Summary of LOJACK CORP - Yahoo! Finance

ITEM 7- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and notes thereto which appear in Item 8 in this Annual Report on Form 10-K. The following discussion contains forward-looking statements and should also be read in conjunction with the risk factors set forth in Item 1A.

Overview

We are a leading global provider of technology products and services for the tracking and recovery of valuable mobile assets. Our proprietary technology, wireless network and unique integration with law enforcement agencies provide an effective means for tracking and recovery of stolen vehicles, construction equipment, motorcycles, cargo and people at risk.

We have three separately managed and reported business segments: domestic, international and Boomerang.

Domestic Segment

We develop and market a variety of products designed to track and recover stolen vehicles, construction equipment, motorcycles, cargo, people at risk and hazardous materials.

Our revenue in the United States is derived primarily from the sale of LoJack Units, LoJack Early Warning, and extended warranty products to consumers. Approximately 85% of domestic sales are made through a distribution network consisting of dealers of new and used automobiles. We have strong consumer brand awareness in the United States.

Given current economic conditions we will look to maximize the variable installation cost of a LoJack Unit by increasing our installation volumes with certified dealers and other third parties. We monitor the quality of these alternative installations through the use of an expanded quality control process. We maintain full warranty service of LoJack Units, both for the convenience of dealers through which the LoJack Units are marketed and to maintain a high degree of quality control and security over our technology.

We also offer warranty products at the point of sale to new customers and through direct sales efforts to our existing customers.

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We record additions to deferred revenue for our LoJack Early Warning product for certain warranty products for which we have been deemed to be the primary obligor of the underlying contract. Since January 1, 2007, we are no longer the primary obligor under any warranty arrangements. We typically receive full payment within 60 days of the transaction, but recognition of the deferred revenue is recognized over the estimated life of the product or service. These payments are a significant component of our cash flow from operations. Additions of these components of deferred revenue net of deferred costs were $16,618,000 for the year ended December 31, 2008, compared to additions of $18,549,000 for the year ended December 31, 2007.

Revenue for SCI is derived from the sale of tracking devices as well as subscription fees for monitoring service alerts and activity reporting. At December 31, 2008 there was approximately $122,000 of deferred revenue relating to SCI subscription based services.

LoJack SafetyNet revenue in 2008 was primarily comprised of the sale of search and rescue receivers, personal locator units and replacements parts to PLI. Beginning in 2009, LoJack SafetyNet will transition from an order fulfillment revenue model servicing one primary customer, PLI, to a fulfillment and service model providing the LoJack SafetyNet solution to caregivers and consumers for a monthly fee. As part of this new business model, we plan to provide the SAR receivers directly to participating law enforcement at nominal or no cost.

International Segment

Internationally, our licensed stolen vehicle recovery technology is operational in 32 countries and territories around the world. We have a licensed presence in Latin and South America, Europe and Africa, and the Asia Pacific Rim. Revenue from this segment consists of product sales to our licensees, royalties and license fees. Revenue from the international segment comprised approximately 32% of consolidated revenue for the year ended December 31, 2008, compared to 24% and 22% in 2007 and 2006, respectively.

We record additions to deferred revenue for international license fees and recognize the revenue over the term of the license (generally ten years). Royalty revenue is recognized when earned.

Italy is the only country outside the United States and Canada where we own and operate a recovery network. Purchasers of LoJack Units in Italy are required to purchase a service contract with LoJack Italia. The terms of service contracts offered range from 12 to 36 months and are payable in full upon activation of the related unit or renewal of a previous service contract. At December 31, 2008 there was approximately $478,000 of deferred revenue relating to LoJack Italia service contracts.

Boomerang Segment

Revenue from our Boomerang segment is derived primarily from the sale of Boomerang Espion, Boomerang Espion Alert, Boomerang, Boomerang2 and BoomerangXpress Units, related products, and service contracts. Revenue from the Boomerang segment comprised approximately 9% of consolidated revenue for the year ended December 31, 2008. Approximately 27% of revenue is derived from the sale of tracking units through auto accessory retailers and automobile dealers, while the remaining 73% of revenue is derived from service contracts. A majority of the insurance companies based in Quebec and Ontario offer rebates to customers who install a Boomerang Unit in their high priced or high risk of theft vehicles, and in many instances, require installation of a Boomerang Unit in such vehicles.

Purchasers of Boomerang Units are required to also purchase a service contract. The terms of service contracts offered range from 12 to 60 months and are payable in full upon activation of the related unit or renewal of a previous service contract. As of December 31, 2008, there was approximately $9,603,000 of deferred revenue resulting from approximately 76,000 active service contracts. Customers are also offered a monthly payment option.

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Key Economic Factors and Trends

Global Economic and Financial Market Crisis. The global economy is in a period of very weak activity, led by the recession in the United States and followed by declines in other major markets around the world. The financial market crisis set off a series of events that generated conditions more severe than those experienced in several decades. The characteristics of the financial crisis are unique, in part due to the complex structure of housing-related securities that were at the center of the financial market turmoil. A steep housing correction, especially in the U.S. and U.K. markets, along with downward valuations of mortgage-backed and related securities, combined to foster a crisis in confidence. Although several other factors contributed to the current economic and financial conditions, the influence of these financial developments was prominent. The interrelationships among financial markets worldwide ultimately resulted in a global economic downturn, the effects of which became evident in the fourth quarter of 2008 as major markets around the world all suffered setbacks.

The general economic outlook is negative, due to the uncertain financial market environment and ongoing policy responses. In 2009, the global automotive industry sales volume is projected to continue to weaken, with a full-year decline of approximately 15% from 2008 levels and a 40% decline compared to 2006 levels. Consumer and business spending has been severely constrained by credit conditions and economic weakness. The impact of prior and future policy actions designed to confront the crisis is not yet apparent, and the current outlook therefore is particularly uncertain.

Consumer Spending and Credit. The current retrenchment in consumer spending is expected to continue through 2009, as even consumers who are willing to spend may find that availability of automotive loans has been diminished as a result of the credit crisis. Over the longer term, spending on new vehicles is expected to resume its correlation with growth in per capita incomes.

Currency Exchange Rate Volatility. The confluence of several economic events has generated significant volatility in currencies. The U.S. dollar strengthened against the Euro and Canadian Dollar during the fourth quarter of 2008.

Key Factors of our Business

As indicated, we are in the midst of a global economic crisis that has included a sudden and substantial decline in the global automotive industry, with aftermarket products like LoJack Units being particularly adversely affected. The dramatic decline in automotive industry sales volume, combined with tight credit markets, and other economic factors and trends described above have constrained our earnings and liquidity.

While the economic environment worsens, we believe that our continued focus on executing our strategic goals for 2009 is the appropriate strategy to achieve our objectives to:

• Effectively manage our business in an increasingly difficult global macro-economic environment by balancing investment in programs and technology necessary for future growth while aggressively managing costs to maintain our solid financial position;

• Upgrade our domestic processes and systems to deliver more customer centric, efficient and flexible solutions that will meet increasing demands and address our changing business;

• Continue to drive international expansion by adding new licensees and geographies and partnering with our existing licensees to manage global economic challenges;

• Grow our operations in Italy and at Boomerang; and

• Support Locator Systems and SCI in developing solutions for people at risk and cargo security, respectively.

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Many companies in the vehicle security industry have marketed stolen vehicle recovery solutions and many automobile manufacturers are installing GPS products at the factory. These factors have not had a material adverse impact on our revenue, unit sales or penetration rates to date. While the long-term impact of these trends is difficult to predict, we are evaluating the effectiveness of additional complementary technology combining GPS and/or cellular based communications with our time-tested RF based stolen vehicle recovery technology.

The percentage of domestic units installed by third parties rose to 51% of total domestic installations for the year ended December 31, 2008 compared to 48% and 41% for the years ended December 31, 2007 and 2006, respectively, allowing us to shift installation costs from fixed to variable.

Our bulk installation program represented 19% of domestic installations for the year ended December 31, 2008 compared to 20% and 24% for the years ended December 31, 2007 and 2006, respectively. The bulk installation program provides a significantly higher penetration of new car sales, improved cost efficiencies and a deeper relationship with our dealer customers.

Critical Accounting Policies and Estimates

The consolidated financial statements include the accounts of LoJack, our wholly-owned subsidiaries and our majority interest in SC Integrity, or SCI. We consolidate entities which we own or control. All intercompany transactions and balances have been eliminated in consolidation. Management is required, in certain instances, to use estimates and assumptions that affect the amounts reported in the consolidated financial statements and the notes included herein. The actual results could differ from those estimates. Our accounting policies are described in Note 1 to the consolidated financial statements included herein at Item 8. A "critical accounting policy" is one that is both important to the portrayal of our financial condition and results of operations and requires management's most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The significant accounting policies and estimates, which we believe to be the most critical in understanding and evaluating our reported financial position and results of operations, include:

Revenue Recognition and Deferred Revenue. We earn revenue primarily from the domestic sale and installation of LoJack Units and LoJack Early Warning, the sale of products and components to international licensees, the receipt of international license fees and royalties, the sale of extended warranty programs and the sale of our Boomerang products and service contracts.

We recognize revenue on domestic and Canadian sales of LoJack Units and Boomerang Units and related products upon installation, or upon shipment to our installation partners and distributors when all revenue recognition criteria have been met.

Revenue relating to the sale of LoJack Early Warning is recognized over the period of the estimated life of vehicle ownership, which management estimates is approximately five years. If the estimated life of vehicle ownership proves to vary materially from the estimates we use, we would be required to change our estimates, which could result in material differences in the amount of revenue recognized in any given period. Historically, there have not been any changes to our five-year estimate.

Revenue relating to the sale of service contracts by our Boomerang segment is recognized over the life of the contract. The term of service contracts offered ranges from 12 to 60 months and are payable in full upon initial activation of the Unit or on renewal of a service contract.

Revenue relating to SCI and LoJack SafetyNet consists of the sale of tracking devices and subscription fees. Sales of units are recognized upon shipment and subscription fees are recognized over the life of the contractual agreement which can range from 12 to 24 months.

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We sell several types of extended warranties. For those warranties to which a third party, and not us, is the primary obligor, we recognize payments for these insurance contracts, net of related costs, in revenue at the time of sale. Effective January 2007, we changed insurance underwriters for our extended warranty products for automobiles. The new underwriter is an authorized provider of insurance services in all states in which we currently operate and thus is the primary obligor. Accordingly, we recognize revenue, net of related costs, at the time of sale.

For those warranty agreements entered into before January 1, 2007 for which we are the primary obligor, revenue is deferred and recognized over the estimated term of the warranties, determined to be equivalent to the estimated life of vehicle ownership, which is five years. If the estimated life of vehicle ownership varies significantly from the estimates we use, material differences in the amount of revenue recognized in any given period could result. Incremental costs directly related to the provision of such warranties are deferred and charged to expense proportionately as the revenue is recognized. Any remaining warranty costs relating to actual claims made are recognized when incurred. We believe the likelihood of material changes to the average estimated life of vehicle ownership is low.

Accounts Receivable. Domestic accounts receivable are due principally from automobile dealers that are geographically dispersed. If the creditworthiness or the financial strength of the dealers were to decline, there could be an adverse effect on our operating results and cash flows. During 2008, there were an unprecedented number of automobile dealership closures due to the state of the United States economy. We provide specific reserves on known losses and supplement that estimate with additional reserves based on our historical loss experience.

The terms under which we generally sell products and components of the LoJack System to international licensees include cash prepayments, purchased private trade credit insurance or, most commonly, established payment terms. Should geopolitical situations change in the countries where our international licensees operate, there could be additional credit risks.

Accounts receivable related to our Boomerang segment consist of payments due from our automotive dealers and accessory retailers.

In the normal course of business, we monitor the financial condition of our customers and limit the amount of credit extended when deemed necessary. The Company maintains reserves for estimated potential credit losses. We have established an allowance for doubtful accounts that corresponds to the creditworthiness of our customers, historical trends and economic circumstances. Changes to these estimates are possible and could result in a material effect on our reported results of operations. As of December 31, 2008, two international licensees accounted for 32% and 20% of accounts receivable. As of December 31, 2007, two international licensees accounted for 22% and 11% of accounts receivable. For the year ended December 31, 2008, one international licensee accounted for 11% of revenue. For the years ended December 31, 2007 and 2006 no customer accounted for more than 10% of revenue.

Valuation of Investments. Periodically, we have made equity investments in our international licensees and other entities. As of December 31, 2008, investments in international licensees of $2,037, 000 included a 12.5% equity interest in our Mexican licensee, with a value of $1,541,000 and a 6.4% interest in our French licensee, with a value of $496, 000. The investment in our Mexican licensee over which we do not exercise significant influence is accounted for using the cost method of accounting and is carried at cost and adjusted only for other-than-temporary declines in fair value, distributions of earnings and additional investments made. Management periodically reviews the carrying value of this investment. Based upon projections of anticipated cash flows, market conditions, legal factors, operational performance, and valuations, when appropriate, we have concluded that there is no impairment to the fair value of this investment that should be viewed as other-than- temporary. Our investment in our French licensee, in the form of common stock, is accounted for in accordance with Financial Accounting Standards Board Statement (FASB) No. 115, Accounting for Certain Investments in Debt and Equity Securities, as an available-for-sale security, and is valued at the quoted closing price on its market

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exchange as of the reporting date. As such, any unrealized gains or losses are included, net of tax, in accumulated other comprehensive income in the statement of stockholders' equity. When the fair value decreases below cost for an extended period or the magnitude of the unrealized loss is significant, the loss may be deemed other-than-temporary. For the year ended December 31, 2008, we recorded an other-than-temporary impairment charge of $1,958,000 for our investment in our French licensee. No realized gains or losses were recorded for the years ended December 31, 2007 and 2006.

We also hold less than a 10% equity interest in our licensees in Argentina and Hong Kong for which the carrying value has previously been reduced to zero in our financial statements.

We may be required to record an impairment charge in a future period with respect to our Mexican licensee if (i) the licensee requires additional capital and is unable to raise sufficient capital to continue operations, (ii) the licensee raises sufficient capital, but at a enterprise value less than currently valued, (iii) its operations and future cash flows vary significantly from current projections, adversely affecting the viability of the business, or
(iv) other negative events were to occur. If the quoted price of the investment in our French licensee were to drop below our new recorded cost basis for an extended period of time we would have to evaluate the investment for further impairment. (Also see Note 5 to the consolidated financial statements included herein at Item 8).

Accounting for Stock Warrants. In June 2005, we entered into a ten year trademark license agreement with Absolute Software, a Vancouver, British Columbia, Canada based computer theft recovery company to brand its consumer offering LoJack for Laptops®. In addition to an annual per unit royalty, Absolute issued to us 1,000,000 warrants to purchase Absolute's common stock with vesting on a pro rata basis over a five year period commencing on July 1, 2006. In accordance with Emerging Issues Task Force Issue No. 00-8, Accounting by a Grantee for an Equity Instrument to be Received in Conjunction with Providing Goods or Services, we have concluded that a measurement date is not achieved until the warrants become vested and exercisable. Prior to reaching a measurement date, the fair value of unvested warrants is calculated utilizing a Black-Scholes option pricing model and the earned and unearned revenue is adjusted to fair value. Once a measurement date has been reached, the fair value of vested warrants is measured and the earned revenue becomes fixed with amortization occurring over the remaining life of the licensing agreement. Subsequent to reaching a measurement date, the vested warrants will be accounted for as derivatives under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which requires that the warrants be recorded at fair value at each reporting date with any changes in fair value being recorded in the income statement. We classify the gains (losses) on investments in other income (expense). During the years ended December 31 2008, 2007 and 2006, we recognized $997,000 (contra revenue), $2,342,000 and $301,000 in revenue from the warrants and ($1,290,000), $575,000 and $398,000 in other income (expense), respectively, related to the holding period gains and losses on the Absolute warrants. Revenue and investment valuation adjustments in the future will vary depending upon the fair value of Absolute's common stock. At December 31, 2008 there are 400,000 unvested Absolute warrants outstanding and we hold 166,500 shares of Absolute common stock.

Valuation of Long-Lived Assets, Intangibles and Goodwill. We assess the recoverability of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable and at least annually in the case of goodwill. Goodwill is associated with our acquisitions of Boomerang, SCI and Locator Systems (Also see Notes 1 and 5 to the consolidated financial statements included herein at Item 8). The carrying amount of goodwill was $14,599,000 and $54,979,000 at December 31, 2008 and 2007, respectively. The decrease of $40,380,000 in 2008 is almost entirely attributable to the goodwill impairment recognized at September 30, 2008 for our Boomerang segment and explained below. We also acquired certain intangible assets with finite lives as a result of our acquisitions. These intangible assets included contractual relationships, completed technology and trade name and trademarks.

On November 17, 2008, or the effective date, the analog network used to track our Boomerang segment's analog tracking units ceased to operate due to the decision by the Canadian cellular telephone companies to abandon their analog networks in favor of digital technology. As Boomerang undertook the task of complying

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with the requirement by replacing all of its analog units in service by the effective date, it became evident during the quarter ended September 30, 2008, that the actual customer attrition and expected future customer attrition was higher than expected. The impact of attrition combined with slow auto sales and the economic slowdown had adversely impacted the Boomerang business.

Given the impact of the above during the quarter ended September 30, 2008, we forecast the future economic impact of these events and the possible impairment of the carrying value of our intangible assets and goodwill. Our updated forecasts indicated that Boomerang's ability to regain profitability would take longer than originally expected. We determined based on the factors described above, a triggering event had occurred and that an evaluation of potential impairment of goodwill and other long-lived assets for the Boomerang segment was required as of September 30, 2008.

As of September 30, 2008, we tested the long-lived assets of our Boomerang segment for recoverability and determined that its intangible assets were not fully recoverable since the expected future undiscounted cash flows attributable to each asset were below their respective carrying values. In accordance with SFAS No. 144, we then determined the fair value of these intangible assets using a discounted cash flow model. As a result of this impairment analysis, the segment recognized an impairment charge of $1,260,000 at September 30, 2008.

As a result of the triggering events outlined above, we tested Boomerang's goodwill for impairment as of September 30, 2008. Utilizing a discounted cash flow method we determined the fair value of the Boomerang reporting unit to be less than its carrying value. We then allocated the fair value to the reporting unit's assets and liabilities and determined that the implied fair value of reporting unit's goodwill was $15,173,000, resulting in an impairment charge of $36,830,000.

We have historically estimated the fair value of our reporting units using a discounted cash flow model, which requires assumptions of future cash flows and operating results. We corroborate the fair value determined using the discounted cash flow model with a market approach or other valuation techniques. We may be required to record impairment charges for our reporting units in the future if
(i) actual results of operations and cash flows fall below our projections,
(ii) the economic downturn is worse than expected and or lasts longer than expected, and/or (iii) the valuation of comparable companies decreases significantly.

Income Taxes and Deferred Taxes. Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions.

We file federal and state income tax returns in the United States and tax returns in 10 international jurisdictions. We must estimate our income tax expense after considering, among other factors, differing tax rates between jurisdictions, allocation factors, tax credits, nondeductible items and changes in enacted tax rates. A 1% change in our 2008 effective income tax rate would have the effect of changing earnings by approximately $319,000, or $0.02 per diluted share after tax.

Deferred taxes arise because of the different treatment between financial statement accounting and tax accounting, known as "temporary differences." The tax effects of these temporary differences are recorded as "deferred tax assets" and "deferred tax liabilities" on the consolidated balance sheet. Deferred tax assets generally result in tax deductions or credits subsequent to the period in which the related item was recorded in the consolidated statement of operations. At December 31, 2008, we recorded a deferred tax asset of $4,990,000 related to LoJack's international subsidiaries cumulative net operating losses since inception. A full valuation allowance has been established against these losses because we determined that it is more likely than not that such tax benefits . . .