SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2009
For the transition period from to
Commission File Number 0-22920
(Name of Registrant as Specified in Its Charter)
(Registrant’s Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15 (d) of the Act. Yes o No þ
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 o
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
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 Non-accelerated filer þ Smaller Reporting Company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ
The aggregate market value of voting and non-voting common stock held by nonaffiliates of the registrant (9,278,229 shares) based on the closing price of the registrant’s common stock as reported on the NASDAQ Global Market on June 30, 2009, was $46,576,710. For purposes of this computation, all officers, directors, and 10% beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed to be an admission that such officers, directors, or 10% beneficial owners are, in fact, affiliates of the registrant.
The number of shares outstanding of the registrant’s Class A Common Stock as of March 26, 2010, was 15,070,501 shares.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive proxy statement pursuant to Regulation 14A within 120 days of the end of the fiscal year ended December 31, 2009. The proxy statement is incorporated herein by reference into the following parts of the Form 10-K:
Part III, Item 10, Directors, Executive Officers and Corporate Governance;
Part III, Item 11, Executive Compensation;
Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related
Part III, Item 13, Certain Relationships and Related Transactions, and Director Independence; and
Part III, Item 14, Principal Accountant Fees and Services.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009
TABLE OF CONTENTS
This document may contain forward-looking statements with respect to Numerex future financial or business performance, conditions or strategies and other financial and business matters, including expectations regarding growth trends and activities in the wireless data business. 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. Numerex 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 press release, and Numerex 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 service revenues; the risks that a substantial portion of our revenues are derived from government contracts that may be terminated by the government at any time; variations in quarterly operating results; delays in the development, introduction, integration and marketing of new wireless services; customer acceptance of services; economic conditions resulting in decreased demand for our products and services; the risk that our strategic alliances and partnerships will not yield substantial revenues; changes in financial and capital markets, and the inability to raise growth capital; the inability to attain revenue and earnings growth in our wireless data business; changes in interest rates; inflation; the introduction, withdrawal, success and timing of business initiatives and strategies; competitive conditions; the inability to realize revenue enhancements; and extent and timing of technological changes. Numerex SEC reports identify additional factors that can affect forward-looking statements.
PART I. BUSINESS
Numerex Corp. (“Numerex” or “Company”) is a wireless provider of a broad spectrum of secure machine-to-machine (M2M) services. We emphasize recurring revenues [through subscription sales] in order to enhance shareholder value creation. We have continuously developed technology, networks, and applications towards that end. We believe that simplifying the development and deployment process is an important key to promoting sustainable growth in the M2M industry. Numerex DNA™ is our way of combining a device, a network and an application to bring a customer’s M2M solution to life rapidly and easily. Our goal is to “jumpstart” the application process for our customers, through our foundation application software technology or Numerex FAST™, and to be a single source for M2M products and services, i.e., a “one stop shop.”
M2M is defined as electronic (wireless) data communications between devices, systems, and people that turns data into useful information across many industries. At Numerex, we concentrate our efforts on several critical vertical markets: commercial and residential security, energy and utilities, healthcare, financial services, and government & transportation. We endeavor to ensure data confidentiality, integrity and availability through the full range of our services.
We believe that Numerex has established a leadership position in M2M through delivering end-to-end, single-source solutions as well as “white label” products, i.e., products that are available for distribution as branded offerings through Value Added Resellers (VARs), vertically focused System Integrators (SIs) and Original Equipment Manufacturers (OEMs) who choose to integrate our products and services into their own solutions. Numerex customers can select from a menu of products and services that address their specific M2M needs.
Numerex has developed industry-specific expertise in offering M2M solutions with a host of value added services. We provide value to our customers in removing much of the complexity associated with the design, development, deployment and support of their own M2M solutions so that they can better focus on their primary business objectives and speed time to market. Generally, our customers serve the final end user such as, for example
consumers as car drivers or homeowners, as well as industrial users who want to better monitor and control their operational processes.
We continue to look for ways to expand our expertise by entering new vertical sectors conducive to our long-term recurring revenue model. We may choose to enter those sectors through industry partnerships, organically, or by acquisition.
Our offerings are wireless-based, using cellular and satellite networks. We are technology-neutral and utilize a diverse range of manufacturing sources and telecommunications standards. We emphasize high-margin application-centered offerings, and have transitioned our business from hardware-only sales to service contracts.
We have developed an integrating platform resting on the data processing power of the internet (a.k.a “cloud computing”) to provide turnkey solutions, i.e., the complete Numerex DNA, to our customers. We call this platform Numerex FAST™ (Foundation Application Software Technology), which is an “Open Platform as a Service,” akin to a traditional “service bureau” that limits upfront investment and risk.
Numerex Corp is headquartered in Atlanta, Georgia, and organized under the laws of the Commonwealth of Pennsylvania. The Company was founded in 1992 and first traded publicly in March 1994 (NASDAQ: NMRX). At the time, the Company focused on “derived channel”, a wireline-based telemetry data communications solution (“telemetry” is eventually subsumed by the ‘M2M’ acronym) and served select vertical markets that included alarm security and line monitoring. In November 1999, we sold our wireline business to British Telecommunications PLC (“BT”) in order to focus on our nascent wireless data communications business.
In May 1998, Numerex Corp., BellSouth Corporation and BellSouth Wireless, which became Cingular in 2001, completed a transaction whereby Cellemetry LLC, a joint venture between Numerex and Cingular, was formed. Cellemetry LLC provided a cost-effective, two-way wireless data communications network throughout the United States, Canada, Mexico, Colombia, Argentina, Paraguay, the Dutch Antilles, and Puerto Rico. On March 28, 2003, we acquired Cingular’s interest in Cellemetry LLC.
During this period, we developed a Short Message Service Center (SMSC)-operated service bureau, “Data1Source,” providing SMS-related services to tier 2 and 3 carriers throughout the US. While Data1Source was subsequently sold, it helped advance our technical expertise in the digital GSM and CDMA realms, and provided a solid bedrock on which to build our current network. In parallel, we expanded our technical platform to serve the mobile tracking and alarm monitoring markets.
At the beginning of 2006, the Company further enhanced its portfolio of wireless products and services through the acquisition of the assets of Airdesk, Inc. Airdesk’s wireless data solutions, network access and technical support have been fully integrated into the Company’s operations.
In 2007, Numerex acquired the assets of Orbit One Communications, Inc which provides satellite data products and services to government agencies and the emergency service market.
In January 2008, Numerex was awarded the international ISO/IEC 27001:2005 Certification (ISO 27001) by BSI Management Systems. ISO 27001 is ISO’s highest security certification for information security that ensures data confidentiality, integrity and availability every step of the way. The ISO 27001 certification facilitates compliance with an array of information security-related legislation and regulations in Numerex’s target markets such as utilities (NERC CIP Cyber Security mandates), financial services (GLBA and PCI DSS), healthcare (HIPAA), government (FISMA), and across markets (state laws governing security breach notification and Sarbanes Oxley Act).
In October 2008, Numerex acquired Ublip, a privately-held M2M software and services company headquartered in Dallas, Texas. With this acquisition, Numerex gained an infusion of technology and expertise, including middleware designed to simplify and jumpstart application development and deployment.
During the past 17 years, we have moved from a product-centric to a solution-centric business. Due to strong organic growth and strategic acquisitions that added to our core competencies in the M2M space, we have
assembled the principal elements of Numerex DNA™ (DNA = Device, Network, and Application) that address all critical components of the M2M value chain.
NUMEREX’S CORE BUSINESS
Numerex has evolved from primarily a proprietary network service into a comprehensive M2M business using a variety of wireless technologies to serve a wide range of markets.
Numerex Production Environment
The four dimensions of our production environment are: Numerex FAST, Numerex DNA, the Numerex enabling services, and service quality.
Through Numerex FAST (Foundation Application Software Technology), which is an Open-Platform-as-a-Service (OPaaS) architecture, we simplify the application development and implementation process. It is delivered as a web-service and exploits the benefits of cloud computing and large scale, relational database technology to solve technical and cost barriers to deployment of advanced device management and smart services.
Openness is central to Numerex‘s Open Platform as a Service, which rests on the flexibility, adaptability and interoperability of Service Oriented Architecture (SOA). Numerex provides scalable Linux-based hosting with the pre-installed applications, ranging from development to fully-developed production-quality virtual servers.
We provide customers with the development tools to write their own device interface or they can contract with our Professional Services group to develop or modify their interface. Numerex FAST supports solutions utilizing different networks and devices. It is the versatile factory that produces Numerex DNA.
Numerex DNA offerings include hardware Devices, Network services and software Applications that are the foundational components of Numerex customers’ M2M solutions. The DNA concept implemented at Numerex is increasingly being used in the industry to explain the nature of M2M.
Our Numerex FAST platform can communicate and support devices developed by a myriad of hardware manufacturers in addition to our own devices such as AnyNET and the SX1.
Numerex has partnerships with US and foreign carriers, including their roaming partners. Numerex utilizes multiple wireless standards and technologies such as GSM, CDMA and satellite services.
Numerex provides several options with various degrees of customization; from (off-the-shelf) pre-packaged web-based applications already deployed in key vertical markets to fully customized applications. In addition, we offer application hosting services.
Numerex offers a variety of value added services to customers, including:
v 24x7 Customer Support: An “around-the-clock” support center, or help desk, to provide assistance to customers;
v Flexible billing: Accurate, timely invoices in flexible formats that detail usage per device, and various billing options. This flexibility is a key differentiator for customers’ end-user billing requirements;
v Integration services: Development support to ensure timely and efficient production, the glue which brings together Numerex DNA;
v Automated provisioning: Automated, Web-based online provisioning of devices for immediate activation and account management;
v Device Management Portal: Designs and sets up customized portals specifically tailored to its customers’ needs;
v Network Operations Center: Customers and industry partners receive 24x7x365 network support from our Network Operations Center in Atlanta, Georgia;
v Product Certification: We have put many devices through the PCS Type Certification Review Board (PTCRB) certification process. Our experience also includes FCC (Federal Communications Commission), CE (conformity marking for the European Economic Area) and Industry Canada type certifications. We have efficient processes to provide accurate documentation to the certification testing labs. This expertise extends to the carrier’s certification process for devices using AT&T, Rogers (Canada), Telcel (Mexico), and other carrier networks. Also, Numerex ‘s Chief Technology Officer is Chairman of the Telecommunications Industry Association (TIA) TR-50 Smart Devices Communications (SDC) engineering committee, which is responsible for developing interface standards for communicating with smart devices used in M2M applications; and
v Ancillary services provided at the customer’s discretion: A host of ancillary services aimed at facilitating and enhancing its customers’ performance such as warehousing, fulfillment, reverse logistics, web-based provisioning and quality assurance.
Numerex’s overall service quality is built on certain critical elements, such as:
v Gateway: Our Network Operation Center (NOC) architecture is built on the latest generation of best of class processing power, using high-grade servers in a totally redundant and hot swappable configuration, i.e., where components can be easily removed and replaced while the system remains in operation. The hardware and software network topology features high grade, robust platforms for increased reliability;
v Redundancy and Reliability: The operations sites are geographically diverse and are interconnected over Synchronous Optical Network bidirectional, fault-tolerant facilities. We believe this architecture provides Numerex Networks with service level standards that meet and exceed requirements for mission-critical applications;
v Secure Network: Numerex is ISO 27001-certified, ISO’s highest security certification for information security that helps to ensure data confidentiality, integrity and availability. Numerex is the first North American M2M service provider to become ISO 27001 certified, and we continue to use advanced security standards throughout our business;
v Network Management: The system allows for the automation of help desk management—from submission to monitoring to lifecycle management of customer issues. It also facilitates the management of tasks and asset inventory records, and indicates which business services are impacted by a given incident or problem. We believe that this helps Technical Support Center develop priorities that resolve customer issues based on business requirements and translates into higher customer satisfaction and quality of service;
v Network Support Services: Building on its operating experience and a solid understanding of data networks and technology, Numerex network support personnel bring a working knowledge of systems and processes for GSM, CDMA, and Satellite service activation, service provisioning, inventory planning and management, and supply chain logistical support; and
v Core Values: Our core values reflect Numerex‘s dedication to providing the best possible service and commitment, i.e., Numerex PRIDE© (People, Responsiveness, Integrity, Development and Excellence).
Numerex primarily employs an indirect sales model through private label/OEM agreements, channel partners, system integrators, and VARs (collectively referred to in some cases as “industry partners”). We also indirectly market and sell certain Numerex branded products and services through distribution and dealer channels, specifically the Uplink product suite.
Our network is integrated and bundled with other Numerex products and services to provide private-labeled solutions for both fixed and portable applications. It is also sold and marketed to VARs, integrators, and application service providers who bundle and resell it with their end-to-end solutions. In addition, the Numerex network is also sold as a data-only network offering for enterprise customers running M2M applications.
Our private-label solutions are designed for and marketed to specific vertical markets. Typically, these customers are sales and marketing organizations with vertical market expertise without adequate technical resources that are seeking rapid entry into a market.
Our three focus areas are: residential and commercial security; fixed wireless; and Location-Based services (mobile wireless). In 2009, we have expanded our international capabilities.
Despite the prolonged decline of the U.S. real estate market, Numerex’s residential and commercial security sales, utilizing a recurring revenue-based business model, have demonstrated resilient growth. We believe that product innovation, service quality and customer intimacy are the hallmarks of our success in the industry.
Our wireless-based products and services are sold through a wide network of independent dealers and distributors. Our technology is well positioned in light of the growing wireless substitution, i.e., the growing replacement of traditional landline phone by wireless service. Preliminary results of the January-June 2009 National Health Interview Survey, released in December 2009, indicate that the American homes with only wireless telephones continues to grow. More than one of every five American homes (22.7%) had only wireless telephones during the second half of 2009, an increase of 2.5% since the first half of 2008.
According to Berg Insight, most of the machines produced annually are for housing and industrial purposes. Home appliances, energy meters, HVAC equipment, health monitoring devices, and POS terminals are examples of machines that can utilize fixed wireless services.
Numerex expects the fixed wireless telemetry segment to continue growing, since it encompasses a broad range of applications and critical government-financed projects. In addition, we believe that services such as remote patient monitoring will also benefit from the wireless substitution.
We were the first M2M business with a dedicated and integrated solution for transitioning analog-based applications to new digital network platforms. We provided an effective migration path to a broad array of businesses, and as a result, in a challenging environment, we have benefitted from account retention.
Location-Based Services (LBS) consist of applications that incorporate value-added features and functions in addition to the real-time generation and delivery of location data. LBS lies at the intersection of many technologies such as the Internet; mobile computing platforms; Geographic Information Systems (GIS); as well as various geo-positioning and wireless communications technologies and the market trend requiring greater visibility, intelligent information, security and worldwide ubiquity for high dollar / critical assets or loads.
The range of LBS applications is extremely diverse, i.e., from intelligent transport systems, such as fleet management, to personal location services.
We provide complete tracking and back-end services that achieve a cost-effective solution to deliver on what the market needs for visibility, security and worldwide coverage that encompasses devices, (satellite and cellular-based) networks and applications ideally suited to our customers’ needs and requirements. These services are primarily supplied on the Numerex FAST and FELIX (Numerex‘s Total Asset Visibility Software) platforms.
Market segments that we currently serve include federal emergency and military programs; energy including oil and gas; and transportation
Numerex has been strengthening its international capabilities in 2009. We believe that we are in a solid position to provide secure and efficient M2M services across the globe, either locally or internationally. Starting with our strong foothold in North America, we are expanding into various international markets.
NUMEREX NON-CORE BUSINESS: DIGITAL MULTIMEDIA, NETWORKING AND WIRELINE DATA COMMUNICATIONS
Numerex’s primary focus is wireless M2M networks and solutions as described above. We continue to offer products and services to certain customers in Digital Multimedia education, networking integration and Derived Channel wireline data communications. These products and services currently comprise about 6% of our revenue base and are managed as a single business group.
We design, develop, and market complete video conferencing and digital multimedia system products and services for high-quality communications networks. We manufacture both the products upon which the systems are based and incorporate third-party products where appropriate. The offerings include PowerPlay™, a digital multimedia solution for high-bandwidth private network applications. PowerPlay provides capability for interactive videoconferencing and is an integrated hardware-software system that supports user-friendly control over network devices. PowerPlay is supplemented by our desktop videoconferencing software version, IPContact™, which offers high-quality and high-performance video.
We provide products under the Digilog brand that assist both wireline and wireless carriers in the engineering, installation, and servicing of new telecommunications control networks. These telecommunications network operational support systems and services can be categorized as: Services, including system integration (rack and stack) and Installation: Products, Test Access and Interconnecting Devices.
This licensed technology creates a “derived channel” on an existing telephone line by using an inaudible frequency below the voice communications spectrum for data transmission. This creates a two-way communication system that continuously monitors the integrity of a user’s telephone line and security system.
Our digital multimedia products and services are marketed through a combination of system integrators and VARs. Our networking products are sold and marketed under the Digilog brand. Distribution is focused on wireless and wireline telecommunications companies through system integration agreements with a number of suppliers of telecommunications and monitoring equipment and services. Our Wireline Data Communications service is marketed under the DCX brand directly to carriers primarily in the United States and Australia.
NUMEREX BUSINESS ENVIRONMENT
For the year ended December 31, 2009, revenue from our largest customer, General Electric (GE), accounted for an aggregate of approximately 14.7% of our total revenue. We do not have any other customers that comprise more than 10% of our total revenue.
We rely on third-party contract manufacturers and wireless network operators/ carriers, both in the United States and overseas, to manufacture most of the equipment used to provide our wireless M2M solutions, networking equipment and products, and to provide the underlying network service infrastructure that we use to support our M2M data network, respectively.
Several businesses that share our M2M space can be viewed as competitors, such as application service providers, Mobile Virtual Network Operators (MVNOs), system integrators, and wireless operators/ carriers that offer a variety of the components and services required for the delivery of complete M2M solutions. However, Numerex believes it has a competitive advantage and is uniquely positioned as an M2M service provider since it provides all of the key components of the M2M value chain, including enabling hardware, multiple wireless technologies and custom applications, and wireless network services. We market and sell complete network-enabled solutions, or individual components, based upon the specific needs of the customer.
We believe that our current M2M services combined with the continuing development of our network offerings and technology positions us to compete effectively with emerging providers of M2M solutions using Global System for Mobile Communications (GSM), Code Division Multiple Access (CDMA) and satellite technology. Other potentially competitive offerings may include “wireless fidelity” (Wi-Fi), World Interoperability for Microwave Access (WiMAX) and other emerging technologies and networks. We believe that principal competitive factors when selecting an M2M service or network-only provider are network reliability, data security, and customer support. We view the recent increased interest in M2M from wireless carriers, such as, but not limited to Verizon’s Open Development Initiative, Sprint’s Emerging Solutions, Vodafone’s Global M2M Services Platform and AT&T’s Control Center, in the United States and abroad, as a source of competitive threats as well as opportunities. Those operators have the capability and wherewithal to provide M2M competitive offerings. However, we offer expertise, experience and services that complement well the operators’ in the M2M arena.
We believe that our M2M service platforms, our network gateways, together with competitive pricing, end-to-end solution offerings, a ‘single source’ approach to the M2M market, extensive experience and intellectual property, will allow Numerex to effectively maintain and increase its current market share.
Our Uplink security products and services have three primary competitors in the existing channels of distribution — Honeywell’s AlarmNet, Telular’s Teleguard and DSC, the security division of TYCO. The principal competitive factors when making a product selection in the business and consumer security industry are hardware price, service price, reliability, industry certification status and feature requirements for specific security applications, for example fire, burglary, bank vault, etc. Additional competitors have entered the market in the last several years with a focus on blending security monitoring and home automation. These products and services are targeted for the do-it-yourself market as opposed to traditional security dealers. Several companies, including GE Security, offer OEM versions or include alarm monitoring technology and network services provided by Numerex. We believe that the Uplink products and services are competitively positioned and priced.
Our Numerex Mobile end-to-end product is offered to a variety of customers, primarily comprised of resellers and VARs. There are many competitors offering vehicle location and recovery services, but the principal direct competitor to our customer base in the new car after-market vehicle location and recovery business is LoJack Corporation, the industry’s market leader. OnStar Corp., a subsidiary of General Motors Corp., which offers a full suite of concierge services, markets and sells their services primarily through automobile manufacturers. Other manufacturers are also moving to provide factory direct “networked cars” including Ford and others. There are also numerous other small companies that currently offer or are developing other wireless products and services for this market. The principal competitive factors are channel distribution, hardware price, network service price, features, and the ability to locate a vehicle at any time on demand.
Our competitive challenge is the pressure to maintain our hardware margins with an on-going process of cost reduction associated with the in-vehicle hardware and the expansion of our distribution network. We believe our mobile hardware-based solution for this market will continue to undergo pricing pressure and will require hardware cost reduction in order to remain competitive.
The market for our technology and platforms has been characterized by rapid technological change. The principal competitive factors in this market include product performance, ease of use, reliability, price, breadth of product lines, sales and distribution capability, technical support and service, customer relations, and general industry and economic conditions. The ability to provide wireless network service, wireless radios, device and modem technology, and end-to-end solutions -- including integration, network and service management -- has set Numerex apart from the competition. We believe that our distribution agreements with module manufacturers give us a competitive advantage in combining the sale of their radio modules with the marketing and selling of our network and technology services.
Technology is subject to abrupt change, and the introduction by competitors of new products, technologies, and applications in our markets could adversely affect our business. Our success will depend, in part, on our ability to enhance our existing products and introduce new products and applications on a timely basis. We plan to continue to devote a portion of our resources to research and development. Our engineering and development expenses were $2.4 million for the year ended December 31, 2009, as compared to $2.2 million for the year ended December 31, 2008 and $1.5 million for the year ended December 31, 2007.
We continue to invest in new services and improvements to our various technologies, especially networks and digital fixed and mobile solutions. We primarily focus on the development of M2M services and enabling platforms, enhancement of our gateway and network services, reductions in the cost of delivery of our network services and solutions, and enhancements and expansion of our application capabilities.
We have concentrated on providing customers with industry-benchmark offerings that go beyond the network requirement. Prudent integration of new digital and Web technology into our wireless businesses is an active and ongoing process. We are committed to taking full advantage of such new technology whenever and wherever it makes sense to our customers.
Our M2M wireless communications business typically provides a limited, one-year repair or replacement warranty on all hardware-based products. Our wireline data communications (Derived Channel) business provides customers with limited one-year repair or replacement warranties on scanners and message switch software, while Subscriber Terminal Units (STUs) are typically sold with a limited one-year repair or replacement warranty. Our digital multimedia business typically provides a limited one-year warranty on parts and labor. Our networking business provides a limited one- or two-year repair or replacement warranty on all telecommunications networking hardware products. In addition, a help desk and training support is offered to users of telecommunications networking products. To date, warranty costs and the cost of maintaining our warranty programs have not been material to our business.
We hold patents either directly (under Numerex Corp.) or through our subsidiaries covering the technologies we have developed in support of our product and service offerings in the United States and various other countries. These patents are by law subject to expiration. It is our practice to apply for patents as we develop new technologies, products, or processes suitable for patent protection. No assurance can be given about the scope of the patent protection.
We also hold other intellectual property rights including, without limitation, copyrights, trademarks, and trade secret protections relating to our technology, products, and processes. Patents have a limited legal lifespan, typically 20 years from the filing date for a utility patent filed on or after June 8, 1995. We believe that rapid technological developments in the telecommunications and locate-bases services industries may limit the protection afforded by patents. We believe that our success will also depend on our manufacturing, engineering, and marketing know-how and the quality and economic value of our products, services, and solutions.
In an effort to maintain the confidentiality and ownership of our trade secrets and proprietary information, we require all of our employees and consultants to sign confidentiality agreements. Employees and consultants involved in technical endeavors also sign invention assignment agreements. We intend these confidentiality and assignment agreements to protect our proprietary information by controlling the disclosure and use of technology to which we have rights. These agreements also provide that we will own all the proprietary technology developed at Numerex or developed using our resources.
Federal, state, and local telecommunications laws and regulations have not posed any significant impediments to either the delivery of wireless data signals/ messaging using our networks. However, we may be subject to certain governmentally imposed telecommunications taxes, surcharges, fees, and other regulatory charges, as well as new laws and regulations governing our business and markets. As we expand our international sales, we may be subject to telecommunications regulations in those foreign jurisdictions.
Our operations and performance depend on overall domestic and global economic conditions. Recessionary forces worldwide have contributed to slowdowns in the technology industry generally, and the specific markets we serve, such as the residential real estate and home security markets. Declining consumer confidence driven by fears of a prolonged recession, may impact the demand for our products, increase price competition in the markets we serve, and increase our risk of carrying excess inventory. On the other hand, an uncertain economic environment may contribute to a sentiment of insecurity that may be conducive to increasing the demand for alarm monitoring services and vehicle tracking solutions. In addition, as federal, state and local governments are considering investing billions of dollars to repair the country’s ailing infrastructure, the demand for “smart” technologies, including the type of products and services offered by Numerex, could increase significantly.
As of March 15, 2010, we had 124 employees in the U.S., consisting of 31 in sales, marketing and customer service, 59 in engineering and operations and 34 in management and administration. We have experienced no work stoppages and none of our employees are represented by collective bargaining arrangements. We believe our relationship with our employees is good.
We make available free of charge through our website at www.numerex.com our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments thereto filed or furnished pursuant to 13(a) or 15(d) of the Securities and Exchange act of 1934, as soon as reasonably practicable after such reports are filed with or furnished to the Securities and Exchange Commission. Our filings are also available through the Securities and Exchange Commission via their website, http://www.sec.gov. You may also read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The information contained on our website is not incorporated by reference in this annual report on form 10-K and should not be considered a part of this report.
Executive Officers of the Registrant
Our executive officers, and all persons chosen to become executive officers, and their ages and positions as of March 31, 2010, are as follows:
*Member of the Board of Directors
Mr. Nicolaides has served as Chief Executive Officer of the Company since April 2000, having served as Chief Operating Officer from April 1999 until March 2000 and as Chairman of the Board since December 1999. From July 1994 until April 1999, Mr. Nicolaides managed a closely held investment partnership.
Mr. Marett has been an Officer of the Company since February 2001. In February 2005 he was named Chief Operating Officer. From 1999 to 2001, Mr. Marett was Vice President, Sales and Marketing, of TManage, Inc., which provided planning, installation, and support services to companies with large remote workforces. From 1997 to 1999 Mr. Marett was Vice President, Business Development, of Mitel Business Communications Systems, a division of Mitel Corporation. Prior to 1997, Mr. Marett held a number of executive positions at Bell Atlantic.
Mr. Catherall has been the Chief Financial Officer of the Company since June 2003. From 1998 to 2002, Mr. Catherall served as Chief Financial Officer of AirGate PCS, a NASDAQ-listed wireless company. From 1996 to 1998, Mr. Catherall was a partner in Tatum CFO LLP, a financial services consulting company. Prior to 1996, he held a number of executive and management positions at MCI Communications.
Mr. Fienberg serves as the Company’s Executive Vice President for Corporate Development and has been with the Company since July 2004. From August 2003 to July 2004, Mr. Fienberg served as Managing Director of an investment banking firm. From 1992 to 2003, Mr. Fienberg was a Senior Vice President and merger and acquisition specialist with Jefferies and Company, Inc.
Mr. Lang has been an Executive Vice President of the Company since January 2008 and directs the focus and execution of sales and marketing. From January 2006 through December 2007 Mr. Lang served as Senior Vice President of Sales for the Company and President of Airdesk, LLC. Prior to joining the Company in January of 2006, Mr. Lang was founder and President of Airdesk, Inc. From 1988 to 1997, Mr. Lang founded and led a wireless voice and data services company and also co-founded an internet services company which was sold to Verio in 1997.
Dr. Smith has served as the Chief Technology Officer since October 9, 2008. From June 2007 to October 2008, he served as the President and Chief Executive Officer of Ublip, Inc. a provider of M2M and location based services that Dr. Smith founded. From January 2002 until June 2007, Dr. Smith served as President and Chief Executive Officer of SensorLogics, Inc., an M2M application service provider that he also founded. From June 1996 until January 2000, Dr. Smith served as regional President and director of NTT/Verio, an internet service provider and web hosting company. From October 1993 until January 1997, he served as President and Chief Executive Officer of OnRamp Technologies, an internet service provider that he co-founded.
Item 1A. Risk Factors
An investment in our common stock involves a high degree of risk. You should carefully consider the following information about these risks before buying shares of our common stock. The following risks and uncertainties are not the only ones facing us. Additional risks and uncertainties of which we are unaware or we currently believe are not material could also adversely affect us. In any case, the value of our common stock could decline, and you could lose all or part of your investment. You should also refer to the other information contained in this Form 10-K or incorporated herein by reference, including our consolidated financial statements and the notes to those statements. See also, “Special Note Regarding Forward-Looking Statements.”
Risks Related to Our Business
We have a history of losses and are uncertain as to our future profitability.
We have had mixed success with regard to generating profits. We incurred losses in 2008 and 2009 after being profitable from 2005-2007. Prior to 2005, we had net operating losses in each year dating back to 1998. In view of our operating costs, and given all other risk factors discussed herein, we may not be profitable in the future. Moreover, as a holding company our primary material assets are our ownership interests in our subsidiaries and in certain intellectual property rights. Consequently, our earnings derive from our subsidiaries and we depend on accumulated cash flows, distributions, and other inter-affiliate transfers from our subsidiaries. In view of all of the risk factors discussed herein, we cannot assure you that the operating results of our subsidiaries, accumulated cash flows, or the distributions they make to us at any given time will be sufficient to sustain our earnings.
A prolonged overall economic downturn, or one or more market-specific downturns, could have a material adverse effect on our financial condition and operating results.
Our operations and performance depend significantly on overall domestic and global economic conditions. Economic conditions worldwide continue to contribute to slowdowns in the technology industry generally, as well as to slowdowns within the specific markets we serve, such as transportation and commercial and residential security. The current, highly uncertain macroeconomic climate including, but not limited to, limited availability of credit, eroding home values and a slowdown in new housing starts, and declining consumer confidence driven by fears of a prolonged recession, threatens to reduce demand for our products, increase price competition in the markets we serve, and increase our risk of carrying excess inventory. In particular, we anticipate that a continued slowdown in the number of new housing starts will result in a slowdown in the sales of our residential alarm monitoring products. If overall conditions worsen significantly, commercial and residential consumers may also decide to cancel wireless monitoring services in an effort to eliminate expenses they may view as “discretionary” or “non-critical”. Similarly, declining vehicle sales associated with an overall economic downturn negatively impacts sales of our vehicle tracking solutions. All of these and other macroeconomic factors could have a material adverse effect on demand for our products and services and on our financial condition and operating results.
The markets in which we operate are highly competitive, and we may not be able to compete effectively.
We face competition from many companies with significantly greater financial resources, well-established brand names, and larger customer bases. Numerous companies also may try to enter our market and expose us to greater price competition. We expect such competition to intensify in the future. If our competitors successfully focus on the markets we serve, our business could be adversely affected.
Our future operating performance depends on the performance of resellers, value added resellers, and other distributors.
We distribute our products through wholesalers, resellers, value-added resellers, and other distributors, many of whom distribute products from competing manufacturers. Many resellers operate on narrow margins and have been adversely affected by current overall economic conditions. Our financial condition and operating results could be materially adversely affected if the financial condition of these resellers weakens, if resellers stop distributing our products, or if uncertainty regarding demand for our products causes resellers to reduce their orders for, and curtail the marketing of, our products. We have invested and will continue to invest in programs to enhance reseller sales. These programs could require a substantial investment while providing no assurance of return or incremental revenue.
We operate in new and rapidly evolving markets where rapid technological change can quickly make products, including those that we offer, obsolete.
The markets we operate in are subject to rapid advances in technology, continuously evolving industry standards and regulatory requirements, and ever-shifting customer requirements. The M2M wireless data communications field, in particular, is currently undergoing profound and rapid technological change. For example, cellular carriers that we rely upon in delivering our network services began dismantling their analog networks in 2008 and by the end of 2009 were only supporting digital connections. While we were largely successful in managing that risk and transitioning our existing customer base to the digital standard, the introduction of unanticipated new technologies by carriers, or the development of unanticipated new end use applications by our customers, could render our current solutions obsolete. In that regard, we must discern current trends and anticipate an uncertain future. We must engage in product development efforts in advance of events that we cannot be sure will happen and time our production cycles and marketing activities accordingly. If our projections are incorrect, or if our product development efforts are not properly directed and timed, or if the demands of the marketplace shift in directions that we failed to anticipate, we may lose market share and revenues as a result. To remain competitive, we continue to support engineering and development efforts intended to bring new products to the markets that we serve. However, those efforts are capital intensive. If we are unable to adequately fund our engineering and development efforts, we may not be successful in keeping our product line current with advances in technology and evolving customer requirements. Even with adequate funding, our development efforts may not yield any appreciable short-term results and may never result in products that produce revenues over and above our cumulative development costs or that gain traction in the marketplace, causing us to either lose market share or fail to increase and forego increased sales and revenues as a result.
Failure of our new products and services to gain market acceptance would adversely affect our financial condition.
Over the past several years, among many initiatives, we have introduced a system enabling alarm signals to be transmitted digitally over the cellular network to central monitoring stations; a cellular and GPS-based vehicle tracking solution; satellite-based asset monitoring and tracking solutions; a multimedia videoconferencing solution, enhanced “back end” services; and, most recently, with our acquisition of uBlip, Inc., enhanced application development capabilities. If these products and services, or any of our other existing products and services, do not perform as expected, or if our sales are less than expected, our business may be adversely affected.
We may experience long sales cycles for our products, as a result of a variety of factors.
Certain of our product offerings, for example our satellite-based asset tracking solutions, are subject to long sales cycles in view of the need for testing of our products in combination with our customers’ applications and third parties’ technologies, the need for regulatory approvals and export clearances, and the need to resolve other complex operational and technical issues. In the government contracting arena in particular, longer sales cycles are reflective of the fact that government contracts can take months or longer to progress from a “request for proposal” to a finalized contract document pursuant to which we are able to sell a finished product or service. Terms and conditions of sale unique to the government sector may also affect when we are able to recognize revenues. For that reason, quarter-over-quarter comparisons of our financial results may not always be meaningful.
If we are unable to provide our suppliers with accurate forecasts of our product needs, margins could be adversely affected.
We are contractually obligated to provide our suppliers with forecasts of our demand for manufactured products. Specific terms and conditions vary by contract, however, if our forecasts do not result in the production of a quantity of units sufficient to meet demand we may be subject to contractual penalties under some of our contracts with our customers. By contrast, overproduction of units based on forecasts that that overestimate demand could result in an accumulation of excess inventory that, under some of our contracts with our customers, would have to be managed at our expense thus adversely impacting our margins. Excess inventory that becomes obsolete or that we are otherwise unable to sell would also be subject to write-offs resulting in adverse affects on our margins.
The loss of one or just a few of our significant customers could negatively impact our revenues.
In 2009, a single customer, General Electric, accounted for approximately 14.7% of our annual revenues and it is possible that such customer’s purchases in 2010 will account for 10% or more of our anticipated revenues for 2010. The loss of such a customer could have a material adverse affect on our revenues, operating income and net earnings.
We are dependent on a number of network service providers, manufacturers and suppliers of our products and product components, the loss of any one of which could adversely impact our ability to service or supply our customers.
The loss or disruption of key telecommunications infrastructure services and key wireless network services supplied to the Company would unfavorably impact our ability to adequately service our customers. Our long-term success depends on our ability to operate, manage, and maintain a reliable and cost effective network, as well as our ability to keep pace with changes in technology. Furthermore, our network operations are dependent on third parties. If we experience technical or logistical impediments to our ability to transfer traffic onto our network, fail to generate additional traffic on our network, or if we experience difficulties with our third party providers, we may not achieve our revenue goals or otherwise be successful in growing our business.
We outsource the manufacturing of our products to independent companies located in the United States and overseas and do not have internal manufacturing capabilities to meet the demands of our customers. Any delay, interruption, or termination of the manufacture of our products could harm our ability to provide our products to our customers and, consequently, could have a material adverse effect on our business and operations. The manufacture of our products requires specialized know-how and capabilities possessed by a limited number of enterprises. Consequently, we are reliant on just a few suppliers for the manufacture of key products and product components. If a key supplier experiences production problems or financial difficulties, we may not be able to obtain enough units to meet demand, which could result in failure to meet our contractual commitments to our customers, further causing us to lose sales and generate less revenue. If any of our products or product components contain significant manufacturing defects that the existing manufacturer or supplier is unable to resolve, we could also have difficulty locating a suitable alternative manufacturer or supplier. Related efforts to design replacement products or product components could also take longer and prove costlier than planned, resulting in a material adverse impact on our financial condition and operating results.
The loss of a few key technical personnel could have an adverse affect on us in the short-term.
We rely on a relatively small number of technical personnel who play key roles in maintaining the back-end technology and systems that enable us to provide network services to our customers and that is also central to our product development efforts. Other personnel have crucial expertise in application development. The loss of some of those personnel could result, temporarily, in shortfalls in the knowledge base of our remaining technical staff concerning existing products and services as well as products and services that are under development.
Our products and services experience quality problems from time to time that can result in decreased sales and operating margin.
Our products and services, and the applications they support, are complex. While we test our products, they may still have errors, defects, or bugs that we find only after commercial production has begun. In the past, we have experienced errors, defects, and bugs in connection with new products. Our customers may not purchase our products if the products have reliability, quality, or compatibility problems. Furthermore, product errors, defects, or bugs could result in additional development costs, diversion of resources from our other development efforts, claims by our customers or others against us, or the loss of credibility with our current and prospective customers. Historically, the time required for us to correct defects has caused delays in product shipments and resulted in lower than expected revenues. Significant capital and resources may be required to address and fix problems in new products. Failure to do so could result in lost revenue, harm to reputation, and significant warranty and other expenses, and could have a material adverse impact on our financial condition and operating results.
We may lose customers if we experience system failures that significantly disrupt the availability and quality of the service our network provides.
The operation of our network depends on our ability to avoid or limit any interruptions in service to our customers. Interruptions in service or performance problems, for whatever reason, could undermine confidence in our services and cause us to lose customers or make it more difficult to attract new customers. In addition, because most of our customers are businesses, any significant interruption in service could result in lost profits or other losses to our customers. Although we attempt to disclaim or limit liability in our agreements with these customers, a court may not enforce a limitation on liability, which could expose us to losses. The failure of any equipment on our network, or that of a customer’s or end user’s equipment, could result in the interruption of service until necessary repairs are made or replacement equipment is installed. Network failures, delays, and errors may result from natural disasters, power losses, security breaches, viruses or terrorist acts. These failures or faults cause delays, service interruptions, expose us to customer liability, or require expensive modifications that could have a material adverse effect on our business and operating results.
We may have difficulty identifying the source of a problem in our network.
If a problem occurs on our network, it may be difficult to identify the source of the problem due to the overlay of our network with cellular, and/or satellite networks and our network’s reliance on those other networks. The occurrence of hardware or software errors, regardless of whether such errors are caused by our products or our network, may result in the delay or loss of market acceptance of our products and services, and any necessary revisions may result in significant and additional expenses. The occurrence of some of these types of problems may seriously harm our business, financial condition, or operations. Given our dependence on cellular, and satellite telecommunications service providers, risks specific or unique to their technologies, i.e., the loss or malfunction of a satellite or satellite ground station, should also be viewed as having the potential to impair our ability to provide services.
A natural disaster or other weather events could diminish our ability to provide service; our revenues may be impacted by weather patterns.
Although our internal platform is very robust and supported by redundant systems including, for example, a leased facility that is physically remote from our primary network operations center and would enable us to maintain continuity of network operations were our primary site to cease operating, there is the possibility that natural or other disasters including, without limitation, hurricanes, tornadoes, earthquakes, or solar flares could damage or destroy our facilities resulting in a disruption of service to our customers. If a future natural or other disaster impairs or destroys any of our facilities, we may be unable to provide service to our customers in the affected area for a period of time. In addition, even if our facilities are not affected by natural disasters, our service could be disrupted if a natural disaster damages the third party cellular or satellite networks we are interconnected with. Further, in the event of an emergency, the telecommunications networks that we rely upon may become capacity constrained or preempted by governmental authorities.
With respect to our satellite-based asset tracking unit in particular, sales may be influenced by weather patterns. For example, if government agencies and emergency responders anticipate a relatively “mild” storm season, they buy fewer of our units for deployment in support of disaster response operations.
We may require additional capital to fund further development, and our competitive position could decline if we are unable to obtain additional capital, or access the credit markets.
To address our long-term capital needs, we intend to continue to pursue strategic relationships that would provide resources for the further development of our product candidates. There can be no assurance, however, that these discussions will result in relationships or additional funding. In addition, we may continue to seek capital through the public or private sale of securities, if market conditions are favorable for doing so. If we are successful in raising additional funds through the issuance of equity securities, stockholders will likely experience dilution, or the equity securities may have rights, preferences, or privileges senior to those of the holders of our common stock. If we raise funds through the issuance of debt securities, those securities would have rights, preferences, and privileges senior to those of our common stock.
The current credit environment has negatively affected credit market liquidity, which could increase borrowing costs or limit availability of funds. If we are not successful in obtaining sufficient capital because we are unable to access the capital markets at financially economical interest rates, it could reduce our product development efforts and may materially adversely affect our future growth, results of operations and financial results, and we may be required to curtail significantly, or eliminate at least temporarily, one or more of our engineering and development programs involving new products and technologies.
If we achieve our growth goals, we may be unable to manage our resulting expansion.
To the extent that we are successful in implementing our business strategy, we may experience periods of rapid expansion. In order to effectively manage growth, whether organic or through acquisitions, we will need to maintain and improve our operations and effectively train and manage our employees. Our expansion through acquisitions is contingent on successful management of those acquisitions, which will require proper integration of new employees, processes and procedures, and information systems, which can be both difficult and demanding from an operational, managerial, cultural, and human resources perspective. We must also expand the capacity of our sales and distribution networks in order to achieve continued growth in our existing and future markets. The failure to manage growth effectively in any of these areas could have a material adverse effect on our financial condition and operating results.
We are subject to risks associated with laws, regulations and industry-imposed standards related to mobile communications devices.
Laws and regulations related to mobile communications devices in the many jurisdictions in which the Company operates are extensive and subject to change. Such changes, which could include but are not limited to restrictions on production, manufacture, distribution, and use of mobile devices, locking the devices to a carrier’s network, or mandating the use of the device on more than one carrier’s network, could have a material adverse effect on our financial condition and operating results. Mobile communication devices we sell are subject to certification and regulation by governmental and standardization bodies, as well as by cellular network carriers for use on their networks. These certification processes are extensive and time consuming, and could result in additional testing requirements, product modifications or delays in product shipment dates, which could have a material adverse effect on our financial condition and operating results.
Our expansion into government markets subjects us to increased regulation. We must comply with a complex set of rules and regulations applicable to government contractors. Failure to comply with an applicable rule or regulation could result in our suspension of doing business with the government or cause us to incur substantial penalties.
Many of the ultimate consumers of our PowerPlay™ hardware and services are elementary and secondary schools that pay for their purchases with funding that they receive through the Schools and Libraries Program (commonly known as the “E-Rate Program”) of the Universal Service Fund, which is administered by the Universal Service Administrative Company (USAC) under the direction of the FCC. Demand for products and services under the E-Rate Program is very difficult to predict and changes in the program itself could also affect demand.
We may be subject to telecommunications taxes, surcharges, and fees, and changes in these could affect our results of operations. And, as we expand beyond the “business-to-business” market and begin providing some services directly to end user consumers, some of our sales could become subject to federal and state level consumer protection laws and other regulations that could prompt adverse legal action in the event of an alleged violation of those laws.
If our goodwill or amortizable intangible assets become impaired we may be required to record a significant charge to earnings.
Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is tested for impairment at least annually. Factors that may be considered a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively impacting our results of operations.
An increasing portion of our future revenue will be derived from contracts with the U.S. government, government agencies, or other U.S. government contractors. These agreements are subject to uncertain future funding and possible termination.
Historically, a significant portion of our revenues from the sale of satellite-based tracking solutions through our location-based services division has been derived from sales made by us indirectly as a subcontractor to a prime government contractor that has the direct relationship with the U.S. government. If the prime contractor loses business with respect to which we serve as a subcontractor, our government business would be hurt. We also maintain a Federal Supply Schedule with the General Services Administration and anticipate doing an increasing amount of business directly with the U.S. government and government agencies. If we, as the prime contractor, were to lose some or all of such business, our revenues derived from the sale of satellite-based tracking solutions would suffer as a result. The funding of U.S. government programs is uncertain and dependent on continued congressional appropriations and administrative allotment of funds based on an annual budgeting process. We cannot assure you that current levels of congressional funding for our location-based services division’s offerings will continue. Furthermore, all of our contracts with the U.S. government are terminable by the U.S. government (or, in certain circumstances, by us) at will. A significant decline in government expenditures generally, or with respect to programs for which we provide products, could adversely affect our business and prospects. Our operating results may also be negatively affected by other developments that affect these government programs generally, including the following:
These developments and other factors could cause governmental agencies to reduce their purchases under existing contracts, to exercise their rights to terminate contracts at-will or to abstain from renewing contracts, any of which would cause our revenue to decline and could otherwise harm our business, financial condition and results of operations.
Agreements with government agencies may lead to claims against us under the Federal False Claims Act or other federal statutes. These claims could result in substantial fines and other penalties.
Our agreements with the U.S. government are subject to substantial financial penalties under the Civil Monetary Penalties Act and the False Claims Act and, in particular, actions under the False Claims Act’s “whistleblower” provisions. Private enforcement of fraud claims against businesses on behalf of the U.S. government has increased due in large part to amendments to the False Claims Act that encourage private individuals to sue on behalf of the government. These whistleblower suits by private individuals, known as qui tam actions, may be filed by almost anyone, including present and former employees. The False Claims Act statute provides for treble damages and up to $11,000 per claim on the basis of the alleged claims. Prosecutions, investigations or qui tam actions could have a material adverse effect on our liquidity, financial condition and results of operations. Finally, various state false claim and anti-kickback laws also may apply to us. Violation of any of the foregoing statutes can result in criminal and/or civil penalties that could have a material adverse effect our business.
U.S. government contracts contain provisions that are unfavorable to us.
U.S. government contracts contain provisions, and are subject to laws and regulations, that give the government rights and remedies not typically found in commercial contracts. These provisions may allow the government to
If the government terminates a contract for convenience, we may recover only our incurred or committed costs, settlement expenses and profit on work completed prior to the termination. If the government terminates a contract for default, we may not recover even those amounts, and instead may be liable for excess costs incurred by the government in procuring undelivered items and services from another source. We may experience performance issues on some of our contracts. We may receive show cause or cure notices under contracts that, if not addressed to the government’s satisfaction, could give the government the right to terminate those contracts for default or to cease procuring our services under those contracts in the future.
Unfavorable results of legal proceedings could materially adversely affect us.
We are subject to various legal proceedings and claims that have arisen out of the ordinary conduct of our business and are not yet resolved and additional claims may arise in the future. Results of legal proceedings cannot be predicted with certainty. Regardless of its merit, litigation may be both time-consuming and disruptive to our operations and cause significant expense and diversion of management attention. In recognition of these considerations, we may enter into material settlements. Should we fail to prevail in certain matters, or should several of these matters be resolved against us in the same reporting period, we may be faced with significant monetary damages or injunctive relief against us that would materially adversely affect a portion of our business and might materially affect our financial condition and operating results.
We operate internationally, which subjects us to international regulation and business uncertainties that create additional risk for us.
We have been doing business directly, or via our distributors, in Australia, Canada, Mexico, and Pakistan, and are expanding, directly or via our distributors, into additional countries in Latin America, Europe, the Middle East, and Asia. Accordingly, we or our distributors are subject to additional risks, such as:
We have only limited experience in marketing and operating our services in certain international markets. Moreover, we have in some cases experienced and expect to continue to experience in some cases higher costs as a percentage of revenues in connection with establishing and providing services in international markets versus the U.S. In addition, certain international markets may be slower than the U.S. in adopting the outsourced communications solutions and so our operations in international markets may not develop at a rate that supports our level of investments.
If we become subject to unanticipated foreign tax liabilities, it could materially increase our costs.
We are doing business in, and are expanding into, foreign tax jurisdictions. We believe that we have complied in all material respects with our obligations to pay taxes in these jurisdictions. If the applicable taxing authorities were to challenge successfully our current tax positions, or if there were changes in the manner in which we conduct our activities, we could become subject to material unanticipated tax liabilities. We may also become subject, prospectively or retrospectively, to additional tax liabilities following changes in tax laws. The application of existing, new or future laws could have adverse effects on our business, prospects and operating results. There have been, and will continue to be, substantial ongoing costs associated with complying with the various indirect tax requirements in the numerous markets in which we conduct or will conduct business.
We may not be aware of certain foreign government regulations.
Because regulatory schemes vary by country, we may be subject to regulations in foreign countries of which we are not presently aware. If that were to be the case, we could be subject to sanctions by a foreign government that could materially and adversely affect our ability to operate in that country. We cannot assure you that any current regulatory approvals held by us are, or will remain, sufficient in the view of foreign regulatory authorities, or that any additional necessary approvals will be granted on a timely basis or at all, in all jurisdictions in which we wish to operate, or that applicable restrictions in those jurisdictions will not be unduly burdensome. The failure to obtain the authorizations necessary to operate satellites internationally could have a material adverse effect on our ability to generate revenue and our overall competitive position. We, our customers and companies with whom we do business may be required to have authority from each country in which we or they provide services or provide our customers use of our products and services. Because regulations in each country are different, we may not be aware if some of our customers and/or companies with which we do business do not hold the requisite licenses and approvals.
Risks Related to Our Intellectual Property
The loss of intellectual property protection both U.S. and international, could have a material adverse effect on our operations.
Our future success and competitive position depend upon our ability to obtain and maintain intellectual property protection, especially with regard to our core business. We cannot be sure that steps taken by us to protect our technology will prevent misappropriation of the technology. Our services are highly dependent upon our technology and the scope and limitations of our proprietary rights therein. If our assertion of proprietary rights is held to be invalid, or if another party’s use of our technology were to occur to any substantial degree, our business, financial condition and results of operations could be materially adversely affected. In order to protect our technology, we rely on a combination of patents, copyrights, and trade secret laws, as well as certain customer licensing agreements, employee and customer confidentiality and non-disclosure agreements, and other similar arrangements. Loss of such protection could compromise any advantage obtained and, therefore, impact our sales, market share, and results. To the extent that our licensees develop inventions or processes independently that may be applicable to our products, disputes may arise as to the ownership of the proprietary rights to this information. These inventions or processes will not necessarily become our property, but may remain the property of these persons or their full-time employers. We could be required to make payments to the owners of these inventions or processes, in the form of either cash or equity, or a combination of both.
Furthermore, our future or pending patent applications may not be issued with the scope of the claims sought by us, if at all. In addition, others may develop technologies that are similar or superior to our technology, duplicate our technology or design around the patents owned or licensed by us. Effective patent, trademark, copyright, and trade secret protection may be unavailable or limited in foreign countries where we may need protection.
We rely on access to third-party patents and intellectual property, and our future results could be materially adversely affected if we are unable to secure such access in the future.
Many of our products are designed to include third-party intellectual property, and in the future we may need to seek or renew licenses relating to various aspects of its products and business methods. Although we believe that, based on past experience and industry practice, such licenses generally could be obtained on reasonable terms, there is no assurance that the necessary licenses would be available on acceptable terms or at all. Some licenses we obtain may be nonexclusive and, therefore, our competitors may have access to the same technology licensed to us. If we fail to obtain a required license or are unable to design around a patent, we may be unable to sell some of our products, and there can be no assurance that we would be able to design and incorporate alternative technologies, without a material adverse effect on our business, financial condition, and results of operations.
Our competitors may obtain patents that could restrict our ability to offer our products and services, or subject us to additional costs, which could impede our ability to offer our products and services and otherwise adversely affect us. We may, from time to time, also be subject to litigation over intellectual property rights or other commercial issues.
Several of our competitors have obtained and can be expected to obtain patents that cover products or services directly or indirectly related to those offered by us. There can be no assurance that we are aware of all patents containing claims that may pose a risk of infringement by its products or services. In addition, patent applications in the United States are confidential until a patent is issued and, accordingly, we cannot evaluate the extent to which our products or services may infringe on future patent rights held by others.
Even with technology that we develop independently, a third party may claim that we are using inventions claimed by their patents and may go to court to stop us from engaging in our normal operations and activities, such as engineering and development and the sale of any of our products or services. Furthermore, because of technological changes in the M2M industry, current extensive patent coverage, and the rapid issuance of new patents, it is possible that certain components of our products and business methods may unknowingly infringe the patents or other intellectual property rights of third parties. From time to time, we have been notified that we may be infringing such rights.
In the highly competitive and technology-dependent telecommunications field in particular, litigation over intellectual property rights is significant business risk, and some entities are pursuing a litigation strategy the goal of which is to monetize otherwise unutilized intellectual property portfolios via licensing arrangements entered into under threat of continued litigation. Regardless of merit, responding to such litigation can consume significant time and expense. In certain cases, we may consider the desirability of entering into licensing agreements, although no assurance can be given that such licenses can be obtained on acceptable terms or that litigation will not occur. If we are found to be infringing such rights, we may be required to pay substantial damages. If there is a temporary or permanent injunction prohibiting us from marketing or selling certain products or a successful claim of infringement against us requires us to pay royalties to a third party, our financial condition and operating results could be materially adversely affected, regardless of whether we can develop non-infringing technology. While in management’s opinion we do not have a potential liability for damages or royalties from any known current legal proceedings or claims related to the infringement of patent or other intellectual property rights that would individually or in the aggregate have a material adverse effect on its financial condition and operating results, the results of such legal proceedings cannot be predicted with certainty. Should we fail to prevail in any of the matters related to infringement of patent or other intellectual property rights of others or should several of these matters be resolved against us in the same reporting period, our financial condition and operating results could be materially adversely affected.
Risks Related to Our Common Stock and Ownership Structure
Because our stock is held by a relatively small number of investors and is thinly traded, it may be more difficult for you to sell your shares or buy additional shares when you desire to do so and the price may be volatile.
Our common stock is currently listed on the NASDAQ. Our stock is thinly traded and we cannot guarantee that an active trading market will develop, or that it will maintain its current market price. A large number of shares of our common stock are held by a small number of investors. An attempt to sell a large number of shares by a large holder could adversely affect the price of our stock. In addition, it may be difficult for a purchaser of our shares of our common stock to sell such shares without experiencing significant price volatility.
The structure of our company limits the voting power of our stockholders and certain factors may inhibit changes in control of our company.
The concentration of ownership of our common stock may have the effect of delaying, deferring, or preventing a change in control, merger, consolidation, or tender offer that could involve a premium over the price of our common stock. Currently, our executive officers, directors and greater-than-five percent stockholders and their affiliates, in the aggregate, beneficially own approximately 39% of our outstanding common stock. These stockholders, if they vote together, are able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions and matters. The interests of these stockholders may be different than those of our unaffiliated stockholders and our unaffiliated stockholders may be dissatisfied with the outcome of votes that may be controlled by our affiliated stockholders.
Our articles of incorporation generally limit holdings by persons of our common stock to no more than 10% without prior approval by our Board. Except as otherwise permitted by the Board, no stockholder has the right to cast more than 10% of the total votes regardless of the number of shares of common stock owned. In addition, if a person acquires holdings in excess of this ownership limit, our Board may terminate all voting rights of the person during the time that the ownership limit is violated, bring a lawsuit against the person seeking divestiture of amounts in excess of the limit, or take other actions as the Board deems appropriate. Our articles of incorporation also have a procedure that gives us the right to purchase shares of common stock held in excess of the ownership limit. In addition, our articles of incorporation permit our Board to authorize the issuance of preferred stock without stockholder approval. Any future series of preferred stock may have voting provisions that could delay or prevent a change in control or other transaction that might involve a premium price or otherwise be in the best interests of our common stockholders.
Item 1B. Unresolved Staff Comments.
Item 2. Properties.
All of our facilities are leased. Set forth below is certain information with respect to our leased facilities:
We conduct engineering, sales and marketing, and administrative activities at many of these locations. We believe that our existing facilities are adequate for our current needs. As we grow and expand into new markets and develop additional hardware, we may require additional space, which we believe will be available at reasonable rates.
We engage in limited manufacturing, equipment and hardware assembly and testing for certain hardware. We also use contract manufacturers for production, sub-assembly and final assembly of certain hardware. We believe there are other manufacturers that could perform this work on comparable terms.
Item 3. Legal Proceedings.
As previously reported, Orbit One Communications, Inc. (“Orbit One”) and David Ronsen (“Ronsen”) filed an action against Numerex alleging, inter alia, breach of contract in frustrating Orbit One’s ability to achieve earn out targets in the acquisition and employment agreements. Numerex has filed counterclaims against the plaintiffs for fraud, theft of trade secrets and confidential information and breach of the Asset Purchase Agreement; and against Messrs. Ronsen, Naden and Rosenzweig for breach of their fiduciary duties and duty of loyalty to Numerex, as well as breach of their respective Severance Agreements. The action is pending before the United States District Court, Southern District of New York. On April 17, 2009, the parties filed cross-motions for summary judgment. On March 12, 2010, the court entered a decision on the cross-motions for summary judgment. The court held that Mr. Ronsen’s claim that he had “good reason” to resign presented material issues of fact requiring a trial. Similarly, the Court held that Numerex’s claims against Orbit One and its principals for breach of contract, fraudulent inducement, breach of fiduciary duty, and other related claims presented material issues of fact requiring a trial. No trial date has been set.
Numerex believes that the plaintiffs' claims in each of the related actions are without merit and intends to defend against the allegations and to vigorously pursue its counterclaims.
Item 4. Reserved.
Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters and Issuer Purchases of Equity Securities.
The Company’s Common Stock trades publicly on the NASDAQ Global Market System under the symbol NMRX.
The following table sets forth, for the fiscal quarters indicated, the high and low sales prices per share for the Common Stock on the NASDAQ Global Market for the applicable periods.
On March 26, 2010, the last reported sale price of our Class A common stock on The NASDAQ Global Market was $4.29 per share.
As of March 26, 2010, there were 60 holders of record of our Common Stock, approximately one beneficial shareholder and 15,070,501 shares of Common Stock outstanding. Because many of the shares of our common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.
We currently do not pay any cash dividends. In deciding whether or not to declare or pay dividends in the future, the Board of Directors will consider all relevant factors, including our earnings, financial condition and working capital, capital expenditure requirements, any restrictions contained in loan agreements and market factors and conditions. We have no plans now or in the foreseeable future to declare or pay cash dividends on our common stock.
The information included under the heading "Performance Graph" in this Item 5 of this Annual Report on Form 10-K is "furnished" and not "filed" and shall not be deemed to be "soliciting material" or subject to Regulation 14A or 14C, nor shall it be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that we specifically incorporate it by reference into any such filing.
The following graph shows a comparison of the cumulative total return for Common Stock, the NASDAQ Composite Index and the NASDAQ Telecomm Index, assuming (i) an investment of $100 in each, on December 31, 2004, the last trading day before the beginning of the Company’s five preceding years, and, (ii) in the case of the Indices, the reinvestment of all dividends.
Item 6. Selected Consolidated Financial Data.
The following selected financial data should be read in conjunction with the consolidated financial statements and the notes contained in “Item 8. Financial Statements and Supplementary Data” and the information contained in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Historical results are not necessarily indicative of future results.
The following financial information was derived using the consolidated financial statements of Numerex Corp. The table lists historical financial data of the Company for the fiscal years ended December 31, 2009, 2008, 2007, 2006 and 2005.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
This Management’s Discussion and Analysis of financial condition and results of operations contains forward-looking statements that involve risks and uncertainties. Please see “Forward Looking Statements” on page  for a discussion of the uncertainties, risks and assumptions associated with these statements. You should read the following discussion in conjunction with our historical consolidated financial statements and the notes thereto appearing elsewhere in this Annual Report on Form 10-K. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those listed under “Risk Factors” in Section 1A of this Annual Report on Form 10-K.
We are a machine-to-machine (M2M) data communications, technology and solutions business. We combine our network services, hardware and applications development capabilities to create packaged and custom designed M2M solutions for customers across multiple market segments.
Fiscal year 2009 represented a decline in revenues over 2008 and 2007. Full year revenues of $50.8 million decreased $21.5 million, or 29.7%, from 2008. This decrease was primarily the result of decreased hardware sales, as service sales for the comparative years increased.
Gross margins for 2009 were 44.0% compared with 35.1% in 2008. Gross margins were favorably affected by an increase in service revenues, which typically earn a higher gross margin than those achieved by hardware sales.
Fiscal year 2009 overheads, which include selling, general and administrative (SG&A) costs, as well as engineering and development expenses and bad debt costs, collectively were $24.0 million or $7.8 million lower than 2008. The decrease was primarily related to the impairment of goodwill and long-lived assets of $5.3 million incurred during 2008. The decrease is also related to a reduction in professional service and promotional fees of $900,000, a reduction in bad debt costs of $565,000, and a reduction in employee related expenses of $500,000.
Our growth rates were slowed by the impact of the economic downturn, which we expect may continue to adversely affect our revenues. Operating results could be impacted by legal expenses related to litigation.
The following is a discussion of our consolidated financial condition and results of operations for the fiscal years ended December 31, 2009, 2008 and 2007.
Critical Accounting Policies
Note A of the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of Numerex’s Consolidated Financial Statements. The following is a brief discussion of the more significant accounting policies and methods used.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The most significant estimates and assumptions relate to revenue recognition, accounts receivable and allowance for doubtful accounts, inventories and the adequacy of reserves for excess and obsolete inventories, accounting for income taxes and valuation of goodwill and other intangible assets. Actual amounts could differ significantly from these estimates.
Revenues are recognized when the following criteria are met: (1) persuasive evidence of the customer arrangement exists, (2) fees are fixed and determinable, (3) delivery and acceptance have occurred, and (4) collectibility is deemed probable. We primarily sell hardware, recurring services (most billed on a monthly basis) and on-demand services. Hardware revenues are recognized at the time title passes to the customer, which is generally at the time of shipment.
We bill most of our recurring service revenues on a monthly basis, which are generated by providing customers access to our M2M communications network (the Network). We sell these services to value added resellers (VARS) and wholesalers of the service. For services sold to VARS, monthly service fees are generally a fixed monthly amount billed at the beginning of each month. For services sold to wholesalers, the customers are billed a fixed base fee in advance and usage fees in arrears at the end of each month. We defer the advance billing of the base fee and recognize the revenues when the services are performed.
We also provide services on a demand basis. These types of services are generally completed in a short period of time (usually less than one month) and are billed and the revenue recognized when the services are completed.
Some of our customers prepay for services for up to a year in advance. These services include our satellite communication services, 24 hour a day access to our internet based mapping software and other support services. Additionally, these prepaid services expire after a specified period of time. We defer these revenues until the services have been performed or, for unused services, when the term expires.
The Company’s arrangements do not generally include acceptance clauses. However, for those arrangements that include multiple deliverables, we first determine whether each service, or deliverable, meets the separation criteria of counterparty is in accordance with ASC Subtopic 985-605 (American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, Software Revenue Recognition), ASC Subtopic 605-25 (Emerging Issues Task Force (“EITF”) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables), and ASC Section 605-10-S99 (Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition). Specifically, if we enter into contracts for the sale of services and hardware, we evaluate whether the services are essential to the functionality of the hardware and whether there is objective fair value evidence for each deliverable in the transaction. If we conclude the services to be provided are not essential to the functionality of the hardware and we can determine objective fair value evidence for each deliverable of the transaction, then we account for each deliverable in the transaction separately, based on the relevant revenue recognition policies. Generally, all deliverables of our multiple element arrangements meet these criteria. We may provide multiple services under the terms of an arrangement and are required to assess whether one or more units of accounting are present. Service fees are typically accounted for as one unit of accounting as fair value evidence for individual tasks or milestones is not available. We follow the guidelines discussed above in determining revenues; however, certain judgments and estimates are made and used to determine revenues recognized in any accounting period. If estimates are revised, material differences may result in the amount and timing of revenues recognized for a given period.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Changes in the financial condition of our customers could result in upward or downward adjustments to the allowance for doubtful accounts.
Inventories and Reserves for Excess, Slow-Moving and Obsolete Inventory
We value our inventory at the lower of cost or market. We continually evaluate the composition of our inventory and identify, with estimates, potential future excess, obsolete and slow-moving inventories. We specifically identify obsolete hardware for reserve purposes and analyze historical usage, forecasted production based on demand forecasts, current economic trends, and historical write-offs when evaluating the adequacy of the reserve for excess and slow-moving inventory. If we are not able to achieve our expectations of the net realizable value of the inventory at its current carrying value, we adjust our reserves accordingly.
Valuation of Goodwill and Long-lived Assets
Goodwill and certain intangible assets with indefinite lives are not amortized but are subject to an annual impairment test, and more frequently, if events or circumstances occur that would indicate a potential decline in our fair value. An impairment charge will be recognized only when the implied fair value of a reporting unit’s goodwill is less than its carrying amount. As of December 31, 2009, we identified four reporting units, 3 of which had associated goodwill. The four reporting units were M2M Services (which excludes Orbit One LLC), Orbit One LLC (“Orbit One”), BNI and Wireline Services. The three reporting units with associated goodwill were M2M Services, Orbit One, LLC and Wireline Services. Due to the consolidation of our hardware management and network platforms in late 2008, we no longer maintained separate reporting for Airdesk and M2M Services, and thus combined the Airdesk reporting unit with M2M Services (excluding Airdesk LLC and Orbit One LLC) reporting unit beginning January 1, 2009. For our 2009 annual review, we used standard modeling techniques to estimate a fair market value for each of the three reporting units containing goodwill. This included a combination of a discounted cash flow models and, where available, the use of public company market comparables in similar industries. We used historical information, our 2010 business plan and expected future development projects to prepare nine year financial projections used in the discounted cash flow analysis for each of the reporting units.
The growth rate assumptions used in our most recent annual impairment test were consistent with operating results for the twelve months ended December 31, 2009, and no events or circumstances occurred that would require us to perform an interim impairment test for these same periods.
A summary of the critical assumptions utilized for our impairment tests are outlined below. We believe this information provides relevant information to understand our goodwill impairment testing and evaluate our goodwill balances.
As of December 31, 2009, a breakdown of our goodwill balance by reporting unit is as follows:
During 2009, we did not record a goodwill impairment charge. In determining whether an impairment charge was necessary, we considered economic conditions, which we expect to improve in 2010 and subsequently return to more normal levels, as compared to general economic conditions of 2009.
For our M2M Services (excluding Orbit One LLC) reporting unit, we use a discounted cash flow model to determine the fair value and a 21% discount rate, as this reporting unit’s risks mirror that of the Company as a whole. Our historical revenue growth rate averaged 17% over the past four years. We use a more conservative revenue growth rate than our historical growth rate in this reporting unit, as we expect the market to mature. We expect our margins to remain at the historical four year average of 42% for this reporting unit for the forecast period. The growth rates used for SG&A and R&D are expected lower than that of our historical growth rates as we built out a new internal service sales team which would not occur in future periods. Depreciation and amortization and capital expenditures are kept at historic run rates. We used historical accounts receivable as a percentage of sales, inventory as a percentage of cost of sales and accounts payable as a percentage of cost of sales to determine the projected changes in working capital requirements.
Based upon our goodwill impairment analysis conducted in the fourth quarter of 2009, a hypothetical reduction in the fair value of our M2M Services (excluding Orbit One LLC) reporting unit of 14.2% , would have resulted in the carrying value of the reporting unit exceeding its fair value and thus require a Step 2 analysis and possible impairment. Over the forecast period, this means that our cumulative projected revenues would have to decrease by 4% (representing a proportional decrease in our average growth rate of 7% over the forecast period), or our cumulative projected profitability would have to decrease by 12%. A 1.9% increase to the discount rate that we applied also would have resulted in the carrying value of the reporting unit exceeding its fair value.
We believe that our cash flow analysis was appropriate as our projections took the present challenging economic environment into account and are consistent with our current operating results.
In our Orbit One reporting unit, we used a discounted cash flow model to determine the fair value as we cannot determine any market comparables for this unit. We used a 21% discounted rate as this reporting unit’s risks mirrored that of the Company as a whole. A combination of existing contractual agreements and targeting of specific industries is used to determine the first year’s revenue growth rate, the following years’ revenue growth rates are based on expected industry growth rates. Margins are projected to decline as a combination of expected pricing pressures in the market and lower margin hardware sales are expected to make up a larger portion of total revenues versus higher margin service sales. SG&A expenses are forecasted to increase in the first year as the result of a build out of necessary sales support to meet projected revenue targets then the SG&A growth are expected to moderate for the balance of the forecast period. Depreciation and amortization and capital expenditures are kept at historic run rates. We used historical accounts receivable as a percentage of sales, inventory as a percentage of cost of sales and accounts payable as a percentage of cost of sales to determine the projected changes in working capital requirements.
Based upon our goodwill impairment analysis conducted in the fourth quarter of 2009, a hypothetical reduction in the fair value of our Orbit One LLC reporting unit of 9.4% , would have resulted in the carrying value of the reporting unit exceeding its fair value and thus require a Step 2 analysis and possible impairment. Over the forecast period, this means that our cumulative projected revenues would have to decrease by 3% (representing a proportional decrease in our average growth rate of 4% over the forecast period), or our cumulative projected profitability would have to decrease by 8%. A 1.0% increase to the discount rate that we applied also would have resulted in the carrying value of the reporting unit exceeding its fair value.
In our Digital Multimedia reporting unit, we used a combination of a discounted cash flow analysis and use of public company market comparables to determine the fair value. Since this reporting unit’s revenues mostly result from government related contracts, the revenue can fluctuate significantly from year to year and over our forecast period. Taking this into consideration, we used two cash flow models for this reporting with two possible revenue streams over the forecast period. We then applied a weighting to each outcome to determine the unit’s fair value on a discounted cash flow basis. We used the company’s overall 21% discount rate as we accounted for this units fluctuating revenue by weighting two separate cash flow models. We gave the combination of these cash flow models greater weighting totaling 90% with the balance on the market comparables since we only had a limited number of market comparables. In the first year of the forecast combined weighted revenues increase over the forecast period over 2009, but do not grow over 2008 revenue levels until 2011 and for the balance of the forecast period. This growth is the result of the completion of new product development projects currently in process, and new contracts. Weighted combined margins were projected to decline due to changes in the mix of hardware and service sales and expected pricing pressures. SG&A expenses are forecast to decrease in the first year as the result of cost reductions planned and returning to historical growth rates. Depreciation and amortization and capital expenditures are kept at historic run rates. We used historical accounts receivable as a percentage of sales, our sales growth rate for inventory and accounts payable as a percentage of cost of sales to determine the projected changes in working capital requirements. The combination of all these factors determined our cash flow growth rates. For the market comparables, we used a combination of EBITDA and sales ratio’s to determine fair value.
Based upon our goodwill impairment analysis conducted in the fourth quarter of 2009, a hypothetical reduction in the fair value of our Digital Multimedia reporting unit of 63% , would have resulted in the carrying value of the reporting unit exceeding its fair value and thus require a Step 2 analysis and possible impairment. Over the forecast period, this means that our cumulative projected revenues would have to decrease by 44%, or our cumulative projected profitability would have to decrease by 44%. A 46% increase to the discount rate that we applied also would have resulted in the carrying value of the reporting unit exceeding its fair value.
Additionally, the sum of the fair value of all our reporting units was less than our market capital at December 31, 2009, indicating that our projections were reasonable and not aggressive.
Deferred Tax Assets
Estimates and judgments are required in the calculation of certain tax liabilities and in the determination of the recoverability of certain deferred tax assets, which arise from net operating losses, tax credit carryforwards and temporary differences between the tax and financial statement recognition of revenue and expense. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period.
ASC 740, "Accounting for Income Taxes", requires that the deferred tax assets be reduced by a valuation allowance, if based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. In evaluating the ability to recover the deferred tax assets, in full or in part, management considers all available positive and negative evidence including past operating results, the existence of cumulative losses in the most recent years and the forecast of future taxable income on a jurisdiction by jurisdiction basis. Management is responsible for the assumptions utilized including the amount of state, federal and international pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment. Actual operating results and the underlying assumptions could differ materially from our current assumptions, judgments and estimates of recoverable net deferred taxes.
Cumulative losses incurred in recent years and the potential impact of the current economic environment on future taxable income represented sufficient negative evidence for management to conclude that the deferred tax assets require a full valuation allowance. As such, management established a full valuation allowance against the net deferred tax assets, which will remain until sufficient positive evidence exists to support reversal. Deferred tax assets generated during the current year primarily due to net operating losses were offset by an increase to the valuation allowance resulting in no net benefit recorded in the current year. Future reversals or increases to the valuation allowance could have a significant impact on our future earnings. Current tax expense resulted from foreign operations and certain state taxes.
Result of Operations
The following table sets forth, for the periods indicated, certain revenue and expense items and the percentage increases and decreases for those items in the Company’s Consolidated Statements of Operations.
See notes to consolidated financial statements.
Fiscal Years Ended December 31, 2009 and December 31, 2008
Net revenues decreased 29.7% to $50.8 million for the year ended December 31, 2009, as compared to $72.3 million for the year ended December 31, 2008. The decrease in total net revenues for the year ended December 31, 2009 is attributable to a 52.9% decrease to $20.3 million in hardware revenues as compared to $43.0 million for the year ended December 31, 2008. The decrease in hardware revenues is due primarily to a decrease in demand for our wireless modules due to the end of the technology transition from analog to digital. The decrease is also due to the effect of the economy on our customers, as well as a result of our tighter credit controls, which were implemented in the second half of 2008.
Cost of hardware sales decreased 53.8% to $17.3 million for the year ended December 31, 2009, as compared to $37.5 million for the year ended December 31, 2008. The decrease was primarily due to the corresponding decrease in hardware sales.
Cost of services increased 18.4% to $11.2 million for the year ended December 31, 2009, as compared to $9.4 million for the year ended December 31, 2008. The increase in cost of services was primarily the result of an increase in the number of subscriptions to our M2M network. Subscription increases were generated by sales of our security hardware as well as by end users and value added resellers who utilize our network to provide customer solutions. We continue to focus on increasing subscriptions to our network due to the recurring nature of the service net sales.
Gross profit, as a percentage of net revenue, was 44.0% for the year ended December 31, 2009, as compared to 35.1% for the year ended December 31, 2008. The increase for 2009, as compared to 2008, is primarily a result of a change in the overall revenue mix. For the year ended December 31, 2009, service revenues were 60.1% and of total revenues, as compared to 40.5% for the year ended December 31, 2008. This causes an overall margin improvement since service revenues have a significantly higher gross margin than those achieved through the sale of hardware.
Selling, general, administrative and other expenses decreased 12.2% to $17.6 million for the year ended December 31, 2009, as compared to $20.1 million for the year ended December 31, 2008. The decrease of $2.5 million is primarily the result of a $1.1 million decrease in employee compensation and other employee related costs, $598,000 decrease in professional service fees, a $455,000 decrease in litigation fees, and a $305,000 decrease in marketing related costs.
Engineering and development expenses increased 10.1% to $2.4 million for the year ended December 31, 2009, as compared to $2.2 million for the year ended December 31, 2008. The increase in engineering and development expenses is primarily the result of increased employee compensation and expenses related to new product testing and certifications.
Bad debt expense decreased to $536,000 for the year ended December 31, 2009, as compared to $1.1 million for the year ended December 31, 2008. We analyze accounts receivable and consider our historical bad debt experience, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Bad debt expense decreased over the prior year as a result of our tighter credit controls particularly in regard to our hardware-only customer sales.
Depreciation and amortization expense increased 9.4% to $3.4 million for the year ended December 31, 2009, as compared to $3.1 million for the year ended December 31, 2008. This increase is primarily the result of increased capital expenditures for computer and office equipment and for capitalized software projects that have been placed into service.
Interest expense increased to $3.9 million in 2009, as compared to $1.5 million in 2008. The increase is primarily the result of the $2.4 million expense associated with the debt conversion. In 2009 we repaid an aggregate of $5.7 million under our outstanding convertible promissory notes. Under generally accepted accounted principles, specifically, ASC 470-20 (formerly FAS 84), an adjustment to the conversion price of the convertible note should be accounted for as an inducement to convert the note, even though there was no economic incentive offered. The increase in interest expense also includes $499,000, the non-cash expense associated with the expensing of the deferred fees associated with the early extinguishment of debt.
The company recorded a tax provision of $285,000 for the year ended December 31, 2009, as compared to a tax provision of $3,047,000 for the year ended December 31, 2008, representing effective tax rates of (5.15)% and (38.44)% respectively. The difference between the company's effective tax rate and the 34% federal statutory rate in the current year resulted primarily from the existence of a valuation allowance against the Company's net deferred tax assets, foreign taxes, state tax accruals, and uncertain tax position.
The weighted average basic shares outstanding increased to 14,409,000 for the year ended December 31, 2009, as compared to 14,144,000 for the year ended December 31, 2008. The increase in weighted average basic shares outstanding for the year ended December 31, 2009 was primarily due to the issuance of 44,000 common shares related to the employee stock option plan and 889,000 common shares issued in lieu of debt payments.
Fiscal Years Ended December 31, 2008 and December 31, 2007
Net revenues increased 6.3% to $72.3 million for the year ended December 31, 2008, as compared to $68.0 million for the year ended December 31, 2007. The increase in total net revenues for the year ended December 31, 2008 is attributable to a 19.0% increase to $29.3 million in service revenues as compared to $24.6 million for the year ended December 31, 2007. The increase in service revenues is due primarily to the growth of network subscriptions and approximately $519,000 of revenue related to the acquisitions of Orbit One, LLC and Ublip, LLC. Hardware sales for the year ended December 31, 2008 remained relatively flat at $43.0 million.
Cost of hardware sales decreased 2.7% to $37.5 million for the year ended December 31, 2008 as compared to $38.5 million for the year ended December 31, 2007. The decrease was primarily the result of reduced costs for our M2M hardware.
Cost of services increased 54.4% to $9.4 million for the year ended December 31, 2008 as compared to $6.1 million for the year ended December 31, 2007. The increase in cost of services was primarily the result of higher service sales volume in M2M attributed to an increase in subscriptions to our M2M network. The increase in subscriptions was a direct correlation to our increase in costs.
Gross profit, as a percentage of net revenue, was 35.1% for the year ended December 31, 2008 as compared to 34.4% for the year ended December 31, 2007. The increase for 2008, as compared to 2007 is primarily a result of a change in the overall revenue mix. In the twelve month period ended December 31, 2007, service revenues were 36.2% of total revenues compared to 40.5% in the twelve month period ended December 31, 2008. This change causes an overall margin improvement since service revenues have a significantly higher gross margin than those achieved through the sale of hardware.
Selling, general, administrative and other expenses increased 23.2% to $20.1 million for the year ended December 31, 2008, as compared to $16.3 million for the year ended December 31, 2007. As a percentage of revenue, selling, general, administrative and other expenses increased to 27.8% for the year ended December 31, 2008 as compared to 24.0% for the year ended December 31, 2007. The increase of $3.8 million is primarily the result of higher general and administrative expenses associated with litigation expenses related to our satellite M2M unit ($2.3 million), higher personnel related costs ($1.1 million) and an increase in sales and marketing expenses ($400,000).
Engineering and development expenses increased 50.7% to $2.2 million for the year ended December 31, 2008, as compared to $1.5 million for the year ended December 31, 2007. The increase in engineering and development expenses is primarily due to higher personnel related expenses.
Bad debt expense increased to $1.1 million for the year ended December 31, 2008, as compared to $635,000 for the year ended December 31, 2007. We analyze accounts receivable and consider our historical bad debt experience, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Bad debt expense increased over the prior year period as a result of our identification of specific collection issues.
Depreciation and amortization expense increased 24.2% to $3.1 million for the year ended December 31, 2008, as compared to $2.5 million for the year ended December 31, 2007. This increase is attributable to amortization beginning on engineering and development projects that have been completed and released, as well as the purchase of depreciable computer and office equipment.
During 2008, we recorded a pre-tax, non-cash charge of $4.0 million for the impairment of goodwill and a pre-tax, non-cash charge of $1.3 million for the impairment of long-lived assets.
Interest expense decreased to $1.6 million in 2008, as compared to $1.9 million in 2007. This decrease was the result of declining debt due to continued payments.
The company recorded a tax provision of $3,047,000 for the year ended December 31, 2008, as compared to a tax provision of $728,000 for the year ended December 31, 2007, representing effective tax rates of (38.44)% and 65.74%, respectively. The difference between the company's effective tax rate and the 34% federal statutory rate in the current year resulted primarily from an increase in the Company's valuation allowance, stock option expenses, impairment charges, state tax accruals, and uncertain tax position expense. The Company's negative effective tax rate in 2008 of (38.44)% can be attributed to the increase in the valuation allowance against net deferred tax assets.
The weighted average basic shares outstanding increased to 14,144,000 for the year ended December 31, 2008, as compared to 13,137,000 for the year ended December 31, 2007. The increase in weighted average basic shares outstanding for the year ended December 31, 2008 was primarily due to the issuance of 27,000 common shares related to the employee stock option plan, 200,000 common shares related to the acquisition of Airdesk, Inc. and 405,000 common shares related to the acquisition of the assets of Ublip, Inc.
Fiscal Years Ended December 31, 2009 and December 31, 2008
M2M Services Segment
Net revenues from M2M Services decreased 28.4% to $47.4 million for the year ended December 31, 2009, as compared to $66.1 million for the year ended December 31, 2008. This decrease was the result a 51.1% decrease in hardware revenue, partially offset by a 6.8% increase in service revenue. The decrease in M2M Services hardware revenue of $20.5 million was primarily the result of a decrease in demand for our wireless modules due to the effect of the prolonged economic slump on our customers, as well as a result of our tighter credit controls, which were implemented in January 2009. The increase in the M2M Services service revenue was primarily the result of connection increases that were generated by sales of our security hardware, sales of our wireless modules used in the door entry control solutions used by real estate agents and brokers, as well as by end users and value added resellers who utilize our network to provide customer solutions. Our wireless subscriptions at December 31, 2009 were 937,000, a 34.0% increase in subscriptions over the year ended December 31, 2008. While subscriptions have increased at a higher rate than service net sales, the average revenue per unit has decreased due to our customer mix. We continue to focus on increasing subscriptions to our network due to the recurring nature of the service revenues.
Cost of hardware sales for our M2M Services segment decreased 52.9% to $17.0 million for the twelve months December 31, 2009, as compared to $36.2 million for the twelve months ended December 31, 2008. The decrease in cost of hardware sales for our M2M Services segment is primarily the result of lower hardware sales.
Cost of service sales for our M2M Services segment increased 24.7% for the year ended December 31, 2009 to $10.2 million, as compared to $8.2 million for the year ended December 31, 2008. M2M Services service net costs increased primarily due to the costs related to the increase in the number of subscriptions to our M2M Services network during the year ended December 31, 2009. Subscription increases were generated by sales of our security hardware as well as by end users and value added resellers who utilize our network to provide customer solutions. We continue to focus on increasing subscriptions to our network due to the recurring nature of the service net sales.
Wireline Services Segment
Net revenue from Wireline Services decreased 44.0% to $3.5 million for the year ended December 31, as compared to $6.2 million for the year ended December 31, 2008. This decrease was primarily the result of a decrease in sales of our interactive videoconferencing hardware (PowerPlay), which is sold directly and indirectly to distance-learning customers. Capital spending by targeted distance learning customers is largely funded by government entities and, as a result, is difficult to predict and can fluctuate significantly from period to period. The decrease in net revenue is also due to service revenues decreasing. Our installation and integration services are primarily, either directly or indirectly, provided to large wireline and wireless telecommunication companies. The decrease in service revenues is due to a decrease in demand for these services.
Cost of hardware sales for our Wireline Services segment decreased 77.2% to $293,000 for the year ended December 31, 2009, as compared to $1.3 million for the year ended December 31, 2008. The decrease in cost of hardware sales for our Wireline Services segment is in direct correlation to the decrease in hardware sales.
Cost of service sales for our Wireline Services segment decreased 22.3% to $970,000 for the year ended December 31, 2009 as compared to $1.2 million for the year ended December 31, 2008. The decrease in cost of service sales for the Wireline Services segment is in direct correlation to the decrease in services net sales.
Fiscal Years Ended December 31, 2008 and December 31, 2007
M2M Services Segment
Net revenues from M2M Services increased 5.3% to $66.1 million for the year ended December 31, 2008, as compared to $62.8 million for the year ended December 31, 2007. This increase was the result a 22.6% increase in service revenues, partially offset by a 3.5% decrease in hardware sales. The increase in M2M Services service sales of $4.8 million was primarily the result of an increase in network subscriptions that were generated by sales of our security hardware as well as by end users and value added resellers who utilize our network to provide customer solutions. We continue to focus on increasing subscriptions to our network due to the recurring nature of the service revenues. Our growth was also attributable to increased subscriptions from wireless modules used in the door entry control solution used by real estate agents and brokers. The slight decrease in the M2M Services hardware revenue was primarily the result of decline in sales of our wireless security devices due to the decreased demand for wireless security hardware now that our customers have fully transitioned from analog network services.
Cost of hardware sales for our M2M Services segment decreased 3.4% to $36.1 million for the twelve months December 31, 2008 as compared to $37.4 million for the twelve months ended December 31, 2007. The decrease in cost of hardware sales for our M2M Services segment for the year ended December 31, 2008 is primarily the result of decreased hardware sales due to the completion of the analog to digital transition in the commercial and residential security market coupled with reduced demand from M2M Services customers for wireless modules adjusting to the macroeconomic slowdown.
Cost of service sales for our M2M Services segment increased 70.4% for the year ended December 31, 2008 to $8.2 million as compared to $4.8 million for the year ended December 31, 2007. M2M Services service net costs increased primarily due to an increase in the number of subscriptions to our wireless M2M Services network during the year ended December 31, 2008. Connection increases were generated by sales of our security hardware as well as by end users and value added resellers who utilize our network to provide customer solutions. We continue to focus on increasing subscriptions to our network due to the recurring nature of the service net sales.
Wireline Services Segment
Net revenue from Wireline Services increased 19.1% to $6.2 million for the year ended December 31, 2008 as compared to $5.2 million for the year ended December 31, 2007. This increase was primarily due to a 63.2% increase in hardware sales. The increase in hardware sales was primarily the result of an increase in sales of our interactive videoconferencing hardware (PowerPlay), which is sold directly and indirectly to distance-learning customers. Capital spending by targeted distance learning customers is largely funded by government entities and, as a result, is difficult to predict and can fluctuate significantly from period to period.
Cost of hardware sales for our Wireline Services segment increased 22.6% to $1.3 million for the year ended December 31, 2008 as compared to $1.0 million for the year ended December 31, 2007. The increase in cost of hardware sales for our Wireline Services segment for year ended December 31, 2008 was primarily the result of higher hardware sales volume in our interactive videoconferencing hardware (PowerPlay).
Cost of service sales for our Wireline Services segment decreased 4.2% to $1.2 million for the year ended December 31, 2008 as compared to $1.3 million for the year ended December 31, 2007. The decrease in cost of service sales for the Wireline Services segment for the year ended December 31, 2008 is in direct correlation to the decrease in services net sales for this segment.
Selected Quarterly Financial Data
The following tables detail certain unaudited financial data of Numerex for each quarter of the last two fiscal years ended December 31, 2009 and 2008, respectively.
Our financial results may fluctuate from quarter to quarter as a result of certain factors related to our business, including the timing of hardware shipments, new hardware introductions and equipment, and hardware and system sales that historically have been of a non-recurring nature.
This information has been prepared from our books and records in accordance with accounting principles generally accepted in the United States of America for interim financial information. In the opinion of management, all (including only normal, recurring) adjustments considered necessary for fair presentation have been included. Interim results for any quarter are not necessarily indicative of the results that may be expected for any future period.
Selected Quarterly Financial Data (Unaudited)
Selected Quarterly Financial Data (Unaudited)