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LRAD > SEC Filings for LRAD > Form 10-K on 21-Nov-2013All Recent SEC Filings

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Form 10-K for LRAD CORP


21-Nov-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The discussion and analysis set forth below should be read in conjunction with the information presented in other sections of this Annual Report on Form 10-K, including "Item 1. Business," "Item 1A. Risk Factors," and "Item 8. Financial Statements and Supplementary Data." This discussion contains forward-looking statements which are based on our current expectations and industry experience, as well as our perception of historical trends, current market conditions, current economic data, expected future developments and other factors that we believe are appropriate under the circumstances. These statements involve risks and uncertainties that could cause actual results to differ materially from those suggested in the forward-looking statements.

Overview

We are a pioneer of highly intelligible, high clarity, directed sound technologies and products. We aggressively seek to create and expand markets for our products, and we are increasing our focus on and investment in worldwide sales and marketing activities while we continue to innovate.

Our revenues increased from $14,792,338 in the fiscal year ended September 30, 2012 to $17,087,930 in the fiscal year ended September 30, 2013. Direct and indirect revenues from the U.S. Military decreased by approximately $2.3 million or 33% compared to fiscal 2012 due to federal defense budget constraints and sequestration. Despite the lower fiscal 2013 U.S. Military revenues, we were awarded a U.S. Navy contract for $12.2 million in June 2013 and delivered an order for the first $2.0 million on this contract during fiscal 2013. In addition, efforts over the past year to grow the international market resulted in a $4.6 million increase, or 84%, in international revenues compared to fiscal 2012. Our international revenue growth was primarily in the public safety market for crowd and riot control, as well as other diverse markets such as tsunami warning systems, wildlife controls, maritime security, marine surveillance and oil and gas security. Our first year revenues for our new LRAD-360X unit grew to $882,000 for tsunami warning systems and homeland security. Despite increased revenues, our net income decreased slightly by $199,208 from $1,462,020 in fiscal year 2012 to $1,262,812 in fiscal year 2013, primarily due to increased legal and other professional fees related to a lawsuit and potential proxy contest during fiscal year 2013 and commission expense to our international partners. We increased our working capital by $2.4 million during fiscal 2013. Future cash flows from operating activities are expected to fluctuate based on working capital requirements, operating expense levels and other factors. We believe we have adequate financial resources to fund operations for the next twelve months.

Our LRAD-X product line uses directionality and focused acoustic output to clearly transmit critical information, instructions and warnings more than 3,500 meters. The LRAD-X product line features improved voice intelligibility and is available in a number of packages that meet the military's stringent environmental requirements in a number of packages and form factors. Through the use of powerful voice commands, prerecorded messages in multiple languages and deterrent tones to create large safety zones while determining the intent and influencing the behavior of an intruder. We continue to expand our LRAD-X product line to provide a complete range of systems from single operator portable to permanently installed, remotely operated. Our LRAD products have been competitively selected over other commercially available systems by U.S. and several foreign militaries. Our current LRAD-X product line includes the following:

LRAD 2000X-launched in fiscal 2012 to meet the requirements of larger security applications-is our largest and loudest AHD and broadcasts highly intelligible voice communication that can be clearly heard and understood over distances in excess of 3,500 meters. This unit is designed to be highly effective in perimeter and border security applications.

LRAD 1000X-selected by the U.S. Navy as its AHD for Block 0 of the Shipboard Protection System-can be manually operated to provide long distance hailing and warning with highly intelligible communication. This unit is available in both fully-integrated and remotely-operated electronics.

LRAD 500X-selected by the U.S. Navy and U.S. Army as their AHD for small vessels and vehicles-is lightweight and can be easily transported to provide security personnel long-range communications and a highly effective hailing and warning capability where needed.

LRAD 300X-a lightweight mid-range AHD developed for small vessels and manned and unmanned vehicles and aircraft. This unit is available with both fully integrated and remotely-operated electronics.

LRAD 100X-a self-contained, battery powered, portable system designed for use in a variety of mass notification, law enforcement and commercial security applications. This unit is ideally suited for short-range perimeter security and communications.

LRAD-RX-selected by the U.S. Navy after a competitive bid as its AHD for Block 2 of the Shipboard Protection System- is our solution for remotely controlled security. The LRAD-RX enables system operators to detect and communicate with an intruder over long distances. It features an LRAD 1000X emitter head, integrated camera, high-intensity searchlight and our proprietary, robust, and Internet protocol-addressable full pan and tilt drive system for precise aiming and tracking. The LRAD-RX can also be integrated with radar to provide automated intruder alerts. Because of its automated capabilities, the LRAD-RX is intended to reduce manpower requirements and false alarms while providing an intelligent, cost-effective security solution.

LRAD 360X- launched in fiscal 2012-is designed with 360-degree directionality to provide features needed for mass notification and emergency warning capabilities. The LRAD 360X is targeted for market applications including campus, border and perimeter security, tsunami, hurricane and tornado warnings, bird safety and control, and asset protection.


We incurred $1,841,369 of research and development expense during fiscal 2013. We continued development of variations of our LRAD 360X based on multiple stacking configurations. We began development of a vehicle mounted product to add perimeter security around vehicles. We worked on different speaker enhancements to increase output and provide varying beam widths. We seek to continually improve the quality and manufacturability of our products to retain our competitive advantage in the AHD market. We believe our improved products provide increased sales opportunities into government and commercial markets and demonstrate our ability to remain the leader in the AHD market. We intend to continue to innovate during fiscal 2014 with consistent levels of research and development expenditures.

Business Outlook

We are experiencing positive response and increased acceptance of our products. We believe we have a solid technology and product foundation with our LRAD-X product line, and we have expanded our product line to service new markets and customers for greater business growth. We believe that we have strong market opportunities within the worldwide government and military sector, as well as increased commercial applications as a result of continued global threats to governments, commerce and law enforcement, and in wildlife preservation and control applications. We intend to continue to expand our selling efforts internationally, especially in the Middle East and South America where we believe there is greater opportunity for the sale of our product. We also plan to continue to expand our presence in the mass notification market with our LRAD 360X product line. Our selling network has expanded to include a number of key integrators and sales representatives within the United States and in a number of worldwide locations. However, we may continue to face challenges in fiscal 2014 due to extreme international economic and geopolitical conditions. A further and continued deterioration in financial markets and confidence in major economies could disrupt the operation of our business. We anticipate continued uncertainty with U.S. Military spending due to ongoing defense budget delays and sequestration spending reductions. We continue to pursue large business opportunities, but it is difficult to anticipate how long it will take to close these opportunities, or if they will ever ultimately come to fruition.

Our products have varying gross margins and therefore, product sales mix materially affects gross profit. In addition, the margins differ based on the channel of trade through which the products are sold. We continue to implement product updates and changes, including raw material and component changes that may impact product costs. We could also have increased competition in our market that could cause pricing pressure. We do not believe that historical gross profit margins should be relied upon as an indicator of future gross profit margins.

We increased the number of business development personnel at the company in late fiscal 2013, and may hire additional business development personnel in fiscal 2014. We may also expend additional resources on marketing our products in future periods. This would increase our selling, general and administrative expenses in fiscal 2014. Also, commission expense will fluctuate based on the level of commissionable sales incurred.

Research and development ("R&D") expenses vary period to period due to the timing of projects, the availability of funds, and the timing, extent and use of outside consulting, design and development firms. In fiscal 2013, R&D expenses were primarily for in-house development, however, we continue to supplement our in-house development with third party consulting resulting in higher expenses. Based on current plans and engineering staffing, we expect fiscal year 2014 R&D expenses to be comparable to expenditures made in fiscal year 2013.

Critical Accounting Policies and Estimates

We have identified the policies below as critical to our business operations and to understanding our results of operations. Our accounting policies are more fully described in our financial statements and related notes located in "Item
8. Financial Statements and Supplementary Data." The impact and any associated risks related to these policies on our business operations are discussed in "Item 1A. Risk Factors" and throughout "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" when such policies affect our reported and expected financial results.

The methods, estimates and judgments we use in applying our accounting policies, in conformity with generally accepted accounting principles in the United States, have a significant impact on the results we report in our financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates affect the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.


Revenue Recognition. We derive our revenues primarily from two sources:
(i) product revenues and (ii) contracts, license fees, other services and freight. Product revenues from customers, including resellers and system integrators, are recognized in the periods that products are shipped (free on board ("FOB") shipping point) or received by customers (FOB destination), when the fee is fixed or determinable, when collection of resulting receivables is probable and we have no remaining obligations. Most revenues to resellers and system integrators are based on firm commitments from the end user, and as a result, resellers and system integrators carry little or no inventory. Revenues from associated engineering and installation contracts are recognized based on milestones or completion of the contracted services. Our customers do not have the right to return product unless the product is found to be defective.

We occasionally license our technology to third parties. Revenues from up-front license fees are evaluated for multiple elements, but are generally recognized ratably over the specified term of the particular license or agreement. Revenues from ongoing per unit license fees are earned based on units shipped and are recognized in the period when the ultimate customer accepts the product, and collection is reasonably assured.

We also sell extended repair and maintenance contracts with terms ranging from one to several years, which provide repair and maintenance services after expiration of the original one year warranty term. Revenues from separately priced extended repair and maintenance contracts are recognized on a straight-line basis, over the contract period, and classified as contract and other revenues.

Share-Based Compensation. We account for share-based compensation in accordance with the provisions of Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 718, "Compensation-Stock Compensation" ("ASC 718") using the modified prospective method which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. ASC 718 requires the use of subjective assumptions, including expected stock price volatility and the estimated term of each award. We estimate the fair value of stock options granted using the Black-Scholes option-pricing model, which is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. This model also utilizes the fair value of our common stock and requires that, at the date of grant, we use the expected term of the share-based award, the expected volatility of the price of our common stock over the expected term, the risk free interest rate and the expected dividend yield of our common stock to determine the estimated fair value. We determine the amount of share-based compensation expense based on awards that we ultimately expect to vest, reduced for estimated forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Allowance for doubtful accounts. Our products are sold to customers in many different markets and geographic locations. We estimate our bad debt reserve on a case-by-case basis due to a limited number of customers. We base these estimates on many factors including customer credit worthiness, past transaction history with the customer, current economic industry trends and changes in customer payment terms. Our judgments and estimates regarding collectability of accounts receivable have an impact on our financial statements.

Valuation of Inventory. Our inventory is comprised of raw materials, assemblies and finished products. We must periodically make judgments and estimates regarding the future utility and carrying value of our inventory. The carrying value of our inventory is periodically reviewed and impairments, if any, are recognized when the expected future benefit from our inventory is less than its carrying value.

Valuation of Intangible Assets. Intangible assets consist of patents and trademarks that are amortized over their estimated useful lives. We must make judgments and estimates regarding the future utility and carrying value of intangible assets. The carrying values of such assets are periodically reviewed and impairments, if any, are recognized when the expected future benefit to be derived from an individual intangible asset is less than its carrying value. This generally occurs when certain assets are no longer consistent with our business strategy and whose expected future value has decreased.

Accrued Expenses. We establish a warranty reserve based on anticipated warranty claims at the time product revenue is recognized. This reserve requires us to make estimates regarding the amount and costs of warranty repairs we expect to make over a period of time. Factors affecting warranty reserve levels include the number of units sold, anticipated cost of warranty repairs, and anticipated rates of warranty claims. Warranty expense is recorded in cost of revenues. We evaluate the adequacy of this reserve each reporting period.

We use the recognition criteria of ASC 450-20, "Loss Contingencies" to estimate the amount of bonuses when it becomes probable a bonus liability will be incurred and we recognize expense ratably over the service period. We accrued bonus expense each quarter based on estimated year-end results, and then adjusted the actual in the fourth quarter based on our final results compared to targets.

Deferred Tax Asset. We have provided a full valuation reserve related to our substantial deferred tax assets. In the future, if sufficient evidence of our ability to generate sufficient future taxable income in certain tax jurisdictions becomes apparent, we may be required to reduce our valuation allowances, resulting in income tax benefits in our consolidated statement of operations. We evaluate quarterly the realizability of the deferred tax assets and assess the need for a valuation allowance. Utilizing the net operating loss ("NOL") carry forwards in future years could be substantially limited due to restrictions imposed under federal and state laws upon a change in ownership or control. Included in the NOL carryforward are deductions from stock options that, if recognized, will be recorded as a credit to additional paid-in capital rather than through our results of operations.


Recent Accounting Pronouncements

A number of new pronouncements have been issued for future implementation as discussed in Note 3, Recent Accounting Pronouncements, to our consolidated financial statements.

Segment and Related Information

We are engaged in the design, development and commercialization of directed sound technologies and products. We present our business as one reportable segment due to the similarity in nature of products marketed, financial performance measures (revenue growth and gross margin), methods of distribution (direct and indirect) and customer markets (each product is sold by the same personnel to government and commercial customers, domestically and internationally). Our chief operating decision making officer reviews financial information on sound products on a consolidated basis. See Note 15 to our consolidated financial statements for further discussion.

Comparison of Results of Operations for Fiscal Years Ended September 30, 2013 and 2012

The following table provides for the periods indicated certain items of our consolidated statements of operations expressed in dollars and as a percentage of net sales. The financial information and discussion below should be read in conjunction with the consolidated financial statements and notes contained in this Annual Report.

                                                 Year ended
                             September 30, 2013              September 30, 2012
                                             % of                            % of           Increase/(Decrease)
                            Amount         Revenues         Amount         Revenues        Amount            %
Revenues:
Product sales            $ 16,001,820          93.6%     $ 14,218,766          96.1%     $ 1,783,054         12.5%
Contract and other          1,086,110           6.4%          573,572           3.9%         512,538         89.4%
Total revenues             17,087,930         100.0%       14,792,338         100.0%       2,295,592         15.5%

Cost of revenues            8,842,631          51.7%        7,313,762          49.4%       1,528,869         20.9%
Gross profit                8,245,299          48.3%        7,478,576          50.6%         766,723         10.3%

Operating expenses:
Selling, general and
administrative              5,438,406          31.8%        4,541,594          30.7%         896,812         19.7%
Research and
development                 1,841,369          10.8%        1,659,673          11.2%         181,696         10.9%
Total operating
expenses                    7,279,775          42.6%        6,201,267          41.9%       1,078,508         17.4%

Income from operations        965,524           5.7%        1,277,309           8.7%        (311,785 )      (24.4% )

Other income                  299,190           1.7%           33,895           0.2%         265,295        782.7%

Income from continuing
operations before
income taxes                1,264,714           7.4%        1,311,204           8.9%         (46,490 )       (3.5% )
Income tax expense
(benefit)                       1,902           0.0%         (150,816 )        (1.0% )       152,718        101.3%
Net income               $  1,262,812           7.4%     $  1,462,020           9.9%     $  (199,208 )      (13.6% )

Revenues

Revenues increased $2,295,592, or 16%, in the fiscal year ended September 30, 2013, as a result of an 84% increase in international revenue, primarily in the public safety market for crowd and riot control, as well as other diverse markets such as tsunami warning systems, wildlife controls, maritime security, marine surveillance and oil and gas. The international growth is partially offset by a 33% reduction in U.S. Military sales due to federal defense budget constraints and sequestration.

Gross Profit

Gross profit for the year ended September 30, 2013 increased by $766,723, or 10.3%, primarily due to increased revenue, partially offset by unfavorable sales mix, and an increase in contracted annual maintenance costs related to a large foreign military sale in March 2011. The gross profit in the prior year included a reduction in the warranty reserve due to the completion of the one year warranty period for the large foreign military order, which was not repeated in the current year.


Selling, General and Administrative Expenses

Selling, general and administrative expenses for the year ended September 30, 2013 increased $896,812, or 19.7%, primarily due to higher sales commissions on certain international sales contracts of $346,518, $332,475 for legal and other professional fees related to the derivative lawsuit and threatened proxy contest settled during fiscal 2013, higher salaries and consulting fees to strengthen our business development team of $139,171, $77,158 in non-cash share-based compensation expense, $63,882 for trade show and advertising expenses, partially offset by a decrease of $62,392 for travel and other expenses.

We incurred non-cash share-based compensation expenses of $681,147 and $603,989 in the fiscal years ended September 30, 2013 and 2012, respectively. The increase is due to option grants in May 2012.

Research and Development Expenses

R&D expenses increased $181,696, or 10.9%, primarily due to higher prototype development and third party product certification costs of $73,535, higher rent expense of $43,535 due to increased square footage in our new facility, $64,626 for the impairment of patents and other expenses.

Included in R&D expenses for the year ended September 30, 2013 was $47,895 of non-cash share-based compensation expenses, compared to $58,800 for the year ended September 30, 2012.

During fiscal years 2013 and 2012, we reviewed the ongoing value of our capitalized intangible assets and identified some of these assets as being no longer consistent with our business strategy. As a result of this review, we reduced the value of these patents by $81,307 and $41,621 for the fiscal years ended September 30, 2013 and 2012, respectively.

Other Income

Other income increased by $265,295 during the year ended September 30, 2013, primarily due to $270,559 in income recognized in relation to a terminated license agreement. We also recognized interest income of $28,631 in the year ended September 30, 2013, compared to $33,895 in the year ended September 30, 2012.

Net Income

Our net income decreased $199,208, or 13.6%, as a result of increased operating expenses. In addition, we recognized income tax expense of $1,902 in the year ended September 30, 2013 compared to a benefit of $150,816 in the year ended September 30, 2012. For additional details, refer to Note 10, Income Taxes.

Liquidity and Capital Resources

Cash at September 30, 2013 was $15,805,195, compared to $13,859,505 at September 30, 2012. Other than cash and expected future cash flows from operating activities in subsequent periods, we have no other unused sources of liquidity at this time.

Principal factors that could affect the availability of our internally generated funds include:

ability to meet sales projections;

government spending levels;

introduction of competing technologies;

product mix and effect on margins;

ability to reduce and manage inventory levels; and

product acceptance in new markets.

Principal factors that could affect our ability to obtain cash from external sources include:

volatility in the capital markets; and

market price and trading volume of our common stock.

Our Board of Directors approved a share buyback program under which the Company may utilize up to $3 million in cash to repurchase outstanding common shares using available cash and from future cash flow from operations through December 31, 2013. Based on our current cash position, our order backlog, and assuming the accuracy of our currently planned expenditures, we believe we have sufficient capital to fund planned levels of operations for at least the next twelve months. However, we operate in a rapidly evolving and often unpredictable business environment that may change the timing or amount of expected future cash receipts and expenditures. Accordingly, there can be no assurance that we may not be required to raise additional funds through the sale of equity or debt securities or from credit facilities. Additional capital, if needed, may not be available on satisfactory terms, if at all.


Cash Flows



Our cash flows from operating, investing and financing activities, as reflected
in the consolidated statements of cash flows, are summarized in the table below:



                                Year ended September 30,
                                   2013             2012
Cash provided by (used in):
Operating activities               1,755,699        194,178
Investing activities                (150,459 )     (205,435 )
Financing activities                 340,450              -

Operating Activities

Our net cash generated from operating activities was $1,755,699 for the fiscal year ended September 30, 2013 compared to $194,178 for the fiscal year ended September 30, 2012. Net income of $1,262,812 for the fiscal year ended September 30, 2013 was adjusted for non-cash items that include share-based compensation expense, depreciation and amortization, inventory obsolescence and impairment of patents. Cash generated from operating activities reflected a decrease in accounts receivable of $559,962, primarily due to receipt of a slow receivable and prepayment terms for certain shipments in the fourth quarter; an increase in accounts payable of $600,690, primarily due to increased inventory purchases based on forecasted orders and accrued settlement fees for the derivative lawsuit; and an increase in accrued and other liabilities of . . .

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