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RELM WIRELESS CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) 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, 2013 and in our subsequent filings with the Securities and Exchange Commission, and include, among others, the following: ? changes or advances in technology; ? the success of our LMR product line; ? competition in the land mobile radio industry; ? general economic and business conditions, including federal, state and local government budget deficits and spending limitations; ? the availability, terms and deployment of capital; ? reliance on contract manufacturers and suppliers; ? heavy reliance on sales to agencies of the United States government; ? our ability to utilize deferred tax assets; ? retention of executive officers and key personnel; ? our ability to manage our growth; ? government regulation; ? our business with manufacturers located in other countries; ? our inventory and debt levels; ? protection of our intellectual property rights; ? fluctuation in our operating results; 9-------------------------------------------------------------------------------- ? acts of war or terrorism; ? any infringement claims; ? provisions in our charter documents and under Nevada law that may discourage a potential takeover; ? maintenance of our NYSE MKT listing; and ? the effect on our stock price and ability to raise equity capital of future sales of shares of our common stock. 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 three and six months ended June 30, 2014 improved compared with the same periods last year. Total sales and sales of P25 digital products increased for both periods, while selling, general and administrative expenses as a percentage of sales declined. These factors combined to yield an increase in operating income compared with the same periods last year. Also, our financial position at the end of the second quarter 2014 improved with an increase in working capital, including growth in cash and trade receivables, and a decrease in inventory, compared with the year ended December 31, 2013 and the immediately preceding quarter ended March 31, 2014. For the three months ended June 30, 2014, total sales increased 46.3% to approximately $9.1 million, compared with approximately $6.2 million for the same quarter last year. Sales of P25 digital products for the second quarter of 2014 increased 81.5% to approximately $6.6 million (72.6% of total sales) compared with approximately $3.6 million (58.6% of total sales) for the same quarter last year. For the six months ended June 30, 2014, total sales increased 27.3% to approximately $16.9 million, compared with approximately $13.3 million for the same quarter last year. Sales of P25 digital products for the six months ended June 30, 2014 increased 46.2% to approximately $12.3 million (72.8% of total sales) compared with approximately $8.4 million (63.4% of total sales) for the same period last year. Gross margins as a percentage of sales for the second quarter ended June 30, 2014 were approximately 42.8%, compared with 43.9% for the same quarter last year, and compared with 40.2% for the first quarter of 2014. For the six months ended June 30, 2014, gross margins as a percentage of sales were approximately 41.6% compared with 44.9% for the same period last year. The gross margins for the quarter are primarily a reflection of the mix of products sold, competitive pressures and manufacturing overhead absorption. For the three and six months ended June 30, 2014, selling, general and administrative expenses (SG&A) totaled approximately $2.8 million (31.3% of sales) and $5.4 million (31.9% of sales), respectively, compared with approximately $2.3 million (37.8% of sales) and $5.1 million (38.3% of sales), respectively, for the same periods last year. Pretax income for the three and six months ended June 30, 2014 increased to approximately $1.0 million and $1.6 million, respectively, compared with approximately $409,000 and $888,000, respectively, for the same periods last year. For the three and six months ended June 30, 2014, income tax expense totaled approximately $357,000 and $484,000, respectively, compared with $212,000 and $286,000, respectively, for the same periods last year. Our income tax expense is largely non-cash due to deferred tax assets derived primarily from our net operating loss carryforwards. 10-------------------------------------------------------------------------------- Net income for the three and six months ended June 30, 2014 was approximately $672,000 ($0.05 per basic and diluted share) and $1.1 million ($0.08 per basic and diluted share), respectively, compared with $197,000 ($0.01 per basic and diluted share) and $602,000 ($0.04 per basic and diluted share), respectively for the same periods last year. As of June 30, 2014, working capital totaled approximately $27.3 million, of which approximately $15.4 million was comprised of cash and trade receivables. As of December 31, 2013 working capital totaled approximately $25.7 million, of which approximately $10.8 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 operations expressed as a percentage of sales: Percentage of Sales Percentage of Sales Three Months Ended Six Months Ended June 30, June 30, June 30, June 30, 2014 2013 2014 2013 Sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of products (57.2 ) (56.1 ) (58.4 ) (55.1 ) Gross margin 42.8 43.9 41.6 44.9 Selling, general and administrative expenses (31.3 ) (37.8 ) (31.9 ) (38.2 ) Net interest expense (0.0 ) (0.0 ) (0.0 ) (0.0 ) Other income (expense ) (0.1 ) 0.5 (0.1 ) 0.1 Pretax income 11.4 6.6 9.6 6.8 Income tax expense (3.9 ) (3.4 ) (2.9 ) (2.2 ) Net income 7.5 % 3.2 % 6.7 % 4.6 % Net Sales For the second quarter ended June 30, 2014, net sales increased 46.3% to approximately $9.1 million, compared with approximately $6.2 million for the same quarter last year. Sales of P25 digital products for the quarter increased 81.5% totaling approximately $6.6 million (72.3% of total sales), compared with approximately $3.6 million (58.6% of total sales) for the same quarter last year. For the six months ended June 30, 2014, net sales increased 27.3% to approximately $16.9 million, compared with approximately $13.3 million for the same period last year. Sales of P25 digital products for the six months ended June 30, 2014 increased 46.2% to approximately $12.3 million (72.8% of total sales) compared with approximately $8.4 million (63.4% of total sales) for the same period last year. The comparative growth in both total sales and sales of digital products was driven primarily by previously announced orders from new customers in state, county and municipal public safety agencies combined with orders from longstanding legacy customers. These orders were for P25 digital products, a substantial portion of which is comprised of our newer KNG models, but also our legacy D-series products. Cost of Products and Gross Profit Margin Gross profit margin as a percentage of sales for the second quarter ended June 30, 2014 was 42.8% compared with 43.9% for the same quarter last year and 40.2% for the preceding quarter. For the six months ended June 30, 2014, gross profit margin as a percentage of sales was 41.6% compared with 44.9% for the same period last year. 11 -------------------------------------------------------------------------------- Our cost of products and gross profit margin are primarily related to material and labor costs, product mix, manufacturing volumes and pricing. The cost of products and corresponding gross profit margin for the first half of 2014, particularly during the first quarter, reflected some competitive pressures and a less favorable mix of product sales. Also, manufacturing volumes were impacted as a result of inventory reduction initiatives. Accordingly, we did not optimize the utilization and absorption of our manufacturing and support expenses. These factors abated somewhat during the second quarter, as gross profit margin improved 2.6% from the first quarter. During the first quarter 2014 we disposed of obsolete inventory that had been fully reserved previously. There was no material impact on our balance sheet or statement of operations as a result of this transaction. 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 costs. We anticipate that our current contract manufacturing relationships or comparable alternatives will be available to us in the future. We believe leveraging increased sales volumes and P-25 product sales, combined with the aforementioned manufacturing improvements, should yield gross margin improvements. 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 second quarter 2014 were approximately $2.8 million (31.3% of sales), compared with $2.3 million (37.8% of sales) for the same quarter last year. For the six months ended June 30, 2014, SG&A expenses totaled approximately $5.4 million (31.9% of sales) compared with approximately $5.1 million (38.3% of sales) for the same period last year. Engineering and product development expenses for the second quarter 2014 totaled approximately $902,000 (10.0% of total sales), compared with $918,000 (14.8% of total sales) for the same quarter last year. For the six months ended June 30, 2014, engineering and product development expenses totaled approximately $1.8 million (10.6% of total sales) compared with $1.8 million (13.8% of total sales) for the same period last year. The decreases are attributed primarily to the amortization of capitalized software, as one project was fully amortized. Marketing and selling expenses for the second quarter 2014 totaled approximately $1.1 million (11.8% of total sales), compared with $732,000 (11.8% of total sales) for the same quarter last year. For the six months ended June 30, 2014, sales and marketing expenses totaled approximately $2.0 million (11.6% of total sales), compared with approximately $1.8 million (13.5% of total sales) for the same period last year. The increase for the second quarter and six month periods relates primarily to commissions and incentives, which directly correlate with the increase in sales. General and administrative expenses for the second quarter 2014 totaled approximately $839,000 (9.3% of total sales), compared with approximately $688,000 (11.1% of total sales) for the same quarter last year. For the six months ended June 30, 2014, general and administrative expenses totaled approximately $1.6 million (9.6% of total sales), compared with $1.5 million (11.1% of total sales) for the same period last year. The increases were attributed primarily to compensation and public company related expenses. Operating Income Operating income for the quarter ended June 30, 2014 totaled approximately $1.0 million (11.5% of sales), compared with approximately $378,000 (6.1% of sales) for the same quarter last year. For the six months ended June 30, 2014, operating income totaled approximately $1.6 million (9.7% of sales), compared with $877,000 (6.6% of sales) for the same period last year. The improvement in operating income was primarily the result of increased total sales, and sales of P25 digital products. 12--------------------------------------------------------------------------------Net Interest Expense We incurred no net interest expense for the second quarter or six months ended June 30, 2014, or for the comparable prior year periods. Interest expense may be incurred from time to time 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 June 30, 2014 was 4.00% per annum. This rate is variable based on the lender's prime rate and our adjusted quick ratio. Income Taxes We recorded income tax expense of approximately $357,000 and $484,000, respectively for the quarter and six months ended June 30, 2014, compared with $212,000 and $286,000, respectively for the same periods last year. Our income tax expense and benefit are primarily non-cash. As of June 30, 2014, our deferred tax assets totaled approximately $6.4 million, and are primarily composed of net operating loss carry forwards (NOLs). These NOLs total $5.9 million for federal and $14.2 million for state purposes, with expirations starting in 2018 through 2030. In order to fully utilize 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 and 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, it is more likely than not that we will realize the benefit of our net deferred tax assets recorded at June 30, 2014. 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 additional valuation allowance related to the deferred tax assets recognized as of June 30, 2014. Liquidity and Capital Resources For the first six months ended June 30, 2014, net cash provided by operating activities totaled approximately $1.4 million, compared with cash used in operating activities totaling approximately $434,000 for the same period last year. Cash provided by operating activities was primarily related to net income and decreases in net inventory. For the six months ended June 30, 2014, we realized net income of approximately $1.1 million, compared with approximately $602,000 for the same period last year. Net inventories decreased during the six months ended June 30, 2014 by approximately $1.3 million as a result of inventory reduction initiatives. Accounts receivable increased approximately $3.4 million during the six months ended June 30, 2014, reflecting sales that were consummated later in the quarter that have not yet completed their collection cycle. For the same period last year, accounts receivable increased approximately $1.5 million. Accounts payable for the six months ended June 30, 2014 increased approximately $762,000 in anticipation of increasing business volumes and related material purchases. For the same period last year trade payables decreased by approximately $194,000. Depreciation and amortization totaled approximately $615,000 for the six months ended June 30, 2014, compared with approximately $740,000 for the same period last year, as some capitalized software was fully amortized. 13-------------------------------------------------------------------------------- Cash used in investing activities for the six months ended June 30, 2014 totaled approximately $328,000 compared with approximately $377,000 for the same quarter last year. Cash used in investing activities for the six months ended June 30, 2014 was primarily for test equipment related to manufacturing and engineering, and to upgrade our company-wide enterprise system. For the same period last year, cash used in investing activities was primarily for the development of software, which was capitalized. We anticipate that future capital expenditures will be funded through our existing cash balance and operating cash flow. Cash provided by financing activities for the six months ended June 30, 2014 totaled approximately $126,000, representing proceeds from the issuance of common stock upon the exercise of stock options. We have a secured revolving credit facility with Silicon Valley Bank with maximum borrowing availability of $5 million (subject to the borrowing base) and a maturity date of December 31, 2014. As of June 30, 2014 and the date of this report, we were in compliance with all covenants under the loan and security agreement, as amended, governing the revolving credit facility. For a description of such covenants and the other terms and conditions of the loan and security agreement, as amended, reference is made to Note 6 (Debt) of our Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. As of June 30, 2014 and the date of this report, there were no borrowings outstanding under the revolving credit facility. As of June 30, 2014 and the date of this report, there was approximately $5,000 million and $2,751 million, respectively, of borrowing available under the revolving credit facility. Our cash balance at June 30, 2014 was approximately $9.2 million. We believe these funds combined with anticipated cash generated from operations and borrowing availability under our revolving credit facility are sufficient to meet our working capital requirements for the foreseeable future. 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, 2013. 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 revenue recognition, allowance for collection of trade receivables, reserves for excess or obsolete inventory, software development 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. There were no changes to our critical accounting policies during the quarter ended June 30, 2014 as described in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. |