ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SPECIAL NOTE CONCERNING
FORWARD-LOOKING STATEMENTS
We believe that it is important to communicate our future expectations to our security holders and to the public. This report, therefore, contains statements about future events and expectations which are “forward-looking statements” within the meaning of Sections 27A of the Securities Act of 1933 and 21E of the Securities Exchange Act of 1934, including the statements about our plans, objectives, expectations and prospects under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” You can expect to identify these statements by forward-looking words such as “may,” “might,” “could,” “would,” ”will,” “anticipate,” “believe,” “plan,” “estimate,” “project,” “expect,” “intend,” “seek” and other similar expressions. Any statement contained in this report that is not a statement of historical fact may be deemed to be a forward-looking statement. Although we believe that the plans, objectives, expectations and prospects reflected in or suggested by our forward-looking statements are reasonable, those statements involve risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements, and we can give no assurance that our plans, objectives, expectations and prospects will be achieved.
Important factors that might cause our actual results to differ materially from the results contemplated by the forward-looking statements are contained in the “Risk Factors” section of and elsewhere in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 and in our subsequent filings with the Securities and Exchange Commission, and include, among others, the following:
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changes in customer preferences;
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our inventory and debt levels;
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heavy reliance on sales to agencies of the United States government;
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federal, state and local government budget deficits and spending limitations;
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quality of management, business abilities and judgment of our personnel;
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the availability, terms and deployment of capital;
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competition in the land mobile radio industry;
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reliance on contract manufacturers;
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limitations in available radio spectrum for use of land mobile radios;
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changes or advances in technology; and
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general economic and business conditions.
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We assume no obligation to publicly update or revise any forward-looking statements made in this report, whether as a result of new information, future events, changes in assumptions or otherwise, after the date of this report. Readers are cautioned not to place undue reliance on these forward-looking statements.
Reported dollar amounts in management’s discussion and analysis are disclosed in millions or as whole dollar amounts.
Executive Summary
Our financial and operating results for the third quarter and nine months ended September 30, 2010 declined compared with the same periods last year.
Sales of P25 digital products for the three months ended September 30, 2010 decreased slightly compared with the same period last year. For the current year’s nine-month period, P25 digital product sales were slightly higher than the same period last year.
Previously announced orders from branches of the U.S. Military for $3.2 million and from the U.S. Department of Agriculture Forest Service for $2.5 million were received near the end of the third quarter of 2010. Consequently, only a portion of these orders was fulfilled in the third quarter. The remainder of these orders is anticipated to be fulfilled during the fourth quarter of 2010.
We also continued to progress with our P25 Trunking development; introducing the initial models of our P25 Trunked products in September 2010.
For the three and nine months ended September 30, 2010, total sales were approximately $7.1 million and $20.6 million, respectively, compared with approximately $8.3 million and $22.1 million for the same periods last year. Sales of P25 digital products for the third quarter of 2010 totaled approximately $4.5 million (63.9% of total sales) compared with approximately $4.9 million (59.4% of total sales) for the same quarter last year. For the nine months ended September 30, 2010, sales of P25 digital products totaled approximately $13.4 million (65.2% of total sales) compared with approximately $13.0 million (58.7% of total sales) for the same period last year.
Gross margins as a percentage of sales for the three months ended September 30, 2010 were 46.4% compared with 51.1% for the same quarter last year. For the nine months ended September 30, 2010 gross margins were approximately 46.8% compared with 48.5% for the same period last year. Our gross margins for the three and nine months ended September 30, 2010 reflect competitive pricing pressures and additional manufacturing costs.
For the three months ended September 30, 2010, selling, general and administrative expenses totaled approximately $3.0 million (42.6% of sales) compared with approximately $2.7 million (32.8% of sales) for the same period last year. For the nine months ended September 30, 2010, selling, general and administrative expenses totaled approximately $8.8 million (42.8% of sales) compared with approximately $7.8 million (35.2% of sales) for the same period last year. Increases from the same periods last year reflect additional marketing and sales costs, as well as product development initiatives.
Pretax income for the three and nine months ended September 30, 2010 totaled approximately $261,000 and $812,000, respectively, compared with approximately $1.5 million and $2.9 million for the same periods last year.
For the three and nine months ended September 30, 2010, we recognized income tax expense, which was primarily non-cash, of approximately $134,000 and $344,000, respectively, compared with approximately $577,000 and $881,000 for the same periods last year.
Net income for the three and nine months ended September 30, 2010 was approximately $127,000 ($0.01 per basic share and diluted share) and $468,000 ($0.03 per basic and diluted share), compared with approximately $927,000 ($0.07 per basic and diluted share) and $2.0 million ($0.15 per basic and diluted share) for the same periods last year.
As of September 30, 2010, working capital totaled approximately $19.6 million, of which approximately $10.8 million was comprised of cash and trade receivables. As of December 31, 2009 working capital totaled approximately $17.7 million of which approximately $11.4 million was comprised of cash and trade receivables.
Results of Operations
As an aid to understanding our operating results for the periods covered by this report, the following table shows selected items from our condensed consolidated statements of income expressed as a percentage of sales:
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Percentage of Sales
Three Months Ended
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Percentage of Sales
Nine months Ended
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Sales
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100.0 |
% |
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100.0 |
% |
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100.0 |
% |
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100.0 |
% |
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Cost of products
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(53.6 |
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(48.9 |
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(53.2 |
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(51.5 |
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Gross margin
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46.4 |
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51.1 |
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46.8 |
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48.5 |
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Selling, general and administrative expenses
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(42.6 |
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(32.8 |
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(42.8 |
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(35.2 |
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Net interest (expense) income
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(0.1 |
) |
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(0.1 |
) |
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(0.0 |
) |
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(0.2 |
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Other income
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(0.0 |
) |
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0.0 |
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(0.0 |
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0.0 |
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Pretax income
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3.7 |
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18.0 |
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4.0 |
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13.1 |
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Income tax expense
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(1.9 |
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(7.0 |
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(1.7 |
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(4.0 |
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Net income
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1.8 |
% |
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11.0 |
% |
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2.3 |
% |
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9.1 |
% |
Net Sales
Net sales for the third quarter ended September 30, 2010, totaled approximately $7.1 million compared with approximately $8.3 million for the same quarter last year. Sales of P25 digital products for the quarter totaled approximately $4.5 million (63.9% of total sales), compared with approximately $4.9 million (59.4% of total sales) for the same quarter last year.
For the nine months ended September 30, 2010, total sales were approximately $20.6 million, compared with approximately $22.1 million for the same period last year. Sales of P25 digital products for the nine-month period totaled approximately $13.4 million (65.2% of total sales) compared with approximately $13.0 million (58.7% of total sales) for the same period last year.
Sales for the three and nine months ended September 30, 2010 declined compared to the same periods last year primarily due to the timing of certain customer orders. Previously announced orders from branches of the U.S. Military for $3.2 million and from the U.S. Department of Agriculture Forest Service for $2.5 million were received near the end of the third quarter of 2010. Consequently, only a portion of these orders was fulfilled in the third quarter. The remainder of these orders is anticipated to be fulfilled during the fourth quarter of 2010.
During the third quarter of 2010 progress continued on the development of our P25 trunking products, culminating in the September 2010 introduction of the first models of our KNG trunked products. Approximately $2.7 million of the aforementioned orders from the U.S. Military were for these new trunked products.
Cost of Products and Gross Margin
Gross margins as a percentage of sales for the three months ended September 30, 2010 were 46.4% compared with 51.1% for the same quarter last year. For the nine months ended September 30, 2010, gross margins as a percentage of sales were 46.8% compared with 48.5% for the same period last year.
Our cost of products and gross margins are primarily related to product mix, manufacturing volumes and pricing. Compared with the same quarter last year, our gross margins for the quarter reflected the impact of product costs and competitive pricing considerations, as well as a change in the mix of products sold. Some of the product costs were related to specific non-recurring circumstances.
We continue to utilize contract manufacturing relationships to maximize production efficiencies and minimize material and labor costs. We also regularly consider manufacturing alternatives to improve quality, speed and to reduce our product costs. We anticipate that the current contract manufacturing relationships or comparable alternatives will be available to us in the future. Leveraging increased sales volumes and P-25 product sales combined with the introduction of planned new products, we believe, should result in further cost improvements and efficiencies. We anticipate that product cost and competitive pricing pressures will continue in future quarters, however, the extent of their impact on gross margins is uncertain.
Selling, General and Administrative Expenses
Selling, general and administrative (SG&A) expenses consist of marketing, sales, commissions, engineering, product development, management information systems, accounting, headquarters and non-cash share-based employee compensation expenses.
SG&A expenses for the third quarter 2010 were approximately $3.0 million (42.6% of sales) compared with approximately $2.7 million (32.8% of sales) for the same quarter last year. For the nine months ended September 30, 2010, SG&A expenses totaled approximately $8.8 million (42.8% of sales) compared with approximately $7.8 million (35.2% of sales) for the same period last year.
Engineering and product development expenses for the three months ended September 30, 2010 increased approximately $267,000 (30.4%) compared with the same quarter last year. For the nine months ended September 30, 2010, engineering and product development expenses increased approximately $571,000 (20.9%) compared with the same period last year. During the first nine months of 2010 we incurred additional costs primarily associated with our KNG P25 engineering and new product development initiatives. In September 2010, we completed the first release of P25 trunking, and introduced the initial models of P25 trunked portable and mobile radios. New products and capabilities in our KNG line are in the pipeline and planned for introduction in coming quarters.
Marketing and selling expenses for the three months ended September 30, 2010 increased by approximately $42,000 (4.0%) compared with the same quarter last year. For the nine months ended September 30, 2010, marketing and selling expenses increased approximately $285,000 (9.5%) compared with the same period last year. During the first nine months of 2010 we increased sales and marketing programs primarily related to our new KNG products. These programs are designed to raise the profile of the Company and its products, as we enter new markets and pursue new customers. Also, for the same period last year we maintained lower selling expenses and payroll in response to sluggish sales. We intend to invest in selling and marketing initiatives that we believe will support our goals for sales growth.
General and administrative expenses for the three months ended September 30, 2010 decreased by approximately $24,000 (3.0%), compared with the same quarter last year primarily as a result of reduced headquarters and public company expenses. For the nine months ended September 30, 2010, general and administrative expenses increased approximately $152,000 (7.3%) compared with the same period last year primarily as a result of non-cash share-based employee compensation expenses.
Operating Income
Operating income for the three and nine months ended September 30, 2010 totaled approximately $269,000 (3.8% of sales) and $826,000 (4.0% of sales), respectively, compared with approximately $1.5 million (18.3% of sales) and $2.9 million (13.3% of sales) for the same periods last year. The decrease in operating income was primarily due to a combination of factors including lower sales, reduced gross margins resulting from pricing and cost changes, and increased operating expenses.
Net Interest Expense
For both the three and nine months ended September 30, 2010, net interest expense totaled approximately $6,000, compared to net interest expense of approximately $5,000 and $41,000, respectively, for the same periods last year. We incur interest expense on outstanding borrowings under our revolving credit facility and earn interest income on our cash balances. The interest rate on such revolving credit facility as of September 30, 2010 was 3.75%. This rate is variable based on the prime rate plus 50 basis points.
Income Taxes
We recorded net income tax expense of approximately $134,000 and $344,000, respectively, for the three and nine months ended September 30, 2010 compared with $577,000 and $881,000 for the same periods last year. Our income tax expense is primarily non-cash as we have the availability of net operating loss carryforwards.
As of September 30, 2010 and December 31, 2009, we had deferred tax assets of approximately $7.5 million and $7.8 million, respectively. These assets are primarily composed of net operating loss carry forwards (NOLs), which are available to offset certain federal and state taxable income. The NOLs expire starting in 2018 through 2028.
In order to fully realize the net deferred tax assets, we will need to generate sufficient taxable income in future years to utilize our NOLs prior to their expiration. ASC Topic 740, “Income Taxes” requires us to analyze all positive and negative evidence to determine if, based on the weight of available evidence, we are more likely than not to realize the benefit of the net deferred tax assets. The recognition of the net deferred tax assets and related tax benefits is based upon our conclusions regarding, among other considerations, estimates of future earnings based on information currently available, current and anticipated customers, contracts and product introductions, as well as historical operating results, and certain tax planning strategies.
We have evaluated the available evidence and the likelihood of realizing the benefit of our net deferred tax assets. From our evaluation we have concluded that based on the weight of available evidence we are more likely than not to realize the benefit of our net deferred tax assets recorded at September 30, 2010. Accordingly, no valuation allowance has been established. We cannot presently estimate what, if any, changes to the valuation of our deferred tax assets may be deemed appropriate in the future. If we incur future losses, it may be necessary to record a valuation allowance related to the deferred tax assets recorded as of September 30, 2010.
In April 2010, we were notified by the Internal Revenue Service of its intent to examine our federal tax return for the fiscal year ended December 31, 2007. The examination has commenced with an anticipated completion date of December 2010.
Changing Prices
In some instances during the nine months ended September 30, 2010, product unit prices were reduced to enhance our competitive position and sales prospects, which reduced gross margins. We anticipate that competitive pricing pressure will continue in future quarters. The extent of their impact is uncertain.
Liquidity and Capital Resources
For the nine months ended September 30, 2010, net cash used in operating activities totaled approximately $1.9 million compared with net cash provided by operating activities of approximately $5.6 million for the same period last year. Cash used in operating activities resulted from approximately $1.5 million of less net income than in the same period last year, as well as changes in inventories, accounts receivable and accounts payable. Net inventories increased during the period by approximately $3.8 million to support the broader line of new products and anticipated demand. For the same period last year, inventory decreased approximately $3.7 million primarily due to product sales from a substantial order with the U.S. Department of Defense. Accounts receivable increased approximately $0.7 million compared with an increase of approximately $2.4 million for the same period last year. The increase in accounts receivable as of September 30, 2010 was primarily the result of sales near the end of the third quarter that are still in their collection cycle. Accounts payable increased as of September 30, 2010 by approximately $1.1 million primarily due to material purchases. For the same period last year, accounts payable decreased by approximately $0.1 million. Deferred tax assets for the first nine months of 2010 decreased by approximately $342,000 compared with $855,000 for the same period last year. Depreciation and amortization totaled approximately $486,000 for the nine months ended September 30, 2010, compared with $503,000 for the same period last year.
Cash used in investing activities was primarily to fund digital software development and the acquisition of assets pertaining to the development of our new digital products. During the nine months ended September 30, 2010 and during the same period last year, we incurred approximately $1.1 million in capitalized software costs. Purchases of property, plant and equipment for the nine months ended September 30, 2010 were approximately $439,000 compared with approximately $341,000 for the same period last year. We anticipate that future capital expenditures will be funded through our existing cash balance and operating cash flow.
Cash generated from financing activities for the nine months ended September 30, 2010 totaled approximately $2.1 million, representing $2.0 million in borrowings under our revolving credit facility, $79,000 in proceeds from the issuance of common stock and $20,000 in tax benefits from the exercise and sale of employees’ stock options. For the same period last year, cash used in financing activities totaled $1.5 million, as we repaid borrowings under our secured revolving credit facility.
On October 20, 2010, we amended our revolving credit facility with Silicon Valley Bank (“SVB”) by amending the related loan and security agreement. Under the amended loan and security agreement, our revolving credit facility’s maximum borrowing availability has been increased to $5.0 million from $3.5 million, its maturity date has been extended to December 31, 2012 from October 23, 2010, the variable rate at which borrowings bear interest has been reduced to prime rate plus 50 basis points from prime rate plus 100 basis points and the Company’s minimum “tangible net worth” requirement has been reset at $25.35 million (such minimum requirement still continuing to be subject to increase by (i) 50% of quarterly net profits and (ii) 75% of the net proceeds received from issuances of equity and issuances of “subordinated debt”).
We continue to be subject to the substantially same customary borrowing terms and conditions under the SVB credit facility as we were prior to amending the loan and security agreement, including the accuracy of representations and warranties, compliance with financial maintenance and restrictive covenants and the absence of events of default.
The foregoing description of our SVB credit facility and the amended loan and security agreement is qualified by reference to Note 10 to our Condensed Consolidated Financial Statements included elsewhere in this report.
We were in compliance with all covenants under the amended loan and security agreement, as of the date of this report. As of the date of this report, borrowings outstanding under the SVB credit facility totaled $2.0 million and we had approximately $0.6 million of additional borrowing availability.
Our cash balance at September 30, 2010 was approximately $6.3 million. We believe these funds combined with anticipated cash generated from operations and borrowing availability under our credit facility with SVB are sufficient to meet our working capital requirements for the next twelve months. However, although we do not anticipate needing additional capital in the near term, the current financial and economic conditions could limit our access to credit and impair our ability to raise capital, if needed, on acceptable terms or at all. We also face other risks that could impact our business, liquidity and financial condition. For a description of these risks, see “Item 1A. Risk Factors” set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.
Critical Accounting Policies
In response to the SEC’s financial reporting release, FR-60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies, we have selected for disclosure our revenue recognition process and our accounting processes involving significant judgments, estimates and assumptions. These processes affect our reported revenues and current assets and are therefore critical in assessing our financial and operating status. We regularly evaluate these processes in preparing our financial statements. The processes for determining the allowance for collection of trade receivables, the reserves for excess or obsolete inventory, and software cost and income taxes involve certain assumptions and estimates that we believe to be reasonable under present facts and circumstances. These estimates and assumptions, if incorrect, could adversely impact our operations and financial position. Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 includes a detailed discussion of these critical accounting policies.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We may be subject to the risk of fluctuating interest rates in the ordinary course of business for borrowings under our revolving credit facility, which bears interest at a variable rate based on the prime rate, in effect from time to time, plus 50 basis points. As of September 30, 2010, borrowings outstanding under the facility totaled $2.0 million.
ITEM 4T. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer (who serves as our principal financial and accounting officer) have evaluated the effectiveness of our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of September 30, 2010. Based on this evaluation, they have concluded that our disclosure controls and procedures were effective as of September 30, 2010.
Changes in Internal Control over Financial Reporting
During the third quarter ended September 30, 2010, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Securities Exchange Act Rules 13a-15 or 15d-15 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Reference is made to Note 9 of the Company’s Condensed Consolidated Financial Statements included elsewhere in this report for the information required by this Item.
ITEM 6. EXHIBITS
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Certification Pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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Certification Pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished pursuant to Item 601(b)(32) of Regulation S-K).
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Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished pursuant to Item 601(b)(32) of Regulation S-K).
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SIGNATURES
Pursuant to the requirements of Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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RELM WIRELESS CORPORATION
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(The “Registrant”)
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Date: November 10, 2010
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By: |
/s/ David P. Storey
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David P. Storey
President and Chief Executive Officer
(Principal executive officer and duly authorized officer)
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Date: November 10, 2010
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By: |
/s/ William P. Kelly
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William P. Kelly
Executive Vice President and
Chief Financial Officer
(Principal financial and accounting
officer and duly authorized officer)
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Exhibit Index
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Exhibit Number
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Description
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Certification Pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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Certification Pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished pursuant to Item 601(b)(32) of Regulation S-K).
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Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished pursuant to Item 601(b)(32) of Regulation S-K).
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20