Overview

We are a machine-to-machine data communications, technology and solutions business. We combine our network services, hardware and applications development capabilities to create packaged and custom designed machine-to-machine solutions for customers across multiple market segments.

Fiscal year 2008 represented an improvement in revenues over 2007 and 2006. Full year revenues of $72.3 million increased $4.3 million, or 6.3%, from 2007. This increase was primarily the result of growth in our Wireless M2M Data Communications business units due to demand for our network services.

Gross margins for 2008 were 35.1% compared with 34.4% in 2007. Gross margins were favorably affected by an increase in service revenues, which typically earn a higher gross margin than those achieved by hardware sales.

Fiscal year 2008 overhead, which includes selling, general and administrative (SG&A) costs, as well as research and development expenses and bad debt costs, collectively were $31.8 million or $10.9 million higher than 2007. The increase was primarily related to our acquisition of the assets of Orbit One Communications, Inc. in late 2007, which increased overhead by approximately $3.3 million, an increase in professional fees related to litigation and impairment of goodwill and long-lived assets of $5.3 million.

Although revenues continued to grow for the year ended December 31, 2008, our growth rates were slowed by the impact of the economic downturn, which we expect may continue to adversely affect our revenues.

The following is a discussion of our consolidated financial condition and results of operations for the fiscal years ended December 31, 2008, 2007 and 2006. This discussion should be read in conjunction with our consolidated financial statements, the related notes thereto, and other financial information included elsewhere in this report.

Critical Accounting Policies

Note A of the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of Numerex's Consolidated Financial Statements. The following is a brief discussion of the more significant accounting policies and methods used.

General

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The most significant estimates and assumptions relate to revenue recognition, accounts receivable and allowance for doubtful accounts, inventories and the adequacy of reserves for excess and obsolete inventories, accounting for income taxes and valuation of goodwill and other intangible assets. Actual amounts could differ significantly from these estimates.

Revenue Recognition

We primarily sell hardware, recurring services (most billed on a monthly basis) and on-demand services. Hardware revenues are recognized at the time title passes to the customer, which is at the time of shipment.

We bill most of our recurring service revenues on a monthly basis, which are generated by providing customers access to our wireless machine-to-machine communications network (the Network). We sell these services to retailers and wholesalers of the service. For services sold to retailers, monthly service fees are generally a fixed monthly amount billed at the beginning of each month. For services sold to wholesalers, the customers are billed a fixed base fee in advance and usage fees in arrears at the end of each month. We defer the advance billing of the base fee and recognize the revenues when the services are performed.

We also provide services on a demand basis. These types of services are generally completed in a short period of time (usually less than one month) and are billed and the revenue recognized when the services are completed.

Some of our customers prepay for services for up to a year in advance. These services include our satellite communication services, 24 hour a day access to our internet based mapping software and other support services. Additionally, these prepaid services expire after a specified period of time. We defer these revenues until the services have been performed or, for unused services, when the term expires.

Accounts Receivable

Trade receivables are stated at gross invoiced amount less discounts, other allowances and provision for uncollectible accounts.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Changes in the financial condition of our customers could result in upward or downward adjustments to the allowance for doubtful accounts.

Inventories and Reserves for Excess, Slow-Moving and Obsolete Inventory

We value our inventory at the lower of cost or market. We continually evaluate the composition of our inventory and identify, with estimates, potential future excess, obsolete and slow-moving inventories. We specifically identify obsolete hardware for reserve purposes and analyze historical usage, forecasted production based on demand forecasts, current economic trends, and historical write-offs when evaluating the adequacy of the reserve for excess and slow-moving inventory. If we are not able to achieve our expectations of the net realizable value of the inventory at its current carrying value, we adjust our reserves accordingly.

Valuation of Goodwill and Long-lived Assets

We perform an annual review of goodwill in accordance with the provisions of FASB Statement No. 142, Goodwill and Other Intangibles ("SFAS 142"), in our fourth fiscal quarter of each year, or more frequently if indicators of a potential impairment exist, to determine if the carrying amount of our recorded goodwill is impaired. For each reporting unit, the impairment review process compares the fair value of each reporting unit where goodwill resides with its carrying value. If the net book value of the reporting unit exceeds the fair value, we would perform the second step of the impairment test which requires the allocation of the reporting unit's fair value to all of its assets and liabilities in a manner similar to a purchase price allocation, with any residual fair value being allocated to goodwill. An impairment charge will be recognized only when the implied fair value of a reporting unit's goodwill is less than its carrying amount. We have identified six reporting units, 4 of which have associated goodwill. The six reporting units are Wireless (which excludes Airdesk, LLC and Orbit One LLC), Airdesk, LLC and Orbit One LLC, Digital Multimedia, Networking Integration and Wireline Data Communications. The four reporting units with associated goodwill are Wireless, Airdesk, LLC, Orbit One, LLC and Digital Multimedia.

For our 2008 review, we used standard modeling techniques to estimate a fair market value for each of the four reporting units containing goodwill. This included a combination of a discounted cash flow analysis and, where available, the use of public company market comparables in similar industries. We used historical information, our 2009 business plan and expected future development projects to prepare six year financial projections used in the discounted cash flow analysis for each of the reporting units.

In accordance with FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"), we evaluate long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If impairment indicators are present, we determine whether the sum of the estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than the asset's carrying value. If the sum is less, we recognize an impairment loss based on the excess of the carrying amount of the asset over its respective fair value. The fair value is estimated using discounted cash flows, appraisals, or other methods. The fair value of the asset then becomes the asset's new carrying value, which we depreciate over the remaining estimated useful life of the asset.

As a result of our 2008 review, we recorded a pre-tax goodwill impairment of $4.0 million and a long-lived intangible asset impairment of $1.3 million. As a result of our 2006 review, we recorded a pre-tax goodwill impairment of $2.1 million related to our Digital Multimedia reporting unit.

Deferred Tax Assets

Estimates and judgments are required in the calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from net operating losses, tax credit carryforwards and temporary differences between the tax and financial statement recognition of revenue and expense. SFAS 109, "Accounting for Income Taxes", also requires that the deferred tax assets be reduced by a valuation allowance, if based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods.

In evaluating the ability to recover the deferred tax assets, in full or in part, management considers all available positive and negative evidence including past operating results, the existence of cumulative losses in the most recent years and the forecast of future taxable income on a jurisdiction by jurisdiction basis. In determining future taxable income, management is responsible for the assumptions utilized including the amount of state, federal and international pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates management is using to manage the underlying businesses. Actual operating results and the underlying amount and category of income in future years could differ materially from our current assumptions, judgments and estimates of recoverable net deferred taxes.

Cumulative losses incurred in recent years and the potential impact of the current economic environment on future taxable income represented sufficient negative evidence to require a full valuation allowance. As such, management established a full valuation allowance against the net deferred tax assets, which will remain until sufficient positive evidence exists to support reversal. The increase in the valuation allowance resulted in net deferred tax expense of approximately $2,766,000. Deferred tax assets generated during the current year primarily due to net operating losses were also offset by an increase to the valuation allowance resulting in no net benefit recorded in the current year. Future reversals or increases to the valuation allowance could have a significant impact on our future earnings.

Result of Operations



The following table sets forth, for the periods indicated, certain revenue and
expense items and the percentage increases and decreases for those items in the
Company's Consolidated Statements of Operations.



                                       For the years ended December 31,            2008 vs. 2007       2007 vs. 2006
(in thousands, except per share
amounts)                              2008             2007           2006           % Change            % Change
Net sales:
Wireless M2M Data
Communications
        Hardware                  $     40,197      $   41,661     $   32,383                -3.5 %              28.7 %
        Service                         25,952          21,164         13,938                22.6 %              51.8 %
         Sub-total                      66,149          62,825         46,321                 5.3 %              35.6 %
Digital Multimedia, Networking
and Wireline  Services
        Hardware                         2,851           1,747          2,142                63.2 %             -18.4 %
        Service                          3,319           3,432          4,325                -3.3 %             -20.7 %
         Sub-total                       6,170           5,179          6,467                19.1 %             -19.9 %
  Total net sales
        Hardware                        43,048          43,408         34,525                -0.8 %              25.7 %
        Service                         29,271          24,596         18,263                19.0 %              34.7 %
         Total net sales                72,319          68,004         52,788                 6.3 %              28.8 %
 Cost of hardware sales                 37,469          38,491         27,967                -2.7 %              37.6 %
 Cost of services                        9,430           6,106          5,899                54.4 %               3.5 %
Gross profit                            25,420          23,407         18,922                 8.6 %              23.7 %
Gross profit %                            35.1 %          34.4 %         35.8 %
 Selling, general, and
administrative expenses                 20,113          16,320         12,088                23.2 %              35.0 %
 Research and development
expenses                                 2,198           1,459          1,067                50.7 %              36.7 %
 Bad debt expense                        1,102             635            198                73.4 %             220.9 %
 Depreciation and amortization           3,107           2,493          1,755                24.2 %              42.1 %
 Goodwill and long-lived asset
impairment                               5,289               -          2,140                  nm                  nm
Operating earnings (loss)               (6,389 )         2,500          1,674              -355.6 %              49.3 %
 Interest expense                       (1,665 )        (1,940 )         (904 )             -14.3 %             114.6 %
 Interest income                           134             575            354               -76.7 %              62.4 %
 Other income and (expense),
net                                         (8 )            33             31                  nm                  nm
 Provision (benefit) for income
taxes                                    3,047             728         (2,950 )             318.5 %                nm
Net earnings (loss)                $   (10,975 )     $     440      $   4,103            -2,594.3 %             -89.3 %
 Basic income (loss) per common
share                             $      (0.78 )    $     0.03     $     0.33
 Diluted income (loss) per
common share                      $      (0.78 )    $     0.03     $     0.32
 Basic weighted average common
shares                                  14,144          13,137         12,502
 Diluted weighted average
common shares                           14,144          13,700         12,985

See notes to consolidated financial statements.

Fiscal Years Ended December 31, 2008 and December 31, 2007

Net revenues increased 6.3% to $72.3 million for the year ended December 31, 2008, as compared to $68.0 million for the year ended December 31, 2007. The increase in total net revenues for the year ended December 31, 2008 is attributable to a 19.0% increase to $29.3 million in service revenues as compared to $24.6 million for the year ended December 31, 2007. The increase in service revenues is due primarily to the growth of network connections and approximately $519,000 of revenue related to the acquisitions of Orbit One, LLC and Ublip, LLC. Hardware sales for the year ended December 31, 2008 remained relatively flat at $43.0 million.

Cost of hardware sales decreased 2.7% to $37.5 million for the year ended December 31, 2008 as compared to $38.5 million for the year ended December 31, 2007. The decrease was primarily the result of reduced costs for our Wireless M2M Communication hardware.

Cost of services increased 54.4% to $9.4 million for the year ended December 31, 2008 as compared to $6.1 million for the year ended December 31, 2007. The increase in cost of services was primarily the result of higher service sales volume in Wireless Data Communications attributed to an increase in connections to our wireless M2M network. The increase in connections was a direct correlation to our increase in costs.

Gross profit, as a percentage of net revenue, was 35.1% for the year ended December 31, 2008 as compared to 34.4% for the year ended December 31, 2007. The increase for 2008, as compared to 2007 is primarily a result of a change in the overall revenue mix. In the twelve month period ended December 31, 2007, service revenues were 36.2% of total revenues compared to 40.5% in the twelve month period ended December 31, 2008. This change drives an overall margin improvement since service revenues have a significantly higher gross margin than those achieved through the sale of hardware.

Selling, general, administrative and other expenses increased 23.2% to $20.1 million for the year ended December 31, 2008, as compared to $16.3 million for the year ended December 31, 2007. As a percentage of revenue, selling, general, administrative and other expenses increased to 27.8% for the year ended December 31, 2008 as compared to 24.0% for the year ended December 31, 2007. The increase of $3.8 million is primarily the result of higher general and administrative expenses associated with litigation expenses related to our satellite M2M unit ($2.3 million), higher personnel related costs ($1.1 million) and an increase in sales and marketing expenses ($400,000).

Research and development expenses increased 50.7% to $2.2 million for the year ended December 31, 2008, as compared to $1.5 million for the year ended December 31, 2007. The increase in research and development expenses is primarily due to higher personnel related expenses.

Bad debt expense increased to $1.1 million for the year ended December 31, 2008, as compared to $635,000 for the year ended December 31, 2007. We analyze accounts receivable and consider our historical bad debt experience, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Bad debt expense increased over the prior year period as a result of our identification of specific collection issues.

Depreciation and amortization expense increased 24.2% to $3.1 million for the year ended December 31, 2008, as compared to $2.5 million for the year ended December 31, 2007. This increase is attributable to amortization beginning on research and development projects that have been completed and released, as well as the purchase of depreciable computer and office equipment.

During 2008, we recorded a pre-tax, non-cash charge of $4.0 million for the impairment of goodwill and a pre-tax, non-cash charge of $1.3 million for the impairment of long-lived assets.

Interest expense decreased to $1.6 million in 2008, as compared to $1.9 million in 2007. This decrease was the result of declining debt due to continued payments.

The company recorded a tax provision of $3,047,000 for the year ended December 31, 2008, as compared to a tax provision of $728,000 for the year ended December 31, 2007, representing effective tax rates of (38.44)% and 65.74%, respectively. The difference between the company's effective tax rate and the 34% federal statutory rate in the current year resulted primarily from an increase in the Company's valuation allowance, stock option expenses, impairment charges, state tax accruals, and uncertain tax position expense. The Company's negative effective tax rate in 2008 of (38.44)% can be attributed to the increase in the valuation allowance against net deferred tax assets.

The weighted average basic shares outstanding increased to 14,144,000 for the year ended December 31, 2008, as compared to 13,137,000 for the year ended December 31, 2007. The increase in weighted average basic shares outstanding for the year ended December 31, 2008 was primarily due to the issuance of 27,000 common shares related to the employee stock option plan, 200,000 common shares related to the acquisition of Airdesk, Inc. and 405,000 common shares related to the acquisition of the assets of Ublip, Inc.

Fiscal Years Ended December 31, 2007 and December 31, 2006

Net revenues increased 28.8% to $68.0 million for the year ended December 31, 2007, as compared to $52.8 million for the year ended December 31, 2006. The increase in total net revenues for the year ended December 31, 2007 is attributable to a 25.7% increase in total hardware sales and a 34.7% increase in service revenue. The hardware sales and service revenue increase for the year ended December 31, 2007, compared to the same period in 2006, was in Wireless Data Communications in the amount of $16.5 million. These increases were partially offset by a decrease in Digital Multimedia, Networking & Wireline Security hardware sales and service revenue of $1.3 million, as compared to fiscal year 2006.

Cost of hardware sales increased 37.6% to $38.5 million for the year ended December 31, 2007, as compared to $28.0 million for the year ended December 31, 2006. The increase in cost of sales was primarily the result of higher hardware sales volume in Wireless Data Communications.

Cost of services was increased 3.5% to $6.1 million for the year ended December 31, 2007, as compared to $5.8 million for the year ended December 31, 2006. The increase in cost of services was primarily the result of higher service sales volume in Wireless Data Communications.

Gross profit, as a percentage of net revenue, was 34.4% for the year ended December 31, 2007, as compared to 35.8% for the year ended December 31, 2006. The total gross profit as a percentage of revenue decreased for the year ended December 31, 2007 compared to 2006 as a result of changing the pricing model in our wireless data communications segment. The pricing model was changed in order to secure additional network connections to support the associated long-term recurring service revenues.

Selling, general, administrative and other expenses increased 34.7% to $16.3 million for the year ended December 31, 2007, as compared to $12.1 million for the year ended December 31, 2006. As a percentage of revenue, selling, general, administrative and other expenses increased to 23.9% for the year ended December 31, 2007 as compared to 22.9% for the year ended December 31, 2006. The increase of $4.2 million was due to higher personnel related costs ($1.2 million), increased spending in sales and marketing to support hardware sales ($790,000), an increase in general & administrative spending as we responded to regulatory requirements such as Sarbanes-Oxley and the adoption of FIN 48 ($981,000), the acquisition of the assets of Orbit One, Inc. ($759,000) and share-based compensation expense ($480,000).

Research and development expenses increased for the year ended December 31, 2007 to $1.5 million, as compared to $1.1 million for the year ended December 31, 2006. The increase in research and development expenses is primarily due to new projects related to new digital hardware that have not reached technical feasibility and therefore work on these projects was expensed as incurred.

Bad debt expense increased 221% to $635,000 for the year ended December 31, 2007, as compared to $198,000 for the year ended December 31, 2006. Bad debt increased over the prior year due to an increase in the bad debt allowance in the current year period as a result of reserving for specific customers based on our assessment of the likelihood of these customers defaulting.

Depreciation and amortization expense increased 42.1% to $2.5 million for the year ended December 31, 2007, as compared to $1.8 million for the year ended December 31, 2006. This increase is attributable to amortization beginning on completed research and development projects as well as the purchase of depreciable computer and office equipment.

We did not record any goodwill impairment for the year ended December 31, 2007. We recorded a pre-tax, non-cash charge of $2.1 million for the impairment of goodwill within the Digital Multimedia, Networking and Wireline segment for the year ended December 31, 2006. Key factors affecting the amount of the impairment charge included the Company's assessment of the long term outlook for its Broadband Networks, Inc. within the Digital Multimedia, Networking and Wireline segment and a determination that a reduction in the goodwill balance in the amount of $2.1 million would be required to more properly reflect the current value of the business.

Interest expense increased to $1.9 million in 2007, as compared to $904,000 for the prior year. This increase was the result of the transactions with the Laurus Master Fund (Laurus) that occurred on May 30, 2006 and December 29, 2006. Interest expense related to these transactions was $1.9 million for the year ended December 31, 2007, as compared to $638,000 for the year ended December 31, 2006.

A foreign currency loss of $28,000 was recorded for the year ended December 31, 2007 down from a $10,000 gain for the year ended December 31, 2006. This decrease was the result of increased foreign currency losses on sales to Canadian and Australian customers.

The company recorded a tax provision of $728,000 for the year ended December 31, 2007, as compared to a tax benefit of $2,950,000 for the year ended December 31, 2006, representing effective tax rates of 65.74% and (256%), respectively. The difference between the company's effective tax rate and the 34% federal statutory rate in the current year resulted primarily from state tax accruals, stock option expenses, and changes in the Company's uncertain tax positions. The overall increase in the effective tax rate from the year ended 2006 compared to the same period in 2007 can be attributed to the company's partial release of the valuation allowance which offset much of the company's net operating loss (NOL) deferred tax assets in 2006. The company is recognizing deferred tax expense in 2007 primarily related to the utilization of these NOLs.

Basic and diluted earnings per common share decreased to $.03 for year ended December 31, 2007, as compared to $.33 and $.32, respectively for the year ended December 31, 2006.

The weighted average basic shares outstanding increased to 13,137,000 for the year ended December 31, 2007 as compared to 12,502,000 for the year ended December 31, 2006. The increase in weighted average basic shares outstanding for year ended was due to the potential issuance of 321,000 common shares related to the acquisition of the assets of Orbit One Communications, Inc., 134,000 common shares related to the exercise of employee stock options and 100,000 common shares related to the acquisition of the assets of Airdesk, Inc.

Segment Information



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