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NMRX > SEC Filings for NMRX > Form 10-Q on 7-Nov-2013All Recent SEC Filings

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Form 10-Q for NUMEREX CORP /PA/


7-Nov-2013

Quarterly Report


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 reposition our platform to capture greater subscription revenue; the risks that a substantial portion of revenue derived from contracts may be terminated at any time; the risks that our strategic suppliers 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 revenue; changes in financial and capital markets and the inability to raise growth capital; 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," the "Company" or "Numerex" refers to Numerex Corp. and subsidiaries.

The following Management's Discussion and Analysis is intended to help the reader understand the results of operations and financial condition of the Company. 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 to the unaudited condensed consolidated financial statements in this Quarterly Report on Form 10-Q for the period ended September 30, 2013.

We are headquartered in Atlanta, Georgia, and organized under the laws of the Commonwealth of Pennsylvania. We are a leading provider of interactive and on-demand machine-to-machine (M2M) technology and service, offered on a subscription basis, used in the development and support of M2M solutions for the enterprise and government markets worldwide.

Our strategy has remained, at its core, the same: to generate long-term and sustainable subscription revenue through the use of our integrated M2M horizontal platforms that we call Numerex DNA®. These platforms incorporate the key M2M elements that generally include hardware and smart Devices (D), cellular and satellite Network services (N), and software Applications (A) that are delivered through Numerex FAST® (Foundation Application Software Technology). In addition, business services are offered to enable the development of efficient, reliable, and secure solutions while accelerating deployment. We are ISO 27001 information security-certified, highlighting our focus on M2M data security, service reliability and round-the-clock support of our customers' M2M solutions. For additional information, please visit www.numerex.com.

NUMEREX CORP. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

While our overall business has grown and we believe that our prospect for future sales opportunities is strong, particularly demand from our channel partners for our network and application platforms, general economic uncertainty remains and may reduce or limit our future growth. We have continued to closely monitor our credit policies in response to the economic climate, especially for our hardware-only sales.

Subscription and support revenue was $13.5 million for the three months ended September 30, 2013, an increase of 22% compared to the three months ended September 30, 2012. We also added 135,000 net new subscriptions during the three-month period ended September 30, 2013, bringing total subscriptions to 2.3 million as of September 30, 2013, an increase of 31.2% compared to 1.8 million as of September 30, 2012. Discontinued operations have no effect on our subscription base as these operations are not part of our core business. Net sales increased 27.8% to $22.0 million for the three months ended September 30, 2013, compared to $17.2 million for the similar period in 2012. Net sales of embedded device and hardware were $8.5 million for the three months ended September 30, 2013, an increase of 38.8% over the similar period in 2012. Income from continuing operations, net of income tax benefit, was $0.6 million, or $0.03 per diluted share for the three months ended September 30, 2013. Cash generated by operating activities of continuing operations was $3.3 million for the nine months ended September 30, 2013.

As part of a strategic planning process conducted during the quarterly period ended June 30, 2013, the decision was made to exit certain businesses and related products that are not core to future business plans. These non-core businesses include BNI Solutions, Inc. (BNI), Digilog, Inc. and DCX Systems, Inc. These businesses were previously reported in our consolidated financial statements as a separate segment, "Other Services". The related products and services include video conferencing hardware and installation of telecommunications equipment, all of which are unrelated to our core M2M communication products and services.

Effective July 1, 2013, we completed a realignment of our internal organizational structure to focus on selected key vertical markets: Security Solutions, Emergency Management Services and Tracking, and Supply Chain Solutions. In conjunction with this, we also reexamined a number of job functions and duties and realigned certain personnel costs among cost of sales, sales and marketing, general and administrative, and engineering and development expense categories based on their new roles as of July 1, 2013. Financial information for periods ending as of and prior to June 30, 2013 has not been reclassified. For the three and nine months ended September 30, 2013, approximately $0.4 million of costs are classified in operating expense that, prior to the realignment, would have been classified in cost of sales. Had this expense remained in cost of sales, gross profit as a percentage of total net sales (gross margin) for the three and nine months ended September 30, 2013 would have been lower by 1.7% and 0.7%, respectively.

Critical Accounting Policies

There have been no material changes in our critical accounting policies, estimates and judgments during the nine months ended September 30, 2013 compared to the disclosures in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2012.

                         NUMEREX CORP. AND SUBSIDIARIES
                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations

Three Months Ended September 30, 2013 and 2012

The following table sets forth selected consolidated statements of operations
data for the periods indicated along with comparative information between the
periods (dollars in thousands):

                                                        Three Months Ended
                                                          September 30,
                                                        2013          2012         % Change
Net sales:
Subscription and support revenue                     $   13,482     $  11,078           21.7 %
Embedded devices and hardware                             8,469         6,100           38.8 %
Total net sales                                          21,951        17,178           27.8 %
Cost of sales, exclusive of depreciation and
amortization shown below:
Subscription and support revenue                          5,622         4,687           19.9 %
Embedded devices and hardware                             7,348         5,403           36.0 %
Gross profit                                              8,981         7,088           26.7 %
                                                           40.9 %        41.3 %
Operating expense:
Sales and marketing                                       2,636         2,032           29.7 %
General and administrative                                3,174         2,498           27.1 %
Engineering and development                               1,317           792           66.3 %
Depreciation and amortization                             1,209           804           50.4 %
Operating income                                            645           962          -33.0 %
Interest expense                                             75            57           31.6 %
Other expense (income), net                                  30            (4 )           nm *
Income from continuing operations before income
taxes                                                       540           909          -40.6 %
Income tax benefit                                          (35 )      (4,786 )        -99.2 %
Income from continuing operations, net of income
tax benefit                                                 575         5,695          -89.5 %
Loss from discontinued operations, net of income
taxes                                                         -          (159 )       -100.0 %
Net income                                           $      575     $   5,536          -89.6 %



* - not meaningful

Subscription and support revenue increased 21.7% to $13.5 million for the three months ended September 30, 2013 compared to $11.1 million for the three months ended September 30, 2012. The increase was related to growth in M2M subscriptions to both new and existing customers. During the three months ended September 30, 2013, we added 135,000 net new subscriptions, bringing total subscriptions to 2.3 million. Embedded devices and hardware revenue increased 38.8% to $8.5 million for the three months ended September 30, 2013, compared to $6.1 million for the three months ended September 30, 2012. The increase was primarily related to a greater sales volume in our modules and security hardware by a combined $3.3 million, which included shipment of a large order that carried over from the period ended June 30, 2013. Embedded device and hardware revenue may not continue at the same level in the quarterly period ending December 31, 2013. The increase in modules and security hardware was partially offset by a decrease in the sales volume of modems and tracking devices. We have also offered modest promotional price discounts for our second generation and other older technology devices and hardware to maintain sales of those products as we continue to introduce new fourth generation (4G) products. Prices of other products and services have remained consistent with the prior year.

Cost of sales for subscription and support revenue increased 19.9% to $5.6 million for the three months ended September 30, 2013 compared to $4.7 million for the three months ended September 30, 2012. The increase reflects additional carrier fees associated with subscription growth and colocation costs for a new redundant network site to support revenue growth and to ensure continued maximum service reliability for our customers. The increase was partially offset by the changes from the realignment of our internal organization described previously. For comparative purposes, $0.3 million of personnel costs for the three months ended September 30, 2013 previously categorized as cost of sales for subscription and support revenue are now reflected in operating expense. Gross margin for subscription and support revenue increased to 58.3% for the three months ended September 30, 2013 from 57.7% for the three months ended September 30, 2012. The year-over-year improvement in gross margin reflects a benefit of 2.3% from the effect of the internal realignment with certain personnel costs previously included in cost of sales now included in operating expense while the redundant network site and other infrastructure costs have, at least temporarily, adversely affected gross margin.

NUMEREX CORP. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cost of sales for embedded devices and hardware increased 36.0% to $7.3 million for the three months ended September 30, 2013 compared to $5.4 million for the three months ended September 30, 2012. The increase primarily reflects greater sales volume. However the increase also includes higher product costs associated with the newer 4G devices and we are beginning to realize increased gross profit on those devices. Gross margin for devices and hardware increased to 13.2% for the three months ended September 30, 2013 from 11.4% for the comparable period in the prior year. The increase in gross margin is the result of a favorable mix of products sold during the quarter and the impact of value engineering projects involving certain embedded devices. The effect of the organizational realignment on cost of sales for devices and hardware was less than $0.1 million and less than 1% of device and hardware sales for the three months ended September 30, 2013.

Sales and marketing expense increased 29.7% to $2.6 million for the three months ended September 30, 2013 compared to $2.0 million for the three months ended September 30, 2012. Sales and marketing expense as a percentage of total net sales increased to 12.0% for the three months ended September 30, 2013 from 11.8% for the three months ended September 30, 2012. The increases in total value and as a percentage of sales were primarily related to a $0.5 million increase in compensation due to additional sales and marketing personnel which also includes the effect of the internal realignment of $0.1 million in the three months ended September 30, 2013. Additionally, there was an increase of $0.2 million in promotional and travel costs related to tradeshows and conventions, offset by a $0.1 million decrease in marketing supplies and materials.

General and administrative expense increased 27.1% to $3.2 million for the three months ended September 30, 2013, compared to $2.5 million for the three months ended September 30, 2012. Salary and stock-based compensation expense increased $0.4 million, which includes an additional $0.1 million in expense for a broad stock-based compensation grant in April 2013. The increase in general and administrative expense also includes $0.2 million in expense from other financial statement captions as a result of the internal realignment and rent expense increased $0.2 million due to our new and expanded office space at the Atlanta headquarters. A portion of the increase is also attributed to an additional $0.1 million in professional and consulting fees. Professional and consulting fees include additional costs incurred in response to and remediation of the internal control deficiencies identified in the audit of our annual financial statements for the year ended December 31, 2012, and legal fees associated with potential new product development for one of our customers. General and administrative expense remained consistent with the prior year period at 14.5% of total net sales.

Engineering and development expense increased 66.3% to $1.3 million for the three months ended September 30, 2013, compared to $0.8 million for the three months ended September 30, 2012. The increase continues to be for personnel resources and third party contractors related to the development of new products, services and applications to support our current customers and to facilitate growth opportunities in our targeted vertical markets. The increase also includes $0.1 million in additional expense from the internal realignment. This activity resulted in engineering and development expense increasing to 6.0% of total net sales for the three months ended September 30, 2013 compared to 4.6% for the three months ended September 30, 2012.

Depreciation and amortization expense increased 50.4% to $1.2 million for the three months ended September 30, 2013, compared to $0.8 million for the three months ended September 30, 2012. The increase includes the amortization of additional internally developed software and, to a lesser extent, intangible assets from the two acquisitions completed in the quarterly periods ended December 31, 2012 and March 31, 2013.

NUMEREX CORP. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Interest expense remained consistent at less than $0.1 million for the three months ended September 30, 2013 and September 30, 2012. All outstanding amounts of principal and accrued interest on our bank loans were repaid in January 2013 using the proceeds from the public offering of our shares of class A common stock. We will continue to recognize interest expense for the seller-financed note payable related to the October 2012 acquisition, deferred financing and other costs to maintain the bank credit facilities and capital leases.

We recorded a nominal income tax benefit from continuing operations for the three months ended September 30, 2013, as compared to an income tax benefit of $4.8 million for the three months ended September 30, 2012. The difference between the recorded income tax benefit and a provision (expense) using the 34.0% federal statutory tax rate for the three months ended September 30, 2013 resulted primarily from a reduction in our reserve for state income taxes related to unrecognized tax benefits. The difference between the recorded income tax benefit and a provision using the federal statutory tax rate for the three months ended September 30, 2012 was due to the release of a portion of the valuation allowance against federal net operating losses and certain other deferred tax assets during the three months ended September 30, 2012. We continue to maintain a valuation allowance against a portion of deferred tax assets that we determined we would likely not utilize before expiration. The deferred tax assets with a valuation allowance consist of certain state net operating losses, tax credits, and foreign net operating losses.

The results from discontinued operations, net of income taxes were breakeven for the three months ended September 30, 2013 compared to $0.2 million of net loss for the three months ended September 30, 2012. As previously discussed, the discontinued businesses are unrelated to our core M2M communication products and services.

                         NUMEREX CORP. AND SUBSIDIARIES
                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Nine Months Ended September 30, 2013 and 2012

The following table sets forth selected consolidated statements of operations
data for the periods indicated along with comparative information between the
periods (dollars in thousands):

                                                        Nine Months Ended
                                                          September 30,
                                                        2013          2012          % Change
Net sales:
Subscription and support revenue                     $   37,932     $  31,426            20.7 %
Embedded devices and hardware                            17,727        15,807            12.1 %
Total net sales                                          55,659        47,233            17.8 %
Cost of sales, exclusive of depreciation and
amortization shown below:
Subscription and support revenue                         16,531        13,076            26.4 %
Embedded devices and hardware                            16,575        13,495            22.8 %
Gross profit                                             22,553        20,662             9.2 %
                                                           40.5 %        43.7 %
Operating expense:
Sales and marketing                                       6,907         6,248            10.5 %
General and administrative                                9,828         7,562            30.0 %
Engineering and development                               3,626         2,401            51.0 %
Depreciation and amortization                             3,485         2,361            47.6 %
Operating (loss) income                                  (1,293 )       2,090          -161.9 %
Interest expense                                            220           204             7.8 %
Other expense, net                                           25             1              nm *
(Loss) income from continuing operations before
income taxes                                             (1,538 )       1,885          -181.6 %
Income tax benefit                                       (2,549 )      (4,775 )         -43.8 %
Income from continuing operations, net of income
tax benefit                                               1,011         6,660           -84.3 %
Loss from discontinued operations, net of income
taxes                                                    (1,437 )        (106 )            nm *
Net (loss) income                                    $     (426 )   $   6,554          -106.5 %


_________________


* - not meaningful

Subscription and support revenue increased 20.7% to $37.9 million for the nine months ended September 30, 2013, compared to $31.4 million for the nine months ended September 30, 2012. The increase was related to growth in M2M subscriptions. During the nine months ended September 30, 2013, we added 423,000 net new subscriptions, bringing total subscriptions to 2.3 million as of September 30, 2013. Embedded devices and hardware revenue increased 12.1% to $17.7million for the nine months ended September 30, 2013, compared to $15.8 million for the nine months ended September 30, 2012. The increase was primarily related to a greater sales volume in our modules and security hardware by a combined $3.7 million, which was partially offset by a decrease in the sales volume of modems and tracking devices. We have also offered modest promotional price discounts for our second generation and other older technology devices and hardware to maintain sales of those products as we continue to introduce new 4G products. Prices of other products and services have remained consistent with the prior year.

Cost of sales for subscription and support revenue increased 26.4% to $16.5 million for the nine months ended September 30, 2013 compared to $13.1 million for the nine months ended September 30, 2012. The increase reflects additional carrier fees associated with subscription growth and colocation costs for a new redundant network site from earlier in the year to support revenue growth and to ensure continued maximum service uptime for our customers. The increase was partially offset by the changes from the realignment of our internal organization. For comparative purposes, $0.3 million of personnel costs for the three months ended September 30, 2013 previously categorized as cost of sales for subscription and support revenue are now reflected in operating expense. Gross margin for subscription and support revenue decreased to 56.4% for the nine months ended September 30, 2013 from 58.4% for the nine months ended September 30, 2012. The redundant network site and other infrastructure costs have, at least temporarily, caused a decrease in gross margin. The decrease in gross margin has been partially offset by an increase of approximately 1.0% from the internal realignment.

NUMEREX CORP. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cost of sales for embedded devices and hardware increased 22.8% to $16.6 million for the nine months ended September 30, 2013 compared to $13.5 million for the nine months ended September 30, 2012. The increase primarily reflects greater sales volume. However the increase also includes higher product costs associated with the newer 4G devices and a $0.5 million increase in the inventory reserve for obsolescence on older technology products. We continue to monitor the valuation of our technologically older inventory and may record additional increases in the reserve for obsolescence in the future. Gross margin for devices and hardware decreased to 6.5% for the nine months ended September 30, 2013 from 14.6% for the comparable period in the prior year. The year over year decrease in gross margin is attributed to the higher costs of the newer 4G devices and the promotional price discounts noted above. The newer products have higher per unit costs than older devices largely because of more advanced components and technology, but those costs are beginning to decrease. The effect of the organizational realignment on cost of sales for devices and hardware was less than $0.1 million and less than 1% of device and hardware sales for the nine months ended September 30, 2013.

Sales and marketing expense increased 10.5% to $6.9 million for the nine months ended September 30, 2013, compared to $6.2 million for the nine months ended September 30, 2012. However, sales and marketing expense decreased as a percentage of total net sales to 12.4% for the nine months ended September 30, 2013 compared to 13.2% for the nine months ended September 30, 2012. The overall increase is primarily due to $0.9 million related to compensation expense for commissions and additional sales and marketing personnel and also includes $0.1 million from the realignment of our internal organization.

General and administrative expense increased 30.0% to $9.8 million for the nine months ended September 30, 2013, compared to $7.6 million for the nine months ended September 30, 2012. General and administrative expense also increased as a percentage of total net sales, to 17.7% for the nine months ended September 30, 2013 from 16.0% for the nine months ended September 30, 2012. A portion of the increase is attributed to an additional $0.9 million in professional and consulting fees, especially through the first six months ended June 30, 2013. Professional fees included (a) additional costs incurred in response to and remediation of the internal control deficiencies identified in the audit of our annual financial statements for the year ended December 31, 2012, (b) legal fees associated with potential new product development for one of our customers and
(c) costs incurred in conjunction with development of our long-term strategic plan. Salary and stock-based compensation increased $0.8 million, including $0.3 million incurred as part of the realignment of our executive team during the three months ended June 30, 2013; an additional $0.2 million in expense for a broad stock-based compensation grant in April 2013; and $0.2 million in expense from the internal realignment in the three months ended September 30, 2013. Rent expense also increased $0.3 million due to our new and expanded office space at the Atlanta headquarters.

. . .

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