these forward-looking statements and future results could differ materially from historical performance.
The following factors, among others, could cause actual results to differ materially from forward-looking statements or historical performance: our inability to reposition our platform to capture greater recurring subscription revenues; the risk that we may not be able to remain in compliance with certain of our ability to efficiently utilize cloud computing to expand our services;debt covenants; the risks that a substantial portion of revenues derived from contracts may be terminated at any time; the risks that our strategic suppliers and/or wireless network operators materially change or disrupt the flow of products or services; variations in quarterly operating results; delays in the development, introduction, integration and marketing of new products and services; customer acceptance of services; economic conditions resulting in decreased demand for our products and services; the risk that our strategic alliances, partnerships and/or wireless network operators will not yield substantial revenues; changes in financial and capital markets, and the inability to raise growth capital on favorable terms, if at all;capital; the inability to attain revenuerevenues and earnings growth; changes in interest rates; inflation; the introduction, withdrawal, success and timing of business initiatives and strategies; competitive conditions; the inability to realize revenue enhancements; disruption in key supplier relationships and/or related services; and the extent and timing of technological changes.
Overview
As used herein, except as otherwise indicated by context, references to “we,” “us,” “our,” the “Company” or “Numerex” refers to Numerex Corp. and subsidiaries.
The following Management’s Discussion and Analysis is intended to help the reader understand our results of operations and financial condition. This discussion and analysis is provided as a supplement to, and should be read in conjunction with, our unaudited condensed consolidated financial statements and the accompanying notes included in this Quarterly Report on Form 10-Q for the period ended September 30, 2015.2016.
We areThe Company is a holding company that, acting through our subsidiaries, is one of the leading providersprovider of managed M2M enterprise solutions enabling the Internet of Things (IoT). The Company's solutions produce new revenue streams or create operating efficiencies for its customers. Numerex provides its technology and services through its integrated platforms, which are generally sold on a subscription basis. The Company offers a portfolio of managed end-to-end IoT solutions including smart devices, network connectivity and service applications capable of addressing the needs of a wide spectrum of vertical markets and industrial customers. The Company's mission is to empower enterprise operations with a presence predominately in North America. We incorporateworld-class, managed IoT solutions that are simple, innovative, scalable, and secure. Numerex is ISO 27001 information security-certified, highlighting the key M2M elementsCompany's focus on data security, service reliability and around-the-clock support of Device (D), Network (N), and Application (A), to create packaged and custom designed M2M solutions for the enterprise and government markets nationwide. We refer to this combination as Numerex DNA.its customers.
Our network services are provided through cellular, satellite, broadband and wireline networks. Cellular networks include national and regional wireless telecommunication carriers and consist of second (2G), third (3G) and fourth generation (4G and LTE) cellular telephone technology. Several wireless carriers have announced their intention to discontinue their 2G networks and fully deploy 3G and 4G networks between 2016 and 20182020 while other carriers have announced their intention to discontinue 2G networks as early as 2020. We intend to continue support existing 2G customers through the transition to subsequent technology. Additionally, we have introduced 3G/4G and LTE products offering advanced services across our product lines.
17 |
In recent years,
Beginning in the third quarter of 2015, we have embarkedbegan to concentrate on selling higher margin, integrated managed service subscriptions that include the full suite of our devices, networks, applications and platform while moving away from the sale of individual components – especially hardware only. We expect this strategic change to help us grow sustainable service revenues along with corresponding higher gross margins. However, we also anticipate hardware revenues will decline significantly in 2016 and remain relatively modest as compared to historical levels thereafter.
During the quarter ended September 30, 2016, we had revenues of $17.4 million, and a net loss of $2.5 million, compared with revenues and net loss of $23.3 million and $16.4 million, respectively, for the quarter ended September 30, 2015.
For the nine months ended September 30, 2016, we had revenues of $53.1 million, and a net loss of $13.2 million; compared with revenues and a net loss of $70.7 million and $16.7 million, respectively, for the nine months ended September 30, 2015.
Our core strategy is to generate long term and sustainable recurring revenues through a portfolio of managed, end-to-end IoT solutions which are generally sold on a strategic transformation as advancessubscription basis and built on our horizontal, integrated platform. Our solutions incorporate the key IoT building blocks – Device, Network, Application and Platform. Our solutions also simplify the implementation and improve the speed to market for enterprise users in technology have changedselect, targeted verticals in the way our customers interact in their professionalasset monitoring and personal livesoptimization, asset tracking, and the way that businesses operate. To meet the changing needs of our customerssafety and to address the changing technological landscape, we are focusing efforts on higher margin and growing areas of business. security markets.
Our strategy requires significant capital investment to develop and enhance our use of technology and to maintain our leadership position and competitive advantage in the markets we serve.
Subscription revenues are recognized monthly as services are provided and sales of embedded devices and hardware are recognized when title passes. Other upfront payment revenues are deferred and amortized on a straight-line basis.
Due to fluctuations of the commencement of new contracts and renewal of existing contracts, we expect variability of sequential quarterly trends in revenues, margins and cash flows. Other factors contributing to sequential quarterly trends include usage, rate changes, and re-pricing of contract renewals and technology changes.
During the second quarter of 2016, management evaluated and determined that the Omnilink and Do-It-Yourself (DIY) product lines and reporting units should be tested for impairment as a result of lower operating results, which are related to strategic changes and delays associated with the launch of a new personal tracking product line. Management initiated a quantitative two-step goodwill impairment test by comparing the carrying value of the net assets of the respective units to its fair value based on a discounted cash flow analysis. Based on our assessment, we have determined that the fair value of these reporting units were less than the respective carrying value and goodwill was impaired, and have recorded $4.2 million in impairment charges for trade names, technology and goodwill as of September 30, 2016, comprised of impairments of $1.6 million for indefinite-lived trade names and $2.3 million for goodwill of the Omnilink reporting unit and $0.1 million for technology and $0.2 million for goodwill of the DIY reporting unit. We will continue to assess the fair value of the reporting units if results of operations continue to not meet forecasts and additional impairment charges may be necessary in the future.
As part of our effort to build and enhance our core business, we conduct ongoing business strategy reviews. During our reviews, we consider opportunities for growth in existing and new markets that may involve growth derived from both existing operations as well as from future acquisitions, if any. To the extent existing business lines and service offerings are not considered to be compatible with delivery of our core business services or with meeting our financial objectives, we may exit non-core lines of business or stop offering these services in part or in whole.
As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014, we perform our annual assessment of goodwill for impairment as of October 1. The valuations of goodwill and other intangible assets require assumptions and estimates of many critical factors, including projections of revenues, costs, operating cash flows, capital expenditures, terminal growth rates and discount rates. As part of our assessment as of October 1, 2014, and as disclosed in our Quarterly Report for the quarterly period ended June 30, 2015, we projected significant growth for certain of our smaller product lines. Lower revenue growth and operating results for these product lines and/or unfavorable changes in other economic factors could impact the underlying key assumptions and our estimated fair values, potentially leading to a future non-cash impairment charge for either or both goodwill and other intangible assets. In September 2015, we recorded a $1.3 million in impairment charges to goodwill and other intangible assets in our Do-It-Yourself (DIY) reporting unit. We also recorded an additional $1.1 million inventory reserve for older inventory and $1.3 million impairment charge for prepaid expenses and other assets. The impairment charge for prepaid expenses and other assets was primarily related to new and modified agreements with wireless carriers and the impairment charge affected multiple reporting units.
On May 5, 2014, we acquired the business operations of Omnilink, the financial results of which have now been included in our consolidated results. The purchase consideration of $37.5 million was composed of a cash payment of $37.3 million and a working capital adjustment of $0.2 million.
During the quarter ended September 30, 2015, we had revenues of $23.3 million and a net loss of $16.4 million compared with revenues and net income from continuing operations for the quarter ended September 30, 2014 of $25.7 million and of $0.3 million, respectively.
For the nine months ended September 30, 2015, we had revenues of $70.7 million and a net loss of $16.7 million compared with revenues and net income from continuing operations for the nine months ended September 30, 2014 of $69.0 million and $1.1 million, respectively.
Subscription and support revenue is recognized monthly as services are provided and sales of embedded devices and hardware are recognized when title passes. Other upfront payment revenue is deferred and amortized on a straight line basis.
Due to fluctuations of the commencement of new contracts and renewal of existing contracts, we expect variability of sequential quarterly trends in revenues, margins and cash flows. Other factors contributing to sequential quarterly trends include usage, rate changes, and re-pricing of contract renewals and technology changes.
Cost of sales for the three and nine months ended September 30, 2015 includes a significant increase in the inventory reserve of $1.1 million and impairment of other assets of $1.3 million. We entered into new and amended agreements with wireless carriers in September 2015 that make adding 2G devices to wireless networks financially unfavorable under most circumstances. As a result of these agreements, we performed a lower of cost or market analysis leading to the increased reserve related to older, 2G cellular telecommunication devices and older satellite devices as well as an accrual for a purchase commitment related to raw materials for the older satellite devices that we will not fulfill.
The $1.3 million impairment of other assets is related to a prepaid discount of carrier fees. In September 2015, we entered into a mutual agreement with the vendor to (1) cancel the existing agreement, (2) repurchase certain equipment from the vendor and (3) assume certain national carrier and other agreements from the vendor. Our consideration included (1) $0.5 million in cash, (2) 30,000 shares of our common stock having a value of $0.3 million (3) a prepayment to license additional network access having a carrying value of $0.4 million for a total of $1.2 million. Consummation of the transaction, which was contingent upon obtaining consents from certain of our vendor’s carriers, closed in October 2015. During negotiations with the vendor in the third quarter of fiscal year 2015, a triggering event was identified, for purposes of assessment of asset impairment, as it was more likely than not that the aforementioned assets may be disposed of significantly before the end of their previously estimated useful life. As a result of this transaction and in conjunction with a separate agreement with a mutual national carrier, we determined that the prepaid expenses had no continuing value. We recorded a charge of $1.3 million in cost of sales to write-off the carrying value of the prepaid carrier fees as a settlement of a pre-existing relationship with the vendor.
Our Do-It-Yourself (DIY) product line and reporting unit is not generating results of operations consistent with our expectations and previous forecasts and management is evaluating different strategic options for the reporting unit. These factors were triggering events that it was more likely than not that the fair value of the DIY reporting unit was less than its carrying amount. As a result, we performed our initial assessment of Goodwill for impairment of the DIY reporting unit, along with other intangible assets of the reporting unit, in the period ending September 30, 2015. The DIY reporting unit included $2.6 million in recorded goodwill and $0.6 million carrying value of patents along with an additional $1.3 million in other intangible assets.
We estimated the fair value of the reporting unit using a combination of market and income approaches and concluded that the estimated fair value of the reporting unit was less than its carrying value. We assessed the implied fair value of goodwill in the same manner as if we were acquiring the reporting unit in a business combination. Specifically, we allocated the estimated fair value of the reporting unit to all of the assets and liabilities of that unit, including any unrecognized intangible assets, in a hypothetical calculation, referred to as Step 2. We assessed the amortizing long-lived assets for impairment based on undiscounted cash flows and concluded that the carrying value of patents may not be recoverable. As a result, the fair value of patents was estimated using an income approach.
Based on preliminary Step 2 calculations, we have recorded impairments of $0.9 million for goodwill and $0.3 million for patents during the period ending September 30, 2015. The amount of the impairments is an estimate that has not been finalized prior to filing this quarterly report. We expect to finalize Step 2 of the goodwill analysis and finalize the impairment of patents during the quarter ended December 31, 2015.
At September 30, 2015, we determined that we would not meet the criteria of “more likely than not” that the cumulative federal net operating losses and certain other deferred tax assets would be recoverable. This determination was based on our cumulative loss over the past three years. Accordingly, we recorded a valuation allowance against these items. The deferred tax assets consist of federal net operating losses, state net operating losses, tax credits, and other deferred tax assets, most of which expire between 2015 and 2035. As a result of recording a valuation allowance as of September 30, 2015, we recognized deferred tax expense of $10.4 million and $10.1 million for the three and nine months ended September 30, 2015. Income tax expense recorded in the future will be reduced or increased to the extent of offsetting decreases or increases to the valuation allowance.
In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider projections of future taxable income, tax planning strategies and the reversal of temporary differences in making this assessment. We will maintain the valuation allowance against the net deferred tax assets until sufficient positive evidence outweighs any negative evidence to support reversal. Future reversals or increases to the valuation allowance could have a significant impact on our future earnings.
Results of Operations
Three Months Ended September 30, 20152016 and 20142015
The following table sets forth selected financial data from our unaudited condensed consolidated resultsstatements of operations and comprehensive loss for the periods indicated including comparative informationalong with the percentage change between the periods (dollars in thousands):
Three Months Ended September 30, | Change from | |||||||||||||||||||||||
2016 | 2015 | 2015 to 2016 | ||||||||||||||||||||||
Net revenues: | ||||||||||||||||||||||||
Subscription and support revenues | $ | 14,388 | 82.6 | % | $ | 15,624 | 67.0 | % | $ | (1,236 | ) | -7.9 | % | |||||||||||
Embedded devices and hardware | 3,024 | 17.4 | % | 7,710 | 33.0 | % | (4,686 | ) | -60.8 | % | ||||||||||||||
Total net revenues | 17,412 | 100.0 | % | 23,334 | 100.0 | % | (5,922 | ) | -25.4 | % | ||||||||||||||
Cost of sales, exclusive of a portion of depreciation and amortization shown below: | ||||||||||||||||||||||||
Subscription and support revenues | 5,828 | 33.5 | % | 6,538 | 28.0 | % | (710 | ) | -10.9 | % | ||||||||||||||
Embedded devices and hardware | 3,082 | 17.7 | % | 6,958 | 29.8 | % | (3,876 | ) | -55.7 | % | ||||||||||||||
Inventory reserves | 27 | 0.2 | % | 1,277 | 5.5 | % | (1,250 | ) | -97.9 | % | ||||||||||||||
Impairment of other asset | - | 0.0 | % | 1,275 | 5.5 | % | (1,275 | ) | -100.0 | % | ||||||||||||||
Gross profit | 8,475 | 48.7 | % | 7,286 | 31.2 | % | 1,189 | 16.3 | % | |||||||||||||||
Operating expenses: | ||||||||||||||||||||||||
Sales and marketing | 3,229 | 18.5 | % | 3,047 | 13.1 | % | 182 | 6.0 | % | |||||||||||||||
General and administrative | 3,280 | 18.8 | % | 4,507 | 19.3 | % | (1,227 | ) | -27.2 | % | ||||||||||||||
Engineering and development | 2,229 | 12.8 | % | 2,201 | 9.4 | % | 28 | 1.3 | % | |||||||||||||||
Depreciation and amortization | 1,658 | 9.5 | % | 2,100 | 9.0 | % | (442 | ) | -21.0 | % | ||||||||||||||
Impairment of goodwill and | ||||||||||||||||||||||||
other intangible assets | - | 0.0 | % | 1,250 | 5.4 | % | (1,250 | ) | n/a | |||||||||||||||
Restructuring charges | 276 | 1.6 | % | - | 0.0 | % | 276 | n/a | ||||||||||||||||
Operating loss | (2,197 | ) | -12.6 | % | (5,819 | ) | -24.9 | % | 3,622 | -62.2 | % | |||||||||||||
Interest expense | 469 | 2.7 | % | 188 | 0.8 | % | 281 | 149.5 | % | |||||||||||||||
Other income, net | (33 | ) | -0.2 | % | (31 | ) | -0.1 | % | (2 | ) | 6.5 | % | ||||||||||||
Loss before income taxes | (2,633 | ) | -15.1 | % | (5,976 | ) | -25.6 | % | 3,343 | -55.9 | % | |||||||||||||
Income tax expense (benefit) | (87 | ) | -0.5 | % | 10,404 | 44.6 | % | (10,491 | ) | -100.8 | % | |||||||||||||
Net loss | $ | (2,546 | ) | -14.6 | % | $ | (16,380 | ) | -70.2 | % | $ | 13,834 | -84.5 | % | ||||||||||
Adjusted EBITDA(1) | $ | 859 | 4.9 | % | $ | 1,660 | 7.1 | % | $ | (801 | ) | -48.3 | % |
Three Months Ended September 30, | ||||||||||||||||||||||||
2015 | 2014 | 2015 vs. 2014 | ||||||||||||||||||||||
Net revenues: | ||||||||||||||||||||||||
Subscription and support revenues | $ | 15,624 | 67.0 | % | $ | 17,429 | 67.9 | % | $ | (1,805 | ) | -10.4 | % | |||||||||||
Embedded devices and hardware | 7,710 | 33.0 | % | 8,234 | 32.1 | % | (524 | ) | -6.4 | % | ||||||||||||||
Total net revenues | 23,334 | 100.0 | % | 25,663 | 100.0 | % | (2,329 | ) | -9.1 | % | ||||||||||||||
Cost of revenue, exclusive of a portion of depreciation and amortization shown below: | ||||||||||||||||||||||||
Subscription and support revenues | 6,538 | 28.0 | % | 7,011 | 27.3 | % | (473 | ) | -6.7 | % | ||||||||||||||
Embedded devices and hardware | 6,958 | 29.8 | % | 7,236 | 28.2 | % | (278 | ) | -3.8 | % | ||||||||||||||
Inventory reserves | 1,277 | 5.5 | % | 129 | 0.5 | % | 1,148 | 889.9 | % | |||||||||||||||
Impairment of other asset | 1,275 | 5.5 | % | - | 0.0 | % | 1,275 | 100.0 | % | |||||||||||||||
Gross profit | 7,286 | 31.2 | % | 11,287 | 44.0 | % | (4,001 | ) | -35.4 | % | ||||||||||||||
Operating expenses: | ||||||||||||||||||||||||
Sales and marketing | 3,047 | 13.1 | % | 3,029 | 11.8 | % | 18 | 0.6 | % | |||||||||||||||
General and administrative | 4,507 | 19.3 | % | 3,429 | 13.4 | % | 1,078 | 31.4 | % | |||||||||||||||
Engineering and development | 2,201 | 9.4 | % | 2,430 | 9.5 | % | (229 | ) | -9.4 | % | ||||||||||||||
Depreciation and amortization | 2,100 | 9.0 | % | 1,597 | 6.2 | % | 503 | 31.5 | % | |||||||||||||||
Impairment of goodwill and other intangible assets | 1,250 | 5.4 | % | - | 0.0 | % | 1,250 | 100.0 | % | |||||||||||||||
Operating(loss) income | (5,819 | ) | -24.9 | % | 802 | 3.1 | % | (6,621 | ) | -825.6 | % | |||||||||||||
Interest expense | 188 | 0.8 | % | 278 | 1.1 | % | (90 | ) | -32.4 | % | ||||||||||||||
Other income, net | (31 | ) | -0.1 | % | (97 | ) | -0.4 | % | 66 | -68.0 | % | |||||||||||||
(Loss) income before income taxes | (5,976 | ) | -25.6 | % | 621 | 2.4 | % | (6,597 | ) | -1062.3 | % | |||||||||||||
Income tax expense | 10,404 | 44.6 | % | 358 | 1.4 | % | 10,046 | 2806.1 | % | |||||||||||||||
Net (loss) income | (16,380 | ) | -70.2 | % | 263 | 1.0 | % | (16,643 | ) | -6328.1 | % | |||||||||||||
Adjusted EBITDA(1) | $ | 1,660 | 7.1 | % | $ | 3,326 | 13.0 | % | $ | (1,666 | ) | -50.1 | % |
_________________
(1) – Adjusted EBITDA is not a financial measure prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). See further discussion, including reconciliation to the most comparable GAAP measure, under the caption Non-GAAP Financial Measures below.
Total revenuerevenues decreased $2.3$5.9 million, or 9.1%25.4%, for the three months ended September 30, 20152016 to $23.3$17.4 million from $25.7$23.3 million for the same period in 2014.2015. The decrease reflectsis primarily attributable to a strategic shift in how we sell our products and services. During the lossthird quarter of one customer due2015, we began to non-paymentconcentrate on selling higher margin, integrated managed service subscriptions that include the full suite, or subsets, of our devices, networks, applications, and otherplatform while moving away from the sale of individual components – especially hardware only.
19 |
Subscription and support revenues decreased $1.2 million, or 7.9%, to $14.4 million from $15.6 million in 2015. The decrease reflects losses associated with network customers’ 2G conversions wherestemming from a period of time in which we did not have a competitive offer.offering. Pricing has remained consistent year over year for similar services, although current period revenues also include higher value services. The decrease in revenue is also attributed to a strategic shift from offering customers a network- or application-only solution, to a higher margin, integrated managed service that includes the full suite of Numerex DNA.
Embeddedembedded devices and hardware revenues is attributed to the shift to the integrated managed service subscription offerings. In addition, sales to our historically largest hardware only customer decreased $0.5 million or 6.4% to $7.7$0.1 million for the three months ended September 30, 20152016 compared to $8.2record sales of $5.2 million for the same period in 2014. The majority2015.
Direct cost of sales for the decrease pertainsthree months ended September 30, 2016 decreased $7.1 million, or 44.3%, to $8.9 million compared to $16.0 million for the timingsame period in 2015. Direct cost of one of our largest customer’s periodic high volume purchases of hardware modules. Purchases from this customer were $5.2subscription and support revenues decreased $0.7 million, and $5.4or 10.9%, to $5.8 million for the three months ended September 30, 20152016 compared to $6.5 million for the same period in 2015. Subscription and 2014, respectively. Salessupport revenues less direct costs were $8.6 million, or 59.5% of embedded devices and hardware are also adversely affected by our shift to a managed service offering of Numerex DNA noted above instead of selling hardware as separate components. Because of this shift, we anticipate hardware revenue will continue to fluctuate and also decrease in total over time.
Total cost of revenuecorresponding revenues for the three months ended September 30, 2015 increased $1.72016 compared to $9.1 million, or 11.6%, to $16.0 million compared to $14.4 million58.2% for the same periodthree months ended September 30, 2015. In addition to lower direct costs associated with lost 2G conversions, we also had a larger proportional decrease in 2014. Comprising that increase, the direct cost of revenue for subscription and support servicesdue in part to lower negotiated network and carrier costs and our strategic efforts to sell higher margin integrated managed services. Direct cost of subscription and support revenues include $0.4 million and $0.3 million of depreciation and amortization for the three months ended September 30, 2016 and 2015, respectively.
Direct cost of sales for embedded devices and hardware, excluding provision for inventory reserves, decreased $0.5$3.9 million, or 6.7%55.7%, to $6.5$3.1 million for the three months ended September 30, 20152016 compared to $7.0 million for the same period in 2014. Subscription and support revenue less direct costs was $9.1 million, or 58.2% of subscription support revenue for the three months ended September 30, 2015 compared to $10.4 million, or 59.8% of subscription support revenue for the three months ended September 30, 2014. The year over year decrease in direct costs of subscription and support revenue and the corresponding increase as a percentage of revenue are attributed to the overall decline in revenue.
The direct cost of revenue for embedded devices and hardware decreased $0.3 million, or 3.8%, to $7.0 million for the three months ended September 30, 2015 compared to $7.2 million for the same period in 2014.2015. Embedded devices and hardware revenue less direct costs was ($0.1) million, or (1.9)% of embedded devices and hardware revenue for the three months ended September 30, 2016, compared to $0.8 million, or 9.8% of embedded devices and hardware revenue for the three months ended September 30, 2015, comparedresulting from the decrease in hardware only sales to $1.0 million, or 12.1% of embedded devices andour historically largest hardware revenue for the three months ended September 30, 2014.only customer. The year over yearoverall decrease in direct costs of embedded devices andis due to lower corresponding revenues related to our strategic move away from hardware relates primarily to overall revenue decline as well as the customer and product mix. Customer and product mix also caused directonly sales.
The decrease in cost of embedded devices and hardware as a percentage of corresponding revenue to increase to 90.2% for the three months ended September 30, 2015 from 87.9% for the same period in 2014.
As describedsales in the Overview above,comparable periods occurred because we entered into new and amended agreements with wireless carriers in September 2015. As a result of these agreements, we performed a lower of cost or market analysis leading to a significant increase in the inventory reserve of $1.1$1.3 million during the three months ended September 30, 2015 related to older, 2G cellular telecommunication devices and older satellite devices as well as an accrual for a purchase commitment related to raw materials for the older satellite devices that we will not fulfill. In addition, one of the amended carrier agreements led to settlement of a pre-existing relationship and a $1.3 million impairment of a prepaid expense during the three months ended September 30, 2015. The prepaid expense was previously recorded in other assets.
Sales and marketing expense remained consistent year over year in total dollars, but increased as a percentage of total revenue to 13.1%Total gross profit for the three months ended September 30, 20152016 increased $1.2 million, or 16.3% to $8.5 million compared to 11.8% of total revenue$7.3 million for the same period in 2014.2015, as a result of the changes discussed above.
GeneralSales and administrative expensesmarketing expense increased $1.1$0.2 million, to $4.5 million for the three-month period ended September 30, 2015, compared to $3.4 million for the three-month period ended September 30, 2014. As a percentage of net sales, general and administrative expenses increased to 19.3%or 6.0%, for the three months ended September 30, 20152016 to $3.2 million compared to 13.4%$3.0 million for the same period in 2015. The increase is primarily attributable to higher sales commissions due to more sales personnel with guaranteed commissions during the three months ended September 30, 2016.
General and administrative expense decreased $1.2 million, or 27.2%, to $3.3 million for the three months ended September 30, 2014. General2016, compared to $4.5 million for the same period in 2015. The decrease is driven primarily by lower recruiting costs and administrativeequity-based compensation expense.
Engineering and development expenses remained consistent at $2.2 million for the three months ended September 30, 2015 includes $0.5 million for2016 and 2015. In the new chief executive officer relocationprevious quarter, we increased the use of more agile, off-shore resources and recruitingincurred some overlapping costs during the three months ended June 30, 2016 compared to the same period in the prior year. As these overlapping costs subside, we expect costs savings in this area. We may experience additional volatility in contract labor and $0.2 million for an immaterial correction of an error relating to international value-addedoverall engineering and sales taxes.development costs in the future as our business and operating needs evolve.
EngineeringDepreciation and development expensesamortization expense, not otherwise included in cost of sales, decreased 9.4%$0.4 million, or 21.0%, to $2.2$1.7 million for the three-month period ended September 30, 2015, compared to $2.4 million for the three-month period ended September 30, 2014. The decrease was primarily attributed to cost management as reduction in employee costs was the main driver. Engineering and development expenses decreased to 9.4% of total revenue for the three months ended September 30, 20152016, compared to 9.5% of total revenue for the same period in 2014.
Depreciation and amortization expense increased 31.5% to $2.1 million for the three-month period ended September 30, 2015, compared to $1.6 million for the three-month period ended September 30, 2014. The increase in depreciation and amortization is related to recently acquired product lines and development of new product and project initiatives, including the amortization of new intangible assets. The increase also includes $0.4 million for managed service devices and hardware used by a financially troubled customer at risk of not being returned to us.
The $1.3 million impairment of goodwill and other intangible assets recorded in the three months ended September 30, 2015 was related to our DIY reporting unit as described in the Overview above.
Interest expense decreased $0.1 million to $0.2 million for the three-month period ended September 30, 2015 compared to $0.3 million for the same period in 2014. The decrease is due to full payment of the seller financed promissory note from the acquisition of a small technology company in 2012.2015.
During the second quarter of 2016, management evaluated and determined that the Omnilink and Do-It-Yourself (DIY) product lines and reporting units should be tested for impairment as a result of lower operating results, which are related to strategic changes and delays associated with the launch of a new personal tracking product line. Management initiated a quantitative two-step goodwill impairment test by comparing the carrying value of the net assets of the respective units to its fair value based on a discounted cash flow analysis. Based on our assessment, we have determined that the fair value of these reporting units were less than the respective carrying value and goodwill was impaired, and have recorded $4.2 million in impairment charges for trade names, technology and goodwill as of June 30, 2016, comprised of impairments of $1.6 million for indefinite-lived trade names and $2.3 million for goodwill of the Omnilink reporting unit, and $0.1 million for technology and $0.2 million for goodwill of the DIY reporting unit.
We recorded a restructuring charge of $0.3 million during the quarter ended September 30, 2016, for severance costs incurred during the period.
Interest expense increased $0.3 million, or 149.5%, to $0.5 million for the three months ended September 30, 2016, compared to $0.2 million for the same period in 2015 due to a higher interest rate on our loan agreement having deferred principal payments and imputed interest expense on a new $1.2 million capital lease for computer equipment, software and other related assets.
We recorded an income tax benefit of $0.1 million for the three months ended September 30, 2016, compared to a provision for income tax expense of $10.4 million for the three months ended September 30, 2015same period in 2015. The effective tax rates were (3.3)% and $0.4 million174.1% for the three months ended September 30, 2014. The effective tax rates were (174.1%)2016 and 57.6% for2015, respectively. For the three months ended September 30, 20152016, the difference in the effective tax rate compared to the federal statutory rate is due primarily to the book and 2014, respectively.tax basis and accounting differences for certain long and indefinite lived intangible assets. We also recognized a provision for income tax expense for certain state income taxes that cannot utilize offsetting net operating losses. The effective tax rate for the three months ended September 30, 2015 differed from the federal statutory rate of 34% primarily as a result of recording the valuation allowance for net deferred tax assets.
For the three months ended September 30, 2014, the difference between our effective tax rate and the federal statutory tax rate resulted primarily from (1) the income tax benefit for the capital loss from the disposaleffect of discontinued operations effective June 30, 2014 and the ability to offset capital gains in the current tax year and to carry back for capital gains in prior tax years, (2) the portion of transaction costs incurred in the Omnilink mergerexpenses that wereare not deductible for income taxestax purposes and (3) state income taxes, including the tax effect of changes in effective state income tax rates, resulting frompartially offset by an income tax benefit on disqualifying dispositions of incentive stock options. Income tax expense recorded in the Omnilink merger.future will be reduced or increased to the extent of offsetting decreases or increases to the valuation allowance.
Nine Months Ended September 30, 20152016 and 20142015
The following table sets forth selected consolidated results of operations for the periods indicated, including comparative information between the periods (dollars in thousands):
Nine Months Ended September 30, | Nine Months Ended September 30, | Change from | ||||||||||||||||||||||||||||||||||||||||||||||
2015 | 2014 | 2015 vs. 2014 | 2016 | 2015 | 2015 to 2016 | |||||||||||||||||||||||||||||||||||||||||||
Net revenues: | ||||||||||||||||||||||||||||||||||||||||||||||||
Subscription and support revenues | $ | 48,874 | 69.2 | % | $ | 47,530 | 68.9 | % | $ | 1,344 | 2.8 | % | $ | 44,183 | 83.3 | % | $ | 48,874 | 69.2 | % | $ | (4,691 | ) | -9.6 | % | |||||||||||||||||||||||
Embedded devices and hardware | 21,791 | 30.8 | % | 21,483 | 31.1 | % | 308 | 1.4 | % | 8,886 | 16.7 | % | 21,791 | 30.8 | % | (12,905 | ) | -59.2 | % | |||||||||||||||||||||||||||||
Total net revenues | 70,665 | 100.0 | % | 69,013 | 100.0 | % | 1,652 | 2.4 | % | 53,069 | 100.0 | % | 70,665 | 100.0 | % | (17,596 | ) | -24.9 | % | |||||||||||||||||||||||||||||
Cost of revenue, exclusive of a portion of depreciation and amortization shown below: | ||||||||||||||||||||||||||||||||||||||||||||||||
Cost of sales, exclusive of a portion of depreciation and amortization shown below: | ||||||||||||||||||||||||||||||||||||||||||||||||
Subscription and support revenues | 19,728 | 27.9 | % | 18,647 | 27.0 | % | 1,081 | 5.8 | % | 17,242 | 32.5 | % | 19,728 | 27.9 | % | (2,486 | ) | -12.6 | % | |||||||||||||||||||||||||||||
Embedded devices and hardware | 19,582 | 27.7 | % | 18,102 | 26.2 | % | 1,480 | 8.2 | % | 9,027 | 17.0 | % | 19,582 | 27.7 | % | (10,555 | ) | -53.9 | % | |||||||||||||||||||||||||||||
Inventory reserves | 1,547 | 2.2 | % | 415 | 0.6 | % | 1,132 | 272.8 | % | 514 | 1.0 | % | 1,547 | 2.2 | % | (1,033 | ) | -66.8 | % | |||||||||||||||||||||||||||||
Impairment of other asset | 1,275 | 1.8 | % | - | 0.0 | % | 1,275 | 100.0 | % | - | 0.0 | % | 1,275 | 5.5 | % | (1,275 | ) | -100.0 | % | |||||||||||||||||||||||||||||
Gross profit | 28,533 | 40.4 | % | 31,849 | 46.1 | % | (3,316 | ) | -10.4 | % | 26,286 | 49.5 | % | 28,533 | 40.4 | % | (2,247 | ) | -7.9 | % | ||||||||||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||||||||||||||||||||||
Sales and marketing | 9,136 | 12.9 | % | 9,066 | 13.1 | % | 70 | 0.8 | % | 9,444 | 17.8 | % | 9,136 | 12.9 | % | 308 | 3.4 | % | ||||||||||||||||||||||||||||||
General and administrative | 12,108 | 17.1 | % | 11,207 | 16.2 | % | 901 | 8.0 | % | 11,269 | 21.2 | % | 12,108 | 17.1 | % | (839 | ) | -6.9 | % | |||||||||||||||||||||||||||||
Engineering and development | 6,695 | 9.5 | % | 5,794 | 8.4 | % | 901 | 15.6 | % | 6,920 | 13.0 | % | 6,695 | 9.5 | % | 225 | 3.4 | % | ||||||||||||||||||||||||||||||
Depreciation and amortization | 5,411 | 7.7 | % | 4,570 | 6.6 | % | 841 | 18.4 | % | 4,992 | 9.4 | % | 5,411 | 7.7 | % | (419 | ) | -7.7 | % | |||||||||||||||||||||||||||||
Impairment of goodwill and other intangible assets | 1,250 | 1.8 | % | - | 0.0 | % | 1,250 | 100.0 | % | |||||||||||||||||||||||||||||||||||||||
Operating (loss) income | (6,067 | ) | -8.6 | % | 1,212 | 1.8 | % | (7,279 | ) | -600.6 | % | |||||||||||||||||||||||||||||||||||||
Impairment of goodwill and | ||||||||||||||||||||||||||||||||||||||||||||||||
other intangible assets | 4,172 | 7.9 | % | 1,250 | 1.8 | % | 2,922 | n/a | ||||||||||||||||||||||||||||||||||||||||
Restructuring charges | 1,520 | 2.9 | % | - | 0.0 | % | 1,520 | n/a | ||||||||||||||||||||||||||||||||||||||||
Operating loss | (12,031 | ) | -22.7 | % | (6,067 | ) | -8.6 | % | (5,964 | ) | 98.3 | % | ||||||||||||||||||||||||||||||||||||
Interest expense | 604 | 0.9 | % | 564 | 0.8 | % | 40 | 7.1 | % | 1,196 | 2.3 | % | 604 | 0.9 | % | 592 | 98.0 | % | ||||||||||||||||||||||||||||||
Loss on extinguishment of debt | 290 | 0.5 | % | - | 0.0 | % | - | n/a | ||||||||||||||||||||||||||||||||||||||||
Other income, net | (100 | ) | -0.1 | % | (1,272 | ) | -1.8 | % | 1,172 | -92.1 | % | (99 | ) | -0.2 | % | (100 | ) | -0.1 | % | 1 | -1.0 | % | ||||||||||||||||||||||||||
(Loss) income from continuing operations before income taxes | (6,571 | ) | -9.3 | % | 1,920 | 2.8 | % | (8,491 | ) | -442.2 | % | |||||||||||||||||||||||||||||||||||||
Income tax expense | 10,159 | 14.4 | % | 283 | 0.4 | % | 9,876 | 3489.8 | % | |||||||||||||||||||||||||||||||||||||||
(Loss) income from continuing operations, net of income taxes | (16,730 | ) | -23.7 | % | 1,637 | 2.4 | % | (18,367 | ) | -1122.0 | % | |||||||||||||||||||||||||||||||||||||
Loss from discontinued operations, net of income taxes | - | 0.0 | % | (492 | ) | -0.7 | % | 492 | -100.0 | % | ||||||||||||||||||||||||||||||||||||||
Net (loss) income | $ | (16,730 | ) | -23.7 | % | $ | 1,145 | 1.7 | % | $ | (17,875 | ) | -1561.1 | % | ||||||||||||||||||||||||||||||||||
Loss before income taxes | (13,418 | ) | -25.3 | % | (6,571 | ) | -9.3 | % | (6,847 | ) | 104.2 | % | ||||||||||||||||||||||||||||||||||||
Income tax expense (benefit) | (257 | ) | -0.5 | % | 10,159 | 14.4 | % | (10,416 | ) | -102.5 | % | |||||||||||||||||||||||||||||||||||||
Net loss | $ | (13,161 | ) | -24.8 | % | $ | (16,730 | ) | -23.7 | % | $ | 3,569 | -21.3 | % | ||||||||||||||||||||||||||||||||||
Adjusted EBITDA(1) | $ | 7,358 | 10.4 | % | $ | 9,078 | 13.2 | % | $ | (1,720 | ) | -18.9 | % | $ | 2,343 | 4.4 | % | $ | 7,358 | 10.4 | % | $ | (5,015 | ) | -68.2 | % |
_________________
(1) – Adjusted EBITDA is not a financial measure prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). See further discussion, including reconciliation to the most comparable GAAP measure, under the caption Non-GAAP Financial Measures below.
Total revenue increased $1.7revenues decreased $17.6 million, or 2.4%24.9%, for the nine months ended September 30, 20152016 to $70.7$53.1 million from $69.0$70.7 million for the same period in 2014.2015. The increasedecrease is primarily attributable to subscriptiona strategic shift in how we sell our products and services. During the third quarter of 2015, we began to concentrate on selling higher margin, integrated managed service subscriptions that include the full suite, or subsets, of our devices, networks, applications, and platform while moving away from the sale of individual components – especially hardware only.
Subscription and support revenues which grew $1.3decreased $4.7 million, or 2.8%9.6%, to $44.2 million from $48.9 million in 2015. The decrease reflects losses associated with network customers’ 2G conversions stemming from $47.5 milliona period of time in 2014 primarily from our introduction of new product lines, including those recently acquired.
Embedded devicewhich we did not have a competitive offering. Pricing has remained consistent year over year for similar services, although current period revenues also include higher value services. The decrease in embedded devices and hardware revenue increased $0.3 million, or 1.4%,revenues is attributed to $21.8the shift to the integrated managed service subscription offerings. In addition, sales to our historically largest hardware only customer decreased to $0.4 million for the nine months ended September 30, 20152016 compared to $21.5$12.5 million recorded infor the same period in 2014. The majority2015.
22 |
Direct cost of sales for the increase pertainsnine months ended September 30, 2016 decreased $15.3 million, or 36.3%, to timing$26.8 million compared to $42.1 million for the same period in 2015. Direct cost of one of our largest customer’s periodic high volume purchases of hardware modules. Purchases from this customer were $12.5subscription and support revenues decreased $2.5 million, and $11.1or 12.6%, to $17.2 million for the nine months ended September 30, 20152016, compared to $19.7 million for the same period in 2015. Subscription and 2014, respectively. The increase in sales to onesupport revenues less direct costs were $26.9 million, or 60.9% of our largest customers was offset by our shift to a managed service offering of Numerex DNA noted above instead of selling hardware as separate components. Because of this shift, we anticipate hardware revenue will continue to fluctuate and also decrease in total over time.
Total cost of revenuecorresponding revenues for the nine months ended September 30, 2015 increased $5.02016 compared to $29.1 million, or 13.4%, to $42.1 million compared to $37.2 million59.6% for the same periodnine months ended September 30, 2015. In addition to lower direct costs associated with lost 2G conversions, we also had a larger proportional decrease in 2014. Comprising that increase, the direct cost of revenue for subscription and support services increased $1.1due in part to lower negotiated network and carrier costs and our strategic efforts to sell higher margin integrated managed services. Direct cost of subscription and support revenues include $1.0 million and $0.7 million of depreciation and amortization for the nine months ended September 30, 2016 and 2015, respectively.
Direct cost of sales for embedded devices and hardware, excluding provision for inventory reserves, decreased $10.6 million, or 5.8%53.9%, to $19.7$9.0 million for the nine months ended September 30, 20152016 compared to $18.6 million for the same period in 2014. Subscription and support revenue less direct costs was $29.1 million, or 59.6% of subscription and support revenue for the nine months ended September 30, 2015 compared to $28.9 million, or 60.8% of subscription and support revenue for the nine months ended September 30, 2014.
The direct cost of revenue for embedded devices and hardware increased $1.5 million, or 8.2% to $19.6 million for the nine months ended September 30, 2015 compared to $18.1 million for the same period in 2014.2015. Embedded devices and hardware revenue less direct costs was $(0.1) million, or (1.6)% of embedded devices and hardware revenue for the nine months ended September 30, 2016, compared to $2.2 million, or 10.1% of embedded devices and hardware revenue for the nine months ended September 30, 2015, comparedresulting from the decrease in hardware only sales to $3.4 million, or 15.7% of embeddedour historically largest hardware only customer. The overall decrease in direct costs is due to lower corresponding revenues related to our strategic move away from hardware only sales. Embedded devices and hardware revenue also declined as we focus on integrated managed services solutions.
Cost of sales for the nine months ended September 30, 2014. The year over year2016 include a significant increase in direct coststhe provision for inventory reserves of embedded devices and hardware is attributed to customer and product mix. Customer and product mix also caused direct cost of embedded devices and hardware as a percentage of corresponding revenue to increase to 89.9% for the nine months ended September 30, 2015 from 84.3% for the same period in 2014.
$0.5 million. As described in the Overview above, we entered into new and amended agreements with wireless carriers in September 2015.2015 that made adding 2G devices to wireless networks financially unfavorable under most circumstances. As a result of these agreements, we performed a lower of cost or market analysis leading to a significant increase in the inventoryincreased reserve of $1.1 million during the nine months ended September 30, 2015 related to older 2G cellular telecommunication devices and older satellite devices as well as an accrual for a purchase commitment related to raw materialsduring the quarter ended September 30, 2015, net of what we believed was saleable in limited markets. At the time of filing our quarterly report for the quarter ended March 31, 2016, we anticipated subsequently completing a large sale of older satellite devices that we will2G and other devices. The anticipated sale was not fulfill. In addition, one ofand is no longer expected to be completed, leading us to record the amended carrier agreements led to settlement of a pre-existing relationship and a $1.3 million impairment of a prepaid expense duringsignificant increase in the provision for inventory reserves.
Total gross profit for the nine months ended September 30, 2015. The prepaid expense was previously recorded2016 decreased $2.2 million, or 7.9% to $26.3 million compared to $28.5 million for the same period in other assets.2015 as a result of the changes discussed above.
Sales and marketing expense remained consistent year over year in both total dollars and as a percentage of total revenue.
General and administrative expense increased $0.9 million, or 8.0%, to $12.1$9.4 million for the nine months ended September 30, 2015,2016 increased by $0.3 million compared to $11.2with $9.1 million for nine monthin the same period ended September 30, 2014. Asin 2015. The year over year increase as a percentage of total net revenue is primarily attributable to higher sales general and administrative expenses increasedcommissions due to 17.1% formore sales personnel with guaranteed commissions during the nine months ended September 30, 2015 compared to 16.2% for the nine months ended September 30, 2014. The increase includes the effect of recently acquired product lines. General and administrative expenses for the nine months ended September 30, 2015 also includes of $0.5 million for the new chief executive officer relocation and recruiting costs and $0.2 million for an immaterial correction of an error relating to international value-added and sales taxes. 2016.
General and administrative expense for the nine months ended September 30, 2015 includes $0.4 million in other professional fees and transaction costs compared to $1.1 million for the comparable period in 2014.
Engineering and development expenses increased 15.6% to $6.7 million for the nine-month period ended September 30, 2015, compared to $5.8 million for the nine-month period ended September 30, 2014. The increase was primarily driven by the continued development associated with newly introduced product lines with $0.3 million related to contract labor and $0.6 million in salary expense for newly hired employees. Engineering and development expense was 9.5% of total revenue for the nine months ended September 30, 2015 compared to 8.4% of total revenue for the same period in 2014.
Depreciation and amortization expense increaseddecreased $0.8 million, or 18.4%6.9%, to $5.4$11.3 million for the nine months ended September 30, 2015,2016, compared to $4.6$12.1 million for the nine monthsame period ended September 30, 2014.in 2015. The increase in depreciationdecrease is driven primarily by lower recruiting costs and amortization is related to recently acquired product linesequity-based compensation expense.
Engineering and development of new product and project initiatives, including the amortization of new intangible assets. The increase also includes $0.4expenses increased $0.2 million, for managed service devices and hardware used by a financially troubled customer at risk of not being returnedor 3.4%, to us.
The $1.3$6.9 million impairment of goodwill and other intangible assets recorded infor the nine months ended September 30, 2015 was related2016, compared to our DIY reporting unit as described in the Overview above.
Other income decreased $1.2$6.7 million for the nine months ended September 30, 2015. The decreaseincrease is relatedprimarily attributable to a pre-tax gainan increase in contract labor. We are increasing our use of $1.1 million on the sale of a cost method investment in a privately-held businessmore agile, off-shore resources and incurred some overlapping costs during the nine months ended September 30, 2014. The carrying value of2016 compared to the investment was $0.2 millionsame period in the prior year. We may experience additional volatility in contract labor and was sold for $1.3 million.overall engineering and development costs in the future as our business and operating needs evolve.
We recorded a provision for income taxDepreciation and amortization expense, not otherwise included in cost of $10.2sales, decreased to $5.0 million and $0.3from $5.4 million for the nine months ended September 30, 20152016 and 2014, respectively.2015.
23 |
During the second quarter of 2016, management evaluated and determined that the Omnilink and Do-It-Yourself (DIY) product lines and reporting units should be tested for impairment as a result of lower operating results, which are related to strategic changes and delays associated with the launch of a new personal tracking product line. Management initiated a quantitative two-step goodwill impairment test by comparing the carrying value of the net assets of the respective units to its fair value based on a discounted cash flow analysis. Based on our assessment, we determined that the fair value of these reporting units were less than the respective carrying value and goodwill was impaired, and recorded $4.2 million in impairment charges for trade names, technology and goodwill as of September 30, 2016, comprised of impairments of $1.6 million for indefinite-lived trade names and $2.3 million for goodwill of the Omnilink reporting unit, and $0.1 million for technology and $0.2 million for goodwill of the DIY reporting unit.
Also as described above, during the quarter ended September 30, 2016, we recorded a restructuring charge of $1.5 million, which includes $0.8 million related to facilities and $0.7 million in severance costs. The restructuring charge for facilities is comprised of $0.4 million for broker and other related fees and $0.4 million non-cash charge for the estimated August 1, 2016 net book value of furniture, fixtures and leasehold improvements as well as moving expenses. Our temporary new corporate headquarters office space, effective tax ratesJuly 15, 2016, is under a one-year lease agreement. We anticipate cash savings of $0.8 million under the new agreement over the next 12 months and are reviewing alternatives for longer-term office space. Severance costs of $0.7 million were (154.6%) and 14.7%incurred during the period.
Interest expense increased $0.6 million, or 98.0%, to $1.2 million for the nine months ended September 30, 2016, compared to $0.6 million for the same period in 2015 due to a higher interest rate on our loan agreement having deferred principal payments and 2014,imputed interest expense on a new $1.2 million capital lease for computer equipment, software and other related assets.
We recorded an income tax benefit of $0.3 million and $10.1 million in income tax expense for the nine month periods ended September 30, 2016 and 2015, respectively. The effective tax rates were (1.9)% and 154.6% for the nine months ended September 30, 2016 and 2015, respectively. For the nine months ended September 30, 2016, the difference in the effective tax rate compared to the federal statutory rate is due primarily to the book and tax basis and accounting differences for certain long and indefinite lived intangible assets. We also recognized a provision for income tax expense for certain state income taxes that cannot utilize offsetting net operating losses. The effective tax rate for the nine months ended September 30, 2015 differed from the federal statutory of 34%rate primarily as a result of recording the valuation allowance for net deferred tax assets.
For the nine months ended September 30, 2014, the difference between our effective tax rate and the federal statutory tax rate resulted primarily from (1) the income tax benefit for the capital loss from the disposaleffect of discontinued operations effective June 30, 2014 and the ability to offset capital gains in the current tax year and to carry back for capital gains in prior tax years, (2) the portion of transaction costs incurred in the Omnilink mergerexpenses that wereare not deductible for income taxestax purposes and (3) state income taxes, including the tax effect of changes in effective state income tax rates, resulting frompartially offset by an income tax benefit on disqualifying dispositions of incentive stock options. Income tax expense recorded in the Omnilink merger.future will be reduced or increased to the extent of offsetting decreases or increases to the valuation allowance.
Segment Information
We have one reportable segment, providing interactive and on-demand Machine to Machine (M2M) enterprise solutions enabling the Internet of Things (IOT)(IoT).
24 |
Non-GAAP Financial Measures
Earnings before interest, taxes, depreciation and amortization expenses (EBITDA) and Adjusted EBITDA, which are presented below, are non-GAAP measures and do not purport to be alternatives to operating income as a measure of operating performance. We believe EBITDA Adjusted EBITDA and Adjusted EBITDA per diluted share are useful to and used by our lender, investors, and other users of the financial statements in evaluating our operating performance because it provides them with an additional tool to compare business performance across periods.
We believe thatthat:
EBITDA is widely used by investors to measure a company’s operating performance without regard to items such as interest, |
Investors commonly adjust EBITDA information to eliminate the effect of equity-based compensation and |
We use EBITDA Adjusted EBITDA and Adjusted EBITDA per diluted share:EBITDA:
as a measure of operating performance to assist in comparing performance from period-to-period on a consistent basis |
as a measure for planning and forecasting overall expectations and for evaluating actual results against such expectations; |
in communications with the board of directors, analysts and investors concerning our financial |
· | in communications with our lender, as the financial covenants in our debt agreement require minimum adjusted EBITDA for the trailing 12 months ranging between $3.7 million and $14.0 million per quarter. |
Although we believe, for the foregoing reasons, that the presentation of non-GAAP financial measures provides useful supplemental information to investors regarding our results of operations, the non-GAAP financial measures should only be considered in addition to, and not as a substitute for, or superior to, any measure of financial performance prepared in accordance with GAAP.
Use of non-GAAP financial measures is subject to inherent limitations because they do not include all the expenses that must be included under GAAP and because they involve the exercise of judgment of which charges should properly be excluded from the non-GAAP financial measure. Management accounts for these limitations by not relying exclusively on non-GAAP financial measures, but only using such information to supplement GAAP financial measures. The non-GAAP financial measures may not be the same non-GAAP measures, and may not be calculated in the same manner, as those used by other companies.
EBITDA is calculated by adding depreciation and amortization expense, impairment of non-current assets, interest expense, other net non-operating expense and income tax expense and subtracting other net non-operating income and income tax benefit to net (loss) income. Adjusted EBITDA is calculated by excluding the effect of equity-based compensation and non-operational itemsadditional non-cash and other charges from the calculation of EBITDA. Management believes that this measure provides additional relevant and useful information to investors and other users of our financial data, including our lender, in evaluating the effectiveness of our operations and underlying business trends in a manner that is consistent with management’s evaluation of business performance.
We believe that excluding depreciation and amortization expenses of property, equipment and intangible assets to calculate EBITDA and Adjusted EBITDA provides supplemental information and an alternative presentation that is useful to our lender and investors’ understanding of our core operating results and trends. Not only are depreciation and amortization expenses based on historical costs of assets that may have little bearing on present or future replacement costs, but also they are based on our estimates of remaining useful lives.
25 |
Equity-based compensation is an important part of total compensation, especially from the perspective of employees. We believe, however, that excluding the effects of equity-based compensation from non-GAAP financial measures provides supplemental information and an alternative presentation useful to investors’ understanding of our core operating results and trends. Investors have indicated that they consider financial measures of our results of operations excluding equity-based compensation as important supplemental information useful to their understanding of our historical results and estimating our future results.
We also believe that, in excluding the effects of equity-based compensation, our non-GAAP financial measures provide investors with transparency into what management uses to measure and forecast our results of operations, to compare on a consistent basis our results of operations for the current period to that of prior periods and to compare our results of operations on a more consistent basis against that of other companies, in making financial and operating decisions and to establish certain management compensation.
Equity-based compensation is an important part of total compensation, especially from the perspective of employees. We believe, however, that supplementing GAAP income from continuing operations by providing income from continuing operations, excluding the effect of equity-based compensation in all periods, is useful to investors because it enables additional and more meaningful period-to-period comparisons.
Adjusted EBITDA excludes restructuring, non-cash, impairment and other charges including a provision for inventory reserves, executive severance and recruiting fees, costs and fees related to an internal ERP systems integration upgrade, a network systems evaluation and acquisition related costs, a large and uncommon reserve for inventory, impairment and write-off of prepaid expenses, and a goodwill impairment charge.costs. We believe that these costs are unusualinfrequent costs that we do not expect to recur on a regular basis, and consequently, we do not consider these charges as a component of ongoing operations.
EBITDA and Adjusted EBITDA are not measures of liquidity calculated in accordance with GAAP, and should be viewed as a supplement to – not a substitute for – results of operations presented on the basis of GAAP. EBITDA and Adjusted EBITDA do not purport to represent cash flow provided by operating activities as defined by GAAP. Furthermore, EBITDA and Adjusted EBITDA are not necessarily comparable to similarly-titled measures reported by other companies.
The following table reconciles the specific items excluded from GAAP in the calculation of EBITDA and Adjusted EBITDA for the periods indicated below (in thousands, except per share amounts):
Three Months | Nine Months | |||||||||||||||
Ended September 30, | Ended September 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
(Loss) income from continuing operations, net of income taxes (GAAP) | $ | (16,380 | ) | $ | 263 | $ | (16,730 | ) | $ | 1,637 | ||||||
Depreciation and amortization expense | 2,381 | 1,789 | 6,163 | 4,969 | ||||||||||||
Interest expense and other non-operating expense (income), net | 157 | 181 | 504 | (708 | ) | |||||||||||
Income tax expense | 10,404 | 358 | 10,159 | 283 | ||||||||||||
EBITDA (non-GAAP) | (3,438 | ) | 2,591 | 96 | 6,181 | |||||||||||
Equity-based compensation expense | 738 | 694 | 2,319 | 1,833 | ||||||||||||
Non-cash and other items | 4,360 | 41 | 4,943 | 1,064 | ||||||||||||
Adjusted EBITDA (non-GAAP) | $ | 1,660 | $ | 3,326 | $ | 7,358 | $ | 9,078 | ||||||||
(Loss) income from continuing operations, net of income taxes, per diluted share (GAAP) | $ | (0.86 | ) | $ | 0.01 | $ | (0.88 | ) | $ | 0.09 | ||||||
EBITDA per diluted share (non-GAAP) | (0.18 | ) | 0.13 | 0.01 | 0.32 | |||||||||||
Adjusted EBITDA per diluted share (non-GAAP) | 0.09 | 0.17 | 0.39 | 0.47 | ||||||||||||
Weighted average shares outstanding used in computing diluted per share amounts | 19,137 | 19,263 | 19,053 | 19,253 |
Three Months | Nine Months | |||||||||||||||
Ended September 30, | Ended September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Net loss | $ | (2,546 | ) | $ | (16,380 | ) | $ | (13,161 | ) | $ | (16,730 | ) | ||||
Depreciation and amortization expense | 2,029 | 2,381 | 5,997 | 6,163 | ||||||||||||
Impairment of goodwill and other intangible assets | - | - | 4,172 | - | ||||||||||||
Interest expense and other non-operating expense, net | 436 | 157 | 1,387 | 504 | ||||||||||||
Income tax (benefit) expense | (87 | ) | 10,404 | (257 | ) | 10,159 | ||||||||||
EBITDA (non-GAAP) | (168 | ) | (3,438 | ) | (1,862 | ) | 96 | |||||||||
Equity-based compensation expense | 751 | 738 | 2,202 | 2,319 | ||||||||||||
Non-cash and other items | 276 | 4,360 | 2,003 | 4,943 | ||||||||||||
Adjusted EBITDA (non-GAAP) | $ | 859 | $ | 1,660 | $ | 2,343 | $ | 7,358 |
Depreciation and amortization expense in the table above includes $0.4 million and $0.3 million for the three months ended September 30, 2016 and 2015, respectively, and $1.0 million and $0.7 million, for the nine months ended September 30, 2015, respectively, recorded in cost of revenue. As noted above, non-cash and other charges include goodwill$0.3 million in restructuring charges for the three months ended September 30, 2016 and intangible write downs, impairment of other assets, unusual$2.0 million associated with the charges for a provision for inventory reserves, executive severance and recruiting fees, costs related to hiring a new chief executive,and fees related to an internal ERP systems integration upgrade, a network systems evaluation and acquisition related costs.costs for the nine months ended September 30, 2016.
26 |
Liquidity and Capital Resources
We use the net cash generated fromto support our operations and to fund new product development, upgrades to our technology and to invest in new businesses. Our sourceDuring the nine months ended September 30, 2016, unrestricted cash balances decreased $6.4 million, with cash on hand used to pay $3.4 million of funds is principally from operations.principal on outstanding long-term debt and associated deferred financing costs for the new debt agreement. We believe that we haveour sources of funds, principally from operations and cash on hand, are sufficient liquidity and capital resources to meet ongoing operations and investing requirements throughrequirements. If we fail to meet the amended financial covenants contained in our cashloan agreement, any outstanding obligations under the loan agreement may be accelerated and we may not have sufficient funds available for mandatory repayment or we may not have the ability to borrow or obtain sufficient funds to repay the accelerated indebtedness on hand and generated from operations and that we will be ableterms acceptable to access funds from external financing arrangements as necessary.us, or at all.
We had working capital of $17.5$12.2 million as of September 30, 2015,2016, compared to $23.7$17.6 million as of December 31, 2014, respectively.2015. We had unrestricted cash balances of $12.5$9.8 million and $17.3$16.2 million as of September 30, 20152016 and December 31, 2014,2015, respectively. Our allowanceDays sales outstanding increased from 44 to 51 days from December 31, 2015 to September 30, 2016 and inventory days on hand increased from 120 to 170 days for doubtful accounts reflected in the accompanying balance sheet includes bad debt reservessame period. We are making efforts to reduce both of these metrics to increase cash on hand and revenue reserves.cash from operating activities. Days payable outstanding also increased from 84 to 103 days from December 31, 2015 to September 30, 2016. We expect days payable outstanding to decrease along with improvements to days’ sales outstanding and inventory days on hand.
Net cash used in operating activities for the nine months ended September 30, 2016 was $0.8 million compared with net cash provided by operating activities of $4.1 million for the nine-month periodnine months ended September 30, 2015 was $4.1 million compared with net cash of $7.1 million provided by operating activities of continuing operations for the nine-month period ended September 30, 2014.The2015. The decrease in cash provided by operations is primarily a result of anour reduced net loss for the period, net of adjustments to reconcile net loss to net cash (used in) provided by operating activities. The use of cash during the nine months ended September 30, 2016 for the increase in gross accounts receivable and gross inventory from December 31, 2014 to September 30, 2015. The increase in gross accounts receivable is primarily due to shippingtiming of sales during the period. Inventory, net of reserves decreased $1.3 million to $6.3 million as of September 30, 2016. The net decrease during the nine months ended September 30, 2016 includes transfers of $2.1 million of inventory to monitoring equipment as part of our managed services business and offset by build up for a large customer’s hardware order nearrecent new product launch. We also disposed of $0.8 million of fully reserved inventory during the end of the period and customers with extended payment terms. The increase in gross inventory results from increased purchases of newer generation inventory.nine months ended September 30, 2016.
Net cash used in investing activities for the nine-month periodnine months ended September 30, 20152016 was $5.3$2.5 million, representing cash expenditures of $2.0$0.8 million for tangible assets and $3.3$1.7 million for purchased software and capitalization of internally developed software.
Net cash used in financing activities for the nine-monththree-month period ended September 30, 20152016 was $3.6$3.2 million, primarily for paymentsnet cash on debt.hand used to repay the Silicon Valley Bank (SVB) debt and payment of deferred financing costs for the new debt agreement.
On May 5, 2014,March 9, 2016, we and certain of our wholly-owned, consolidated subsidiaries entered into a Second Amendednew term loan agreement with Crystal Financial LLC as Term Agent, and Restatedthe term lenders party thereto (the “Crystal Loan and Security Agreement (the “Loan Agreement”) pursuant to which the term lenders made a term loan to us in the amount of $17.0 million. The net proceeds from the term loan (after payment of the fees and expenses of the Term Agent), along with Silicon Valley Bank (“SVB”). The$2.9 million of cash on hand, were used to repay the $19.4 million outstanding debt under the SVB Loan Agreement was entered into byand pay related transaction fees. We recorded a charge of $0.3 million to loss on extinguishment of debt for unamortized deferred financing costs related to the Company in contemplation of the cash funding required in connection with our acquisition of Omnilink (see Note B – Merger) and to provide additional funding as needed for future capital investments for the business. In that regard, theSVB Loan Agreement provides for $30.0 million of aggregate credit which is comprised of a $25.0 million term loan that was specifically structured and designated as funds to be borrowed and used byduring the Company toward payment of cash purchase consideration for the Omnilink transaction and an additional $5.0 million revolving line of credit for general corporate needs.nine months ended September 30, 2016.
The maturities for bothmaturity date of the term and revolving credit facilities contemplated in the Loan Agreementloan is March 9, 2020. We are May 5, 2019. As is typical in the case of term loan structures, the Loan Agreement provides for mandatory scheduledrequired to make regular quarterly principal payments of principal as set forth in$0.6 million beginning September 1, 2017 with the table below that will cumulatively have the effect of repaying 80%, or $20.0 million, of the principal borrowed beforebalance due on the maturity date, in May, 2019. The remaining principal of $5.0 million will be due at maturity if not otherwise repaid earlier by way of voluntary Permitted Prepaymentsprepayments, or by mandatoryupon the occurrence of certain Prepayment Events or Excess Cash Flow Recapture Payments (as defined in the Crystal Loan Agreement), or as a result of acceleration of the loan as a result of an event of default. Prepayments of the loan are subject to a prepayment penalty of 3% of the amount prepaid if prepayment occurs prior to the first anniversary of the closing date and 2% of the amount prepaid if the prepayment occurs on or after the first anniversary of the closing date but prior to the second anniversary date of the closing date. There is no prepayment penalty for prepayments that occur on or after the second anniversary of the closing date. The interest rate payable on the outstanding loan amount is determined by reference to LIBOR plus a margin established in the agreement. At September 30, 2016, the applicable interest rate was 9.35%.
Loan Agreement Principal Repayment Schedule
27 |
Quarterly | Annually | |||||||
June 2014 - March 2015 | $ | 625,000 | $ | 2,500,000 | ||||
June 2015 - March 2016 | 937,500 | 3,750,000 | ||||||
June 2016 - March 2017 | 937,500 | 3,750,000 | ||||||
June 2017 - March 2018 | 1,250,000 | 5,000,000 | ||||||
June 2018 - March 2019 | 1,250,000 | 5,000,000 | ||||||
Outstanding balance due May 2019 | - | 5,000,000 |
Our obligations under the Crystal Loan Agreement are secured by a first priority security interest in substantially all of our assets and the assets of our subsidiaries. In addition, we are required to meet certain financial and other restrictive covenants customary with this type of facility, including maintaining a senior leverage ratio, a fixed charge coverage ratiominimum Adjusted EBITDA, minimum Consolidated Fixed Charge Coverage Ratio, maximum Consolidated Total Net Leverage, maximum subscriber Churn, and minimum liquidity availability.Liquidity, all of which are defined in the Crystal Loan Agreement. We are also prohibited from paying dividends.incurring indebtedness, disposing of or permitting liens on our assets and making restricted payments, including cash dividends on shares of our common stock, except as expressly permitted under the Crystal Loan Agreement. The Loan Agreementagreement contains customary events of default. If a default occurs and is not cured within anythe applicable cure period or is not waived, any outstanding obligations under the Loan Agreementagreement may be accelerated. It is unlikely
On July 29, 2016 and November3, 2016, we would have adequate funds to repay such amounts priorentered into an amendment to the scheduled maturityCrystal Loan Agreement to modify the covenant related to the maximum subscriber Churn and update the definition of Adjusted EBITDA. As a result of the loan. Ifamendments, we fail to repay such amounts, SVB may foreclose on the assets we have pledged under the Loan Agreement, which include substantiallywere in compliance with all of our assets and those of our domestic subsidiaries.
Ascovenants as of September 30, 2015,2016.
In March 2016, we did not meet the fixed charge coverage ratio covenant. We entered into a 60-month lease arrangement for computer and network equipment, software and related costs having a value of $1.2 million. The lease commenced in April 2016 and is accounted for as a capital lease, reflecting the first amendmentcorresponding assets and related obligations in our consolidated balance sheet.
In June 2016, we entered into agreements to relocate our corporate headquarters. One agreement is a sublease of the Loan Agreementoffice space formerly occupied by our corporate headquarters and includes all furniture and fixtures. The sublease agreement is effective August 1, 2016 and coterminous with the prime lease agreement expiring on November 3, 2015 (the “Amendment”). The Amendment does not permit any subsequent advancesSeptember 29, 2022. Rental income from the sublease will be $0.9 million annually plus 2.5% annual escalation, recorded as a reduction to rental expense in general and administrative expense. We also executed a one-year lease agreement for temporary new corporate headquarters office space effective July 15, 2016. Annual rent expense will be $0.1 million through July 2017, also recorded in general and administrative expense. We anticipate cash savings of $0.8 million under the Credit Facility, waived the fixed charge coverage ratio for the three months ended September 30, 2015 and added a monthly liquidity ratio covenant. While we believe that we will continue to have sufficient cash available to operate our business and to meet our financial obligations and debt covenantsnew agreement over the next 12 months there can be no assurances that our operations will generate sufficient cash, that we will be able to comply with applicable loan covenants or that credit facilities will be available in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs.and are reviewing alternatives for longer-term and lower cost office space.
Off-Balance Sheet Arrangements
As of September 30, 2015,2016, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Critical Accounting Policies
There have been no material changes in our critical accounting policies, estimates and judgments during the ninethree months ended September 30, 20152016 compared to the disclosures in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2014.2015.
As a result of the adoption of a recent accounting pronouncement, certain balance sheet amounts as of December 31, 2015 have been reclassified to conform to the current period presentation. See Note A – Summary of Significant Accounting Policies.
Item 3. | Quantitative and Qualitative Disclosures about Market Risks. |
The market risk in our financial instruments represents the potential loss arising from adverse changes in financial rates. We are exposed to market risk in the area of interest rates. These exposures are directly related to our normal funding and investing activities. We are subject to interest rate market risk in connection with our long-term debt. Our principal interest rate exposure relates to outstanding amounts under our $25.0 million term loan. Our term loan provides for variable interest rates determined by reference to the prime rate or LIBOR rate. A one-eighth percent increase or decrease in assumed interest rates for the $25.0 million term loan for the one year period following its inception would result in a corresponding increase or decrease in interest expense of $30,000.
We also hold cash balances in accounts with commercial banks in the United States and foreign countries. These cash balances represent operating balances only and are invested in short-term time deposits of the local bank. Such operating cash balances held at banks outside the United States are denominated in the local currencycurrency. We held $0.1 million and are minor.$0.5 million in foreign bank accounts at September 30, 2016 and December 31, 2015, respectively.
28 |
Foreign Currency
The assets and liabilities of our foreign operations are translated into U.S. dollars at current exchange rates, and revenues and expenses are translated at the ending exchange rate from the prior period which materially approximates the average exchange rates for each period. Resulting translation adjustments are reflected as other comprehensive (loss) incomeloss in the consolidated statements of operations and comprehensive loss and within shareholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. Except for transactions with customers and vendors in Canada, substantially all other transactions are denominated in U.S. dollars. Foreign operations were not significant to us for the quarterthree months ended September 30, 2016 or fiscal year ended December 31, 2015.
Interest Rate Risk
We are exposed to changes in interest rates on our long-term debt that carries variable rate interest. The impact of a 100-basis point change in interest rates would result in a change in annual interest expense of $0.2 million.
Item 4. | Controls and Procedures. |
Evaluation of Disclosure Controls and Procedures
As of September 30, 2015,2016, under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), management has evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on management’s identification of the previously reported deficiencies in internal control over financial reporting that evaluation, the CEO and CFOit considers to be material weaknesses, management has concluded that as of September 30, 2015, the Company's disclosure controls and procedures were not effective at September 30, 2016. Steps being undertaken to remediate these weaknesses are discussed below.
The Company is continuing to reinforce its processes to address the reasonable assurance level in timely alertingpreviously reported material weaknesses. Management of the Company believes the steps being taken to remediate these weaknesses are appropriate and expects them to material information requiredbe fully remediated before the end of its fiscal year. Remediation efforts include:
· | Evaluation Process for Impairment of Goodwill and Other Intangible Assets Material Weakness: |
· | Enhance the formality of rigor of review as it relates to assumptions that are utilized pertaining to the goodwill impairment evaluation process, and |
· | Perform more rigorous sensitivity analyses on financial projections and other inputs. |
· | Capitalized Internally Developed Software Material Weakness: |
· | Implement additional monitoring controls as it relates to internal costs that are incurred and capitalized, and |
· | Implement additional monitoring controls verifying the hours and rates that are incorporated into the capitalized internally developed software calculation. |
The Company is committed to maintaining a strong internal control environment and believes that these remediation efforts will represent significant improvements in our controls. The Company has started to implement these steps; however, some of these steps will take time to be fully integrated and confirmed to be effective and sustainable. Additional controls may also be required over time. Until the remediation steps set forth above are fully implemented and tested, the material weaknesses described above will continue to exist.
Notwithstanding the material weaknesses described above, management has concluded that the Company’s unaudited condensed consolidated financial statements included in this report present fairly, in all material respects, the Company's periodic SEC reports. ThereCompany’s financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.
29 |
Changes in Internal Control Over Financial Reporting
During the quarter ended September 30, 2016, there were no significant changes in the Company'sour internal controlscontrol over financial reporting during(as such term is defined in Rules 13a-15(f) and 15d-15(f) under the third quarter of 2015Exchange Act) that have materially affected, or are reasonably likely to materially affect, the Company'sour internal control over financial reporting.
reporting, except as discussed above with regards to remediation of material weaknesses.
30 |
Item 1. | Legal Proceedings. |
We currently are not involved in any pending material litigation.
Item 1A. | Risk Factors. |
For information regarding factors that could affect our results of operations, financial condition and liquidity, see the risk factors discussion set forth in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 20142015 as previously filed with the SEC, and the information under “Forward-Looking Statements” included in this Quarterly Report on Form 10-Q.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
None - not applicable.
Item 3. | Defaults Upon Senior Securities. |
None - not applicable.
Item 4. | Mine Safety Disclosures. |
None - not applicable.
Item 5. | Other Information. |
Loan Agreement
On November 3, 2015, the Company and certain of its subsidiaries2016, we entered into an amendment to the Amendment withCrystal Loan Agreement to modify the Bank. The Amendment does not permit any subsequent advances undercovenant related to the Credit Facility, waived the fixed charge coverage ratio for the three months ended September 30, 2015 and added a monthly liquidity ratio covenant (as such term ismaximum subscriber Churn as defined in the Amendment)Crystal Loan Agreement and update the definition of at least 1.00 to 1.00.Adjusted EBITDA. See Note G – Debt.
The foregoing summarydescription of the amendment to theCrystal Loan Agreement isdoes not purport to be complete and is qualified in its entirety by reference to the amendment,such agreement, a copy of which is attached heretoincluded as Exhibit 10.2.
Employment Agreement
On November 4, 2016, the Company and Stratton Nicolaides, Executive Chairman, entered into a new employment agreement (“New Employment Agreement”) effective January 1, 2016. Pursuantan exhibit to the New Employment Agreement, Mr. Nicolaides will step down as Executive Chairman and will become non-Executive Chairman and Senior Advisor to the Chief Executive Officer and the Board of Directors. In this capacity, Mr. Nicolaides will make himself available for up to 35 hours per week to the members of the Board of Directors (including the Chief Executive Officer) and other members of the executive management team at the direction of the Chief Executive Officer. The term of the New Agreement is for 36 months, commencingQuarterly Report on January 1, 2016, and will be automatically extended by an additional 12 months at the end of the initial term and on each succeeding anniversary unless written notice is given by the Company or Mr. Nicolaides in accordance with the New Employment Agreement. The Company may terminate the New Employment Agreement for “cause.” Mr. Nicolaides will receive a salary of $20,000 per month and shall be entitled to continue to participate in all benefits plans generally available to other senior executive of the Company, including vacation.
The foregoing summary of the New Employment Agreement is not complete and is qualified in its entirety by reference to the agreement, which is attached hereto as Exhibit 10.3.
Separation Agreement
On November 5, 2016, the Company and Louis Fienberg, formerly EVP Corporate Development, entered into a separation agreement and general release (“Separation Agreement”). Pursuant to the Separation Agreement, for and in consideration of mutual promises, releases and covenants, Mr. Fienberg will receive $125,000 lump sum cash payment, six monthly payment of $20,833.33, accelerated vesting of 22,425 non-vested restricted share units, and the right to exercise all vested stock options or stock appreciation rights through July 29, 2016.
The foregoing summary of the Separation Agreement is not complete and is qualified in its entirety by reference to the agreement, which is attached hereto as Exhibit 10.4.Form 10-Q.
Item 6. |
Exhibit |
Number | Description | |
10.1 | Second Amendment to |
Certification of Chairman and Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) |
31.2 | Certification of Chief Financial Officer, Executive Vice President, and Principal Financial and Accounting Officer Pursuant to Exchange Act Rule 13a-14(a) |
32.1 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of |
32.2 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of |
101 | The following financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, |
____________________
* Indicates a compensatory management contract arrangement.This exhibit is furnished and will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 (15 U.S.C. 78r), or otherwise subject to the liability of that section. Such exhibit will not be deemed to be incorporated by reference into any filing under the Securities Act or Securities Exchange Act, except to the extent that the Registrant specifically incorporates it by reference.
32 |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
NUMEREX CORP. | |
(Registrant) | |
November | /s/ Marc Zionts |
Marc Zionts | |
Chief Executive Officer | |
November | /s/ |
Chief Financial Officer and | |
Principal Financial and Accounting Officer |
33 |