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[December 14, 2012]
TELULAR CORP - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
(Edgar Glimpses Via Acquire Media NewsEdge) INTRODUCTION Telular develops products and services that utilize wireless networks to provide data connectivity among people and machines. Telular's software-as-a-service ("SaaS") offerings are created through Telular's competence in developing complex software systems and wireless electronics that utilize the data transport capabilities of today's commercial wireless networks. To enable these services, Telular is a significant reseller of such commercial wireless services.
20 -------------------------------------------------------------------------------- Telular generates a majority of its revenue through the delivery of M2M services such as event monitoring and asset tracking services through its Telguard, SkyBitz and TankLink services. A portion of its revenue comes from the sale of specialty wireless hardware products designed by Telular for use exclusively with its M2M services. Telular's operating expense levels are based in large part on its expectations for its future revenues. If anticipated sales in any quarter do not occur as expected, expenditure and inventory levels could be disproportionately high, and Telular's operating results for that quarter, and potentially for future quarters, could be adversely affected. Certain factors that could significantly impact expected results are described in "Forward Looking Information" and in Item 1A, Risk Factors.
The market for Telular's products is primarily in North and South America and consists of a number of vertical applications including Telguard security alarm conveyance; SkyBitz asset tracking; and TankLink storage tank monitoring. These markets are addressed primarily through indirect channels consisting of third party agents, Value Added Resellers ("VARs") and distributors along with in-house sales and customer support teams. A direct sales model is utilized for certain large customers in each line of business. Fabrication of Telular's products is accomplished through contract manufacturers located in China, Mexico and the United States.
Telular believes that its future success depends on its ability to continue to meet customers' needs through product innovation, including the creation of event monitoring services that can be sold with products. Research and development activities sponsored by Telular for the years ended September 30, 2012, 2011 and 2010 were $4,139, $2,623 and $3,010, respectively. Telular anticipates research and development activities to continue at approximately the same levels as in the past.
The following details areas of product delivery and research during fiscal 2012 and anticipated in fiscal 2013.
Telguard - Telular's engineering team continues to update the Telguard product and service portfolio through incremental feature development, both in hardware devices and software functionality. In fiscal 2012, Telular completed and launched the conversion of the entire Telguard hardware product line to 3G/4G capability. While most of the development for our 3G/4G conversion was accomplished in fiscal 2011, we launched the products in 2012 and also modified and released the TG1X, our largest volume seller, during 2012. Product innovation within this space is important for the long-term success of Telguard and we expect to continue to enhance our Telguard software platform and underlying hardware products going forward. In fiscal 2012, the Telguard Message Center ("TMC") which contains the underlying core software for the Telguard service, was enhanced such that Telular can offer service to dealers in Canada.
Furthermore, the architecture of TMC will be updated so that it can support even more end-user, feature development and increased traffic volumes in the future.
During fiscal 2013 we plan to enhance dramatically the interactive services and home automation features of our Telguard service line.
SkyBitz - SkyBitz was acquired by Telular on February 1, 2012 and on that same day, SkyBitz released to the market its newest hardware device, the GTP series, which for the first time provides global satellite tracking capability via the Iridium satellite network. Subsequent to the release of the first GTP model, additional work was undertaken to complete variations of that device that allowed for GPS location capability; remote antenna mounting; and cargo sensing capability. For fiscal 2013, we are working on improving SkyBitz's terrestrial device as well as releasing an updated version of its InSight SaaS application.
TankLink - During fiscal 2012, TankLink introduced its intrinsically safe device as well as an expanded array of differential pressure sensors which allow the solution to work in a wider range of applications, including for gasoline, solvents, and corrosive acids. Telular plans to further enhance all elements of the TankLink portfolio during fiscal 2013 to update the hardware as well as support additional customer use cases for the solution.
Other M2M Solutions -Telular continues to evaluate additional M2M markets to determine the viability of creating or acquiring a product and/or service in these markets.
OUTLOOK The statements contained in this outlook are based on current expectations.
These statements are forward looking, and actual results may differ materially.
Telular expects to expend most of its marketing and product development resources on the M2M space, including continuing to capitalize on its favorable market position in the domestic security alarm market by virtue of its well-regarded Telguard offering, as well as continuing to improve overall penetration in the asset tracking and tank level monitoring markets through SkyBitz and TankLink, respectively.
21 --------------------------------------------------------------------------------UNIT SALES During fiscal 2012, Telular sold approximately 133,200 Telguard units, compared with approximately 90,200 Telguard units for fiscal 2011. We sold approximately 6,500 tank monitoring units in fiscal 2012, as compared to sales of 6,400 tank monitoring units in fiscal 2011. SkyBitz sold approximately 30,200 asset tracking units in fiscal 2012. Our Telguard subscriber base increased in fiscal 2012 to approximately 617,500, up from approximately 563,500 subscribers in fiscal 2011. This increase was a result of the introduction of two new products, TG1 Express and our PERS unit (personal emergency response system) in addition to converting our Telguard product line to 3G/4G. TankLink products continued to see increase market penetration and acceptance. Telular implemented a targeted pricing discount program and will continue to develop new customer relationships to maintain sales volumes. The Telguard Advantage Program ("TAP") was implemented to offer security dealers the opportunity to achieve preferred pricing for Telguard products. We expect Telguard product sales of between 30,000 and 40,000 units on a quarterly basis throughout fiscal 2013 and increased unit sales for our asset tracking and tank monitoring products.
SERVICE REVENUE Service revenues in our event monitoring segment have grown consistently year over year, increasing to $34,381 in fiscal 2012 from $31,161 in fiscal 2011. In addition, SkyBitz contributed $12,001 of asset tracking service revenues for fiscal 2012. Total service subscribers increased, from approximately 586,100 subscribers at the end of fiscal 2011 to approximately 839,800 subscribers at the end of fiscal 2012. Telular ended fiscal year 2012 with an average revenue per unit ("ARPU") of $5.29. Service revenue was 58% and 62% of total revenues for fiscal 2012 and 2011, respectively.
Telguard service ARPU, was $4.34 for fiscal 2012, as compared to $4.14 for fiscal 2011. The increase in ARPU was due to the combination of adding new subscribers during the year while eliminating lower ARPU customers as a result of the account reconciliation project of a major customer.
RECENT DEVELOPMENTS On November 6, 2012, Telular announced the declaration of an increase in its quarterly dividend from $0.11 per share to $0.12 per share. The dividend was paid on November 30, 2012 to shareholders of record at the close of business on November 20, 2012. The dividend was paid in cash and in additional restricted stock units ("RSUs"), as required by the restricted stock agreement. The cash portion of the dividend was $2,036 and was paid to holders of Telular's common stock on the date of record. Holders of RSUs, on the date of record, received an additional 5,319 RSUs valued at $52. The effect on Telular's financial statements was to reduce cash by $2,036, increase non-cash compensation by $52 and decrease equity by $2,088.
RESULTS OF OPERATIONS (In Thousands, Except Share Data and Unit Data) Fiscal Year 2012 Compared to Fiscal Year 2011 Revenues and Costs of Sales Change 2012 2011 Amount Percentage Revenues by Segment: Event monitoring $ 57,304 $ 50,498 $ 6,806 13% Asset tracking 22,543 - 22,543 > 100% Total revenues $ 79,847 $ 50,498 $ 29,349 58% Change 2012 2011 Amount Percentage Revenues M2M service revenue $ 46,382 $ 31,161 $ 15,221 49% M2M hardware sales 32,260 16,089 16,171 101% Subtotal M2M 78,642 47,250 31,392 66% Other product sales 1,205 3,248 (2,043 ) -63% Total revenue 79,847 50,498 29,349 58% Cost of sales M2M service cost of sales 12,925 10,773 2,152 20% M2M hardware cost of sales 23,166 11,046 12,120 110% Subtotal M2M 36,091 21,819 14,272 65% Other product cost of sales 1,164 3,527 (2,363 ) -67% Total cost of sales 37,255 25,346 11,909 47% Gross margin $ 42,592 $ 25,152 $ 17,440 69% 22--------------------------------------------------------------------------------Revenues Segment EM revenues increased 13% primarily due to an 18% increase in Telguard revenues and a 21% increase in TankLink revenues offset by a decrease of 63% in terminal product revenues. Telguard revenues increased primarily as a result of introduction of new product offerings such as our TG1 Express, PERS and the conversion of our product lines to 3G/4G technology. TankLink's increase in revenues is primarily due to a stronger demand for tank monitoring products. The decrease in our terminal revenues reflects Telular's exit from that line of business.
Telular purchased SkyBitz on February 1, 2012. There were no revenues in fiscal 2011 for the AT segment.
Type M2M service revenue increased 49% primarily due to the inclusion of SkyBitz in fiscal 2012 and an increase in billable units as a result of stronger demand for new product offerings. Billable units increased to 839,800 at September 30, 2012 from 586,100 at September 30, 2011. Telguard ARPU increased slightly from $4.24 at the end of fiscal 2011 to $4.37 at the end of fiscal 2012. Combined ARPU for Telguard, TankLink and SkyBitz was $5.47 as of September 30, 2012. Service revenue represented 58% and 62% of total revenues for fiscal years 2012 and 2011, respectively.
M2M hardware revenues increased 101%. Telular sold approximately 169,800 monitoring and tracking hardware units during fiscal 2012 compared to 96,600 for fiscal 2011. This increase was primarily due to the inclusion of SkyBitz in fiscal 2012 and to increased sales of security products as a result of new product offerings and the conversion of the products in that line of business to 3G/4G technology.
Cost of Sales M2M service costs increased 20% primarily as a result of including SkyBitz in fiscal 2012. As a percentage of service revenue, service cost was 28% for fiscal 2012 and 35% for fiscal 2011. This decrease was due to the migration to a cellular carrier that has reduced rates. The reduction of costs related to this migration began in the third quarter of fiscal 2011. Gross margin for M2M services was 72% in fiscal 2012 as compared to 65% in fiscal 2011. This increase in gross margin is primarily due to an increase in customers with a higher ARPU.
M2M hardware cost of sales increased 110% primarily due to including SkyBitz sales in fiscal 2012, an increase in sales volume for both Telguard and TankLink products and a slight increase in per unit costs for the Telguard 3G/4G products. As a percentage of M2M hardware product revenue, M2M hardware cost of sales was 72% in fiscal 2012 as compared to 69% in fiscal 2011. Gross margin for M2M hardware was 28% in fiscal 2012 as compared to 31% in fiscal 2011. This decrease was primarily due to the increase in unit costs to produce the 3G/4G products.
23-------------------------------------------------------------------------------- Operating Expenses Change % of Revenues 2012 2011 Amount Percentage 2012 2011 Engineering and development $ 7,644 $ 4,580 $ 3,064 67% 9 % 9 % Selling and marketing 11,073 7,171 3,902 54% 14 % 14 % General and administrative 13,531 7,056 6,475 92% 17 % 14 % $ 32,248 $ 18,807 $ 13,441 40 % 37 % Engineering and Development Engineering and development expenses increased $3,064 primarily due to including SkyBitz expenses in fiscal 2012 of $2,221, and the following increases in engineering and development expenses for Telular and TankLink: · $580 of salaries and related benefits attributable to an increase in personnel; · $144 in outside services related to increased usage of engineering consultants for specific projects to augment existing staff; · $70 of facility costs and expenses for product design and prototype builds; and, · $49 of various other expenses including travel and recruitment fees.
Selling and Marketing Selling and marketing expenses increased $3,902 primarily due to including SkyBitz expenses in fiscal 2012 of $3,372, and the following increases in selling and marketing expenses for Telular and TankLink: · $220 of salaries and related benefits attributable to increases in customer support staff; · $274 in third-party services which includes commissions paid to outside agents as a result of increased sales volumes; and, · $36 of travel and various other expenses.
General and Administrative (G&A) G&A expenses increased $6,475 primarily due to including SkyBitz expenses in fiscal 2012 of $6,370, of which $3,586 was an increase in amortization expense due to capitalized intangibles related to the acquisition and an increase of $105 of G&A expenses related to Telular and TankLink. The components of the $105 increase are as follows: · $327 increase in expenses related to the acquisition of SkyBitz; · $151 increase in amortization costs related to the intangibles assets capitalized as part of the acquisition of the SMARTank business unit from SmartLogix; · $57 increase in bank fees related to the amortization of the bank loan used for the acquisition of SkyBitz; · $45 increase in investor relations expenses and NASDQ fees; · $254 decrease in legal expenses as Telular was able to successfully resolve a patent infringement lawsuit in the fourth quarter of fiscal 2011; and · $221 decrease in salaries and related payroll benefits. In the first quarter of fiscal 2011, Telular paid a one-time bonus to holders of stock option in conjunction with the payment of Telular's special dividend. There was no similar expense recorded in fiscal 2012.
Other (Expense) income Other (expense) income decreased $696 in fiscal 2012 compared to fiscal 2011.
This decrease was due to the increase in interest expense related to the Second Amended Loan Agreement with SVB entered into in connections with the purchase of SkyBitz.
Income Taxes The provision for income taxes increased $1,558 to $3,850 for fiscal 2012 as compared to $2,292 for fiscal 2011 primarily due to the increase in taxable income as a result of non-deductible expenses related to the acquisition of SkyBitz.
Net Income Telular recorded net income of $5,899, or $0.34 per fully diluted share for fiscal 2012 compared to net income of $4,154 or $0.26 per fully diluted share for fiscal 2011. This represents a 42% increase and is attributable to increased gross margins while holding operating costs constant as a percentage of revenues.
24 --------------------------------------------------------------------------------Fiscal Year 2011 Compared to Fiscal Year 2010 In fiscal years 2011 and 2010, Telular presented consolidated financial information under one reportable segment.
Revenues and Costs of Sales Change 2011 2010 Amount Percentage Net product sales Monitoring Equipment $ 16,089 $ 16,300 $ (211 ) -1% Terminal 3,248 3,595 (347 ) -10% Total product revenues 19,337 19,895 (558 ) -3% Service revenues 31,161 27,459 3,702 13% Total revenues 50,498 47,354 3,144 7% Cost of sales Products 14,573 16,413 (1,840 ) -11% Services 10,773 10,964 (191 ) -2% 25,346 27,377 (2,031 ) -7% Gross margin $ 25,152 $ 19,977 $ 5,175 Revenues Product revenues decreased 3% primarily due to decreased sales in Telguard monitoring equipment and terminal products, partially offset by an increase in TankLink product revenues. Revenues from sales of our Telguard monitoring equipment decreased 12% primarily due to lower demand as a result of a change in pricing terms within agreements between ADT, our largest security dealer customer and its network of authorized dealers. During the second half of fiscal 2010, the dealer implemented a monthly service charge to the end user for any system sold by an authorized dealer that included a Telguard product. Due to this surcharge, the authorized dealers generally opted to choose other security products over Telguard products which resulted in decreased sales volume; approximately 90,200 Telguard units were sold in fiscal 2011 compared with approximately 103,100 for fiscal 2010. Telular has implemented targeted pricing discount programs and will develop new customer relationships to maintain sales volumes. The Telguard Advantage Program ("TAP") was implemented to offer security dealers the opportunity to achieve preferred pricing Telguard products.
Telguard's average selling price remained consistent year-over year. The decrease in terminal product revenues reflects continued depressed demand in both the U.S. and in the Central American Latin American ("CALA") regions. Of the $3,248 of total terminal sales in fiscal 2011, only $283 were from international sales compared to $3,595 of total terminal sales in fiscal 2010, of which $491 were from international sales. TankLink product revenues increased 79% to $3,323 in fiscal 2011 from $1,859 in fiscal 2010. This increase is primarily due to the purchase of the SMARTank business unit from SmartLogix on January 7, 2011. TankLink is now dealing directly with the end-user customers, resulting in higher revenues. As a result of dealing directly with the end-user customers, TankLink's average unit selling price increased 31%. Approximately 6,400 TankLink units were sold in fiscal 2011 compared to approximately 4,600 units in fiscal 2010.
Service revenues increased 13% as a result of increases in the ARPU for new Telguard and TankLink customers and increased activations for TankLink in fiscal 2011. Telguard experienced a net decrease in subscribers; declining from approximately 567,800 subscribers at the end of fiscal 2010 to approximately 563,500 subscribers at the end of fiscal 2011. This decrease was a result of subscribers being deactivated due to an ongoing account reconciliation project by a major customer. Telguard's ARPU for fiscal 2011 was $4.14, a 4% increase over fiscal 2010's annual ARPU of $3.97. TankLink's ARPU rose to $11.58 in fiscal 2011 from $6.75 in fiscal 2010. This increase is primarily due to the purchase of the SMARTank business unit and being able to bill those customers directly.
Cost of Sales The decrease in product cost of sales of 11% is primarily due to reduced production costs primarily from re-engineering of component parts. Telular cannot be certain that it will continue to be able to reduce production costs in the future. Service cost of sales decreased 2% due to a reduction in the cost of providing monitoring services. Telular has successfully migrated its customer base to a new carrier that has reduced rates based on volume.
25 -------------------------------------------------------------------------------- Product margins, as a percentage of product revenues, increased to 25% in fiscal 2011 from 18% in fiscal 2010. This increase is a result of reduced cost of sales and increases in the TankLink product average selling price.
Service margins, as a percentage of service revenues, increased to 65% in fiscal year 2011 from 60% in fiscal year 2010. This increase was primarily due to reductions in fulfillment costs and higher ARPUs.
Operating Expenses Change % of Revenues 2011 2010 Amount Percentage 2011 2010 Engineering and development $ 4,580 $ 4,562 $ 18 0% 9 % 10 % Selling and marketing 7,171 5,935 1,236 21% 14 % 12 % General and administrative 7,056 6,119 937 15% 14 % 13 % $ 18,807 $ 16,616 $ 2,191 37 % 35 % Engineering and Development Engineering and development expenses remained relatively consistent between fiscal years. The increase of $18 was primarily due to: · $75 in prototype materials and testing services; and, · $26 in facility costs primarily due to increased depreciation as a result of increased purchases of capital assets.
Offsetting these increases was a $36 decrease in payroll expenses resulting from $231 in decreases in salaries and benefits as a result of reduced headcount, partially offset by a $195 increase in bonuses as a result of a one-time bonus paid to holders of stock options in conjunction with the payment of Telular's special dividend; and, a $47 decrease in consulting expenses as a result of reduced utilization of contract engineers. Telular expects to fill open positions in fiscal 2012.
Selling and Marketing Selling and marketing expenses increased by $1,236 (21%) primarily due to: · $400 in payroll related expenses as a result of increased sales and marketing personnel and expenses such as commissions that fluctuate with sales volume and a one-time bonus paid to holders of stock options in conjunction with the payment of Telular's special dividend; · $431 in advertising and tradeshows as Telular increased its marketing efforts; · $282 in outside services and third party commissions primarily related to a service agreement with SmartLogix in which Telular appointed SmartLogix as an exclusive sales representative for the purpose of selling tank monitoring equipment and services to customers in the fuels and lubricants market. Telular purchased the SMARTank business unit from SmartLogix on January 7, 2011; and, · $123 in travel expenses incurred in conjunction with increased marketing sales efforts.
General and Administrative (G&A) G&A expenses increased by $937 (15%) primarily due to the following increases: · $415 in payroll related expenses primarily as a result of a one-time bonus paid to holders of stock options in conjunction with the payment of Telular's special dividend; · $449 in amortization expense related to the intangibles recorded as a result of the purchase of the SMARTank business; · $64 in franchise tax fees related to the State of Delaware; and, · $60 in investor relations expenses, including increased travel and increased NASDAQ fees.
Offsetting these increases was a decrease in professional fees of $51, primarily due to reduced legal fees.
Other Income Other income decreased by $293 primarily due to a decrease in interest income.
In fiscal 2010 Telular was receiving interest on the outstanding trade receivable from SmartLogix. This trade receivable, approximately $4,484, was forgiven as part of the consideration for the purchase of the SMARTank business unit on January 7, 2011 from SmartLogix.
Income Taxes Telular recorded a current income tax provision of $299 and a deferred income tax provision of $1,993 for fiscal year 2011 as compared with a current provision of $139 and a deferred income tax benefit of $34,505 for fiscal year 2010. The increase in the current provision was primarily due to the increase in federal and state taxable income in fiscal year 2011. The deferred tax benefit was due to the reversal of the valuation allowances on net deferred tax assets; primarily Telular's net operating loss carryforwards.
26 -------------------------------------------------------------------------------- Net Income Telular recorded net income of $4,154 or $0.26 per fully diluted share for fiscal 2011 compared to net income of $38,121 or $2.49 per fully diluted share for fiscal year 2010. This decrease was primarily due to the income tax benefit recorded from the reversal of net deferred tax asset valuation allowances in fiscal 2010.
LIQUIDITY AND CAPITAL RESOURCES Management regularly reviews Telular's working capital and available borrowings in addition to its cash and cash equivalent balance to determine if it has enough cash to operate the business. On September 30, 2012, Telular had cash and cash equivalents of $12,676 and net working capital of $16,630, compared to cash and cash equivalents of $12,642 and net working capital of $15,515 a year earlier.
On January 22, 2011, Telular executed an Amended and Restated Loan and Security Agreement (the "Amended Loan Agreement") with Silicon Valley Bank ("SVB"). The Amended Loan Agreement provided for a two year term with total maximum borrowings of $10,000. Telular had the option under the Amended Loan Agreement to have interest calculated on SVB's prime rate (with a floor of 5%) up to a maximum of prime plus 0.5% or calculated on the current LIBOR rate up to a maximum of LIBOR plus 3.0%. The Amended Loan Agreement also permitted Telular to borrow up to $7,000 under a revolving line of credit, with the ability to convert up to $5,000 of borrowings under the revolver into a three year term loan. The Amended Loan Agreement required Telular to comply with certain financial covenants such as maintaining certain levels of assets to liabilities and minimum levels of cash flow generation. Telular had no outstanding borrowings under the Amended Loan Agreement as of February 1, 2012, on which date Telular and SVB amended the Amended Loan Agreement in connection with the SkyBitz acquisition.
Simultaneous with the acquisition of SkyBitz on February 1, 2012, Telular executed a Second Amended and Restated Loan and Security Agreement (the "Second Amended Loan Agreement") with SVB. Under the Second Amended Loan Agreement, Telular borrowed $30,000 in the form of a term loan that was applied as a portion of the cash consideration for the acquisition of SkyBitz. The term loan matures on February 1, 2017, the 5th anniversary of the amendment. The loan requires quarterly payments of interest and principal, with annual principal amortization of 10%, 15%, 20%, 20% and 25% in each of the first five years, respectively, with the final 10% due on the maturity date. At the option of Telular, interest will be incurred based on a rate ranging from 2.25% to 2.75% (depending on the calculation of the senior leverage ratio) above the published LIBOR rates, or at a rate of .25% to .75% above the Prime interest rate. The interest rate was 3% as of September 30, 2012. The Second Amended Loan Agreement requires Telular to comply with certain financial covenants such as maintaining a maximum senior leverage ratio and a minimum fixed charge coverage ratio. The loan is secured by substantially all of the assets of Telular. At September 30, 2012 the outstanding loan balance was $28,500 and Telular was in compliance with all financial covenants. As of September 30, 2012, $338 of loan fees and related costs were paid by Telular and are being amortized over the term of the loan.
Management expects trade accounts receivable and inventory to turn into cash in short periods of time. As such, given Telular's level of cash and cash equivalents, trade accounts receivable and inventory, management believes Telular has adequate resources to fund current and planned operations in a manner consistent with historical practices. The tables below discuss the liquidity components of continuing operations for fiscal years 2012 and 2011.
27 -------------------------------------------------------------------------------- Fiscal 2012 Telular generated cash of $12,752 from continuing operations during fiscal 2012 compared to cash generated of $14,442 during the same period of fiscal 2011. The components of the change for fiscal 2012 are as follows: $ 5,899 Net income; cash provided.
The increase in trade accounts receivable is primarily due to increased sales and the timing of product sales during the fourth (2,659 ) quarter of fiscal 2012.
The increase in inventory is due to increased inventory levels in (2,885 ) long-lead items, primarily in the Asset Tracking segment.
1,667 Trade accounts payable primarily consists of amounts due to Telular's contract manufacturers and monitoring service providers. The increase was primarily due to the timing ofreceipt of invoices from these vendors and their payment and as a result of additional trade payables due to the acquisition of SkyBitz.
The decrease in accrued liabilities was primarily due to payment of the earn-out related to the purchase of the SMARTank line of (200 ) business.
10,029 Non-cash expenses (benefits): $2,504 from the increase in deferred tax provision related to decrease in net deferred tax assets; $1,489 from stock based compensation; $1,521 from depreciation expense; $4,481 of amortization expense primarily due to the addition of $23,500 of intangibles related to the acquisition of SkyBitz; and, $34 from the loss on disposal of operating assets.
901 Net cash provide by other working capital items is primarily due to increase in current tax provision and to the increased expenditures for intangible assets such as patents.
$ 12,752 Total cash provided by continuing operations Fiscal 2011 The Company generated cash of $14,442 from continuing operations during fiscal 2011 compared to cash generated of $10,883 during the same period of fiscal 2010. The components of the change for fiscal 2011 are as follows: $ 4,154 Income from continuing operations; cash provided.
1,635 The decrease in trade accounts receivable is due to the timely collection of outstanding balances, resulting from a more favorable product mix. Service revenue represents 62% of Telular's total revenues for the twelve month period ended September 30, 2011. The accounts receivable associated with this revenue stream are generally collected within 30 days of invoicing. The timely collections along with reduced product billings resulted in the decrease. 2,252 The decrease in inventory reflects the Company's overall inventory strategy; sell from existing stock while adjusting production levels to augment the changes in sales levels.
(315 ) Trade accounts payable primarily consists of amounts due to Telular's contract manufacturers and monitoring service providers. The decrease was primarily due to the timing of receipt of invoices from these vendors and their payment. In the prior year, fiscal 2010, payment was made before year-end to these vendors.
1,228 The increase in accrued liabilities was primarily due to $1,165 increase in the estimated earn-out related to the purchase of the SMARTank line of business; $351 increase in deferred revenue due to increased advanced tank monitoring services related to SMARTank customers; $118 decrease in legal fees related to a patent infringement lawsuit; and, $170 decrease in variousmiscellaneous accrued expenses.
5,506 Non-cash expenses (benefits): $1,994 from the increase in deferred tax provision related to decrease in net deferred tax assets; $1,676 from stock based compensation; $1,045 from depreciation expense; $742 of amortization expense; and, $49 from the loss on disposal of operating assets.
(18 ) Net cash used by other working capital items, primarily the acquisition of intangibles; patents, trademarks, a licensing fee and the increase in income taxes payable.
$ 14,442 Total cash provided by continuing operations 28-------------------------------------------------------------------------------- Capital expenditures for fiscal years 2012 and 2011 were $1,343 and $1,113, respectively. The 2012 expenditures were primarily for technical improvements to Telular's message center and related customer website, production test equipment and tooling, product certification costs and improvements to Telular's internal computer network. The 2011 expenditures were for improvements to internal network equipment, production equipment, such as test stations for new products, and product certification costs for new products. Telular anticipates funding future capital additions with cash from operations.
On July 25, 2008, Telular's Board approved a plan to repurchase up to $5,000 of Telular's common stock on the open market. From August 2008 through March 2010, Telular repurchased 2,108,490 at a cumulative cost of $3,775. On April 27, 2010, Telular's Board approved an additional repurchase of $3,775. From May 2010 through September 2010, Telular repurchased an additional 123,816 of Telular's common stock on the open market at a cost of $412. During fiscal years 2012 and 2011 there were no shares repurchased under the plan. As of September 30, 2012, the approximate dollar value of shares that may yet be purchased under the plan is $4,588. Additionally, on June 9, 2009, Telular completed a modified 'Dutch Auction" tender offer buying back 2,344,857 shares of common stock at a cost of $5,386. Cumulatively through September 30, 2012, Telular has repurchased 4,577,163 shares at a cost of $9,573.
Telular generally requires its foreign customers to prepay, obtain letters of credit or qualify for credit. Also, to mitigate the effects of currency fluctuations on Telular's results of operations, Telular conducts all of its international transactions in US dollars.
The following table sets forth our total contractual obligations as of September 30, 2012: Payments Due by Period Less than Contractual Cash Obligations Total 1 year 1-3years 4-5 years After 5 years Operating leases $ 3,733 $ 1,173 $ 2,049 $ 511 $ - Purchase Commitments 11,540 11,540 - - -Total contractual cash obligations $ 15,273 $ 12,713 $ 2,049 $ 511 $ - Purchase commitments are for purchases made in the normal course of business to meet operational requirements, consisting primarily of raw materials and finished goods inventory. Telular expects to satisfy these commitments primarily from cash from the revenues generated by the delivery of backlogged orders.
CRITICAL ACCOUNTING POLICIES Management's Discussion and Analysis of Financial Condition and Results of Operations discusses Telular's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
On an on-going basis, management evaluates its estimates and judgments, including those related to the net realizable value of inventories and intangible assets. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies, among others, affect the presentation of Telular's financial condition and results of operations.
Revenue Recognition Telular's revenue is primarily generated from three sources: · The sale of hardware units, under non-recurring agreements; · The provision of monitoring services, under recurring agreements; and, · The provision of ancillary services such as installation and non-warranty repairs and royalty revenue.
Revenue is recognized when persuasive evidence of an agreement exists, the hardware unit or the service has been delivered, fees and prices are fixed and determinable and collectability is probable when all other significant obligations have been fulfilled.
29 -------------------------------------------------------------------------------- Telular recognizes revenue and associated costs from hardware unit sales at the time of shipment of products which is when title transfers. Hardware unit discounts are recorded as a reduction in revenue in the same period that the revenue is recognized. Telular offers customers the right to return hardware units that do not function properly within a limited time after delivery, see the section entitled "Reserve for Warranty" below. Telular continuously monitors and tracks such hardware unit returns and records a provision for the estimated amount of such future returns, based on historical experience. While such returns have historically been within expectations, Telular cannot guarantee that it will continue to experience the same return rates that it has experienced in the past. Any significant increase in hardware unit failure rates and the resulting credit returns could have a material adverse impact on operating results for the period or periods in which such returns materialize.
Monitoring service revenue is recognized at the time the service is provided. Payments received in advance of providing monitoring services are deferred and recognized over the period in which the service is delivered. Costs associated with providing the monitoring service are recorded when the service is provided.
For those arrangements that include multiple deliverables, Telular follows the guidance in Accounting Standard Codification ("ASC") Subtopic 605-25, as amended by Accounting Standards Update ("ASU") 2009-13. ASC Subtopic 605-25 established criteria for determining if a revenue arrangement has multiple deliverables. ASU 2009-13 amended the multiple-element revenue guidance to (1) modify the separation criteria by eliminating the criterion that requires objective and reliable evidence of fair value for the undelivered item, and (2) eliminate the use of the residual method of allocation and instead required that arrangement consideration be allocated, at the inception of the arrangement, to all deliverables based on their relative selling price. Certain multiple-element revenue arrangements include both product and monitoring services. Telular has determined that the revenue from multiple-deliverable arrangements has met the criteria for treating each revenue source as a separate element. Consideration is allocated to the deliverables at inception of an arrangement using the relative selling price method, based on Telular's best estimate of selling price. Key factors that are considered when establishing a selling price are the industry segment to which the products and services are sold, estimated selling price of our competitors, where available, and an internally established gross margin range. Product revenue is billed and recognized upon shipment to the customer while monitoring services revenue is billed periodically, usually monthly, and recognized when the service is provided.
Telular recognizes ancillary service revenues when the service is delivered. Costs associated with these services are recorded in the period the service is delivered. Royalty revenue, which is based on a percentage of sales by the licensee, is estimated by Telular, based upon historical data provided by the licensee, in the period in which management estimated the sales have taken place. Telular periodically reconciles these estimates to the actual payments received from the licensee, adjusting revenue accordingly. Historically, Telular's estimates have not been materially different than the payments received from the licensee.
Allowance for Doubtful Accounts Telular maintains an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make payment for products and services. Telular evaluates the collectability of customer receivables by considering the payment history and the financial stability of its customers. If Telular believes that an account receivable may not be collected, a charge is recorded to the allowance account. At September 30, 2012 and 2011, the allowance for doubtful accounts related to trades accounts receivable from continuing operations was $351 and $39, respectively. The increase in the allowance for doubtful accounts is attributable to the inclusion of SkyBitz's allowance for doubtful accounts.
Reserve for Inventory Obsolescence Significant management judgment is required to determine the reserve for obsolete or excess inventory. Telular generally considers inventory quantities greater than a one-year supply, based on current year activity, to be excess, unless that inventory has alternative uses. Telular also provides for the total value of inventories that are determined to be obsolete based on criteria such as customer demand and changing technologies. At September 30, 2012 and 2011, the inventory reserves were $283 and $649, respectively. Changes in strategic direction, such as discontinuance or expansion of product lines, changes in technology or changes in market conditions, could result in significant changes in required reserves. The decrease in the reserve for inventory obsolescence reflects the disposition of obsolete inventory related to terminal products.
Reserve for Warranty Telular maintains a reserve for products that are returned within Telular's warranty period due to inoperability. Telular has different warranty periods for its different product groups: the security monitoring products has a 24 month warranty period; the asset tracking and tank monitoring products typically have a 12 month warranty period. Significant management judgment is required to determine the warranty reserve. Telular utilizes historical information regarding units returned within the appropriate warranty period and the costs incurred to repair returned units. Telular then estimates required warranty reserves for future products that may be returned. As of September 30, 2012 and 2011, the warranty reserve was $1,542 and $115, respectively. The increase in the warranty reserve is due to the inclusion of SkyBitz's warranty reserve, primarily related to five-year warranties offered in past years as a consideration to certain customers. SkyBitz is no longer offering such warranties.
30 --------------------------------------------------------------------------------Goodwill and Intangible Assets Telular evaluates the fair value and recoverability of goodwill, in accordance with Accounting Standards Update No. 2011-08, Intangibles - Goodwill and Other (Topic 350), ("ASU 350"), at least annually or whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable.
Telular first assesses various qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The following are examples, though not all inclusive, of events and circumstances that shall be considered: · macroeconomic conditions; · industry and market conditions such as industry in which the entity operates and competition; · product cost factors; · overall company financial performance and entity-specific events such as changes in management; and, · sustained decrease in share price.
If, after assessing the totality of events or circumstances, it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, Telular will then perform impairment tests to determine the fair value of the reporting unit. In determining fair value and recoverability, Telular makes projections regarding future cash flows. These projections are based on assumptions and estimates of: · growth rates for net revenues, cost of sales and operating expenses for the monitoring and terminal businesses; · anticipated future economic conditions; · the assignment of discount rates relative to risk associated with companies in similar industries; and, · estimates of terminal values.
An impairment loss is assessed and recognized in operating earnings when the fair value of the asset is less than its carrying amount. As of September 30, 2012 and 2011, goodwill was not impaired.
Telular reviews for the impairment of intangible assets whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Telular evaluates recoverability of other intangible assets by comparing the amount of the intangible asset to future net undiscounted cash flows generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets calculated using a discounted cash flow analysis.
Income Taxes In determining income for financial statement purposes, Telular must make certain estimates and judgments. These estimates and judgments affect the calculation of certain tax liabilities and the determination of the recoverability of certain of the deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense.
In evaluating the ability to recover its deferred tax assets, Telular considers all available positive and negative evidence including its past operating results, the existence of cumulative losses and its forecast of future taxable income. In estimating future taxable income, Telular developed assumptions including the amount of future federal and state pre-tax operating income, the reversal of temporary differences, the utilization of net operating loss carryforwards to offset taxable income 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 Telular is using to manage the underlying business.
Telular has recorded significant valuation allowances that are intended to be maintained until it is more likely than not the deferred tax asset will be realized. As of September 30, 2012 and 2011, the valuation allowance of $5,711 and $5,612, respectively, is primarily for state net operating losses that will expire before they can be realized. The realization of the remaining deferred tax assets is primarily dependent on future taxable income in the appropriate state jurisdiction. Significant factors that could negatively impact Telular's determination of the recognition of the net deferred tax assets would be changes in the ownership of Telular and changes in tax laws and rates. Based on Internal Revenue Code Section 382 ("Section 382"), changes in the ownership of Telular may limit the utilization of net operating loss carryforwards. Any Section 382 limitation may require that Telular record an additional valuation allowance against its deferred tax assets. Management is not aware, at this time, of any such ownership changes that would have a negative impact on the recognition of the net deferred tax assets. Any reduction in future taxable income may require that Telular record an additional valuation allowance against the deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in such period and could have a material impact on Telular's future earnings.
31-------------------------------------------------------------------------------- Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. The State of Illinois increased its corporate income tax rate from 7.3% to 9.5% in January 2011. The State also suspended the use of net operating losses to offset current taxable income for three years. Telular implemented a tax strategy that would lower taxable income apportioned to Illinois, thereby lowering the current state tax payable. This strategy reduced Telular's estimated use of future net operating losses in Illinois, resulting in the increase in the valuation allowance against the net deferred tax assets which increased Telular's deferred tax provision in fiscal 2011.
During fiscal 2010, Telular reversed $37.0 million of valuation allowance after a comprehensive assessment of deferred tax asset realizability that was triggered by the achievement of three years of cumulative book income. The primary rationale for the reversal of the valuation allowance and thus, the realization of deferred tax assets, is the assumption that Telular will generate sufficient future taxable income. This conclusion is based on forecasted taxable income over the period that existing net operating losses are scheduled to expire. Reasons that there is now sufficient forecasted taxable income include (1) the exit from the FCP market in fiscal 2007 which had been generating significant operating losses, and (2) Telular's continued focus in recent years towards growing its higher margin recurring service. With these key strategic changes, Telular's current operating model provided the basis upon which it was reasonable to assume that taxable income would continue. Telular's taxable income forecast used as the basis for this determination was a conservative estimate for taxable income growth from 2010 through 2016, and no growth thereafter. Further, the forecast did not incorporate any new business lines or depend upon any material transaction such as an acquisition or any other unusual or non-routine event to achieve the results necessary in order to realize the estimated taxable income.
Under the uncertain tax position provisions of ASC 740, Income Taxes, Telular would recognize liabilities for tax issues in the U.S based on Telular's estimate of whether, and the extent to which, additional taxes will be due. These tax liabilities would be recorded in income taxes in the Consolidated Balance Sheets. As of September 30, 2012 and 2011, Telular has no uncertain tax positions recorded in its financial statements. Telular does not include interest and penalties related to income tax matters in income tax expense.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS The discussion of recently issued accounting pronouncements is hereby incorporated by reference from Item 8, notes to consolidated financial statements.
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