Attached files

file filename
EX-10.4 - EXHIBIT 10.4 - NUMEREX CORP /PA/t83431_ex10-4.htm
EX-31.2 - EXHIBIT 31.2 - NUMEREX CORP /PA/t83431_ex31-2.htm
EX-10.3 - EXHIBIT 10.3 - NUMEREX CORP /PA/t83431_ex10-3.htm
EX-31.1 - EXHIBIT 31.1 - NUMEREX CORP /PA/t83431_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - NUMEREX CORP /PA/t83431_ex32-1.htm
EX-32.2 - EXHIBIT 32.2 - NUMEREX CORP /PA/t83431_ex32-2.htm
EX-10.5 - EXHIBIT 10.5 - NUMEREX CORP /PA/t83431_ex10-5.htm
EX-10.2 - EXHIBIT 10.2 - NUMEREX CORP /PA/t83431_ex10-2.htm
EX-10.1 - EXHIBIT 10.1 - NUMEREX CORP /PA/t83431_ex10-1.htm
EX-10.6 - EXHIBIT 10.6 - NUMEREX CORP /PA/t83431_ex10-6.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
  For the quarterly period ended September 30, 2015

 

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
  For the transition period from __________ to __________

 

Commission file number: 000-22920

 

NUMEREX CORP.

(Exact name of registrant as specified in its charter)

 

Pennsylvania   11-2948749
(State or other jurisdiction
of incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

3330 Cumberland Parkway, Suite 700

Atlanta, GA 30339-2119
(Address of principal executive offices) (Zip Code)

 

(770) 693-5950
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ     No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.                                                                                                                                                                         Yes þ No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

  Large accelerated filer  ¨ Accelerated filer  þ
  Non-accelerated filer  ¨ (Do not check if a smaller reporting company) Smaller reporting company  ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).                                                                                                                                                                      Yes ¨     No þ

 

As of November 3, 2015,19,254,706 shares of the registrant's Class A common stock, no par value (being the registrant's only class of common stock outstanding) were outstanding.

 

 

 

   

 

  

NUMEREX CORP. AND SUBSIDIARIES

TABLE OF CONTENTS

 

    Page
PART I—FINANCIAL INFORMATION  
Item 1. Financial Statements. 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk. 30
Item 4. Controls and Procedures. 30
     
PART II—OTHER INFORMATION  
Item 1. Legal Proceedings. 31
Item 1A. Risk Factors. 31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 31
Item 3. Defaults Upon Senior Securities. 31
Item 4. Mine Safety Disclosures. 31
Item 5. Other Information. 32
Item 6. Exhibits. 33
SIGNATURES  

 

 2 

 

 

NUMEREX CORP. AND SUBSIDIARIES

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

Index to Financial Statements Page
   
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014 4
Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income for the three and nine months ended September 30, 2015 and 2014 5
Unaudited Condensed Consolidated Statement of Shareholders' Equity for the nine months ended September 30, 2015 6
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014 7
Unaudited Condensed Notes to Consolidated Financial Statements 9

 

 3 

 

 

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

 

   September 30,   December 31, 
   2015   2014 
ASSETS          
CURRENT ASSETS          
Cash and cash equivalents  $12,482   $17,270 
Accounts receivable, less allowance for doubtful accounts of $2,052 and $1,106   14,092    12,287 
Financing receivables, current   1,789    1,595 
Inventory, net of reserves   7,974    8,410 
Prepaid expenses and other current assets   2,054    2,329 
Deferred tax assets, current   -    3,161 
TOTAL CURRENT ASSETS   38,391    45,052 
           
Financing receivables, less current portion   2,687    2,984 
Property and equipment, net of accumulated depreciation and amortization   4,492    4,889 
Software, net of accumulated amortization   6,958    6,106 
Other intangible assets, net of accumulated amortization   17,512    19,163 
Goodwill   43,424    44,348 
Deferred tax assets, less current portion   -    5,816 
Other assets   1,107    2,585 
TOTAL ASSETS  $114,571   $130,943 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
CURRENT LIABILITIES          
Accounts payable  $12,011   $12,257 
Accrued expenses and other current liabilities   3,062    2,471 
Deferred revenues   2,026    2,258 
Current portion of long-term debt   3,750    4,251 
Obligations under capital lease   -    148 
TOTAL CURRENT LIABILITIES   20,849    21,385 
           
Long-term debt, less current portion   16,537    19,350 
Noncurrent deferred taxes   1,170    - 
Other liabilities   1,759    1,346 
TOTAL LIABILITIES   40,315    42,081 
           
COMMITMENTS AND CONTINGENCIES          
           
SHAREHOLDERS’ EQUITY          
Preferred stock, no par value; 3,000 authorized; none issued   -    - 
Class A common stock, no par value; 30,000 authorized; 20,532 and 20,284 issued; 19,225 and 18,992 outstanding   -    - 
Class B common stock, no par value; 5,000 authorized; none issued   -    - 
Additional paid-in capital   101,319    99,056 
Treasury stock, at cost; 1,307 and 1,292 shares   (5,444)   (5,352)
Accumulated other comprehensive loss   (95)   (48)
Accumulated deficit   (21,524)   (4,794)
TOTAL SHAREHOLDERS' EQUITY   74,256    88,862 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY  $114,571   $130,943 

 

The accompanying notes are an integral part of these financial statements.

 

 4 

 

 

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE (LOSS) INCOME

(In thousands, except per share data)

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2015   2014   2015   2014 
Net revenues:                    
Subscription and support revenues  $15,624   $17,429   $48,874   $47,530 
Embedded devices and hardware   7,710    8,234    21,791    21,483 
Total net revenues   23,334    25,663    70,665    69,013 
Cost of sales, exclusive of a portion of depreciation and amortization shown below:                    
Subscription and support revenues   6,538    7,011    19,728    18,647 
Embedded devices and hardware   6,958    7,236    19,582    18,102 
Inventory reserves   1,277    129    1,547    415 
Impairment of other asset   1,275    -    1,275    - 
Gross profit   7,286    11,287    28,533    31,849 
Operating expenses:                    
Sales and marketing   3,047    3,029    9,136    9,066 
General and administrative   4,507    3,429    12,108    11,207 
Engineering and development   2,201    2,430    6,695    5,794 
Depreciation and amortization   2,100    1,597    5,411    4,570 
Impairment of goodwill and other intangible assets   1,250    -    1,250    - 
Operating (loss) income   (5,819)   802    (6,067)   1,212 
Interest expense   188    278    604    564 
Other income, net   (31)   (97)   (100)   (1,272)
(Loss) income from continuing operations before income taxes   (5,976)   621    (6,571)   1,920 
Income tax expense   10,404    358    10,159    283 
(Loss) income from continuing operations, net of income taxes   (16,380)   263    (16,730)   1,637 
Loss from discontinued operations, net of income taxes   -    -    -    (492)
Net (loss) income   (16,380)   263    (16,730)   1,145 
Other items of comprehensive income, net of income taxes:                    
Foreign currency translation adjustment   30    (13)   47    (10)
Comprehensive (loss) income  $(16,350)  $250   $(16,683)  $1,135 
                     
Basic (loss) earnings per share:                    
(Loss) income from continuing operations  $(0.86)  $0.01   $(0.88)  $0.09 
Loss from discontinued operations   -    -    -    (0.03)
Net (loss) income  $(0.86)  $0.01   $(0.88)  $0.06 
                     
Diluted (loss) earnings per share:                    
(Loss) income from continuing operations  $(0.86)  $0.01   $(0.88)  $0.09 
Loss from discontinued operations   -    -    -    (0.03)
Net (loss) income  $(0.86)  $0.01   $(0.88)  $0.06 
                     
Weighted average shares outstanding used in computing earnings per share:                    
Basic   19,137    18,956    19,053    18,900 
Diluted   19,137    19,263    19,053    19,253 

  

The accompanying notes are an integral part of these financial statements.

 

 5 

 

 

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

(in thousands)

 

               Accumulated Other       Total 
   Common   Additional   Treasury   Comprehensive   Accumulated   Shareholders' 
   Shares   Paid-in Capital   Stock   Loss   Deficit   Equity 
Balance at January 1, 2015   20,284   $99,056   $(5,352)  $(48)  $(4,794)  $88,862 
Equity-based compensation expense   133    2,319    -    -    -    2,319 
Equity-based compensation plan activity   114    138    -    -    -    138 
Value of shares retained to pay employee taxes   -    (199)   (92)   -    -    (291)
Translation adjustment   -    -    -    (47)   -    (47)
Other   1    5    -    -    -    5 
Net loss   -    -    -    -    (16,730)   (16,730)
Balance at September 30, 2015   20,532   $101,319   $(5,444)  $(95)  $(21,524)  $74,256 

 

The accompanying notes are an integral part of these financial statements.

 

 6 

 

  

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

   Nine Months Ended 
   September 30, 
   2015   2014 
Cash flows from operating activities:          
Net (loss) income  $(16,730)  $1,145 
Less loss from discontinued operations, net of income taxes   -    (492)
(Loss) income from continuing operations, net of income taxes   (16,730)   1,637 
Adjustments to reconcile net (loss) income from continuing operations to net cash provided by operating activities:          
Depreciation and amortization   6,163    4,969 
Impairment of goodwill, other intangible assets and other assets   2,525    - 
Equity-based compensation expense   2,319    1,833 
Deferred income taxes   10,147    36 
Bad debt expense   400    364 
Inventory reserves   1,547    415 
Gain on sale of cost method investment   -    (1,109)
Other non-cash expense   63    76 
Changes in assets and liabilities, net of effects of acquisitions:          
Accounts and financing receivables   (1,898)   (1,638)
Inventory, net   (861)   613 
Accounts payable   (31)   208 
Deferred revenue   231    (77)
Other   249    (275)
Net cash provided by operating activities   4,124    7,052 
Cash flows from investing activities:          
Net cash paid for acquisition   -    (37,113)
Purchases of property and equipment   (1,984)   (1,335)
Capitalized software development and purchases of software   (3,314)   (2,709)
Proceeds from sale of cost basis investment   -    1,309 
Net cash used in investing activities   (5,298)   (39,848)
Cash flows from financing activities:          
Principal payments on debt   (3,313)   (1,725)
Principal payments on capital lease obligations   (148)   (221)
Proceeds from long-term debt   -    25,000 
Equity-based compensation plan activity   138    935 
Payment of taxes on equity-based awards   (291)   (288)
Deferred financing costs   -    (293)
Net cash (used in) provided by financing activities   (3,614)   23,408 
Cash flows from discontinued operations:          
Cash provided by operating activities   -    142 
Net decrease in cash and cash equivalents   (4,788)   (9,246)
Cash and cash equivalents at beginning of period   17,270    25,603 
Cash and cash equivalents at end of period  $12,482   $16,357 

 

The accompanying notes are an integral part of these financial statements.

 

 7 

 

  

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED

STATEMENTS OF CASH FLOWS — CONTINUED

(In thousands)

 

   Nine Months Ended 
   September 30, 
   2015   2014 
Supplemental disclosures of cash flow information:          
Cash paid for interest  $513   $488 
Cash paid for income taxes   70    83 
Disclosure of non-cash investing and financing activities:          
Capital expenditures in accounts payable   203    386 
Note issued in conjunction with disposal of discontinued operations   -    35 

 

The accompanying notes are an integral part of these financial statements.

 

 8 

 

  

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

NOTE A – NATURE OF OPERATIONS AND BASIS OF PRESENTATION

 

Numerex Corp. (NASDAQ: NMRX) is a leading provider of managed machine-to-machine (M2M) enterprise solutions enabling the Internet of Things (IoT).  The Company provides its technology and services through its integrated M2M horizontal platforms, which are generally sold on a subscription basis. The Company offers Numerex DNA® that may include hardware and smart Devices, cellular and satellite Network services, and software applications that are delivered through our M2M platform. The Company also provides business services to enable the development of efficient, reliable, and secure solutions while accelerating deployment. Numerex is ISO 27001 information security-certified, highlighting the Company’s focus on M2M data security, service reliability and around-the-clock support of its customers’ M2M solutions.

 

We prepared the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, referred to as GAAP, for interim financial information and the Rules and Regulations issued by the Securities Exchange Commission, or SEC, as applicable. These financial statements include all of our accounts and those of our wholly-owned subsidiaries. We have eliminated intercompany transactions and balances in consolidation.

 

Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted, although we believe that the disclosures made are adequate to make the information not misleading. In the opinion of management, the accompanying financial statements reflect all adjustments, which consist of normal recurring adjustments unless otherwise disclosed, considered necessary for a fair presentation of our financial position as of September 30, 2015 and our operating results and cash flows for the interim periods presented. The accompanying condensed consolidated balance sheet as of December 31, 2014 was derived from our audited financial statements, but does not include all disclosures required by GAAP. The financial information presented herein should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2014 which includes information and disclosures not included in this quarterly report.

 

The preparation of financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Actual results may differ materially from these estimates. Operating results for the three and nine months ended September 30, 2015, may not be indicative of the results that may be expected for the year ending December 31, 2015 or any future periods.

 

NOTE B – MERGER

 

On May 5, 2014, in accordance with the terms and conditions of the merger agreement, we merged our wholly-owned subsidiary with and into Omnilink Systems Inc. (Omnilink) with Omnilink surviving the merger as a wholly-owned subsidiary of Numerex. The purchase price of $37.5 million was composed of a cash payment of $37.3 million and a working capital adjustment of $0.2 million.

 

Omnilink provides tracking and monitoring services for people and valuable assets via Omnilink’s M2M platform that connects hardware, networks, software, and support services. Our combination with Omnilink has provided operating synergies and created growth opportunities through product enhancement and channel expansion. The assets, liabilities and operating results of Omnilink are included in our condensed consolidated financial statements commencing from the merger date.

 

 9 

 

  

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

The following table summarizes the fair values of the assets acquired and liabilities assumed as of the closing date of the Omnilink merger (dollars in thousands):

 

       Estimated
   Fair Value   Useful Lives
Cash  $195   n/a
Accounts receivable   2,677   n/a
Inventory   873   n/a
Prepaid and other assets   377   n/a
Property and equipment   1,613   4 (a)
Deferred tax asset   2,400   n/a
Customer relationships   6,056   11
Technology   4,998   14
Trade names   3,632   Indefinite
Goodwill   17,518   Indefinite
Total identifiable assets acquired   40,339    
         
Accounts payable   (1,756)  n/a
Accrued expenses   (1,037)  n/a
Deferred revenue   (64)  n/a
Total liabilities assumed   (2,857)   
Net assets acquired  $37,482    

 ________________

(a)The weighted average remaining useful life for all property and equipment is approximately four years.

 

The total purchase consideration for the merger was allocated to identifiable assets purchased and liabilities assumed based on fair value. The estimated fair value attributed to intangible assets, other than goodwill, was based on common valuation techniques. The fair value of acquired software was estimated using a cost approach based on assumptions of our historical software development costs. The fair value of trade names was based on an income approach with key assumptions including estimated royalty rates to license the trade names from a third party. The valuation of customer relationships utilized an income approach and discounted cash flows taking into consideration the number of customer relationships acquired and estimated customer turnover.

 

The gross amount of accounts receivable in the table above is $2.9 million. Based on the nature and financial strength of the customers on the date of acquisition, we expected to collect amounts due for the accounts receivable of $2.7 million.

 

The value of the deferred tax asset and goodwill as disclosed above reflect a subsequent measurement period adjustment of $0.2 million recorded during the three months ended June 30, 2015 to record the final calculation of acquired deferred tax assets. The residual allocation to goodwill results from such factors as an assembled workforce, expected significant synergies for market growth and profitability as well as Omnilink’s service and product lines contributing to our becoming the market leader in select M2M vertical markets. The total amount of goodwill will not be deductible for income tax purposes.

 

 10 

 

  

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

The measurement period adjustment resulted in recasting the December 31, 2014 consolidated balance sheet, as follows (in thousands):

 

   December 31,   Measurement   December 31, 
   2014   Period   2014 
   As Reported   Adjustment   Recast 
Assets               
Goodwill  $44,548   $(200)  $44,348 
Deferred tax assets, less current portion   5,616    200    5,816 
   $50,164   $-   $50,164 

 

The measurement period adjustment had no effect on the statements of operations and comprehensive (loss) income or cash flows.

 

NOTE C - INVENTORY

 

Inventory consisted of the following (in thousands):

 

   September 30,   December 31, 
   2015   2014 
Raw materials  $2,109   $2,228 
Finished goods   8,559    7,579 
Inventory reserves   (2,694)   (1,397)
   $7,974   $8,410 

 

In September 2015, we entered into new and amended agreements with wireless carriers that make adding 2G devices to wireless networks financially unfavorable under most circumstances. As a result of these agreements, we performed a lower of cost or market analysis leading to a significant increase in the inventory reserve of $1.1 million related to older, second generation (2G) cellular telecommunication devices and older satellite devices as well as an accrual for a purchase commitment related to raw materials for the older satellite devices that we will not fulfill.

 

NOTE D – PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following (in thousands):

 

   September 30,   December 31, 
   2015   2014 
Computer, network and other equipment  $6,394   $5,925 
Monitoring equipment   2,834    1,705 
Furniture and fixtures   888    746 
Leasehold improvements   357    328 
Total property and equipment   10,473    8,704 
Accumulated depreciation and amortization   (5,981)   (3,815)
   $4,492   $4,889 

 

Monitoring equipment includes devices and hardware owned by us and used by customers under managed service arrangements. Depreciation expense for monitoring equipment included in cost of sales for subscription and support revenues in the accompanying condensed consolidated statements of operations and comprehensive (loss) income was $0.3 million and $0.2 million for the three months ended September 30, 2015 and 2014, respectively, and $0.8 million and $0.4 million for the nine months ended September 30, 2015 and 2014, respectively.

 

 11 

 

  

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

During the three and nine months ended September 30, 2015, we recognized additional depreciation expense of $0.4 million for managed service devices and hardware used by a financially troubled customer.

 

NOTE E – INTANGIBLE ASSETS

 

Intangible Assets Other Than Goodwill

 

Intangible assets other than goodwill are summarized as follows (dollars in thousands):

 

   As of September 30, 2015  As of December 31, 2014 
      Gross           Gross         
   Remaining  Carrying   Accumulated   Net Book   Carrying   Accumulated   Net Book 
   Useful Lives  Amount   Amortization   Value   Amount   Amortization   Value 
Purchased and developed software  1.2  $13,233   $(8,658)  $4,575   $11,176   $(6,409)  $4,767 
Software in development  n/a   2,383    -    2,383    1,339    -    1,339 
Total software      15,616    (8,658)   6,958    12,515    (6,409)   6,106 
Licenses  0.4   12,786    (12,081)   705    12,763    (11,886)   877 
Customer relationships  7.8   8,287    (2,064)   6,223    8,287    (1,359)   6,928 
Technologies  12.6   4,998    (506)   4,492    4,998    (237)   4,761 
Patents and trademarks  3.6   4,018    (2,027)   1,991    3,343    (1,657)   1,686 
Trade names  Indefinite   3,632    -    3,632    3,632    -    3,632 
Other  n/a   469    -    469    1,279    -    1,279 
Total other intangible assets      34,190    (16,678)   17,512    34,302    (15,139)   19,163 
      $49,806   $(25,336)  $24,470   $46,817   $(21,548)  $25,269 

 

Remaining useful lives in the preceding table were calculated on a weighted average basis as of September 30, 2015. We did not incur significant costs to renew or extend the term of acquired intangible assets during the three or nine months ending September 30, 2015. 

 

Amortization expense related to intangible assets was $1.3 million and $3.8 million for the three and nine months ended September 30, 2015 compared to $1.2 million and $3.4 million and for the respective periods in 2014. Amortization expense recorded in cost of subscription revenues in the accompanying condensed consolidated statements of operations and comprehensive (loss) income was $0.3 million and $0.8 million for the three and nine months ended September 30, 2015, and $0.2 million and $0.4 million for the three and nine months ended September 30, 2014. Additionally, we have capitalized approximately $0.6 million and $1.8 million of internally generated software development costs for the three and nine months ended September 30, 2015, respectively and $0.6 million and $1.6 million for the three and nine months ended September 30, 2014, respectively.

 

Impairment of Goodwill and Patents and Trademarks

 

Our Do-It-Yourself (DIY) product line and reporting unit is not generating results of operations consistent with our expectations and previous forecasts and management is evaluating different strategic options for the reporting unit. These factors were triggering events that it was more likely than not that the fair value of the DIY reporting unit was less than its carrying amount. As a result, we performed our initial assessment of Goodwill for impairment of the DIY reporting unit, along with other intangible assets of the reporting unit, in the period ending September 30, 2015. The DIY reporting unit included $2.6 million in recorded goodwill and $0.6 million carrying value of patents along with an additional $1.3 million in other intangible assets.

 

We estimated the fair value of the reporting unit using a combination of market and income approaches and concluded that the estimated fair value of the reporting unit was less than its carrying value. We assessed the implied fair value of goodwill in the same manner as if we were acquiring the reporting unit in a business combination. Specifically, we allocated the estimated fair value of the reporting unit to all of the assets and liabilities of that unit, including any unrecognized intangible assets, in a hypothetical calculation, referred to as Step 2. We assessed the amortizing long-lived assets for impairment based on undiscounted cash flows and concluded that the carrying value of patents may not be recoverable. As a result, the fair value of patents was estimated using an income approach.

 

 12 

 

  

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

Based on preliminary Step 2 calculations, we have recorded impairments of $0.9 million for goodwill and $0.3 million for patents during the period ending September 30, 2015. The amount of the impairments is an estimate that has not been finalized prior to filing this quarterly report. We expect to finalize Step 2 of the goodwill analysis and finalize the impairment of patents during the quarter ended December 31, 2015.

 

Activity for the carrying amount of goodwill for the nine months ended September 30, 2015 is summarized as follows (in thousands):

 

January 1, 2015  $44,348 
DIY reporting unit impairment   (924)
September 30, 2015  $43,424 

 

The January 1, 2015 goodwill balance of $44,348 reflects a final measurement period adjustment of $0.2 million related to deferred tax assets. See Note B – Merger.

 

NOTE F – OTHER ASSETS

 

Other noncurrent assets consisted of the following (in thousands):

 

   September 30,   December 31, 
   2015   2014 
Deferred activation fees  $414   $310 
Prepaid carrier fees   375    1,860 
Deferred financing fees   201    260 
Deposits   117    155 
   $1,107   $2,585 

  

During 2011, we purchased and installed telecommunication infrastructure equipment and related equipment to improve the capacity and functionality of our devices operating on one of our carrier networks. To comply with the needs of one of our carriers and in exchange for more favorable carrier fees, we transferred the legal right to the equipment to the vendor. Thus, our existing agreement with this vendor was amended to provide for the new carrier fees and the legal transfer of the equipment. We accounted for this transaction as a non-monetary exchange. The $2.2 million cost of the equipment was determined to be its fair value and we recorded this transaction by transferring the equipment cost to prepaid carrier fees. During 2014, we made a prepayment of $0.4 million to the same carrier to license additional network access. Both prepaid expenses were being amortized in cost of sales for subscription and support revenue on a straight-line basis over the term of the agreement, which was to expire in 2021.

 

In September 2015, we entered into a mutual agreement with the vendor to (1) cancel the existing agreement, (2) purchase certain equipment from the vendor and (3) assume certain national carrier and other agreements from the vendor. Our consideration included (1) $0.5 million in cash, (2) 30,000 shares of our common stock having a value of $0.3 million (3) the prepayment above to license additional network access having a carrying value of $0.4 million for a total of $1.2 million. Consummation of the transaction, which was contingent upon obtaining consents from certain of our vendor’s carriers, closed in October 2015. During negotiations with the vendor in the third quarter of fiscal year 2015, a triggering event was identified, for purposes of assessment of long-lived assets for impairment, as it was more likely than not that the aforementioned assets may be disposed of significantly before the end of their previously estimated useful life. As a result of this transaction and in conjunction with a separate agreement with a mutual national carrier, we determined that the prepaid expenses had no continuing value. We recorded a charge of $1.3 million in cost of sales to write-off the carrying value of the prepaid carrier fees as a settlement of a pre-existing relationship with the vendor. The impairment charge affected multiple reporting units.

 

 13 

 

  

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

NOTE G – INCOME TAXES

 

We calculate our interim income tax provision in accordance with the accounting guidance for income taxes in interim periods. At the end of each interim period, we make our best estimate of the annual expected effective tax rate and apply that rate to our ordinary year-to-date income or loss.  In addition, we calculate a year-to-date adjustment to increase or decrease our income tax provision to take into account our current expected effective tax rate.  The tax or benefit related to significant, unusual, or extraordinary items that will be separately reported or reported net of their related tax effect are individually computed and recognized in the interim period in which those items occur.

 

In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider projections of future taxable income, tax planning strategies and the reversal of temporary differences in making this assessment.

 

At September 30, 2015, we determined that we would not meet the criteria of “more likely than not” that the cumulative federal net operating losses and certain other deferred tax assets would be recoverable. This determination was based on our cumulative loss over the past three years. Accordingly, we recorded a valuation allowance against these items. The deferred tax assets consist of federal net operating losses, state net operating losses, tax credits, and other deferred tax assets, most of which expire between 2015 and 2035. We will maintain the valuation allowance against the net deferred tax assets until sufficient positive evidence outweighs any negative evidence to support reversal. Future reversals or increases to the valuation allowance could have a significant impact on our future earnings.

 

As a result of recording a valuation allowance as of September 30, 2015, we recognized deferred tax expense of $10.4 million, representing an effective tax rate of (174.1%), for the three months ended September 30, 2015 and deferred tax expense of $10.1 million, representing an effective tax rate of (154.6%), for the nine months ended September 30, 2015. The remaining difference of $0.3 million in income tax expense for the three months ended September 30, 2015 is primarily reversing the previous year-to-date benefit. For the nine months ended September 30, 2015, the remaining difference of $0.1 million in income tax expense is for state income taxes that cannot utilize offsetting net operating losses. Income tax expense recorded in the future will be reduced or increased to the extent of offsetting decreases or increases to the valuation allowance.

 

For the three and nine months ended September 30, 2014, we recorded income tax expense from continuing operations of $0.4 million and $0.3 million, respectively, representing effective tax rates of 57.6% and 14.7%, respectively. Our income tax expense of $0.4 million for the three months ended September 30, 2014 included a year-to-date adjustment of $0.2 million or 31.3% of the quarter’s pre-tax income, to increase our tax provision for the six months ended June 30, 2014 to the estimated annual effective tax rate. Our effective tax rates for the three and nine months ended September 30, 2014 differed from the federal statutory rate applied to income and losses before income taxes primarily as a result of a number of discrete items, including (1) the effect of expenses that are not deductible for income tax purposes, including a portion of transaction costs incurred in the Omnilink merger and (2) state income taxes, including the tax effect of changes in effective state income tax rates resulting from the merger with Omnilink. In addition, the effective tax rate for the nine months ended September 30, 2014, was reduced for the income tax benefit from the capital loss on the disposal of BNI due to the ability to offset capital gains in our current tax year and to carry back for capital gains in prior tax years.

 

We file U.S., state and foreign income tax returns in jurisdictions with varying statutes of limitation. The 2012 through 2014 tax years generally remain subject to examination by federal and most state tax authorities. However, certain returns from years in which net operating losses have arisen are still open for examination by the tax authorities.

 

 14 

 

  

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

NOTE H – DEBT

 

Debt consisted of the following (dollars in thousands):

 

   September 30,   December 31, 
   2015   2014 
Note payable to Silicon Valley Bank, with interest at our option of prime rate or LIBOR rate plus margin  $20,287   $23,125 
Seller financed note payable, with interest at 4.25%, monthly payments of principal and interest, secured by equipment, due September 2015   -    476 
    20,287    23,601 
Less current portion of long-term debt   3,750    4,251 
Noncurrent portion of long-term debt  $16,537   $19,350 

   

On May 5, 2014, we entered into a Second Amended and Restated Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank in order to, among other things, establish a term loan of $25.0 million and a revolving line of credit of up to $5.0 million (collectively, the “Credit Facility”). As of September 30, 2015,we had no outstanding balance on the revolving line of credit. The proceeds from the term loan were used to finance the Omnilink merger. See Note B –– Merger.

 

The maturity date of the loan is May 5, 2019 with regular required quarterly principal payments which began June 30, 2014. The scheduled outstanding principal balance of $5.0 million will be due at maturity if not otherwise repaid earlier by way of voluntary Permitted Prepayments or by mandatory Excess Cash Flow Recapture Payments (as defined in the Loan Agreement). The interest rate applicable to amounts drawn pursuant to the Loan Agreement is currently 2.75% and is, at our option, determined by reference to the prime rate or LIBOR rate plus a margin established in the Loan Agreement.

 

Our obligations under the Credit Facility are secured by substantially all of our assets and the assets of our subsidiaries. In addition, we are required to meet certain financial and other restrictive covenants customary with this type of facility, including maintaining a senior leverage ratio, a fixed charge coverage ratio and minimum liquidity availability. We are also prohibited from entering into any debt agreements senior to the Credit Facility and paying dividends. The Amended Loan Agreement contains customary events of default. If a default occurs and is not cured within the applicable cure period or is not waived, any outstanding obligations under the Credit Facility may be accelerated.

 

As of September 30, 2015, we did not meet the fixed charge coverage ratio covenant. We entered into the first amendment to the Loan Agreement on November 3, 2015 (the “Amendment”). The Amendment does not permit any subsequent advances under the Credit Facility, waived the fixed charge coverage ratio for the three months ended September 30, 2015 and added a monthly liquidity ratio covenant. As a result of the waiver and our expectation of maintaining compliance with all of the covenants in the future, we have continued to record scheduled principal payments due after twelve months as noncurrent.

 

In connection with our acquisition of a small technology business in October 2012, we entered into a Promissory Note of $1.9 million payable to the sellers of the business. The Promissory Note was paid in full as of September 30, 2015.

 

NOTE I – NET (LOSS) EARNINGS PER SHARE

 

Basic (loss) earnings per share is computed by dividing net (loss) income available to common shareholders by the weighted average number of common shares outstanding during the period excluding the dilutive impact of common stock equivalents. Diluted earnings per share include the effect of all potentially dilutive securities on earnings per share. The dilutive effect of outstanding equity-based compensation awards is computed using the treasury stock method. The computation of diluted earnings per share does not assume exercise of securities that would have an anti-dilutive effect on earnings.

 

 15 

 

  

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

The following table presents a reconciliation of the shares used in the calculation of basic and diluted net (loss) income per share from continuing operations contained in our condensed consolidated statements of operations and comprehensive (loss) income (in thousands):

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2015   2014   2015   2014 
                 
(Loss) income from continuing operations, net of income taxes  $(16,380)  $263   $(16,730)  $1,637 
                     
Weighted average shares outstanding:                    
Basic   19,137    18,956    19,053    18,900 
Dilutive effect of common stock equivalents   -    307    -    353 
Total   19,137    19,263    19,053    19,253 
                     
Anti-dilutive equity-based compensation awards   2,294    757    2,294    757 

  

NOTE J – RECENT ACCOUNTING PRONOUNCEMENTS

 

In September 2015, the Financial Accounting Standards Board (FASB) issued an accounting standards update to simplify the accounting for measurement-period adjustments for an acquirer in a business combination. The update will require an acquirer to recognize any adjustments to provisional amounts of the initial accounting for a business combination with a corresponding adjustment to goodwill in the reporting period in which the adjustments are determined in the measurement period, as opposed to revising prior periods presented in financial statements. Thus, an acquirer shall adjust its financial statements as needed, including recognizing in its current-period earnings the full effect of changes in depreciation, amortization, or other income effects, by line item, if any, as a result of the change to the provisional amounts calculated as if the accounting had been completed at the acquisition date. This update is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. We do not expect the adoption of this guidance to have a material impact on our financial statements.

 

In July 2015, the FASB issued guidance intended to simplify the presentation of applicable inventory at the lower of cost or net realizable value. The new guidance clarifies that net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The new guidance will be effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. We do not expect the adoption of this guidance to have a material impact on our financial position or results of operations.

 

In March 2015, the FASB issued guidance about simplifying the presentation of debt issuance costs. The guidance is intended to help clarify debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected. The amendments are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within fiscal years beginning after December 15, 2016. We do not expect the adoption of this guidance to have a material impact on our financial position or results of operations.

 

In August 2014, the FASB issued guidance about disclosing an entity’s ability to continue as a going concern. The guidance is intended to define management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The standard will be effective for annual periods ending after December 15, 2016, and for interim and annual periods thereafter, with early application permitted. We do not expect the adoption of this guidance to have a material impact on our financial position or results of operations.

 

In June 2014, the FASB issued guidance that applies to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. It requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition and follows existing accounting guidance for the treatment of performance conditions. The standard will be effective for us prospectively for fiscal years, and interim reporting periods within those years, beginning January 1, 2016, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our financial position or results of operations.

 

 16 

 

 

NUMEREX CORP. AND SUBSIDIARIES

UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

In May 2014, the FASB issued new accounting guidance for revenue recognized from contracts with customers. The core principle of the guidance is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The guidance was set to become effective for us for fiscal years, and interim reporting periods within those years, beginning January 1, 2017 and will require retrospective application when adopted. On July 9, 2015, the FASB voted to defer the effective date by one year to December 15, 2017 for interim and annual reporting periods beginning after that date and permitted early adoption of the standard, but not before the original effective date of December 15, 2016. We are currently evaluating how the adoption of this standard will impact our Consolidated Financial Statements.

 

NOTE K – SUBSEQUENT EVENTS

 

On October 8, 2015, we closed on a mutual agreement with a vendor to (1) cancel the existing agreement, (2) purchase certain equipment from the vendor and (3) assume certain national carrier and other agreements from the vendor in exchange for $0.5 million in cash and 30,000 shares of our common stock having a value of $0.3 million. See Note F – Other Assets.

 

On November 3, 2015, we entered into the first amendment to the Loan Agreement. See Note H – Debt.

 

 17 

 

 

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Forward Looking Statements

 

This document contains, and other statements may contain, forward-looking statements with respect to our future financial or business performance, conditions or strategies and other financial and business matters, including expectations regarding growth trends and activities. Forward-looking statements are typically identified by words or phrases such as "believe," "expect," "anticipate," "intend," "estimate," "assume," "strategy," "plan," "outlook," "outcome," "continue," "remain," "trend," and variations of such words and similar expressions, or future or conditional verbs such as "will," "would," "should," "could," "may," or similar expressions. We caution that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. These forward-looking statements speak only as of the date of this filing, and we assume 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 capture greater recurring subscription revenues; our ability to efficiently utilize cloud computing to expand our services; the risks that a substantial portion of revenues derived from contracts may be terminated at any time; the risks that our strategic suppliers and/or wireless network operators materially change or disrupt the flow of products or services; variations in quarterly operating results; delays in the development, introduction, integration and marketing of new products and services; customer acceptance of services; economic conditions resulting in decreased demand for our products and services; the risk that our strategic alliances, partnerships and/or wireless network operators will not yield substantial revenues; changes in financial and capital markets and the inability to raise growth capital on favorable terms, if at all; the inability to attain revenue and earnings growth; changes in interest rates; inflation; the introduction, withdrawal, success and timing of business initiatives and strategies; competitive conditions; the inability to realize revenue enhancements; disruption in key supplier relationships and/or related services; and the extent and timing of technological changes.

 

Overview

 

As used herein, except as otherwise indicated by context, references to “we,” “us,” “our,” or “Numerex” refers to Numerex Corp. and subsidiaries.

 

The following Management’s Discussion and Analysis is intended to help the reader understand our results of operations and financial condition. This discussion and analysis is provided as a supplement to, and should be read in conjunction with, our unaudited condensed consolidated financial statements and the accompanying notes included in this Quarterly Report on Form 10-Q for the period ended September 30, 2015.

 

We are a holding company that, acting through our subsidiaries, is one of the leading providers of managed M2M enterprise solutions with a presence predominately in North America. We incorporate the key M2M elements of Device (D), Network (N), and Application (A), to create packaged and custom designed M2M solutions for the enterprise and government markets nationwide. We refer to this combination as Numerex DNA.

 

Our network services are provided through national and regional wireless telecommunication carriers and consist of second (2G), third (3G) and fourth generation (4G and LTE) cellular telephone technology. Several wireless carriers have announced their intention to discontinue their 2G networks and fully deploy 3G and 4G networks between 2016 and 2018 while other carriers have announced their intention to discontinue 2G networks as early as 2020. We intend to continue support existing 2G customers through the transition to subsequent technology. Additionally, we have introduced 3G/4G products offering advanced services across our product lines.

 

In recent years, we have embarked on a strategic transformation as advances in technology have changed the way our customers interact in their professional and personal lives and the way that businesses operate. To meet the changing needs of our customers and to address the changing technological landscape, we are focusing efforts on higher margin and growing areas of business. Our strategy requires significant capital investment to develop and enhance our use of technology and to maintain our leadership position and competitive advantage in the markets we serve.

 

 18 

 

  

As part of our effort to build and enhance our core business, we conduct ongoing business strategy reviews. During our reviews, we consider opportunities for growth in existing and new markets that may involve growth derived from both existing operations as well as from future acquisitions, if any. To the extent existing business lines and service offerings are not considered to be compatible with delivery of our core business services or with meeting our financial objectives, we may exit non-core lines of business or stop offering these services in part or in whole.

 

As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014, we perform our annual assessment of goodwill for impairment as of October 1. The valuations of goodwill and other intangible assets require assumptions and estimates of many critical factors, including projections of revenues, costs, operating cash flows, capital expenditures, terminal growth rates and discount rates. As part of our assessment as of October 1, 2014, and as disclosed in our Quarterly Report for the quarterly period ended June 30, 2015, we projected significant growth for certain of our smaller product lines. Lower revenue growth and operating results for these product lines and/or unfavorable changes in other economic factors could impact the underlying key assumptions and our estimated fair values, potentially leading to a future non-cash impairment charge for either or both goodwill and other intangible assets. In September 2015, we recorded a $1.3 million in impairment charges to goodwill and other intangible assets in our Do-It-Yourself (DIY) reporting unit. We also recorded an additional $1.1 million inventory reserve for older inventory and $1.3 million impairment charge for prepaid expenses and other assets. The impairment charge for prepaid expenses and other assets was primarily related to new and modified agreements with wireless carriers and the impairment charge affected multiple reporting units.

 

On May 5, 2014, we acquired the business operations of Omnilink, the financial results of which have now been included in our consolidated results. The purchase consideration of $37.5 million was composed of a cash payment of $37.3 million and a working capital adjustment of $0.2 million.

 

During the quarter ended September 30, 2015, we had revenues of $23.3 million and a net loss of $16.4 million compared with revenues and net income from continuing operations for the quarter ended September 30, 2014 of $25.7 million and of $0.3 million, respectively.

 

For the nine months ended September 30, 2015, we had revenues of $70.7 million and a net loss of $16.7 million compared with revenues and net income from continuing operations for the nine months ended September 30, 2014 of $69.0 million and $1.1 million, respectively.

 

Subscription and support revenue is recognized monthly as services are provided and sales of embedded devices and hardware are recognized when title passes. Other upfront payment revenue is deferred and amortized on a straight line basis.

 

Due to fluctuations of the commencement of new contracts and renewal of existing contracts, we expect variability of sequential quarterly trends in revenues, margins and cash flows. Other factors contributing to sequential quarterly trends include usage, rate changes, and re-pricing of contract renewals and technology changes.

 

Cost of sales for the three and nine months ended September 30, 2015 includes a significant increase in the inventory reserve of $1.1 million and impairment of other assets of $1.3 million. We entered into new and amended agreements with wireless carriers in September 2015 that make adding 2G devices to wireless networks financially unfavorable under most circumstances. As a result of these agreements, we performed a lower of cost or market analysis leading to the increased reserve related to older, 2G cellular telecommunication devices and older satellite devices as well as an accrual for a purchase commitment related to raw materials for the older satellite devices that we will not fulfill.

 

The $1.3 million impairment of other assets is related to a prepaid discount of carrier fees. In September 2015, we entered into a mutual agreement with the vendor to (1) cancel the existing agreement, (2) repurchase certain equipment from the vendor and (3) assume certain national carrier and other agreements from the vendor. Our consideration included (1) $0.5 million in cash, (2) 30,000 shares of our common stock having a value of $0.3 million (3) a prepayment to license additional network access having a carrying value of $0.4 million for a total of $1.2 million. Consummation of the transaction, which was contingent upon obtaining consents from certain of our vendor’s carriers, closed in October 2015. During negotiations with the vendor in the third quarter of fiscal year 2015, a triggering event was identified, for purposes of assessment of asset impairment, as it was more likely than not that the aforementioned assets may be disposed of significantly before the end of their previously estimated useful life. As a result of this transaction and in conjunction with a separate agreement with a mutual national carrier, we determined that the prepaid expenses had no continuing value. We recorded a charge of $1.3 million in cost of sales to write-off the carrying value of the prepaid carrier fees as a settlement of a pre-existing relationship with the vendor.

 

 19 

 

  

Our Do-It-Yourself (DIY) product line and reporting unit is not generating results of operations consistent with our expectations and previous forecasts and management is evaluating different strategic options for the reporting unit. These factors were triggering events that it was more likely than not that the fair value of the DIY reporting unit was less than its carrying amount. As a result, we performed our initial assessment of Goodwill for impairment of the DIY reporting unit, along with other intangible assets of the reporting unit, in the period ending September 30, 2015. The DIY reporting unit included $2.6 million in recorded goodwill and $0.6 million carrying value of patents along with an additional $1.3 million in other intangible assets.

 

We estimated the fair value of the reporting unit using a combination of market and income approaches and concluded that the estimated fair value of the reporting unit was less than its carrying value. We assessed the implied fair value of goodwill in the same manner as if we were acquiring the reporting unit in a business combination. Specifically, we allocated the estimated fair value of the reporting unit to all of the assets and liabilities of that unit, including any unrecognized intangible assets, in a hypothetical calculation, referred to as Step 2. We assessed the amortizing long-lived assets for impairment based on undiscounted cash flows and concluded that the carrying value of patents may not be recoverable. As a result, the fair value of patents was estimated using an income approach.

 

Based on preliminary Step 2 calculations, we have recorded impairments of $0.9 million for goodwill and $0.3 million for patents during the period ending September 30, 2015. The amount of the impairments is an estimate that has not been finalized prior to filing this quarterly report. We expect to finalize Step 2 of the goodwill analysis and finalize the impairment of patents during the quarter ended December 31, 2015.

 

At September 30, 2015, we determined that we would not meet the criteria of “more likely than not” that the cumulative federal net operating losses and certain other deferred tax assets would be recoverable. This determination was based on our cumulative loss over the past three years. Accordingly, we recorded a valuation allowance against these items. The deferred tax assets consist of federal net operating losses, state net operating losses, tax credits, and other deferred tax assets, most of which expire between 2015 and 2035. As a result of recording a valuation allowance as of September 30, 2015, we recognized deferred tax expense of $10.4 million and $10.1 million for the three and nine months ended September 30, 2015. Income tax expense recorded in the future will be reduced or increased to the extent of offsetting decreases or increases to the valuation allowance.

 

In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider projections of future taxable income, tax planning strategies and the reversal of temporary differences in making this assessment. We will maintain the valuation allowance against the net deferred tax assets until sufficient positive evidence outweighs any negative evidence to support reversal. Future reversals or increases to the valuation allowance could have a significant impact on our future earnings.

 

 20 

 

  

Results of Operations

 

Three Months Ended September 30, 2015 and 2014

 

The following table sets forth selected consolidated results of operations for the periods indicated, including comparative information between the periods (dollars in thousands):

 

   Three Months Ended September 30,         
   2015   2014   2015 vs. 2014 
Net revenues:                              
Subscription and support revenues  $15,624    67.0%  $17,429    67.9%  $(1,805)   -10.4%
Embedded devices and hardware   7,710    33.0%   8,234    32.1%   (524)   -6.4%
Total net revenues   23,334    100.0%   25,663    100.0%   (2,329)   -9.1%
Cost of revenue, exclusive of a portion of depreciation and amortization shown below:                              
Subscription and support revenues   6,538    28.0%   7,011    27.3%   (473)   -6.7%
Embedded devices and hardware   6,958    29.8%   7,236    28.2%   (278)   -3.8%
Inventory reserves   1,277    5.5%   129    0.5%   1,148    889.9%
Impairment of other asset   1,275    5.5%   -    0.0%   1,275    100.0%
Gross profit   7,286    31.2%   11,287    44.0%   (4,001)   -35.4%
Operating expenses:                              
Sales and marketing   3,047    13.1%   3,029    11.8%   18    0.6%
General and administrative   4,507    19.3%   3,429    13.4%   1,078    31.4%
Engineering and development   2,201    9.4%   2,430    9.5%   (229)   -9.4%
Depreciation and amortization   2,100    9.0%   1,597    6.2%   503    31.5%
Impairment of goodwill and other intangible assets   1,250    5.4%   -    0.0%   1,250    100.0%
Operating(loss) income   (5,819)   -24.9%   802    3.1%   (6,621)   -825.6%
Interest expense   188    0.8%   278    1.1%   (90)   -32.4%
Other income, net   (31)   -0.1%   (97)   -0.4%   66    -68.0%
(Loss) income before income taxes   (5,976)   -25.6%   621    2.4%   (6,597)   -1062.3%
Income tax expense   10,404    44.6%   358    1.4%   10,046    2806.1%
Net (loss) income   (16,380)   -70.2%   263    1.0%   (16,643)   -6328.1%
Adjusted EBITDA(1)  $1,660    7.1%  $3,326    13.0%  $(1,666)   -50.1%

_________________

(1) – Adjusted EBITDA is not a financial measure prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). See further discussion, including reconciliation to the most comparable GAAP measure, under the caption Non-GAAP Financial Measures below.

 

Total revenue decreased $2.3 million, or 9.1%, for the three months ended September 30, 2015 to $23.3 million from $25.7 million for the same period in 2014. The decrease reflects the loss of one customer due to non-payment and other losses associated with network customers’ 2G conversions where we did not have a competitive offer. The decrease in revenue is also attributed to a strategic shift from offering customers a network- or application-only solution, to a higher margin, integrated managed service that includes the full suite of Numerex DNA.
 

Embedded devices and hardware revenues decreased $0.5 million or 6.4% to $7.7 million for the three months ended September 30, 2015 compared to $8.2 million for the same period in 2014. The majority of the decrease pertains to the timing of one of our largest customer’s periodic high volume purchases of hardware modules. Purchases from this customer were $5.2 million and $5.4 million for the three months ended September 30, 2015 and 2014, respectively. Sales of embedded devices and hardware are also adversely affected by our shift to a managed service offering of Numerex DNA noted above instead of selling hardware as separate components. Because of this shift, we anticipate hardware revenue will continue to fluctuate and also decrease in total over time.

 

 21 

 

  

Total cost of revenue for the three months ended September 30, 2015 increased $1.7 million, or 11.6%, to $16.0 million compared to $14.4 million for the same period in 2014. Comprising that increase, the direct cost of revenue for subscription and support services decreased $0.5 million, or 6.7%, to $6.5 million for the three months ended September 30, 2015 compared to $7.0 million for the same period in 2014. Subscription and support revenue less direct costs was $9.1 million, or 58.2% of subscription support revenue for the three months ended September 30, 2015 compared to $10.4 million, or 59.8% of subscription support revenue for the three months ended September 30, 2014. The year over year decrease in direct costs of subscription and support revenue and the corresponding increase as a percentage of revenue are attributed to the overall decline in revenue.

 

The direct cost of revenue for embedded devices and hardware decreased $0.3 million, or 3.8%, to $7.0 million for the three months ended September 30, 2015 compared to $7.2 million for the same period in 2014. Embedded devices and hardware revenue less direct costs was $0.8 million, or 9.8% of embedded devices and hardware revenue for the three months ended September 30, 2015 compared to $1.0 million, or 12.1% of embedded devices and hardware revenue for the three months ended September 30, 2014. The year over year decrease in direct costs of embedded devices and hardware relates primarily to overall revenue decline as well as the customer and product mix. Customer and product mix also caused direct cost of embedded devices and hardware as a percentage of corresponding revenue to increase to 90.2% for the three months ended September 30, 2015 from 87.9% for the same period in 2014.

 

As described in the Overview above, we entered into new and amended agreements with wireless carriers in September 2015. As a result of these agreements, we performed a lower of cost or market analysis leading to a significant increase in the inventory reserve of $1.1 million during the three months ended September 30, 2015 related to older, 2G cellular telecommunication devices and older satellite devices as well as an accrual for a purchase commitment related to raw materials for the older satellite devices that we will not fulfill. In addition, one of the amended carrier agreements led to settlement of a pre-existing relationship and a $1.3 million impairment of a prepaid expense during the three months ended September 30, 2015. The prepaid expense was previously recorded in other assets.

 

Sales and marketing expense remained consistent year over year in total dollars, but increased as a percentage of total revenue to 13.1% for the three months ended September 30, 2015 compared to 11.8% of total revenue for the same period in 2014.

 

General and administrative expenses increased $1.1 million to $4.5 million for the three-month period ended September 30, 2015, compared to $3.4 million for the three-month period ended September 30, 2014. As a percentage of net sales, general and administrative expenses increased to 19.3% for the three months ended September 30, 2015 compared to 13.4% for the three months ended September 30, 2014. General and administrative expenses for the three months ended September 30, 2015 includes $0.5 million for the new chief executive officer relocation and recruiting costs and $0.2 million for an immaterial correction of an error relating to international value-added and sales taxes.

 

Engineering and development expenses decreased 9.4% to $2.2 million for the three-month period ended September 30, 2015, compared to $2.4 million for the three-month period ended September 30, 2014. The decrease was primarily attributed to cost management as reduction in employee costs was the main driver. Engineering and development expenses decreased to 9.4% of total revenue for the three months ended September 30, 2015 compared to 9.5% of total revenue for the same period in 2014.

 

Depreciation and amortization expense increased 31.5% to $2.1 million for the three-month period ended September 30, 2015, compared to $1.6 million for the three-month period ended September 30, 2014. The increase in depreciation and amortization is related to recently acquired product lines and development of new product and project initiatives, including the amortization of new intangible assets. The increase also includes $0.4 million for managed service devices and hardware used by a financially troubled customer at risk of not being returned to us.

 

The $1.3 million impairment of goodwill and other intangible assets recorded in the three months ended September 30, 2015 was related to our DIY reporting unit as described in the Overview above.

 

Interest expense decreased $0.1 million to $0.2 million for the three-month period ended September 30, 2015 compared to $0.3 million for the same period in 2014. The decrease is due to full payment of the seller financed promissory note from the acquisition of a small technology company in 2012.

 

 22 

 

  

We recorded a provision for income tax expense of $10.4 million for the three months ended September 30, 2015 and $0.4 million for the three months ended September 30, 2014. The effective tax rates were (174.1%) and 57.6% for the three months ended September 30, 2015 and 2014, respectively. The effective tax rate for the three months ended September 30, 2015 differed from the federal statutory rate of 34% primarily as a result of recording the valuation allowance for net deferred tax assets.

 

For the three months ended September 30, 2014, the difference between our effective tax rate and the federal statutory tax rate resulted primarily from (1) the income tax benefit for the capital loss from the disposal of discontinued operations effective June 30, 2014 and the ability to offset capital gains in the current tax year and to carry back for capital gains in prior tax years, (2) the portion of transaction costs incurred in the Omnilink merger that were not deductible for income taxes and (3) state income taxes, including the tax effect of changes in effective state income tax rates resulting from the Omnilink merger.

 

 23 

 

  

Nine Months Ended September 30, 2015 and 2014

 

The following table sets forth selected consolidated results of operations for the periods indicated, including comparative information between the periods (dollars in thousands):

 

   Nine Months Ended September 30,         
   2015   2014   2015 vs. 2014 
Net revenues:                              
Subscription and support revenues  $48,874    69.2%  $47,530    68.9%  $1,344    2.8%
Embedded devices and hardware   21,791    30.8%   21,483    31.1%   308    1.4%
Total net revenues   70,665    100.0%   69,013    100.0%   1,652    2.4%
Cost of revenue, exclusive of a portion of depreciation and amortization shown below:                              
Subscription and support revenues   19,728    27.9%   18,647    27.0%   1,081    5.8%
Embedded devices and hardware   19,582    27.7%   18,102    26.2%   1,480    8.2%
Inventory reserves   1,547    2.2%   415    0.6%   1,132    272.8%
Impairment of other asset   1,275    1.8%   -    0.0%   1,275    100.0%
Gross profit   28,533    40.4%   31,849    46.1%   (3,316)   -10.4%
Operating expenses:                              
Sales and marketing   9,136    12.9%   9,066    13.1%   70    0.8%
General and administrative   12,108    17.1%   11,207    16.2%   901    8.0%
Engineering and development   6,695    9.5%   5,794    8.4%   901    15.6%
Depreciation and amortization   5,411    7.7%   4,570    6.6%   841    18.4%
Impairment of goodwill and other intangible assets   1,250    1.8%   -    0.0%   1,250    100.0%
Operating (loss) income   (6,067)   -8.6%   1,212    1.8%   (7,279)   -600.6%
Interest expense   604    0.9%   564    0.8%   40    7.1%
Other income, net   (100)   -0.1%   (1,272)   -1.8%   1,172    -92.1%
(Loss) income from continuing operations before income taxes   (6,571)   -9.3%   1,920    2.8%   (8,491)   -442.2%
Income tax expense   10,159    14.4%   283    0.4%   9,876    3489.8%
(Loss) income from continuing operations, net of income taxes   (16,730)   -23.7%   1,637    2.4%   (18,367)   -1122.0%
Loss from discontinued operations, net of income taxes   -    0.0%   (492)   -0.7%   492    -100.0%
Net (loss) income  $(16,730)   -23.7%  $1,145    1.7%  $(17,875)   -1561.1%
Adjusted EBITDA(1)  $7,358    10.4%  $9,078    13.2%  $(1,720)   -18.9%

 _________________

(1) – Adjusted EBITDA is not a financial measure prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). See further discussion, including reconciliation to the most comparable GAAP measure, under the caption Non-GAAP Financial Measures below.

 

Total revenue increased $1.7 million, or 2.4%, for the nine months ended September 30, 2015 to $70.7 million from $69.0 million for the same period in 2014. The increase is primarily attributable to subscription and support revenues which grew $1.3 million, or 2.8%, to $48.9 million from $47.5 million in 2014 primarily from our introduction of new product lines, including those recently acquired.

 

Embedded device and hardware revenue increased $0.3 million, or 1.4%, to $21.8 million for the nine months ended September 30, 2015 compared to $21.5 million recorded in the same period in 2014. The majority of the increase pertains to timing of one of our largest customer’s periodic high volume purchases of hardware modules. Purchases from this customer were $12.5 million and $11.1 million for the nine months ended September 30, 2015 and 2014, respectively. The increase in sales to one of our largest customers was offset by our shift to a managed service offering of Numerex DNA noted above instead of selling hardware as separate components. Because of this shift, we anticipate hardware revenue will continue to fluctuate and also decrease in total over time.

 

 24 

 

  

Total cost of revenue for the nine months ended September 30, 2015 increased $5.0 million, or 13.4%, to $42.1 million compared to $37.2 million for the same period in 2014. Comprising that increase, the direct cost of revenue for subscription and support services increased $1.1 million, or 5.8%, to $19.7 million for the nine months ended September 30, 2015 compared to $18.6 million for the same period in 2014. Subscription and support revenue less direct costs was $29.1 million, or 59.6% of subscription and support revenue for the nine months ended September 30, 2015 compared to $28.9 million, or 60.8% of subscription and support revenue for the nine months ended September 30, 2014.

 

The direct cost of revenue for embedded devices and hardware increased $1.5 million, or 8.2% to $19.6 million for the nine months ended September 30, 2015 compared to $18.1 million for the same period in 2014. Embedded devices and hardware revenue less direct costs was $2.2 million, or 10.1% of embedded devices and hardware revenue for the nine months ended September 30, 2015 compared to $3.4 million, or 15.7% of embedded devices and hardware revenue for the nine months ended September 30, 2014. The year over year increase in direct costs of embedded devices and hardware is attributed to customer and product mix. Customer and product mix also caused direct cost of embedded devices and hardware as a percentage of corresponding revenue to increase to 89.9% for the nine months ended September 30, 2015 from 84.3% for the same period in 2014.

 

As described in the Overview above, we entered into new and amended agreements with wireless carriers in September 2015. As a result of these agreements, we performed a lower of cost or market analysis leading to a significant increase in the inventory reserve of $1.1 million during the nine months ended September 30, 2015 related to older, 2G cellular telecommunication devices and older satellite devices as well as an accrual for a purchase commitment related to raw materials for the older satellite devices that we will not fulfill. In addition, one of the amended carrier agreements led to settlement of a pre-existing relationship and a $1.3 million impairment of a prepaid expense during the nine months ended September 30, 2015. The prepaid expense was previously recorded in other assets.

 

Sales and marketing expense remained consistent year over year in both total dollars and as a percentage of total revenue.

 

General and administrative expense increased $0.9 million, or 8.0%, to $12.1 million for the nine months ended September 30, 2015, compared to $11.2 million for nine month period ended September 30, 2014. As a percentage of net sales, general and administrative expenses increased to 17.1% for the nine months ended September 30, 2015 compared to 16.2% for the nine months ended September 30, 2014. The increase includes the effect of recently acquired product lines. General and administrative expenses for the nine months ended September 30, 2015 also includes of $0.5 million for the new chief executive officer relocation and recruiting costs and $0.2 million for an immaterial correction of an error relating to international value-added and sales taxes. General and administrative expense for the nine months ended September 30, 2015 includes $0.4 million in other professional fees and transaction costs compared to $1.1 million for the comparable period in 2014.

 

Engineering and development expenses increased 15.6% to $6.7 million for the nine-month period ended September 30, 2015, compared to $5.8 million for the nine-month period ended September 30, 2014. The increase was primarily driven by the continued development associated with newly introduced product lines with $0.3 million related to contract labor and $0.6 million in salary expense for newly hired employees. Engineering and development expense was 9.5% of total revenue for the nine months ended September 30, 2015 compared to 8.4% of total revenue for the same period in 2014.

 

Depreciation and amortization expense increased $0.8 million, or 18.4%, to $5.4 million for the nine months ended September 30, 2015, compared to $4.6 million for the nine month period ended September 30, 2014. The increase in depreciation and amortization is related to recently acquired product lines and development of new product and project initiatives, including the amortization of new intangible assets. The increase also includes $0.4 million for managed service devices and hardware used by a financially troubled customer at risk of not being returned to us.

 

The $1.3 million impairment of goodwill and other intangible assets recorded in the nine months ended September 30, 2015 was related to our DIY reporting unit as described in the Overview above.

 

 25 

 

  

Other income decreased $1.2 million for the nine months ended September 30, 2015. The decrease is related to a pre-tax gain of $1.1 million on the sale of a cost method investment in a privately-held business during the nine months ended September 30, 2014. The carrying value of the investment was $0.2 million and was sold for $1.3 million.

 

We recorded a provision for income tax expense of $10.2 million and $0.3 million for the nine months ended September 30, 2015 and 2014, respectively. The effective tax rates were (154.6%) and 14.7% for the nine months ended September 30, 2015 and 2014, respectively. The effective tax rate for the nine months ended September 30, 2015 differed from the federal statutory of 34% primarily as a result of recording the valuation allowance for net deferred tax assets.

 

For the nine months ended September 30, 2014, the difference between our effective tax rate and the federal statutory tax rate resulted primarily from (1) the income tax benefit for the capital loss from the disposal of discontinued operations effective June 30, 2014 and the ability to offset capital gains in the current tax year and to carry back for capital gains in prior tax years, (2) the portion of transaction costs incurred in the Omnilink merger that were not deductible for income taxes and (3) state income taxes, including the tax effect of changes in effective state income tax rates resulting from the Omnilink merger.

 

Segment Information

 

We have one reportable segment, providing interactive and on-demand Machine to Machine (M2M) enterprise solutions enabling the Internet of Things (IOT).

 

Non-GAAP Financial Measures

 

Earnings before interest, taxes, depreciation and amortization expenses (EBITDA) and Adjusted EBITDA, which are presented below, are non-GAAP measures and do not purport to be alternatives to operating income as a measure of operating performance. We believe EBITDA, Adjusted EBITDA and Adjusted EBITDA per diluted share are useful to and used by investors and other users of the financial statements in evaluating our operating performance because it provides them with an additional tool to compare business performance across periods.
 

We believe that

 

EBITDA is widely used by investors to measure a company’s operating performance without regard to items such as interest expense, income taxes, depreciation and amortization, which can vary substantially from company-to-company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired; and
Investors commonly adjust EBITDA information to eliminate the effect of equity-based compensation and non-cash and other charges which vary widely from company-to-company and impair comparability.

 

We use EBITDA, Adjusted EBITDA and Adjusted EBITDA per diluted share:

 

as a measure of operating performance to assist in comparing performance from period-to-period on a consistent basis
as a measure for planning and forecasting overall expectations and for evaluating actual results against such expectations; and
in communications with the board of directors, analysts and investors concerning our financial performance.

 

Although we believe, for the foregoing reasons, that the presentation of non-GAAP financial measures provides useful supplemental information to investors regarding our results of operations, the non-GAAP financial measures should only be considered in addition to, and not as a substitute for, or superior to, any measure of financial performance prepared in accordance with GAAP.

 

Use of non-GAAP financial measures is subject to inherent limitations because they do not include all the expenses that must be included under GAAP and because they involve the exercise of judgment of which charges should properly be excluded from the non-GAAP financial measure. Management accounts for these limitations by not relying exclusively on non-GAAP financial measures, but only using such information to supplement GAAP financial measures. The non-GAAP financial measures may not be the same non-GAAP measures, and may not be calculated in the same manner, as those used by other companies.

 

 26 

 

  

Adjusted EBITDA is calculated by excluding the effect of equity-based compensation and non-operational items from the calculation of EBITDA. Management believes that this measure provides additional relevant and useful information to investors and other users of our financial data in evaluating the effectiveness of our operations and underlying business trends in a manner that is consistent with management’s evaluation of business performance.

 

We believe that excluding depreciation and amortization of property, equipment and intangible assets to calculate EBITDA and Adjusted EBITDA provides supplemental information and an alternative presentation that is useful to investors’ understanding of our core operating results and trends. Not only are depreciation and amortization expenses based on historical costs of assets that may have little bearing on present or future replacement costs, but also they are based on our estimates of remaining useful lives.

 

We believe that excluding the effects of equity-based compensation from non-GAAP financial measures provides supplemental information and an alternative presentation useful to investors’ understanding of our core operating results and trends. Investors have indicated that they consider financial measures of our results of operations excluding equity-based compensation as important supplemental information useful to their understanding of our historical results and estimating our future results.

 

We also believe that, in excluding the effects of equity-based compensation, our non-GAAP financial measures provide investors with transparency into what management uses to measure and forecast our results of operations, to compare on a consistent basis our results of operations for the current period to that of prior periods and to compare our results of operations on a more consistent basis against that of other companies, in making financial and operating decisions and to establish certain management compensation.

 

Equity-based compensation is an important part of total compensation, especially from the perspective of employees. We believe, however, that supplementing GAAP income from continuing operations by providing income from continuing operations, excluding the effect of equity-based compensation in all periods, is useful to investors because it enables additional and more meaningful period-to-period comparisons.  

 

Adjusted EBITDA excludes non-cash and other charges including costs and fees related to an internal ERP systems integration upgrade, a network systems evaluation, acquisition related costs, a large and uncommon reserve for inventory, impairment and write-off of prepaid expenses, and a goodwill impairment charge. We believe that these costs are unusual costs that we do not expect to recur on a regular basis, and consequently, we do not consider these charges as a component of ongoing operations.

 

EBITDA and Adjusted EBITDA are not measures of liquidity calculated in accordance with GAAP, and should be viewed as a supplement to – not a substitute for – results of operations presented on the basis of GAAP. EBITDA and Adjusted EBITDA do not purport to represent cash flow provided by operating activities as defined by GAAP. Furthermore, EBITDA and Adjusted EBITDA are not necessarily comparable to similarly-titled measures reported by other companies.

 

 27 

 

  

The following table reconciles the specific items excluded from GAAP in the calculation of EBITDA and Adjusted EBITDA for the periods indicated below (in thousands except per share amounts):

 

   Three Months   Nine Months 
   Ended September 30,   Ended September 30, 
   2015   2014   2015   2014 
(Loss) income from continuing operations, net of income taxes (GAAP)  $(16,380)  $263   $(16,730)  $1,637 
Depreciation and amortization expense   2,381    1,789    6,163    4,969 
Interest expense and other non-operating expense (income), net   157    181    504    (708)
Income tax expense   10,404    358    10,159    283 
EBITDA (non-GAAP)   (3,438)   2,591    96    6,181 
Equity-based compensation expense   738    694    2,319    1,833 
Non-cash and other items   4,360    41    4,943    1,064 
Adjusted EBITDA (non-GAAP)  $1,660   $3,326   $7,358   $9,078 
                     
(Loss) income from continuing operations, net of income taxes, per diluted share (GAAP)  $(0.86)  $0.01   $(0.88)  $0.09 
EBITDA per diluted share (non-GAAP)   (0.18)   0.13    0.01    0.32 
Adjusted EBITDA per diluted share (non-GAAP)   0.09    0.17    0.39    0.47 
                     
Weighted average shares outstanding used in computing diluted per share amounts   19,137    19,263    19,053    19,253 

  

As noted above, non-cash and other charges include goodwill and intangible write downs, impairment of other assets, unusual inventory reserves, costs related to hiring a new chief executive, fees related to an internal ERP systems integration upgrade, a network systems evaluation, and acquisition related costs.

 

Liquidity and Capital Resources

 

We use the net cash generated from our operations to fund new product development, upgrades to our technology and to invest in new businesses. Our source of funds is principally from operations. We believe that we have sufficient liquidity and capital resources to meet ongoing operations and investing requirements through our cash on hand and generated from operations and that we will be able to access funds from external financing arrangements as necessary.

 

We had working capital of $17.5 million as of September 30, 2015, compared to $23.7 million as of December 31, 2014, respectively. We had cash balances of $12.5 million and $17.3 million as of September 30, 2015 and December 31, 2014, respectively. Our allowance for doubtful accounts reflected in the accompanying balance sheet includes bad debt reserves and revenue reserves.

 

Net cash provided by operating activities for the nine-month period ended September 30, 2015 was $4.1 million compared with net cash of $7.1 million provided by operating activities of continuing operations for the nine-month period ended September 30, 2014. The decrease in cash provided by operations is primarily a result of an increase in gross accounts receivable and gross inventory from December 31, 2014 to September 30, 2015. The increase in gross accounts receivable is primarily due to shipping a large customer’s hardware order near the end of the period and customers with extended payment terms. The increase in gross inventory results from increased purchases of newer generation inventory.

 

Net cash used in investing activities for the nine-month period ended September 30, 2015 was $5.3 million, representing expenditures of $2.0 million for tangible assets, and $3.3 million for software and capitalization of internally developed software.

 

Net cash used in financing activities for the nine-month period ended September 30, 2015 was $3.6 million, primarily for payments on debt.

 

 28 

 

  

On May 5, 2014, we entered into a Second Amended and Restated Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank (“SVB”). The Loan Agreement was entered into by the Company in contemplation of the cash funding required in connection with our acquisition of Omnilink (see Note B – Merger) and to provide additional funding as needed for future capital investments for the business. In that regard, the Loan Agreement provides for $30.0 million of aggregate credit which is comprised of a $25.0 million term loan that was specifically structured and designated as funds to be borrowed and used by the Company toward payment of cash purchase consideration for the Omnilink transaction and an additional $5.0 million revolving line of credit for general corporate needs.

 

The maturities for both the term and revolving credit facilities contemplated in the Loan Agreement are May 5, 2019. As is typical in the case of term loan structures, the Loan Agreement provides for mandatory scheduled quarterly payments of principal as set forth in the table below that will cumulatively have the effect of repaying 80%, or $20.0 million, of the principal borrowed before the maturity date in May, 2019. The remaining principal of $5.0 million will be due at maturity if not otherwise repaid earlier by way of voluntary Permitted Prepayments or by mandatory Excess Cash Flow Recapture Payments (as defined in the Loan Agreement).

 

Loan Agreement Principal Repayment Schedule

 

   Quarterly   Annually 
June 2014 - March 2015  $625,000   $2,500,000 
June 2015 - March 2016   937,500    3,750,000 
June 2016 - March 2017   937,500    3,750,000 
June 2017 - March 2018   1,250,000    5,000,000 
June 2018 - March 2019   1,250,000    5,000,000 
Outstanding balance due May 2019   -    5,000,000 

 

Our obligations under the Loan Agreement are secured by substantially all of our assets and the assets of our subsidiaries. In addition, we are required to meet certain financial and other restrictive covenants customary with this type of facility, including maintaining a senior leverage ratio, a fixed charge coverage ratio and minimum liquidity availability. We are also prohibited from paying dividends. The Loan Agreement contains customary events of default. If a default occurs and is not cured within any applicable cure period or is not waived, any outstanding obligations under the Loan Agreement may be accelerated. It is unlikely we would have adequate funds to repay such amounts prior to the scheduled maturity of the loan. If we fail to repay such amounts, SVB may foreclose on the assets we have pledged under the Loan Agreement, which include substantially all of our assets and those of our domestic subsidiaries.

 

As of September 30, 2015, we did not meet the fixed charge coverage ratio covenant. We entered into the first amendment to the Loan Agreement on November 3, 2015 (the “Amendment”). The Amendment does not permit any subsequent advances under the Credit Facility, waived the fixed charge coverage ratio for the three months ended September 30, 2015 and added a monthly liquidity ratio covenant. While we believe that we will continue to have sufficient cash available to operate our business and to meet our financial obligations and debt covenants over the next 12 months, there can be no assurances that our operations will generate sufficient cash, that we will be able to comply with applicable loan covenants or that credit facilities will be available in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs.

 

 29 

 

 

Off-Balance Sheet Arrangements

 

As of September 30, 2015, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

 

Critical Accounting Policies

 

There have been no material changes in our critical accounting policies, estimates and judgments during the nine months ended September 30, 2015 compared to the disclosures in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2014.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risks.

  

The market risk in our financial instruments represents the potential loss arising from adverse changes in financial rates. We are exposed to market risk in the area of interest rates. These exposures are directly related to our normal funding and investing activities. We are subject to interest rate market risk in connection with our long-term debt. Our principal interest rate exposure relates to outstanding amounts under our $25.0 million term loan. Our term loan provides for variable interest rates determined by reference to the prime rate or LIBOR rate. A one-eighth percent increase or decrease in assumed interest rates for the $25.0 million term loan for the one year period following its inception would result in a corresponding increase or decrease in interest expense of $30,000.

 

We also hold cash balances in accounts with commercial banks in the United States and foreign countries. These cash balances represent operating balances only and are invested in short-term time deposits of the local bank. Such operating cash balances held at banks outside the United States are denominated in the local currency and are minor.

 

Foreign Currency

 

The assets and liabilities of our foreign operations are translated into U.S. dollars at current exchange rates, and revenues and expenses are translated at the ending exchange rate from the prior period which materially approximates the average exchange rates for each period. Resulting translation adjustments are reflected as other comprehensive (loss) income within shareholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. Except for transactions with customers and vendors in Canada, substantially all other transactions are denominated in U.S. dollars. Foreign operations were not significant to us for the quarter ended September 30, 2015.

 

Item 4. Controls and Procedures.

 

As of September 30, 2015, under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), management has evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the CEO and CFO concluded that, as of September 30, 2015, the Company's disclosure controls and procedures were effective at the reasonable assurance level in timely alerting them to material information required to be included in the Company's periodic SEC reports. There were no changes in the Company's internal controls over financial reporting during the third quarter of 2015 that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting. 

 

 30 

 

  

PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

We currently are not involved in any pending material litigation.

 

Item 1A. Risk Factors.

 

For information regarding factors that could affect our results of operations, financial condition and liquidity, see the risk factors discussion set forth in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 as previously filed with the SEC, and the information under “Forward-Looking Statements” included in this Quarterly Report on Form 10-Q.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

None - not applicable.

 

Item 3. Defaults Upon Senior Securities.

 

None - not applicable.

 

Item 4. Mine Safety Disclosures.

 

None - not applicable.

 

 31 

 

 

Item 5. Other Information.

 

Loan Agreement

 

On November 3, 2015, the Company and certain of its subsidiaries entered into the Amendment with the Bank. The Amendment does not permit any subsequent advances under the Credit Facility, waived the fixed charge coverage ratio for the three months ended September 30, 2015 and added a monthly liquidity ratio covenant (as such term is defined in the Amendment) of at least 1.00 to 1.00.

 

The foregoing summary of the amendment to the Loan Agreement is not complete and is qualified in its entirety by reference to the amendment, which is attached hereto as Exhibit 10.2.

 

Employment Agreement

 

On November 4, 2016, the Company and Stratton Nicolaides, Executive Chairman, entered into a new employment agreement (“New Employment Agreement”) effective January 1, 2016. Pursuant to the New Employment Agreement, Mr. Nicolaides will step down as Executive Chairman and will become non-Executive Chairman and Senior Advisor to the Chief Executive Officer and the Board of Directors. In this capacity, Mr. Nicolaides will make himself available for up to 35 hours per week to the members of the Board of Directors (including the Chief Executive Officer) and other members of the executive management team at the direction of the Chief Executive Officer. The term of the New Agreement is for 36 months, commencing on January 1, 2016, and will be automatically extended by an additional 12 months at the end of the initial term and on each succeeding anniversary unless written notice is given by the Company or Mr. Nicolaides in accordance with the New Employment Agreement. The Company may terminate the New Employment Agreement for “cause.” Mr. Nicolaides will receive a salary of $20,000 per month and shall be entitled to continue to participate in all benefits plans generally available to other senior executive of the Company, including vacation.

 

The foregoing summary of the New Employment Agreement is not complete and is qualified in its entirety by reference to the agreement, which is attached hereto as Exhibit 10.3.

 

Separation Agreement

 

On November 5, 2016, the Company and Louis Fienberg, formerly EVP Corporate Development, entered into a separation agreement and general release (“Separation Agreement”). Pursuant to the Separation Agreement, for and in consideration of mutual promises, releases and covenants, Mr. Fienberg will receive $125,000 lump sum cash payment, six monthly payment of $20,833.33, accelerated vesting of 22,425 non-vested restricted share units, and the right to exercise all vested stock options or stock appreciation rights through July 29, 2016.

 

The foregoing summary of the Separation Agreement is not complete and is qualified in its entirety by reference to the agreement, which is attached hereto as Exhibit 10.4.

 

 32 

 

  

Item 6. Exhibits

 

  Exhibit 10.1 M Zionts Employment Agreement.*

 

  Exhibit 10.2 First Amendment to Second Amended And Restated Loan And Security Agreement dated November 3, 2015.

 

Exhibit 10.3Stratton Nicolaides Employment Agreement dated November 4, 2015*

 

Exhibit 10.4Louis Fienberg Separation Agreement and General Release dated November 5, 2015*

 

  Exhibit 10.5 Shu Gan Offer Letter for Employment dated September 22, 2015*

 

Exhibit 10.6Vin Constello Offer Letter for Employment dated September 22, 2015*

 

  Exhibit 31.1 Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a).

 

  Exhibit 31.2 Certification of Chief Financial Officer, Executive Vice President, and Principal Financial and Accounting Officer Pursuant to Exchange Act Rule 13a-14(a).

 

  Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

  Exhibit 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

  Exhibit 101 The following financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015, formatted in eXtensible Business Reporting Language (XBRL): (i) Condensed Consolidated Balance Sheets at September 30, 2015 and December 31, 2014, (ii) Unaudited Condensed Consolidated Statement of Operations and Comprehensive (Loss) Income for the three and nine months ended September 30, 2015 and 2014, (iii) Unaudited Consolidated Statements of Cash Flows for the three months ended September 30, 2015 and 2014, (iv) Unaudited Condensed Consolidated Statement of Shareholders Equity for the three months ended September 30, 2015 and (v) Unaudited Condensed Notes to Consolidated Financial Statements.

____________________

* Indicates a compensatory management contract arrangement.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  NUMEREX CORP.
  (Registrant)
   
November 9, 2015 /s/ Marc Zionts
  Marc Zionts
  Chief Executive Officer
   
November 9, 2015 /s/ Richard A. Flynt
  Richard A. Flynt
  Chief Financial Officer and
  Principal Financial and Accounting Officer

 

 33