ITEM 1A - RISK FACTORS
RISKS RELATING TO OUR BUSINESS
Our business faces many risks. The risks described below may not be the only risks we face. Additional risks that we do not yet know of, or that we currently think are immaterial, may also impair our business operations or financial results. If any of the events or circumstances described in the following risks actually occur, our business, financial condition or results of operations could suffer and the trading price of our equity securities could decline. Our shareholders should consider the following risks and the information contained under the heading “Warning Regarding Forward-Looking Statements” in Item 7 before deciding to invest in our securities.
Our business and results of operations are substantially dependent on new vehicle sales levels in the United States and the sales of LoJack products in our particular geographic markets.
Our business depends on the automotive industry for new vehicle sales in the United States and sales of LoJack products in our particular geographic markets. For instance, a great majority of our domestic gross unit sales for the year ended December 31, 2014 were made through a distribution network consisting of automobile dealers that offer LoJack Units as an option on both their new and used automobiles. Sales levels in the automotive industry may be impacted by, among other things:
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Changing economic conditions, such as the unfavorable economic conditions which have affected the United States recently, including low economic growth, high unemployment, and the decline in wealth resulting from depressed housing and equity markets;
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Concerns over sovereign debt levels in the United States and/or Europe, and the possible negative implications to banks and the global economy arising out of the European debt crisis, which could have an adverse effect on the U.S. economy, credit availability, consumer confidence and the demand for new and used vehicles;
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Changes in interest rates or in the availability of financing for vehicles and accessories, which can significantly impact new vehicle sales due to the direct relationship between interest rates and monthly loan payments and the impact on customers' borrowing capacity and disposable income; and
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Consumer spending in the automotive industry, as such spending is often discretionary and may decline during economic downturns when consumers have less disposable income.
We believe that these factors, among others such as fuel prices, manufacturer incentives (and consumers' reactions to such offers), inventory availability, product quality and affordability and innovation, could affect vehicle sales levels and sales of LoJack products. Our product sales may differ from overall automotive industry sales due to particular economic conditions and other factors in the geographic markets in which we operate. A decline in the automotive industry or in new or used vehicle sales in our markets could have a material adverse effect on our business, financial condition and results of operations.
Any negative impact on the sales, licensing and marketing efforts of our principal products could adversely affect our business, financial condition and results of operations.
Our business depends primarily on the sale, licensing and market acceptance of our principal product, the LoJack System and related products and services, in the United States, Canada and 30 foreign countries. Because our revenue is dependent on the success of our principal products, any factor affecting their marketability could have a material adverse effect on our business, financial condition and results of operations. Factors that could harm the successful sale and licensing of our products include, among others:
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If automobile dealers with whom we have relationships stop selling or emphasizing our products in connection with their vehicle sales;
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If we become over-weighted in low growth vehicle brands or models and/or under-weighted in high growth vehicle brands or models;
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If law enforcement agencies that currently utilize our LoJack System in the United States do not renew our service contracts or if such law enforcement agencies grant service contracts to our competitors;
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If we are unable to maintain the FCC frequency used for operation of the LoJack System;
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If we are unable to fully develop and sustain a market for our products and services in Italy;
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If we are unable to maintain or increase acceptance in the consumer market for our LoJack products and services;
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If our foreign licensees are unable to establish or maintain a market for our products in their jurisdictions;
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If we are unable to develop enhancements to our products as required by market demand;
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If we are unable to protect our proprietary rights;
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If one or more of our competitors introduces a product or system that renders our products obsolete or less competitive;
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If third parties are able to locate or impair the function of LoJack Units or Boomerang Units in vehicles or impair the functioning of the LoJack or Boomerang Systems, potentially adversely affecting our recovery rates; or
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If vehicle manufacturers adopt practices, implement new technologies or create systems which adversely affect the efficacy of or the need for the LoJack System.
Our inability to maintain and grow sales from our pre-install program could adversely affect our business, financial condition and results of operations.
We achieved a significant portion of our domestic sales in 2014 through our pre-install program with certain automobile dealerships. Pre-install sales accounted for 56% of our unit sales in the domestic dealer channel for the year ended December 31, 2014. This program provides for LoJack Units to be installed on automobiles in a dealer’s inventory in advance of the sale or lease of such automobiles to customers. The dealer makes a profit upon the sale of the LoJack Unit through to the customer at the time of sale or lease of the pre-loaded vehicle. Decreased vehicle margins resulting from price transparency and increased brand competition have put pressure on dealerships to increase profit contributions in other areas of the dealership, including after-market products such as the LoJack System. These factors have contributed to increased dealer receptivity to our pre-install program and increased volumes within selling dealers during 2013 and 2014. Negative changes in the automotive industry or the market for after-market products could result in an unwillingness of dealers to participate in our pre-install program because of the increased financial exposure that they may face from LoJack Units not being sold through to customers. In addition, dealers may decide not to participate in our pre-install program if we are unable to successfully execute and support all phases of the program, including installation of the LoJack Units and training of dealer employees. A decrease in sales through our pre-install program could have a material adverse effect on our business, financial condition and results of operations.
Unfavorable results of pending legal proceedings could materially adversely affect us.
We are subject to various legal proceedings and claims that have arisen which are not yet resolved and additional claims may arise in the future. Some of these matters are described in greater detail in “Item 3 - Legal Proceedings” below. Regardless of merit, litigation may be both time-consuming and disruptive to our operations and cause significant expense and diversion of management attention. Should we fail to prevail in certain matters, we may be faced with significant monetary damages or injunctive relief that could materially adversely affect our business, financial condition and results of operations. Moreover, we have filed, and may in the future file, legal proceedings against third parties or make counterclaims against third parties in proceedings that they initiate. There can be no assurance that we will prevail in such efforts, either on the merits or with respect to particular relief sought, nor any assurance that any awarded damages ultimately will be paid to us.
We face significant competition from OEMs and makers of location based services and automobile products to be sold by automobile dealers.
We compete with other makers of stolen vehicle recovery devices, but more significantly, we also face competition from all products which are sold by automobile dealers in the after-market space, including vehicle security devices, GPS products and navigation systems. Such products compete with us for consumer funds in the automobile products after-market. We also face competition from OEMs, including divisions of well-known automobile manufacturers, who have diversified their product offerings and place increased sales pressure on dealers to purchase OEM-supplied or approved equipment and products. Our ability to adequately respond to changes in the automotive market and to compete effectively is key to our success, and there can be no assurance that we will be able to respond successfully to market changes in the future.
Our growth depends in part on the development, production and market acceptance of new products and sales channels which we cannot assure will happen successfully.
To maintain competitiveness in our industry, we must support and enhance our existing products and develop new products in response to market demands. Product development involves a high degree of risk and uncertainty due to unforeseen difficulties and costs. We may not be successful in developing, marketing and releasing new products that we believe are necessary to respond to technological developments, evolving industry standards, increasing sophistication and complexities in vehicles or changing customer preferences. In addition, our new product enhancements may not adequately meet the requirements of the marketplace and may not achieve the broad market acceptance necessary to generate significant revenue. If the release date of any future products or enhancements is delayed, or if these products or enhancements fail to achieve market acceptance when released, we may not be able to recover our research and development costs and our competitive position in the marketplace may be harmed.
If we are unable to maintain our brand and product quality, it may damage our reputation which could have a material adverse effect on our business, financial condition and results of operations.
We have established a strong reputation for the quality and effectiveness of our products in the tracking and recovery of stolen mobile assets. Our continued success depends on our ability to market our products and develop sales techniques tailored
to the needs of our customers, maintain our brand image for our existing products and effectively establish brand image for new products and brand extensions. Brand value is largely based on consumer perceptions. Even isolated business incidents that erode consumer trust can significantly reduce brand value. Product quality issues could tarnish the image of the LoJack brand and may reduce demand for our products and cause consumers to choose other products. Poor product quality, poor installation practices, or low recovery rates could affect our profitability and could negatively affect brand image and our reputation. Damage to our reputation or loss of consumer confidence in our products for any of these reasons could have a material adverse effect on our business, financial condition and results of operations, as well as require additional resources to rebuild our reputation.
We are dependent upon the success and continued relationships with the large regional or national dealer groups in the United States which currently sell our products.
Our revenue in the United States is derived primarily from the sale of LoJack Units, LoJack Early Warning Units and related products and extended product and recovery warranties to automobile dealers and retailers who resell the units to consumers. In 2014, approximately 86% of our revenue in the United States originated through this distribution network of automobile dealers which is geographically diverse, but which includes several large national dealer groups. Our business could be materially adversely impacted by the loss of business with any of the large regional or national dealer groups with whom we conduct business. To the extent that these dealer groups are affiliated with certain automobile brands, our business could also be adversely impacted by a decline in consumer demand for these brands.
We are subject to financial and reputational risks due to product quality and liability issues.
We rely on third-party manufacturers of our LoJack Units and critical components of LoJack Units. Product quality and liability issues present significant risks. Our efforts and the efforts of our third party suppliers to maintain product quality may not be successful. From time to time, we receive reports from our customers, licensees or partners regarding potential quality issues with respect to our products or components of our products. As previously reported, we have confirmed that certain batteries manufactured by our former battery manufacturer that were included in certain self-powered LoJack Units sold in the United States and to our international licensees are exhibiting variability in performance that could impact the ability of the LoJack Unit to transmit a signal when called upon for stolen vehicle recovery. As a result of this battery evaluation, we have incurred, and expect to continue to incur, significant costs and expenses, including, but not limited to, costs related to a quality assurance notification program in the United States for vehicle customers currently under warranty, quality assurance programs in other countries and markets, and other business concessions. Costs and expenses related to the battery evaluation or other potential quality issues also may include, among other things, those related to quality assurance programs, product or battery replacements, warranty claims, extension of product warranties, payments or other concessions to our B2B customers, legal or other professional fees, litigation, and harm to our brand image and reputation, any of which could have a material adverse effect on our business, financial condition and results of operations. A product quality issue also could generate substantial negative publicity about our products and business, result in lower recovery rates for stolen vehicles, and/or interfere with our manufacturing plans and product delivery obligations as we seek to replace or repair affected products. Although we may have product liability insurance with respect to certain of our products, a number of criteria need to be met in order for our coverage to apply. If we do not have insurance sufficient to cover the costs associated with a product quality issue, the expenses we would incur in connection with a product quality issue could have a material adverse effect on our business, financial condition and results of operations.
We depend on a limited number of third parties to manufacture and supply quality infrastructure components for our principal products. If our suppliers cannot provide the components or services we require and in such quality as we expect, our ability to market and sell our products could be harmed.
We rely on third-party manufacturers of our LoJack Units, a critical component of our LoJack System. If our suppliers fail to supply these components in a timely manner that meets our quantity, quality, cost requirements, or technical specifications, we may not be able to access alternative sources of these components within a reasonable period of time or at commercially reasonable rates. Our manufacturers are located outside the United States and their facilities are geographically concentrated in a specific region. We outsource much of the transportation and logistics management and while these arrangements may lower operating costs, they reduce our direct control over production and distribution. Such diminished control may reduce our flexibility and ability to quickly respond to changing conditions. A reduction or interruption in the supply of LoJack Units, or a significant increase in the price of these units, could have a material adverse effect on our marketing and sales initiatives, which could adversely affect our financial results domestically and internationally. Our agreements with our manufacturers include warranties and quality control measures, but any unanticipated product defect or warranty liability, whether pursuant to arrangements with contract manufacturers or otherwise, could have a material adverse effect on our reputation, financial condition and operating results.
Moreover, we may introduce new component suppliers from time to time, including battery manufacturers. Any disruption in the production of batteries or other components for LoJack Units, failure of any batteries or other components to meet our specifications or other issues in the introduction of a new supplier could cause us to incur material cost increases or create supply disruptions to our customers, which could have a material adverse effect on sales of LoJack Units and our results of operations.
We may be unable to obtain financing on acceptable terms or at all, which would have a material adverse effect on our business, financial condition and results of operations.
We may require additional financing to make future investments in new technologies, products, or international markets, to acquire complementary businesses, or to provide additional working capital. In the future, we may decide to raise additional funds through public or private debt or equity financings to fund our activities. If we issue additional equity securities, shareholder value will be diluted and the new equity securities may have rights, preferences or privileges senior to those of our common stock. In addition, if we raise funds through debt financings, we will have to pay interest and may be subject to restrictive and other covenants, which could negatively impact our business. If we cannot raise funds on acceptable terms, if and when needed, we may not be able to make strategic investments, develop or enhance our products, take advantage of acquisition and other opportunities, respond to competitive challenges or unanticipated industry changes, or fund our anticipated working capital needs, any of which could have a material adverse effect on our business, financial condition and results of operations.
In March 2015, we entered into a commitment letter with our lenders with respect to an amendment to our existing credit facility which will provide for, among other things, a reduction in our total facility commitment and other restrictions on our future borrowing, including a borrowing base calculated as a percentage of our domestic accounts receivable. The amendment also will require us to maintain a minimum cash balance in the U.S. of $2,000,000 at all times as well as maintain certain financial performance measures. These limitations on our borrowing could result in inadequate funds to make anticipated investments in our business, which would negatively impact our results of operations. Furthermore, if we do not generate sufficient earnings and cash flow from operations, we may fail to comply with our loan covenants and such failure could result in an event of default that, if not cured or waived, could adversely impact our financial condition. In this regard, we failed to satisfy certain of our existing financial covenants in our credit facility for the fiscal year ended December 31, 2014, which our lenders have agreed to waive as part of the amendment to our credit facility. Closing on the amendment to our credit facility and related waivers are subject to certain conditions, including, but not limited to, the completion of definitive documentation and no material adverse changes in our business. If we fail to complete the amendment to our credit facility as anticipated, we may be required to repay, refinance or otherwise restructure our debt, which could have a material adverse effect on our business, financial condition and results of operations.
The steps we have taken and may take in the future to reduce our cost structure may be insufficient to result in consistent profitability.
During 2014, we implemented programs to operate more efficiently and better align our cost structure with our plans for future growth, including the elimination or alignment of positions within our company and a plan to consolidate our Canadian operations to reduce costs and more closely align this business with our U.S. operations. Risks associated with these actions include incurrence of restructuring charges, additional unexpected costs, adverse effects on employee morale and the failure to meet operational targets due to the loss of employees, any of which may impair our ability to achieve anticipated cost reductions or may otherwise harm our business. Because of these and other factors, we cannot predict whether we will realize the purpose and anticipated benefits of our restructuring measures, and if we do not, our business, financial condition and results of operations may be adversely affected. Moreover, the steps we have taken and may take in the future may not reduce our cost structure to a level appropriate in relation to our future sales and, therefore, these anticipated cost reductions may be insufficient to result in consistent profitability.
We may not be able to maintain or improve our historical gross margin levels.
During 2014, our gross margin decreased compared to 2013 primarily due to costs related to our restructuring activities and our quality assurance notification program. Price concessions to our international licensees relating to the battery evaluation may result in future margin erosion with respect to sales to those licensees. In addition, our gross margin is impacted by changes in product mix, customer mix and geographic location of sales. In particular, our margin tends to be lower with respect to sales through our pre-install program, and we may experience lower margins with respect to sales of our telematics products and services as we grow this portion of our business. While we have taken steps to try to mitigate margin erosion, there is no assurance that we will be successful. Any failure to maintain or improve our gross margins will adversely affect our financial results.
If we are unable to hire or retain key employees, it could have a negative impact on our business.
Our success as a company depends substantially on the contributions and abilities of our executive officers. We must continue to recruit, retain and motivate management and other employees sufficient to maintain our current business and support our strategic initiatives. Our operating results could be adversely affected by increased costs due to greater competition for employees, higher employee turnover or increased employee benefit costs. Any unplanned turnover could diminish our institutional knowledge base and erode our competitive advantage.
Failure to procure and maintain contracts with local law enforcement agencies would materially adversely affect the marketability of the LoJack System and would inhibit sales in the United States and Italy.
In the United States and Italy, the LoJack System is designed to be integrated into existing law enforcement computer systems and telecommunication systems and procedures. A LoJack Unit will not be effective if the vehicle in which it is installed is located outside a covered jurisdiction where we have procured an agreement with local law enforcement agencies. We have agreements covering 29 states and the District of Columbia in the United States and certain geographical areas of Italy. These agreements are generally for terms of up to five years. Renewal or extension of any of these agreements, either formally or informally, may be subject to competitive bidding. We cannot guarantee that we will be able to renew or extend our existing agreements with local law enforcement agencies or obtain agreements in new target jurisdictions in the future. Our competitors may seek agreements with local law enforcement agencies and if they obtain such agreements, we may be adversely affected. Furthermore, if we are unable to procure and maintain contracts with local law enforcement agencies in our existing and target markets, our financial results will be materially and adversely affected.
Regulations applicable to the sale of extended warranty products could materially impact our business and results of operations.
We offer warranty products that may be purchased as a supplement to the original purchaser’s warranty. These products are sold primarily through the Financing and Insurance, or F&I, departments of automobile dealers and are subject to complex federal and state laws and regulations. There can be no assurance that regulatory authorities in the jurisdictions in which these products are offered will not seek to regulate or restrict these products. Failure to comply with applicable laws and regulations could result in fines or other penalties including orders by state regulators to discontinue sales of the warranty products in one or more jurisdictions. Such a result could materially and adversely affect our business, results of operations and financial condition.
We currently transfer the majority of the administration and liability obligations associated with these warranty products to a third party upon purchase by the consumer. State laws and regulations, however, may limit or condition our ability to transfer these administration and liability obligations to third parties, which could in turn impact the way revenue is recognized from these products. Failure to comply with these laws could result in fines or other penalties, including orders by state regulators to discontinue sales of these product offerings as currently structured. Such a result could materially and adversely affect our business, financial condition and results of operations.
Regulations that restrict the importation of our products in certain countries could materially impact our business and results of operations.
We face uncertainty regarding developing governmental regulations in Argentina that may affect sales to our licensee in that country. In February 2012, Argentine authorities began requiring all importers to request and receive approval from the Argentine Tax and Customs Authority prior to each import transaction. As a result, during the remainder of 2012 and early 2013, we did not ship any units to Argentina. Our Argentine licensee informed us that it and its affiliates had developed several commodity export programs with the expectation that our licensee would be permitted to import a dollar amount of goods approximately equivalent to the dollar amount of exports our licensee and its affiliates generate. Subsequently, we were able to make several shipments of product to our licensee in Argentina in 2013 and 2014. However, the amount of these shipments was less than the dollar amount that our licensee told us it had generated to date in exports. Future sales to our Argentine licensee will remain contingent upon the ability of our licensee to comply with government trade policies regulating the importation of manufactured goods. If our Argentine licensee and its affiliates are unable to generate significant exports or if the government changes its policies, we may not be able to ship products to Argentina at all or in volumes consistent with prior years. Any regulations in Argentina or other countries in which our licensees are located that prevent or limit our ability to sell products to our licensees in those countries could have a material adverse effect on our business, financial condition and results of operations.
Economic, political and other risks associated with the operations in our International Segment could adversely affect our revenue and earnings.
Our revenue and profit growth is partially dependent on the continuation of our license agreements with our international licensees and the success of their operations. Changes to our licensees’ existing management teams, or failure of our licensees to meet their working capital needs or execute fully on their existing business plans, could negatively impact: (1) the value of our equity investments; (2) the collectability of our receivables; and (3) our target revenue and profits from our International segment; and could also delay or preclude altogether our ability to generate revenue in key international markets. Moreover, our licensees’ operations and our own international operations expose us to risks inherent in doing business outside of the United States including:
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Potentially weak protection of intellectual property rights;
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Economic and geo-political instability and fluctuations;
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Import or export licensing requirements;
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Trade or currency restrictions;
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Business models that are more heavily weighted towards periodic payments rather than receiving full payment upon sale of the product;
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Changes in regulatory requirements, tariffs or government mandates;
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Seasonal reductions in business activities in some parts of the world, such as during the summer months in Europe;
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In-country pricing which may be adversely impacted by fluctuations in exchange rates;
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Potentially adverse tax consequences;
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Limited access to capital to invest in infrastructure, hire and train employees; and
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Uncertainties related to product acceptance.
In addition, we have entered into long-term and evergreen agreements with several of our international licensees. The extended term of these agreements could affect our ability to negotiate changes or amendments to our relationships with these licensees should market conditions so warrant or business concerns arise. Furthermore, some of our international licensees represent our interests in several international jurisdictions. Difficulties or disputes with our licensees concerning a particular international jurisdiction could impact our ability to do business successfully in other jurisdictions in which those licensees represent our interests.
Any of these factors could harm the operations of our licensees and, consequently, adversely affect our business, financial condition and results of operations.
We may be unable to re-enter the Brazilian market in a timely manner or on favorable terms.
In January 2015, as part of a legal settlement with Tracker do Brasil LTDA (“Tracker”), we terminated Tracker as our exclusive licensee in the country of Brazil. As of the date of this Annual Report on Form 10-K, we are working on a plan for re-entering the Brazilian market. We may face challenges in identifying suitable licensees for our technology in Brazil or otherwise in re-entering the Brazilian market due to legal and regulatory requirements, the development of required hardware or infrastructure, competition from established providers of stolen vehicle recovery products in Brazil, and/or continued acceptance of our products and services. No assurances can be given that we will be able to re-enter the Brazilian market in a timely manner or on terms favorable to us, or that we will be able to realize the expected benefits of terminating our relationship with Tracker in Brazil.
If we fail to protect and enforce our intellectual property rights, our competitiveness could be impeded and our business and operating results could be harmed.
We seek to protect our intellectual property rights through patents, trademarks, copyrights, trade secret laws, confidentiality agreements and licensing arrangements, but we may not be able to adequately protect our technology from misappropriation or infringement. We cannot ensure that our existing intellectual property rights will not be invalidated, circumvented, challenged or rendered unenforceable. In addition, the laws of some countries in which we offer or plan to offer our products through our international licensees may not protect our intellectual property rights to the same extent as the laws of the United States and/or Canada, increasing the possibility of piracy of our technology which could adversely affect our business and operating results.
We may litigate to enforce our intellectual property rights and to protect our trade secrets. Such litigation can be time consuming and expensive, with outcomes often difficult to predict. Our failure to successfully protect or enforce our intellectual property rights could have an adverse effect on our business, financial condition and results of operations.
If a court determines that our technology infringes on third parties’ intellectual property, we will likely face significant costs and we may lose our rights to the technology, which would harm our business.
We may inadvertently violate the intellectual property rights of other parties and those third parties may choose to assert infringement claims against us. If we are unsuccessful in any litigation based on a claim of infringement, in addition to exposure to substantial monetary damages, we could be required to expend considerable resources to modify our products, to develop non-infringing technology or to obtain licenses to permit our continued use of the technology that is the subject matter of the litigation. If we are unsuccessful in these endeavors, we may be enjoined from using the technology subject to the infringement claim which could cause us to incur substantial liabilities and could adversely affect our business, financial condition and results of operations, perhaps significantly.
Our failure to successfully integrate businesses that we may acquire could disrupt our business and negatively impact our future financial condition and operating results.
We may make strategic acquisitions of complementary companies, products or technologies, and such acquisitions could disrupt our business, divert our management’s attention from our core business objectives or involve unforeseen difficulties and costs. We may not be able to successfully integrate the business, technology or personnel that we have acquired or those we might acquire in the future in a timely manner, or at all, and this could harm our business, financial condition and results of operations. Any of these risks could negatively impact our ability to fully realize the expected benefits of our acquisitions. Moreover, we may be unable to find attractive acquisition opportunities or may lose these opportunities to competitors, some of whom may have greater resources than we do.
Expansion into the telematics business could subject us to increased costs and risks and may not achieve the intended results.
We have invested, and in the future intend to invest, in the telematics business, including through our alliances with TomTom and Trackunit A/S. There can be no assurance that these investments will be successful or profitable and will not negatively impact our business, results of operations and financial condition. Expanding our business activities into telematics for fleet management and the tracking of commercial equipment could subject us to various risks that differ from the ones we have faced in the past, including:
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Distraction of management and other personnel from our stolen vehicle recovery business;
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Inexperience in the telematics market and with a software-as-a-service, or SaaS, business model;
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Competitive challenges in the telematics market, which is highly fragmented and rapidly changing and has low barriers to entry;
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Failure of small and medium-sized businesses, commercial fleets, automotive dealerships and/or law enforcement agencies to adopt fleet management solutions;
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Difficulties in selling fleet management solutions to small and medium-sized businesses, which generally have limited budgets and are price sensitive and difficult to reach with targeted sales campaigns;
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Challenges in retaining customers, including as a result of high failure rates among small and medium-sized businesses and ease in switching among solutions;
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Failure of original equipment manufacturers, rental firms, construction contractors and similar users of commercial equipment to adopt telematics solutions;
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Inability to meet minimum service level commitments to customers;
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Failure to attract and retain highly qualified sales personnel for these products and services;
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Disruption, failure or increase in the costs associated with the use of GPS networks;
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Failure of the solutions we offer to keep pace with technological developments and other changes in the telematics industry; and
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Evolving regulation and changes in applicable laws relating to data privacy that may apply to the collection, management or storage of data.
If we do not successfully manage our strategic alliance with TomTom and other strategic relationships, we may not realize the expected benefits from such relationships and we may experience delays in product development.
In 2013, we entered into a strategic alliance with TomTom, through which we have begun to offer fleet telematics solutions to small and medium-sized businesses, commercial fleets, automotive dealerships and law enforcement agencies. In 2014, we entered into a strategic alliance with Trackunit A/S with respect to tracking solutions for commercial equipment. There can be no assurance that we will realize the expected benefits from these strategic alliances or other strategic relationships that we may enter into in the future. Management of such relationships may adversely affect or disrupt our core business, decrease our profitability, cause us to incur significant expenses, or divert management resources that otherwise would be available for other initiatives. In addition, parties to such arrangements may fail to fully perform their obligations or meet our expectations or cooperate with us satisfactorily for various reasons, and there may be conflicts or other collaboration failures and inefficiencies between us and the other parties. If we encounter difficulties in integrating the other party’s technology with our technology or these relationships otherwise fail to materialize as expected, we could suffer delays in product development or other operational difficulties.
Moreover, we cannot assure you that we will be able to maintain our relationships with TomTom and Trackunit or to develop additional strategic relationships with other parties. In particular, our agreement with TomTom has an initial term of 36 months, and either party may terminate the agreement for breach or if the other party ceases to carry on its business or similar events. TomTom also may terminate the agreement if a competitor of TomTom acquires greater than fifty percent of our capital stock or we fail to meet certain minimum sales levels. If this agreement were to be terminated, we would lose our right to offer fleet management solutions utilizing TomTom’s technology, which could have a material adverse effect on our future business and results of operations.
Our failure to successfully execute on our ongoing investments could disrupt our business and negatively impact our future financial condition and operating results.
In 2012, we began the process of implementing an enterprise resource planning system. Since 2012, we have invested approximately $10,589,000 in this initiative and expect that additional financial resources and senior management focus will be required during the first half of 2015. There can be no assurance that this investment, or any similar investment in our systems, will enable us to simplify our business processes and automate many of our existing processes significantly enough to provide an acceptable return on the investment.
A failure of our information systems or any security breach or unauthorized disclosure of confidential information could have a material adverse effect on our business.
Our business is dependent upon the efficient operation of our information systems. In particular, we rely on our information systems to effectively manage our pricing strategy and tools, sales, inventory, and installation efforts, the preparation of our consolidated financial and operating data, and customer information. The failure of our information systems to perform as designed or the failure to maintain and enhance or protect the integrity of these systems could disrupt our business operations, impact sales and results of operations, expose us to customer or third-party claims, or result in adverse publicity. We have substantially completed the process of upgrading our enterprise resource planning system, and any problems associated with the implementation of our new platform or the failure to complete such implementation on a timely basis could adversely affect our business and results of operations.
Additionally, we collect, process, and retain sensitive and confidential customer information in the normal course of our business. Despite the security measures we have in place and any additional measures we may implement in the future, our facilities and systems, and those of our third-party service providers, could be vulnerable to security breaches, computer viruses, lost or misplaced data, programming errors, human errors, acts of vandalism, or other events. Any security breach or event resulting in the misappropriation, loss, or other unauthorized disclosure of confidential information, whether by us directly or our third-party service providers, could damage our reputation, expose us to the risks of litigation and liability, disrupt our business, or otherwise affect our results of operations.
RISKS RELATING TO OUR COMMON STOCK
There are risks inherent in owning our common stock.
The market price and volume of our common stock have been, and may continue to be, subject to significant fluctuations. These may arise from general stock market conditions, the impact of the risk factors described above on our business, financial condition and results of operations, a change in sentiment in the market regarding us or our business prospects, the general lack of liquidity in the trading market for our common stock, or from other factors.
Sizeable future sales of our common stock may depress the share price for our common stock or prevent or delay our ability to sell equity investments in our Company at competitive rates.
If we or our shareholders sell sizeable amounts of shares of our common stock, including shares issued upon the exercise of options, or if the perception exists that we or our shareholders may sell a substantial number of shares of our common stock, the market price of our common stock may fall. In addition, any substantial sales of these securities in the public market might make it more difficult for us to sell equity or equity related securities in the future at a time and in a place we deem appropriate or necessary for our business objectives.
The foregoing risk factors may be considered forward-looking statements. Except as required by law, we undertake no obligation to release publicly the result of any revision to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
ITEM 1B
ITEM 1B - UNRESOLVED STAFF COMMENTS
None.
ITEM 2
ITEM 2 - PROPERTIES
Our corporate headquarters is located in Canton, Massachusetts, the lease for which expires in December 2025. In addition, we lease facilities for our sales and operations personnel in California and Georgia under operating leases that expire in 2020 and 2018, respectively. SCI operates out of a single facility in Texas, the lease for which expires in 2017.
The Canadian executive office, marketing, sales, customer care and installation activities are currently carried out in a single facility located in leased premises in Montreal, Quebec. The Montreal lease expires in 2017.
We also maintain facilities in Dublin, Ireland and Rome and Milan, Italy for our administrative, sales and operations personnel under leases that expire in 2019, 2015 and 2017, respectively.
We do not own any real estate.
Because our operations do not require any special facilities, we do not anticipate any difficulty in finding space adequate for our purposes at reasonable rates, should the need arise. We believe that our current facilities are adequate for our current operations.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
As of December 31, 2014, we were subject to various legal proceedings and claims discussed below, as well as certain other legal proceedings and claims that have not been fully resolved and that have arisen in the ordinary course of business. During 2014 and subsequent to year-end, we resolved several matters as management continues to focus on trying to eliminate the cost and distraction of legal proceedings. The results of legal proceedings, however, cannot be predicted with certainty. Should we fail to prevail in any of these legal matters, our financial condition and results of operations could be materially adversely affected.
New York Litigation
On October 13, 2010, a suit was filed by G.L.M. Security & Sound, Inc. against LoJack Corporation in United States District Court for the Eastern District of New York, or the New York Court, alleging breach of contract, misrepresentation, and violation of the New York franchise law, violation of Mass. Gen. Laws c. 93A and the Robinson-Patman Act, among other claims. The plaintiff sought damages of $10,000,000, punitive damages, interest and attorney’s fees, and treble damages. The Company filed a motion to dismiss all counts. Thereafter, G.L.M. moved to amend its complaint and to add a claim for breach of fiduciary duty. The Company then filed an opposition to G.L.M.'s motion to amend and sought dismissal of all counts.
On September 30, 2011, the New York Court ruled on the motions referenced above and denied, as futile, the plaintiff's request to amend the complaint with respect to the misrepresentation, New York franchise law, violation of Mass. Gen. Laws c. 93A and breach of fiduciary duty claims. The New York Court granted the plaintiff permission to re-plead the tortious interference with business relations and Robinson-Patman Act claims. The breach of contract and breach of covenant of good faith and fair dealing claims also remained viable.
On October 14, 2011, the plaintiff filed a motion for reconsideration of the dismissal of the violation of Mass. Gen. Laws c. 93A and the violation of the New York franchise law claims. The Company opposed this motion.
On November 21, 2011, the plaintiff filed its First Amended Complaint, alleging breach of contract, breach of the covenant of good faith and fair dealing, tortious interference with business relations, violation of the New York Franchise Act, violation of Mass. Gen. Laws c. 93A and the Robinson-Patman Act, among other claims. On December 5, 2011, the Company moved to strike the First Amended Complaint in its entirety, including those portions of the First Amended Complaint previously dismissed or subject to the pending motion for reconsideration, and in the alternative for dismissal of some or all claims.
On September 28, 2012, the New York Court entered a Memorandum & Order deciding all of the pending motions. The Court dismissed the plaintiff's claims for tortious interference and violation of the Robinson-Patman Act. The Court denied plaintiff's motion for reconsideration of the previously dismissed claim for violation of the New York Franchise Act. The Court also struck plaintiff's request for punitive damages and attorney's fees in connection with its breach of contract and duty of good faith and fair dealing claims. The Court reconsidered its prior decision and allowed plaintiff's Mass. Gen. Laws c. 93A claim to proceed on a limited basis.
On November 12, 2013, the Company filed a motion seeking summary judgment on G.L.M.'s three remaining counts as well as its counterclaim against G.L.M. G.L.M. opposed the Company's request for summary judgment and also filed a cross-motion for summary judgment on a portion of its breach of contract claim. The United States District Court, Eastern District of New York heard oral argument on all of these pending motions on February 12, 2014. The Court took all matters under advisement.
On September 19, 2014, the Court entered summary judgment in favor of the Company on G.L.M’s three remaining claims for breach of contract, breach of the duty of good faith and fair dealing, and violation of Mass. Gen. Laws c. 93A. The Court denied G.L.M.’s attempt to amend its complaint on the basis of futility and undue delay. The Court also entered summary judgment
in favor of the Company on its counterclaim for breach of contract. The Court set a deadline for the parties to provide a schedule to brief the issue of monetary damages related to the Company’s successful counterclaim for breach of contract.
The Company intends to pursue all rights and remedies available to it in connection with its counterclaim. The decision of the Court remains subject to possible appeal by G.L.M. The Company cannot predict the ultimate outcome of the case nor the amount of damages that the Company may be awarded by the Court.
Brazilian Licensee Litigation
As previously reported, on September 27, 2011, LoJack Ireland, a subsidiary of LoJack Corporation, received a demand for arbitration with the International Centre for Dispute Resolution of the American Arbitration Association (“ICDR”) filed by Tracker do Brasil LTDA (“Tracker”), which licenses the LoJack technology in Brazil. The demand for arbitration was made by Tracker following the stipulation by the parties to the entry of an order in Norfolk Superior Court in Massachusetts that Tracker’s dispute be re-filed for arbitration with the ICDR. The filing alleged interference with contractual relations, fraud/intentional misrepresentation, negligent misrepresentation, breach of contract, breach of the implied covenant of good faith and fair dealing, and violation of Mass. Gen. Laws c. 93A relating to product pricing and the fulfillment of purchase orders to the licensee. The claimant sought, among other things, $55,000,000 in actual damages, treble damages, and attorneys' fees, and also declaratory and injunctive relief.
On November 22, 2011, LoJack Ireland brought a counterclaim against Tracker in the ICDR. The counterclaim asserted Tracker’s breach of contract, breach of the implied covenant of good faith and fair dealing, business defamation, negligent misrepresentation, and violation of Mass. Gen. Laws c. 93A, and sought recovery of monetary damages from past and continuing economic injury as well as damages and reasonable attorneys' fees and costs under Mass. Gen. Laws c. 93A.
On June 28, 2012, the arbitration proceedings were bifurcated into a liability and a damages phase.
On August 7, 2012, Tracker agreed to arbitrate LoJack Ireland’s counterclaims.
On April 19, 2013, LoJack Ireland submitted an amended counterclaim pursuant to a ruling by the arbitration panel, which permitted LoJack Ireland to amend its counterclaims, asserting that Tracker is selling or leasing competitive non-LoJack products. The Amended Counterclaim reasserted LoJack Ireland's prior counterclaims and alleges Tracker’s additional violations of the Lanham Act, Mass. Gen. Laws ch. 266, § 91, and the Massachusetts common law, as well as additional grounds for Tracker’s breach of contract, breach of the implied covenant of good faith and fair dealing, and violation of Mass. Gen. Laws c. 93A. In addition to monetary damages from past and continuing economic injury and reasonable attorneys' fees and costs, LoJack Ireland sought injunctive relief, disgorgement of all profits and/or pecuniary gain derived directly or indirectly from Tracker’s trademark infringement, unfair competition, and trademark dilution, and a declaratory judgment that the License Agreement with Tracker is terminated as a result of Tracker do Brasil LTDA's material breaches thereof.
On December 24, 2013, the arbitration panel issued a preliminary injunction against Tracker, enjoining Tracker and its officers, employees and agents from using, publishing, disseminating or circulating LoJack trademarks, trade names, copyrights or other intellectual property or confidential information to advertise, market, sell or lease non-LoJack products, or in any other way representing that a non-LoJack product is a LoJack product. In addition, to the extent Tracker uses the “LoJack” name or intellectual property in any advertising or marketing communications for stolen vehicle recovery products, such name or intellectual property may only be associated with, and related to, those products that are manufactured or licensed by LoJack. Further, to the extent Tracker advertises, markets or offers to sell, lease or otherwise disseminate other stolen vehicle recovery products, Tracker must clearly state and identify the manufacturer, licensor, or distributor of such non-LoJack products with at least the same prominence that is used to name and identify LoJack products and in such a manner that the non-LoJack products cannot be confused as being LoJack products.
The hearings on the liability phase and the Amended Counterclaim of the arbitration were completed in March 2013 and in November 2013, respectively.
On May 9, 2014, the arbitration panel issued a partial final award on the liability phase of the arbitration, dismissing all of Tracker’s claims against LoJack Ireland. LoJack Ireland’s counterclaims against Tracker for breach of contract and breach of the implied covenant of good faith and fair dealing were upheld in material part, as noted further below. LoJack Ireland’s counterclaim that Tracker engaged in unfair competition was also upheld.
The arbitration panel ruled that Tracker made unauthorized use of LoJack’s trademarks, copyrights, technology and other confidential information to advertise, lease, sell or market non-LoJack products, representing them to the public as LoJack products. The arbitration panel also ruled that Tracker’s conduct violated Massachusetts common law of unfair competition. In addition to Tracker’s use of LoJack’s trademarks/trade names and copyrights to sell non-LoJack products, the panel found that Tracker “passed off” non-LoJack products as LoJack products and that this conduct did deceive or likely could deceive customers into believing that they were buying a LoJack product when they were not. The arbitration panel found that such conduct constitutes unfair
competition under Massachusetts common law. LoJack Ireland’s Lanham Act, Mass. Gen. Laws ch. 266, § 91, Mass. Gen. Laws c. 93A, and defamation claims against Tracker were dismissed.
Also, because Tracker failed to meet its minimum unit purchase requirements under the parties’ License Agreement, the panel further concluded that LoJack Ireland has the right to terminate such License Agreement upon the giving of 60 days written notice to Tracker.
The arbitration panel reserved jurisdiction for the purpose of determining damages and costs in favor of LoJack Ireland at a future damages phase of the arbitration. Except for these issues, the partial final award is in full and final settlement of all claims and counterclaims submitted to the arbitration panel with respect to liability.
On July 12, 2014, the arbitration panel issued a further ruling, holding that Tracker has not adequately informed its customers that some of the stolen vehicle recovery units that Tracker is providing to them were made by a Chinese manufacturer. Tracker was ordered to send letters to both its insurance company customers and to its individual customers, informing them that Tracker has been marketing and leasing stolen vehicle recovery tracking devices that customers may have thought were LoJack products, but that some of these tracking devices actually are manufactured by another company.
On January 28, 2015, LoJack Ireland reached a legal settlement with Tracker with respect to the counterclaims included in the arbitration. Under the settlement, Tracker is required to pay LoJack Ireland $2.0 million in cash and provide $3.0 million of value in the form of gross margin through product sales. The cash payments are to be paid by Tracker evenly over the twelve months ending January 2016. Of the total value, $4.0 million is expected to be received by LoJack in 2015 and the remaining $1.0 million in the first seven months of 2016. The product sales are a combination of last time purchases by Tracker in Brazil and other purchases by Tracker affiliates with valid license agreements in other territories. The settlement also terminates all litigation between the parties, although LoJack Ireland’s damages claim may be re-instated in the event that Tracker does not comply with the terms of the settlement agreement, and also provides for the immediate termination of Tracker as LoJack’s exclusive licensee in the country of Brazil.
Battery Evaluation
We were notified in 2013 by some of our international licensees that some of the batteries manufactured by our former battery manufacturer, EVE Energy Co., Ltd., or EVE, and included in self-powered LoJack Units these licensees had purchased from us exhibited degraded performance below LoJack’s quality standards. These notifications led us to perform our own investigation. While our investigation is still underway, we have confirmed that batteries manufactured by EVE that were included in certain self-powered LoJack Units sold in the United States and to our international licensees are exhibiting variability in performance that could impact the ability of the LoJack Unit to transmit a signal when called upon for stolen vehicle recovery. We manufacture both vehicle and self (battery) powered LoJack Units and this degraded performance only potentially affects the transmit battery pack in our self-powered units. As of the date of this report, the majority of LoJack Units in circulation are vehicle powered.
In our effort to maintain a high recovery rate of stolen vehicles with LoJack Units, we commenced a quality assurance notification program in the U. S. related to the battery evaluation for vehicle product customers with EVE batteries in self-powered LoJack Units currently under base or extended warranty. As of the date of this report, we have recorded an accrual in the amount of $8,040,000 with respect to certain costs associated with this program and other business concessions related to the EVE battery performance matter, based on our best estimates where a potential loss is considered probable. Because of the on-going nature of this matter, we cannot predict what other actions will be required or otherwise taken by LoJack, nor can we predict the outcome nor estimate the possible loss or range of loss with respect to any such actions.
The Company and its subsidiaries have incurred, and expect to continue to incur, significant costs and expenses related to the on-going investigation of the reported battery evaluation and the actions that we have decided to take to address this matter. These costs and expenses may include, among others, those related to quality assurance programs, product or battery replacements, warranty claims, extension of product warranties, legal and other professional fees, litigation, and payments or other business concessions to our B2B customers. On October 27, 2014, the Company and LoJack Ireland commenced arbitration proceedings against EVE by filing a notice of arbitration with the Hong Kong International Arbitration Centre. The filing alleges that EVE breached representations and warranties relating to the quality and performance of the batteries supplied by EVE. We have also filed a formal claim under our relevant insurance policy and, as of the date of this report, are in discussions with our insurance carrier as to whether this matter will be covered by insurance. Our relevant insurance policy provides up to $5,000,000 of coverage and includes a deductible of $100,000. There can be no assurances that we will be able to recover any amounts from EVE or our insurance company to help reduce our financial exposure.
ITEM 4
ITEM 4 - MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5
ITEM 5 -
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is traded on the NASDAQ Global Select Market under the symbol: LOJN.
Stockholders
On March 1, 2015, there were approximately 1,600 record holders of our common stock. We believe the actual number of beneficial owners of our common stock is approximately 4,100 because a large number of the shares of our common stock are held in custodial or nominee accounts for the benefit of persons other than the record holders.
Dividends
We have never paid a dividend, and have no current intention to pay a dividend. At the present time we expect that future earnings will be retained for use in our business. The payment of dividends is currently prohibited under the terms of our credit agreement.
Issuer Purchases of Equity Securities
On February 28, 2006, our Board of Directors authorized our stock repurchase plan, or the Repurchase Plan. The Repurchase Plan authorized us to purchase up to 2,000,000 shares of our outstanding common stock on or before February 25, 2008. From the date of the adoption of the Repurchase Plan through December 18, 2006, we repurchased 1,244,566 shares. On December 19, 2006, our Board of Directors increased the remaining authorization to 2,000,000 shares. On February 15, 2008, our Board of Directors authorized 1,000,000 shares to be repurchased under the Repurchase Plan, pursuant to a plan intended to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and renewed the 2006 management discretionary authority to repurchase 2,000,000 shares, for a total repurchase authorization of 3,000,000 shares. In November 2011, we resumed our repurchase activity under the Repurchase Plan. For the year ended December 31, 2014, we did not repurchase any shares under the Repurchase Plan. As of December 31, 2014, there were 1,205,129 shares available for repurchase under the Repurchase Plan.
Repurchase activity for the quarter ended December 31, 2014 was as follows:
(1)
All share repurchases in the fourth quarter of 2014 were shares acquired from our employees or directors in accordance with our 2008 Stock Incentive Plan as a result of share withholdings to pay income tax related to the lapse of restrictions on restricted stock and, thus, did not impact the shares available for repurchase under the Repurchase Plan.
Unregistered Sales of Equity Securities
None.
Common Stock Sales Price Information
The following table sets forth the range of the high and low sales price information for our common stock for the periods indicated, as reported by the NASDAQ Global Select Market. This information reflects inter-dealer prices, without retail mark-up, markdown or commission and may not necessarily reflect actual transactions.
Stock Performance Graph
The following line graph compares the yearly percentage change in the cumulative shareholder return on our common stock to the NASDAQ Composite Index and a Company-selected peer group index over the five-year period beginning December 31, 2008 and ending December 31, 2014. Cumulative shareholder return has been measured on a weighted-average basis based on market capitalizations of the component companies comprising the peer group index at the close of trading on the last trading day preceding the beginning of each year assuming an initial investment of $100 and reinvestment of dividends.
During 2012, our human resources department partnered with an executive compensation consultancy to compile executive compensation data which included a comparison of composite data of companies of similar size in our industry. As a result of this study, we constructed a new peer group for fiscal year 2013 based on company size and industry and including a mix of service and product-based companies. Our new peer group is comprised of the following companies: Anaren, Inc., CalAmp Corp., Cobra Electronics Corporation, Digi International Inc., Identive Group, Inc., KVH Industries, Inc., NAPCO Security Technologies, Inc., PCTEL, Inc., Sparton Corporation, STRATTEC Security Corporation and VASCO Data Security International, Inc.
Our peer group may change from time to time to reflect changes in the market. The stock price performance shown on the graph is not necessarily indicative of future performance.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among LoJack Corporation, the NASDAQ Composite Index and Peer Group
Source: Returns were derived from Research Data Group, Inc.
Note: The stock price performance shown on the graph above is not necessarily indicative of future price performance. This graph shall not be deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act, regardless of any general incorporation language in such filing.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The selected condensed consolidated financial data set forth below are derived from our audited consolidated financial statements. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” at Item 7
ITEM 7 -
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and notes thereto which appear in Item 8 in this Annual Report on Form 10-K.
WARNING REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 and other federal securities laws contain certain safe harbors regarding forward-looking statements. From time to time, information we provide or statements made by our employees may contain “forward-looking” information, which involves risk and uncertainty. Any statements in this report that are not statements of historical fact are forward-looking statements (including, but not limited to, statements concerning the characteristics and growth of our markets and customers, our expected investments in LoJack Italia, SCI, and SafetyNet, our strategies for addressing changes in the automotive market, our growth strategies and strategic goals and objectives, our plans for future operations and products, the expected benefits of our alliances with TomTom and Trackunit S/A, our proposed re-entry into the Brazilian market, our expected operating expenses and cost management initiatives, our expected capital expenditures, our expected liquidity and capital resources, and the proposed changes to our credit facility and future financing sources). Forward-looking statements can often be identified by words such as “anticipate”, “expects”, “intends”, “plans”, “believes”, “seeks”, “estimates”, “may”, “will”, “should”, “would”, “could”, “potential”, “continue”, “ongoing”, or similar expressions and variations or negatives of these words. Such forward-looking statements are based on a number of assumptions and involve a number of risks and uncertainties, and accordingly, actual results could differ materially. Risk factors that may cause such differences are described in Part I, Item 1A - Risk Factors.
Overview
LoJack is a global leader in providing after-market safety, security and protection products and services for tracking and recovering cars, trucks and other valuable mobile assets. For nearly 30 years, LoJack has been built upon strong and open relationships with law enforcement, licensees and automotive dealers. LoJack’s proprietary wireless technology network has led to the recovery of nearly $4 billion of stolen vehicles globally.
With the introduction of LoJack® Fleet Management in 2013 and LoJack® Connect in 2014, LoJack is evolving towards being a provider of products and services for the “connected car” and a future of connecting people with information and technology, both inside and outside their vehicle.
We have three separately managed and reported business segments: North America, International and All Other.
North America Segment
Our revenue in the United States is derived primarily from the sale of LoJack Units, LoJack Early Warning, and extended warranty products to consumers. In 2014, approximately 86% of such sales in the United States market were made through a distribution network consisting of dealers of new and used vehicles. We believe that we have strong consumer brand awareness in the United States.
The price paid by the consumer for a LoJack Unit includes installation. We maintain a workforce that performs these installations and we supplement our installation capacity by contracting with and certifying select dealers and other third parties to install our products. We continually seek to minimize the fixed costs related to the installation of a LoJack Unit by increasing our installation volumes with certified dealers and other third parties. We monitor the quality of these installations through the use of an expanded quality control process.
We also offer warranty products at the point of sale to new customers and through direct sales efforts to our existing customers.
We record additions to deferred revenue for the automated notification service related to our LoJack Early Warning product and for certain warranty products for which we are the primary obligor of the underlying contract. We typically receive full payment within 60 days of the transaction, but recognition of the deferred revenue is recognized over the estimated life of the product or service. These payments are a significant component of our cash flow from operations. In the United States, additions to deferred revenue, net of deferred costs, were $4,301,000 for the year ended December 31, 2014, compared to additions of $4,815,000 for the year ended December 31, 2013.
A significant portion of our revenue in Canada is derived from the recognition of revenue from service contracts for Boomerang Units. However, as discussed above, we have completed our transition of the selling model in the Canadian market from the Boomerang Unit to the LoJack Unit model. Certain insurance companies in Canada offer rebates to customers who install a stolen vehicle recovery product in their vehicles, and in some instances, insurance companies require installation of a stolen vehicle recovery product in such vehicles.
Those who purchased Boomerang Units were also required to enter into a service contract. The terms of service contracts offered ranged from 12 to 60 months and were generally payable in full upon activation of the related unit or renewal of a previous service contract. Customers were also offered a month-to-month option. As of December 31, 2014, there was approximately $427,000 of deferred revenue, compared to $1,977,000 as of December 31, 2013, resulting from approximately 3,800 active Boomerang Unit service contracts.
Concurrent with the migration from Boomerang technology to LoJack technology in the Canadian market during the second quarter of 2011, we have transitioned the selling model in that market from a subscription based model to a product based model. Therefore, as the LoJack Unit becomes a larger component of the LoJack Canada installed base, we expect this transition to have a positive impact on our revenue recognition in Canada, as we expect the proportion of revenue recognized as product revenue to increase. As of December 31, 2014, there was approximately $1,506,000 of deferred revenue on LoJack Unit sales.
Revenue from the North America segment accounted for approximately 70% of consolidated revenue for the year ended December 31, 2014, compared to 71% and 74% in 2013 and 2012, respectively.
International Segment
Internationally, our licensed stolen vehicle recovery technology is operational in 30 countries and territories around the world. We have licensed our stolen vehicle recovery technology in Latin America, the Caribbean, Europe and Africa. Revenue from this segment consists of product sales to our licensees, royalties, licensing fees, and subscription and installation services. Revenue from the international segment accounted for approximately 27% of consolidated revenue for the year ended December 31, 2014, compared to 26% and 23% in 2013 and 2012, respectively.
We record additions to deferred revenue for international license fees and recognize the revenue over the term of the license (generally ten years). Royalty revenue is recognized in the year it is earned.
Italy is the only country outside the United States and Canada where we own and operate a stolen vehicle recovery network. Customers who purchase LoJack Units in Italy are also required to enter into a service contract with LoJack Italia. The terms of service contracts offered range from 12 to 84 months and are payable in full upon activation of the related unit or renewal of a previous service contract. At December 31, 2014 and 2013, there was approximately $3,049,000 and $2,794,000, respectively, of deferred revenue relating to LoJack Italia service contracts.
All Other Segment
SCI revenue is derived from the sale, lease or service of tracking devices as well as subscription fees for monitoring service alerts and activity reporting. At December 31, 2014, there was approximately $64,000 of deferred revenue relating to SCI subscription based services.
SafetyNet revenue in 2014 was primarily comprised of the sale of transmitters and replacement parts. In 2014, the SafetyNet business model was primarily a fulfillment and service model providing the SafetyNet solution to caregivers and consumers for a monthly fee. As part of this business model, we provide SAR Receivers directly to participating public safety and law enforcement agencies at nominal or no cost.
Revenue from the all other segment accounted for approximately 3% of consolidated revenue for the years ended December 31, 2014, 2013 and 2012.
Key Economic Factors and Trends Affecting our Business
Economic and market data and industry statistics and forecasts used throughout this Annual Report are based upon management's review of independent industry publications, reports by market research firms and other independent and publicly available sources. Although we believe that these third-party sources are reliable, we do not guarantee the accuracy or completeness of this information and have not independently verified this information.
According to the International Monetary Fund, global GDP continued to grow at a rate of approximately 3% in 2014. Faster economic growth continues to be restricted by slow recovery from the recent economic downturn and financial crisis and restrictive financial and lending conditions. A slowdown of economic activity in several key newly-developed and emerging markets have also limited global economic activity. The impact on the light vehicle automotive market was varied. European Union light vehicle sales increased by approximately 5%. In our licensee markets of Brazil, Argentina, and South Africa, light vehicle sales declined by approximately 6%, 27%, and 1%, respectively. Mexico’s light vehicle markets realized positive growth of approximately 7%. The U.S. light vehicle automotive market posted growth of approximately 6% compared with the prior year.
During 2015, global economic growth is expected to increase slightly to approximately 3.8%, led primarily by continued fiscal recovery among advanced economies, namely the United States. Emerging economies are also expected to experience stronger growth in 2015, driven by fiscal stimulus and export growth into the recovering United States and European Union. The United States is expected to realize moderate growth of 3.1%, while European economies are expected to achieve a nominal increase of 1.3%. International automotive growth for 2014 is estimated to continue to be varied. Growth in the European Union is expected to be between 3% and 4% for the full year. Our key emerging market licensee territories of South Africa, Brazil and Mexico are expected to experience moderate growth between 1% and 4%, while the Argentina market is expected to decline by 23%. U.S. retail automotive growth is expected to be in line with the U.S. economy; analysts are estimating light vehicle sales volume growth between 2% and 3%.
North America Segment
Our focus on the U.S. automotive business resulted in performance improvement during 2014, with unit sales in the dealer channel increasing 3% as compared to the prior year.
The U.S. automotive industry continued to realize solid growth in 2014, remaining one of the more positive stories in the U.S. retail economy, with 2014 growth exceeding that of the U.S. economy as a whole. Retail vehicle sales grew approximately 9%, with total light vehicle sales increasing 6%. Factors which contributed to this strong industry performance included pent-up consumer demand for new vehicles, an average vehicle age of almost 11 years, an annual scrappage rate of over 13 million vehicles, historically low interest rates, continually increasing credit availability, adequate inventories of new vehicles and new vehicle models being added to manufacturers' product lines. These factors, in addition to limited used vehicle inventories and higher used car prices, combined to make new car purchases an attractive option for consumers. There continued to be variability in growth rates and changes in market share among vehicle brands, the most impactful being Ford, General Motors and Chrysler, which all benefited from demand for new model introductions and the growth in the sale of pickup trucks.
Industry experts are projecting the automotive industry to grow in line with the U.S. economy in 2015, with growth in the 2% to 3% range. Although all of the 2014 growth factors are expected to remain factors into 2015, strong comparable sales volumes against 2014, and lower demand from the most accessible pool of buyers has weakened growth expectations as compared to 2014. Pent-up demand for light vehicles remains strong across all socio-economic segments, but the economy has not yet improved to a point where the means to buy has returned to all of those hurt by the latest Recession. Buying from low income households and small businesses is expected to continue to lag the rest of the market, as sluggish economic growth and high unemployment impacts these consumers' access to the market.
Two key factors positively impacted demand for our products in 2014. The first factor was the strong and sustained auto demand experienced during 2014. The 2014 fiscal year was the fifth year in a row of solid U.S. automotive industry growth, and 2015 is projected to remain positive. The second factor was the increasing need for profitable, value-add products within Financing and Insurance departments at automotive dealers. Decreased vehicle margins resulting from price transparency and increased brand competition have put pressure on dealerships to increase profit contributions in other areas of the dealership. Our well-
known brand and long history of delivering on our consumer value proposition, coupled with a strong value proposition for the dealer, make the LoJack Stolen Vehicle Recovery system an attractive alternative to other after-market products available to the dealership. These two factors have contributed to increased dealer receptivity to our pre-install programs and increased volumes within selling dealers during 2014. Sluggish U.S. employment growth, lackluster GDP growth and European economic headwinds continue to be obstacles to sustaining this industry optimism.
Revenue from our commercial business declined 10% as compared to the prior year; however demand for our commercial stolen vehicle recovery product remained strong. There has been a high level of interest in our ruggedized self-powered product, which was recognized as one of Equipment Today's 2012 Contractors' Top 50 New Products. Total U.S. construction spending increased approximately 4% in 2014. Construction starts are expected to outpace economic growth in 2015 at 9%. As the rebound in the construction market continues, rental revenue for construction and industrial equipment is forecast to grow between 9% and 10% in 2015 and grow at an average rate of 9% annually from 2015 to 2018.
In our Canadian business, we have increased our emphasis in both the commercial and dealer channels and on our expansion into the Ontario market. During the fourth quarter of 2014, we announced our plan to consolidate and streamline our Canadian operations by integrating and supporting core functions (such as Sales, Operations, Human Resources, Legal and Law Enforcement) out of our U.S. Headquarters. In addition, we will be refocusing our market strategy in Canada by concentrating our stolen vehicle recovery sales efforts in the province of Ontario, while continuing to support all of our Canadian customers who have existing stolen vehicle recovery products installed on their vehicles.
International Segment
In 2014, shipments in our international business declined by approximately 2% compared to the same period last year, primarily as a result of challenging economic environments in our key licensee markets in Europe and South Africa. These declines were partially offset by increases in shipments to our licensees in Argentina and Central America.
In 2014, the Euro Area realized marginal GDP growth of approximately 1%, as member states attempted to avoid a relapse into recession under pressure from depressed economic activity, tight consumer credit availability, and government fiscal austerity measures. In Latin America, Mexican GDP growth of 2% in 2014 fell below initial expectations, inhibited by weak government spending, external demand for exports, oil production, and employment creation. Argentina fell into recession in 2014 and realized a GDP decline of 2% compared to 2013; elevated inflation above 60% annually, currency, capital, and trade restrictions, and uncertainties related to the lingering sovereign debt disputes with creditors have heavily depressed Argentine economic activity. In Brazil, GDP contracted in the first half of the year, reflecting weak investment and a moderation in consumption, and continued weakness in business and consumer confidence. South Africa realized moderate GDP growth of 1% compared to 2013, though economic activity was significantly inhibited by industrial labor tensions, high inflation, and unemployment.
In the past, we have experienced quarterly fluctuations in purchases in the International segment, with sales in many of our international markets tending to be higher in the fourth quarter of the year as licensees seek to achieve lower pricing with higher annual unit purchases. We also are experiencing downward pricing pressure and reductions in unit volumes in a number of our markets due to a variety of factors that vary from country to country. Those factors include the relative maturity of the stolen vehicle recovery market in certain highly developed territories, re-use of our products in certain territories, declining theft rates in certain territories, and increasing competitive pressures by both very high frequency, or VHF, and GPS based tracking systems. We also are faced with uncertainty regarding developing governmental policies and enforcement actions in Argentina that have affected, and may continue to affect, sales to our licensee in that country.
In Argentina, government controls restricting the importation of goods and the ongoing devaluation of the Argentine peso continue to make the exportation of goods from any country to Argentina difficult, and have resulted in a challenging operating environment for foreign companies seeking to do to business in Argentina. On February 1, 2012, Argentine authorities began requiring all importers to request and receive approval from the Argentine Tax and Customs Authority, or AFIP, prior to each import transaction. Subsequently, importers were asked to match imports on a dollar-for-dollar basis with exports prior to receiving authorization from AFIP to import goods. Several states and governmental bodies, including the U.S., Japan and the European Union, submitted complaints and formal requests for the World Trade Organization, or WTO, to establish a Panel to rule on the legality of Argentina's trade measures. The WTO's Director-General composed such a Panel on May 27, 2013. On August 22, 2014, the WTO dispute panel found against Argentina. On September 26, 2014, Argentina filed a notice of Appeal and generally, the Appellate Body has up to three months to conclude its report. Currently, it is unclear whether these proceedings with the WTO will result in changes to Argentina's trade policies that are favorable to our business.
Our Argentine licensee continues to indicate that there is strong market demand for our product, supported by strong vehicle sales growth and insurance company mandates requiring customers to use an SVR product. In 2015, LoJack’s ability to fulfill our licensee’s orders based on this demand will remain contingent upon the ability of our licensee to comply with government trade policies regulating the importation of manufactured goods. If our Argentine licensee and its affiliates are unable to generate
significant exports or if the government changes its trade policies, we may not be able to ship products to Argentina in volumes consistent with prior years.
In 2014, we were unable to ship any product for sale in the Brazilian market as a result of a legal dispute between us and our Brazilian licensee, Tracker do Brasil LTDA (see Part 1, Item 3, "Legal Proceedings" for detail on the Brazilian licensee litigation). On January 28, 2015, LoJack Ireland reached a legal settlement with Tracker with respect to the counterclaims included in the arbitration. Under the settlement, Tracker is required to pay LoJack Ireland $2.0 million in cash and provide $3.0 million of value in the form of gross margin through product sales. The cash payments are to be paid by Tracker evenly over the twelve months ending January 2016. Of the total value, $4.0 million is expected to be received by us in 2015 and the remaining $1.0 million in the first seven months of 2016. The product sales are a combination of last time purchases by Tracker in Brazil and other purchases by Tracker affiliates with valid license agreements in other territories. The settlement also terminates all litigation between the parties, although LoJack Ireland’s damages claim may be re-instated in the event that Tracker does not comply with the terms of the settlement agreement, and also provides for the immediate termination of Tracker as LoJack’s exclusive licensee in the country of Brazil. We continue to view Brazil as an attractive marketplace for the sale of our stolen vehicle recovery system and telematics solutions, and are currently engaged in planning to re-enter in the Brazilian market.
Certain of our European territories are operating in an environment of low economic growth, driven by low consumer confidence, government wage and pension reductions, high unemployment, and tight consumer credit availability. These conditions have inhibited consumer spending and are restraining a significant recovery of the European automobile market. In 2014, certain European automobile industry trade associations have indicated that light vehicle sales in the European Union increased by approximately 5% compared to 2013. The effect of weak vehicle sales has been mitigated in part by a positive market response to our new self-powered product.
Our business in Italy continued to grow in total number of subscribers during 2014, and our revenues grew by 55% compared to 2013 primarily due to a larger subscriber base. We entered 2014 with approximately 33,600 subscribers in Italy, and continued growing the number of subscribers, adding approximately 13,700 net new subscribers in 2014. As of December 31, 2014, our business in Italy had a total of approximately 47,300 subscribers. While we continue to grow our subscriber base in Italy, our overall performance is limited in part due to the weakness in the Italian economy, tight access to credit by both our channel partners and consumers, and the limited recovery in the new vehicle market. During 2014, new car registrations were reported to have increased by 4% as compared to the same period in 2013. Certain auto industry analysts are projecting light vehicle registrations in Italy to grow between 5% and 6% in 2015.
All Other Segment
During the year, the incidents of cargo theft continued to trend upward along with commodity product line value increases and reported loss amounts. As a result of this trend, combined with the true direct and indirect replacement costs of lost shipments and increased regulatory emphasis on shipping condition integrity, brand owners and manufacturers continue to seek the type of visibility, risk reduction, prevention, control and recovery capability that SCI provides, both in the U.S. and for the international segments of its clients' supply chains. Supply chain extension into global markets is a trend that continues to build and we believe that SCI is positioned to capitalize on this trend.
Key Factors of our Business
We embarked upon a critical evaluation of our business during 2011 and developed a strategy designed to stabilize the business financially and to control growth. During 2012, we improved our internal processes and continued to explore opportunities to expand our core businesses in the United States and internationally. Our focus on the U.S. automotive business resulted in significant improvement in performance during 2012, with unit sales in the dealer channel increasing 11% as compared to the prior year, and unit sales in the fourth quarter exceeding retail market performance by 9.5 percentage points, or 21% growth, while internationally we experienced challenges in certain markets which resulted in a 2% decrease in licensee unit volume as compared to the prior year. We continued the expansion of our U.S. business in 2013, most particularly within the expansion of our pre-install program and the international business rebounded as well. While we continued to expand on the pre-install program in 2014, our U.S. business experienced a 4% decline in revenue as compared to the prior year primarily because pre-installed units have a lower average revenue per unit than standard installations. Pre-installed units accounted for 56% of our units sold in the domestic dealer channel in 2014, compared to 47% for the prior year.
During the third quarter of 2014, we implemented a program to optimize our operating model to reduce our operating expenditures and improve our profitability. The program includes reducing headcount in areas where there is redundancy or where we can gain efficiencies (shifting headcount to the areas of the organization that will better align to our business needs and the go-forward plan). On July 15, 2014, we eliminated or realigned approximately 18 positions within the Company. As a result of this program, we incurred a pre-tax charge of approximately $840,000 in the third quarter of 2014, comprised of severance and other employee-related costs. Substantially all of these charges will result in cash expenditures over the next four fiscal quarters.
The reduction plan, combined with previous cost management actions, is expected to enable the Company to manage through this transitional time, while enabling us to pursue our strategic direction, serve our customers and provide a stronger organization for our employees.
We were notified in 2013 by some of our international licensees that some of the batteries manufactured by our former battery manufacturer, EVE Energy Co., Ltd., or EVE, and included in self-powered LoJack Units these licensees had purchased from us exhibited degraded performance below LoJack’s quality standards. These notifications led us to perform our own investigation. While our investigation is still underway, we have confirmed that batteries manufactured by EVE that were included in certain self-powered LoJack Units sold in the United States and to our international licensees are exhibiting variability in performance that could impact the ability of the LoJack Unit to transmit a signal when called upon for stolen vehicle recovery. We manufacture both vehicle and self (battery) powered LoJack Units and this degraded performance only potentially affects the transmit battery pack in our self-powered units. As of the date of this report, the majority of LoJack Units in circulation are vehicle powered.
In our effort to maintain a high recovery rate of stolen vehicles with LoJack Units, we commenced a quality assurance notification program in the U. S. related to the battery evaluation for vehicle product customers with EVE batteries in self-powered LoJack Units currently under base or extended warranty. As of the date of this report, we have recorded an accrual in the amount of $8,040,000 with respect to certain costs associated with this program, quality assurance programs in other countries and markets, and other business concessions related to the EVE battery performance matter, based on our best estimates where a potential loss is considered probable. Because of the on-going nature of this matter, we cannot predict what other actions will be required or otherwise taken by LoJack, nor can we predict the outcome nor estimate the possible loss or range of loss with respect to any such actions.
The Company and its subsidiaries have incurred, and expect to continue to incur, significant costs and expenses related to the on-going investigation of the reported battery evaluation and the actions that we have decided to take to address this matter. These costs and expenses may include, among others, those related to quality assurance programs, product or battery replacements, warranty claims, extension of product warranties, legal and other professional fees, and payments or other business concessions to our B2B customers. On October 27, 2014, the Company and LoJack Ireland commenced arbitration proceedings against EVE by filing a notice of arbitration with the Hong Kong International Arbitration Centre. The filing alleges that EVE breached representations and warranties relating to the quality and performance of the batteries supplied by EVE. We have also filed a formal claim under our relevant insurance policy, but have not received confirmation from our insurance carrier that this matter will be covered by insurance. Our relevant insurance policy provides up to $5,000,000 of coverage and includes a deductible of $100,000. While we believe that this insurance policy and claims under our contract with our former battery manufacturer may help to reduce our financial exposure, no assurances can be made that we will be able to recover any amounts from these parties.
Further negotiations with our international licensees relating to the battery evaluation may result in price concessions, which could cause future margin erosion with respect to sales to those licensees.
In our international business we face a number of challenges and opportunities. In particular, during 2012 the Argentine government imposed significant trade restrictions on imports that have precluded our licensee in that country from purchasing product from us. The restrictions continued through 2013 and 2014, and while we were successful in exporting some units to Argentina in 2013 and 2014, our licensee was unable to arrange for governmental approval to purchase the amount of product commensurate with its demand for stolen vehicle recovery products in Argentina. Our European business has been impacted by ongoing recessionary pressures. We continue to explore opportunities to expand into new territories and to meet the demand for our products in our existing markets.
We believe that our continued focus on executing our strategic goals for 2015 will enable us to continue our growth efforts and:
•
Build on the momentum of our pre-install program established in 2014 to grow our domestic business in a profitable way;
•
Grow our existing core licensee business while identifying new international go-to-market opportunities;
•
Expand our products and service offerings through our strategic alliances, allowing us to access a growing list of opportunities that align with our company strengths and goals;
•
Increase our investment in those businesses that we view as potential significant sources of future revenue and profit;
•
Streamline and simplify our business processes to improve the overall experience for our customers;
•
Continue to aggressively manage our cost structure and discretionary spending; and
•
Develop and maintain highly differentiated products and services in each line of our business while broadening our knowledge of the industry, current markets and potential new markets to pursue going forward.
Critical Accounting Policies and Estimates
The consolidated financial statements include the accounts of LoJack, our wholly-owned subsidiaries and our majority interest in SCI. We consolidate entities which we own or control. All intercompany transactions and balances have been eliminated in consolidation. Management is required, in certain instances, to use estimates and assumptions that affect the amounts reported in the consolidated financial statements and the notes included in this report. The actual results could differ from those estimates. Our accounting policies are described in Note 1 to the consolidated financial statements included herein at Item 8. A critical accounting policy is one that is both important to the portrayal of our financial condition and results of operations and requires management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The significant accounting policies and estimates, which we believe to be the most critical in understanding and evaluating our reported financial position and results of operations, include:
Revenue Recognition and Deferred Revenue. We earn revenue primarily from the domestic sale and installation of LoJack Units and LoJack Early Warning, the sale of products and components to international licensees, royalties, the sale of extended warranty programs and the sale of our LoJack Canada products and service contracts.
We recognize revenue on domestic sales of LoJack Units upon installation, or upon shipment to our installation partners and distributors when all revenue recognition criteria have been met.
In Canada, the sale of a LoJack Unit constitutes a multiple element arrangement under Accounting Standards Codification, or ASC, 605 subtopic 25, Revenue Recognition: Multiple Element Arrangements. The LoJack Unit includes LoJack Unit hardware, installation service and the tracking and recovery service, which is provided by the Company over the period of vehicle ownership.
The delivered elements of a multiple element arrangement (LoJack Unit hardware and installation service) must meet certain criteria to qualify each component of the combined LoJack Unit for separate accounting. Management performed an analysis and has determined that each of the delivered elements in the arrangement qualify for separate accounting based on the applicable guidance.
In the United States and Canada, sales of a combined LoJack and Early Warning Unit constitute a multiple element arrangement under ASC 605 subtopic 25. The combined LoJack and Early Warning Unit includes LoJack Unit hardware, Early Warning hardware, installation service, and an Early Warning ongoing automated notification service, which is provided by the Company over the period of vehicle ownership.
The delivered elements of a multiple element arrangement (LoJack Unit hardware and Early Warning hardware and installation service) must meet certain criteria to qualify each component of the combined LoJack and Early Warning Unit for separate accounting. We performed an analysis and determined that each of the delivered elements in the arrangement qualify for separate accounting based on the applicable guidance.
The guidance establishes a hierarchy for determining the selling price of a deliverable in a multiple element arrangement. The selling price for each deliverable is based on vendor-specific objective evidence, or VSOE, if available, third-party evidence, or TPE, if VSOE is not available, or management’s best estimated selling price, or BESP, if neither VSOE nor TPE are available. The residual method of allocation is no longer permitted under the relevant guidance and thus we are required to allocate consideration at the inception of the arrangement to all deliverables using the relative selling price allocation method. The relative selling price method allocates any discount in the arrangement proportionately to each deliverable on the basis of the deliverable’s estimated fair value. We determined an estimated fair value for each element in the arrangement as follows: (i) LoJack Unit hardware selling price has been determined using VSOE; (ii) Early Warning hardware selling price has been determined based on BESP; (iii) installation service selling price has been determined using TPE; (iv) Early Warning ongoing notification service selling price has been determined based on BESP; and (v) Canadian tracking and recovery service selling price has been determined based on BESP. We analyze the selling prices used in our allocation of arrangement consideration, at a minimum, on an annual basis. Selling prices would be analyzed on a more frequent basis if a significant change in the business necessitates a more timely analysis or if we experience significant variances in our selling prices.
The LoJack and Early Warning hardware and installation service components of each sale are considered to have met delivery requirements for revenue recognition upon installation of the LoJack and Early Warning Unit; however, revenue from the ongoing notification service, as well as the tracking and recovery service in Canada, are deferred and recognized over an estimated life of new vehicle ownership, which management estimates is five years. Management continually monitors and evaluates this estimate based on published industry data. If the estimated life of new vehicle ownership proves to vary materially from the estimates we use, we would be required to change our estimates, which could result in material differences in the amount of revenue recognized in any given period. Historically, we have not made any changes to our five-year estimate.
Revenue relating to the sale of service contracts associated with our Boomerang product line is recognized over the life of the contract. The term of service contracts offered ranges from 12 to 60 months and are generally payable in full upon initial activation of the Boomerang Unit or on renewal of a service contract. Customers are also offered a month-to-month option.
We sell several types of extended warranties. For those warranties for which a third party, and not LoJack, is the primary obligor, we recognize payments for these insurance contracts in revenue at the time of sale. For warranties for which we are the primary obligor, revenue is deferred and recognized over the estimated term of the warranties, determined to be equivalent to the estimated life of new vehicle ownership, which is five years. If the estimated life of new vehicle ownership varies significantly from the estimates we use, material differences in the amount of revenue recognized in any given period could result. Incremental costs directly related to the provision of such warranties are deferred and charged to expense proportionately as the revenue is recognized. Any remaining warranty costs relating to actual claims made are recognized when incurred. We believe the likelihood of material changes to the average estimated life of vehicle ownership is low.
In December 2011, we transferred the servicing and liability obligations for a portion of our extended warranty contracts originated in 2010 to a third party, eliminating any additional services or liability exposure as the primary obligor for those contracts. As a result, approximately $2,586,000 of previously recorded deferred revenue that was being recognized over time was accelerated and recognized as current revenue during the fourth quarter of 2011. During the first quarter of 2012, we transferred the servicing and liability obligations for the majority of our extended warranty contracts originated in 2011 to the same third party. As a result, approximately $3,134,000 of previously recorded deferred revenue that was being recognized over time was accelerated and recognized as current revenue during the first quarter of 2012. Beginning in 2012, the majority of all servicing and liability obligations associated with new contracts sold are being transferred to the third party upon purchase by the consumer. As such, for the majority of extended warranty contracts originated after 2011, we will recognize revenue upon delivery as opposed to deferring the revenue and recognizing it over the life of the contract.
For those warranties for which a third party, and not LoJack, is the primary obligor, we record revenue on a gross basis, with related unit costs being included in cost of goods sold. We considered the factors for gross and net revenue recording and determined that despite not being the primary obligor for the majority of these arrangements, gross revenue reporting was appropriate based on the relevant accounting guidance. Specifically, we have latitude in establishing price; we can change the product offering; we have discretion in supplier selection; we are involved in the determination of product or service specifications; we bear the credit risk; and the amount that we earn on each contract is not fixed. During the years ended December 31, 2014, 2013 and 2012, we recognized $6,272,000, $6,435,000 and $10,216,000, respectively, of revenue related to the sale of our extended warranty products for which we are not the primary obligor. We recognized cost of goods sold on these warranties of $1,139,000, $1,084,000 and $1,293,000 during the years ended December 31, 2014, 2013 and 2012, respectively.
Accounts Receivable and Allowance for Doubtful Accounts. In our North America segment, our customers, primarily automobile dealerships in the United States, are billed for product sales either via bulk sale or at the time of installation. The customer base is principally automobile dealers that are geographically dispersed. Payment terms for LoJack performed installations are generally 10 days. Payment terms for bulk product sales to LoJack certified dealer installers and expeditors range from 30 to 90 days. Except for contract termination due to misconduct or insolvency, which requires the return of all LoJack Units and materials, all LoJack Unit sales to these parties are final with no right of return.
Accounts receivable related to our Canadian customers consists of payments due from our commercial accounts, automotive dealers, accessory retailers and, in limited situations, consumers. Payment terms range from 30 to 60 days from shipment or invoicing. Initial service contracts and subsequent renewals are generally recognized as deferred revenue upon payment via credit card and as a result there is no significant collection risk for a substantial portion of our revenue in Canada.
If the creditworthiness or the financial strength of our dealers were to decline, there could be an adverse effect on our operating results and cash flows. We provide specific reserves for known losses and supplement that estimate with additional reserves based on our historical loss experience. There have been no changes to our North America segment’s billing and returns policy for the periods presented.
Our international customers or licensees are billed for product sales, royalties and in some cases, license fees. Payment terms for our international licensees vary, depending on the length of the supply chain, the financial strength of the licensee and the business climate in the market our licensee operates and are generally longer than our North America business. We mitigate the credit risk in our International segment by obtaining, in many cases, private trade credit insurance for our large international customers. Changes in the geopolitical situation in the countries where we have international customers could create additional credit risk and bad debt exposure. Sales of LoJack Units and component systems to international customers are final with no right of return.
In our All Other segment, our customers are billed for product sales generally at the time of shipment. Payment terms range from 30 to 90 days and all sales are final with no right of return.
The following table presents accounts receivable and the related allowance for doubtful accounts by our segments (dollars in thousands):
In the normal course of business, we monitor the financial condition of our customers and limit the amount of credit extended when deemed necessary. We maintain reserves for estimated potential credit losses. We have established an allowance for doubtful accounts that corresponds to the creditworthiness of our customers, historical trends and economic circumstances. Changes to these estimates are possible and could result in a material effect on our reported results of operations. Approximately 84% and 83% of the North America segment’s gross accounts receivable balances were less than 60 days old at December 31, 2014 and 2013, respectively.
As of December 31, 2014, two international licensees accounted for 21% and 15% of total accounts receivable. As of December 31, 2013, two international licensees accounted for 14% and 16% of total accounts receivable. For both the years ended December 31, 2014 and 2013, our South African licensee, Tracker South Africa, accounted for 11% of revenue. For the year ended December 31, 2012 no international licensee accounted for more than 10% of revenue.
Income Taxes and Deferred Taxes. Our annual tax rate is based on our income (loss), statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions.
We file federal and state income tax returns in the United States and tax returns in 8 international jurisdictions. We estimate our income tax expense after considering, among other factors, differing tax rates between jurisdictions, allocation factors, tax credits, nondeductible items and changes in enacted tax rates.
Deferred taxes arise because of differences in treatment between financial statement accounting and tax accounting, known as temporary differences. The tax effects of these temporary differences are recorded as deferred tax assets and deferred tax liabilities on the consolidated balance sheet. Deferred tax assets generally result in tax deductions or credits subsequent to the period in which the related item was recorded in the consolidated statement of operations. At December 31, 2014, we maintain a full valuation allowance against our worldwide deferred tax assets, net of deferred tax liabilities, with the exception of Ireland, which has deferred tax assets of $0. If sufficient evidence of our ability to generate future taxable income in any of the jurisdictions in which we currently maintain a valuation allowance becomes more likely than not, we may reduce our valuation allowance, which would result in an income tax benefit being recorded in our consolidated statement of operations.
Due to complexity within and diversity among the various jurisdictions in which we do business, there is a risk that a governmental agency may disagree with the manner in which we have computed our taxes. Additionally, due to the lack of uniformity among all of the foreign and domestic taxing authorities, there may be situations where the tax treatment of an item in one jurisdiction is different from the tax treatment in another jurisdiction or that a transaction causes a tax liability to arise in another jurisdiction.
As of December 31, 2014 and December 31, 2013, we had no material uncertain tax positions. However, if an uncertain tax position does arise, the Company will recognize interest and penalties related to income tax matters within income tax expense. At December 31, 2014 and December 31, 2013, we had no accrued interest and penalties.
We are subject to U.S. federal income tax, as well as income tax in multiple state and foreign jurisdictions. We have substantially concluded all U.S. federal tax matters through 2011 and state income tax matters for years through 2006. All material foreign income tax matters through 2008 have been substantially concluded as well.
Effective January 1, 2006, LoJack Ireland commenced operations. As a result of this business structure, a substantial part of our international business activities are supported by LoJack Ireland. LoJack Ireland’s business activities are taxed at a rate of 12.5%.
In general, it is the practice and intention of the Company to indefinitely reinvest the earnings of its non-U.S. subsidiaries in those operations. As of December 31, 2014, the Company has not made a provision for U.S. or additional foreign withholding taxes on approximately $8,619,000 of the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries because such earnings are considered to be indefinitely reinvested in the business. Generally, such amounts become subject to U.S. taxation upon the remittance of dividends and under certain other circumstances. It is not practicable to estimate the amount of deferred tax liability related to investments in these foreign subsidiaries.
Recently Adopted Accounting Guidance and Accounting Guidance Issued But Not Yet Adopted
See Note 1 to the accompanying consolidated financial statements included herein at Item 8, for accounting standards adopted recently and issued but not yet adopted.
RESULTS OF OPERATIONS
Revenue
For the year ended December 31, 2014, consolidated revenue decreased $6,639,000, or 5%, as compared to 2013. Consolidated revenue for the year ended December 31, 2013 increased $7,679,000, or 6%, as compared to 2012. The following table presents revenue by our segments (dollars in thousands):
North America Segment
Revenue related to our North America segment decreased $5,487,000, or 6%, in 2014 as compared to 2013 and increased $701,000, or 1%, in 2013 as compared to 2012.
In 2014, revenue in our North America segment for our dealer channel decreased 3% as compared to the same period in 2013. Revenue in our North America segment from our heavy equipment, or commercial, channel decreased 10% over the same period in 2013. Our motorcycle and direct distribution channels in the United States market saw revenue declines of 69% and 10%, respectively, as compared to the same period in 2013.
In 2013, revenue in our North America segment for our dealer channel increased 3% as compared to the same period in 2012. Revenue in our North America segment from our heavy equipment, or commercial, channel increased 27% over the same period in 2012. Our motorcycle and direct distribution channels in the United States market saw revenue declines of 40% and 15%, respectively, as compared to the same period in 2012.
The activity which resulted in the decrease in our North America segment revenue for the year ended December 31, 2014 as compared to the same period in 2013 was primarily attributable to:
•
A decrease of $1,581,000, or 20%, in revenue from our warranty products, primarily due to a decrease in the number of warranty products sold as compared to 2013, largely due to a 23% increase in our pre-install sales volume, as these sales typically have a lower attachment rate for warranty products;
•
A decrease of $1,654,000, or 23%, in revenue from our Canadian business, driven by a $2,371,000, or 50%, decrease in service revenue primarily resulting from a 48% decline in the average number of subscribers, partially offset by a $717,000, or 28%, increase in unit revenue driven by a 27% increase in the number of base units sold;
•
A decrease of $975,000, or 1%, in revenue from the sale of LoJack Units due to a 3% decrease in average revenue per unit resulting from the continued success of our pre-install program, partially offset by a 2% increase in unit volume during 2014 as compared to 2013;
•
A decrease of $370,000, or 4%, in revenue from our Early Warning products;
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A decrease of $299,000 in all other revenue, primarily the result of increases in promotions offered and partially offset by an increase in revenue from repairs and inspections; and
•
A decrease of $593,000, or 69%, in revenue from the sale of motorcycle products, including units and warranty products.
The activity which resulted in the increase in our North America segment revenue for the year ended December 31, 2013 as compared to the same period in 2012 was primarily attributable to:
•
An increase of $10,106,000, or 16%, in revenue from the sale of LoJack Units due to a 25% increase in unit volume during 2013 as compared to 2012, partially offset by a 7% decrease in average revenue per unit; partially offset by
•
A decrease of $4,928,000, or 38%, in revenue from our warranty products. The decrease is primarily the result of the transfer of the servicing and liability obligations for the majority of our extended warranty contracts originated in 2011 to a third party as the primary obligor during March 2012, thus eliminating any additional services or future liability for us from those contracts. As a result, approximately $3,134,000 of previously recorded deferred revenue that was being recognized over time was accelerated and recognized as current revenue during the first quarter of 2012. Additionally, in 2013 we experienced a decrease in the number of warranty products sold as compared to 2012, largely due to the success of our pre-install program;
•
A decrease of $732,000 in all other revenue, primarily the result of a $323,000 increase in sales referral discounts offered to our dealers, a $222,000 increase in promotions offered, a $367,000 decrease in revenue from recourse agreements, partially offset by a $132,000 increase in revenue from repairs and inspections;
•
A decrease of $2,029,000, or 22%, in revenue from our Canadian business, driven by a $2,472,000, or 34%, decrease in service revenue primarily resulting from a 31% decline in the average number of subscribers to 30,000 subscribers for the year ended December 31, 2013, partially offset by a $443,000, or 21%, increase in unit revenue driven by a 13% increase in the number of base units sold and a 7% increase in the average revenue per unit;
•
A decrease of $1,139,000, or 10%, in revenue from our Early Warning products; and
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A decrease of $581,000, or 40%, in revenue from the sale of motorcycle products, including units and warranty products.
International Segment
Revenue related to our International segment decreased $966,000, or 3%, in 2014 as compared to 2013, and increased $6,643,000, or 22%, in 2013 as compared to 2012.
The decrease in International segment revenue for 2014 as compared to 2013 was primarily attributable to:
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A decrease of $2,185,000, or 7%, in product revenue from our licensees as a result of a 2% decrease in the number of units sold and a 5% decrease in average revenue per unit; and
•
A decrease of $827,000, or 42%, in revenue from the sale of infrastructure components, royalty, license fee, and other revenue from our licensees; partially offset by
•
An increase of $2,047,000, or 55%, in revenue from our Italy business.
The increase in International segment revenue for 2013 as compared to 2012 was primarily attributable to:
•
An increase of $6,112,000, or 25%, in product revenue from our licensees as a result of a 22% increase in the number of units sold and a 2% increase in average revenue per unit;
•
An increase of $222,000, or 13%, in revenue from the sale of infrastructure components, royalty, license fee, and other revenue from our licensees; and
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An increase of $309,000, or 9%, in revenue from our Italy business.
All Other Segment
Revenue related to our All Other segment decreased $186,000, or 4%, in 2014 as compared to 2013, and increased $335,000, or 8%, in 2013 as compared to 2012.
The decrease in All Other segment revenue from 2013 to 2014 was primarily the result of a $174,000, or 4%, decrease in revenue from SCI. The increase in All Other segment revenue from 2012 to 2013 was primarily the result of a $300,000, or 8%, increase in revenue from SCI.
Cost of Goods Sold
The following table presents cost of goods sold by our segments (dollars in thousands):
As a percentage of total revenue, total cost of goods sold was 55%, 45% and 46% in 2014, 2013 and 2012, respectively.
North America Segment
As a percentage of North America segment revenue, North America segment cost of goods sold was 60%, 48% and 48% in 2014, 2013 and 2012, respectively.
The increase in cost of goods sold as a percentage of revenue was primarily due to an accrual recorded during the year ended December 31, 2014 for the estimated costs and expenses associated with our quality assurance program related to the evaluation of certain batteries which have exhibited degraded performance below our quality standards, as discussed in Note 10 to the consolidated financial statements of this report, as well as a decrease in average revenue per unit.
International Segment
As a percentage of International segment revenue, International segment cost of goods sold was 46%, 39% and 44% in 2014, 2013 and 2012, respectively. The increase from 2013 to 2014 was primarily due to an accrual recorded during the year ended December 31, 2014 for the estimated costs and expenses associated with our assistance to our international licensees with respect to their quality assurance programs related to the evaluation of certain batteries which have exhibited degraded performance below our quality standards as discussed in Note 10 to the consolidated financial statements of this report, as well as a 5% decrease in average revenue per unit and a shift in product mix. The decrease in cost of goods sold as a percentage of revenue from 2012 to 2013 was primarily driven by a 2% increase in average revenue per unit and decreased product costs due to a change in product mix.
All Other Segment
As a percentage of All Other segment revenue, All Other segment cost of goods sold was 22%, 22% and 32% in 2014, 2013 and 2012, respectively.
The decrease in cost of goods sold as a percentage of revenue from 2012 to 2013 was primarily the result of the release of a previously recorded warranty provision in our SafetyNet business as well as lower fixed cost of goods sold per unit at SCI due to increased volume.
Operating Expenses
The following table presents our consolidated operating expenses (dollars in thousands):
Product Development
As a percentage of total revenue, product development expenses were 4% in 2014, 2013 and 2012. Product development expense increased $296,000 in 2014 as compared to 2013 and increased $24,000 in 2013 as compared to 2012. The increase in 2014 was primarily due to a $196,000 increase in research and development expenses and a $143,000 increase in consulting expenses, partially offset by a $137,000 decrease in compensation expense. The increase in 2013 was primarily due to a $566,000 increase in compensation expense, partially offset by a $318,000 decrease in consulting expenses, a $163,000 decrease in research and development expenses and various other decreases in other product development expenses.
We expect product development expenses as a percentage of revenue in 2015 to increase slightly from 2014 to support new products and development.
Sales and Marketing
As a percentage of total revenue, sales and marketing expenses were 24%, 23% and 22% in 2014, 2013 and 2012, respectively. Sales and marketing expenses increased $658,000 in 2014 as compared to 2013 and increased $2,987,000 in 2013 as compared to 2012.
The increase in 2014 as compared to 2013 was primarily attributable to:
•
Increased compensation expense of $411,000, including $1,458,000 of increased salary expense and $530,000 of increased severance expense, partially offset by a $1,630,000 decrease in sales commissions;
•
Increased advertising expenses of $459,000; and
•
Increased expenses relating to lead generation services for our telematics business of $623,000; partially offset by
•
Decreased bad debt expense of $124,000; and
•
Decreased market research expenses of $555,000.
The increase in 2013 as compared to 2012 was attributable to:
•
Increased compensation expense of $2,807,000, including $1,067,000 of increased salary expense, a $342,000 increase in benefits expense and a $1,405,000 increase in sales commissions;
•
Increased bad debt expense of $104,000; and
•
Increased market research expenses of $697,000; partially offset by
•
Decreased consulting expenses of $352,000;
•
Decreased production agency expenses of $170,000; and
•
Decreased rent expense of $203,000.
We expect sales and marketing expenses as a percentage of revenue to decrease slightly in 2015.
General and Administrative
As a percentage of total revenue, general and administrative expenses were 26%, 26% and 25% in 2014, 2013 and 2012, respectively. General and administrative expenses decreased by $685,000 in 2014 as compared to 2013 and increased by $3,294,000 in 2013 as compared to 2012.
The decrease in 2014 as compared to 2013 was primarily attributable to:
•
A decrease of $2,917,000 in outside legal expenses due to decreased litigation;
•
A decrease of $844,000 in compensation expense, primarily related to a $1,824,000 decrease in bonus expense and a $152,000 decrease in expenses relating to temporary employees, partially offset by a $301,000 increase in severance expense and a $985,000 increase in benefits expenses;
•
A decrease of $179,000 in travel expenses;
•
A decrease of $150,000 in patent counsel expenses; and
•
A decrease of $123,000 in training expenses; partially offset by
•
An increase of $385,000 primarily relating to increased general and administrative expense at SCI;
•
An increase of $712,000 in consulting expense;
•
An increase of $558,000 in expenses relating to maintenance contracts;
•
An increase of $402,000 in recruiting expenses;
•
An increase of $305,000 in bad debt expense;
•
An increase of $163,000 in office rent expense; and
•
An increase of $675,000 in sales tax expense.
The remaining difference related to smaller changes in various other general and administrative expense accounts.
The increase in 2013 as compared to 2012 was primarily attributable to:
•
Increased compensation expense of $946,000, primarily related to a $249,000 increase in benefits expense, a $1,131,000 increase in bonus expense and a $239,000 increase in severance expense, partially offset by a $481,000 decrease in stock based compensation expense and a $200,000 decrease in expenses relating to temporary employees;
•
An increase of $236,000 primarily relating to increased general and administrative expense at SCI;
•
An increase of $605,000 in consulting expense;
•
An increase of $912,000 in outside legal expense;
•
An increase of $626,000 in maintenance contracts;
•
An increase of $127,000 in facilities related expenses; and
•
An increase of $205,000 in insurance related expenses; partially offset by
•
A decrease of $119,000 in accounting expenses;
•
A decrease of $206,000 in moving expenses; and
•
A decrease of $263,000 in bad debt expense.
The remaining increase related to smaller changes in various other general and administrative expense accounts.
General and administrative expenses as a percentage of revenue are expected to decrease in 2015 due to reduced litigation and related legal expenses.
Legal Settlement
On October 18, 2012, we entered into a settlement agreement with the named plaintiffs in the wage and hour litigation in California discussed in Part II, Item 1, "Legal Proceedings" of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013. During the year ended December 31, 2012, we recorded an accrual of $6,930,000 with respect to our potential obligations under the settlement agreement. The settlement agreement was subject to both preliminary and final approval by the Superior Court. The Superior Court granted preliminary approval on December 3, 2012, and the notice of the settlement was distributed to class members in January 2013. The Superior Court then granted final approval on April 30, 2013, and the settlement became final on July 1, 2013. Based on the number of settlement shares claimed, the Company's total obligation for the State Court Case was $7,477,000, which was $623,000 less than the maximum possible settlement payment previously accrued for. As a result, in June 2013, we reversed approximately $623,000 of the original accrual based on the actual number of settlement shares claimed as discussed above.
Depreciation and Amortization
As a percentage of total revenue, depreciation and amortization expense was 3%, in 2014, 2013 and 2012.
Depreciation and amortization expense decreased by $462,000 in 2014 as compared to 2013 and decreased by $532,000 in 2013 as compared to 2012. The decreases in both 2014 and 2013 were primarily related to the retirement of assets and certain assets becoming fully depreciated during the years ended December 31, 2014 and 2013.
Depreciation and amortization expense as a percentage of revenue in 2015 is expected to increase from 2014 as we implement our Enterprise Resource Planning system. We expect capital expenditures for 2015 to be between $3,400,000 and $5,000,000.
Impairment of Goodwill
Our annual measurement date for impairment testing is November 30 for SCI and SafetyNet. Tests for impairment are also performed on an interim basis if there are triggering events identified. As of each measurement date a qualitative analysis is first performed, assessing the likelihood that it is more-likely-than-not that the fair value of the reporting unit is less than the carrying value. If it is determined that this is more likely than not, a further analysis is performed which compares the carrying value of the reporting unit to its estimated fair value. An impairment charge is measured based upon the excess of the carrying value of goodwill over the implied fair value if impairment is indicated.
At November 30, 2012, we conducted our review of the SafetyNet reporting unit to determine if a triggering event had occurred. As part of this review, management noted that SafetyNet had continuously missed revenue and subscription objectives, despite the greatly reduced targets established. After assessing the totality of events and circumstances on a qualitative basis, it was determined that it was more likely than not that the fair value of the reporting unit was less than its carrying amount and thus the first step of the goodwill impairment test was performed. Upon performing step one and step two of the goodwill impairment test, it was determined that the implied fair value of the goodwill was “de minimis.” As a result, during the year ended December 31, 2012, we recorded a goodwill impairment charge of $472,000, which eliminated the goodwill balance of the SafetyNet reporting unit going forward. No impairment charges were recorded for the years ended December 31, 2014 or 2013.
Other Income (Expense)
The following table presents our other income and expenses (dollars in thousands):
Other income (expense) for 2014 decreased by $1,094,000, or 675%, as compared to 2013. The decrease was primarily due to a $684,000 decrease in gains from the sale of marketable securities, a $172,000 decrease in dividend income and $184,000 increase in losses on foreign currency transactions; partially offset by decreased interest expense of $127,000.
Other income (expense) for 2013 increased by $359,000, or 182%, as compared to 2012. This increase was largely attributable to increased other income of $616,000, due primarily to a $591,000 gain realized upon the sale of our shares of Absolute Software common stock. The increase was partially offset by increased interest expense of $214,000, primarily due to increased borrowing during the year.
Provision (Benefit) for Income Taxes
We recorded a $176,000 benefit for income taxes for the year ended December 31, 2014. This amount is comprised of the provision for income taxes for our Irish subsidiary and miscellaneous state tax provisions.
The effective tax rate is significantly lower than the U.S. statutory rate as a result of recording a moderate taxable profit in our Irish operations. Furthermore, we recorded a tax provision on our year to date Irish profits and are recording no tax benefit for the year to date losses of the remaining entities of our worldwide group. We continue to maintain a full valuation allowance against the net deferred tax assets of the U.S. and our non-Irish foreign subsidiaries at December 31, 2014.
Deferred taxes arise because of differences in treatment between financial statement accounting and tax accounting, known as temporary differences. The tax effects of these temporary differences are recorded as deferred tax assets and deferred tax liabilities on the consolidated balance sheet. Deferred tax assets generally result in tax deductions or credits subsequent to the period in which the related item was recorded in the consolidated statement of operations. At December 31, 2014, we maintain a full valuation allowance against our worldwide deferred tax assets, net of deferred tax liabilities, with the exception of Ireland, which has deferred tax assets of $0. If sufficient evidence of our ability to generate future taxable income in any of the jurisdictions in which we currently maintain a valuation allowance becomes more likely than not, we may reduce our valuation allowance, which would result in an income tax benefit being recorded in our consolidated statement of operations.
At December 31, 2013, we recorded a $2,518,000 benefit for income taxes. This amount was primarily related to discrete tax benefits of $2,450,000 and $997,000, due to the release of tax reserves associated with the settlement of tax examinations and an expiration of a statute of limitations during the second and third quarters, respectively. In 2012, we recorded a provision for income taxes of approximately $472,000, which was substantially due to the larger than expected losses in 2012 in our tax paying Irish subsidiary and principally due to general business losses and legal fees associated Brazil’s legal issues.
Net Income (Loss) Attributable to LoJack Corporation and Income (Loss) Per Share
As a result of the foregoing, for the years ended December 31, 2014, 2013 and 2012, net income (loss) attributable to LoJack Corporation and diluted income (loss) per share were as follows (dollars in thousands, except for per share amounts):
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity is primarily contingent on working capital generated by continued customer demand for our products and services and continuing our existing relationships with automobile dealers, insurance companies, international licensees and certain law enforcement agencies. We believe that we will be able to keep pace with required technological changes in our products and expect that our sales and marketing initiatives will continue to drive demand.
SCI has issued 11% Convertible Promissory Notes, totaling $1,482,000, which mature on August 1, 2017. The amount of the notes due to noncontrolling holders of SCI is $478,000 and is classified as long-term debt on our consolidated balance sheet.
On December 29, 2009, we entered into the Credit Agreement with RBS Citizens, N.A., as Lender, Administrative Agent and Lead Arranger, and TD Bank, N.A., as a Lender and Issuing Bank. The Credit Agreement provided for a multicurrency revolving credit facility in the maximum amount of $30,000,000, subject to a borrowing base calculation (or its equivalent in alternate currencies). The maturity date for the revolving credit loan was July 31, 2015.
On September 19, 2014, we entered into a fifth amendment to the Credit Agreement. The amendment provided for: (i) an extension of the maturity date for revolving credit loans under the Credit Agreement to July 31, 2017; (ii) a modification to the
stock repurchase covenant providing for stock repurchases of up to $5,000,000 for the period commencing on the date of the amendment through the maturity date; (iii) a modification to the Debt Service Coverage Ratio to exclude permitted stock repurchases from such calculation; (iv) deletion of the financial covenant regarding capital expenditures; and (v) modifications to certain definitions including Applicable Margin and Consolidated EBITDA. As a result of the amendment, certain one-time costs related to legal proceedings and restructuring matters were to be excluded in determining our compliance with applicable financial covenants in the Credit Agreement, and costs associated with the reported quality assurance notification program were to be recognized on a net cash flow basis for this purpose.
On March 13, 2015, we entered into a commitment letter with our lenders which provides for the granting of waivers with respect to our non-compliance with certain of the existing financial covenants in our credit facility for the fiscal year ended December 31, 2014, in connection with an amendment to our Credit Agreement, to be entered into by the parties. The amendment will include, among other things: (i) a reduction in our total facility commitment amount to $12,000,000 with up to $7,000,000 in outstanding borrowings on the closing date of the amendment; (ii) a mandatory reduction in our total commitment amount of $2,000,000 on August 31, 2015 and an additional $2,000,000 on October 31, 2015; (iii) an interest rate for Eurodollar loans of LIBOR plus 3.25%; (iv) a commitment fee of 0.50% on the unused portions of the credit facility, with additional quarterly commitment fees payable by us; (v) a prohibition on all dividends, stock repurchases or other restricted payments; and (vi) adjustments to certain of the financial covenants included in the Credit Agreement. Under the revised terms, our obligations under the Credit Agreement could not, at any time, exceed the lesser of (a) the commitment amount less a reserve or (b) the results of our revised borrowing base calculation. Our borrowing base will be calculated as 80% of our domestic accounts receivable. The reserve will be set at $3,000,000 and is to be reduced to $2,000,000 on August 31, 2015 and to $1,000,000 on October 31, 2015. In addition to the aforementioned terms, we will be required to maintain a minimum cash balance in the U.S. of $2,000,000 at all times as well as maintain certain financial performance measures, including minimum quick ratio and minimum adjusted EBITDA requirements. Such commitments of the lenders are subject to certain conditions, including, but not limited to, the completion of definitive documentation and no material adverse changes in our business.
As of December 31, 2014, we had total outstanding borrowings of $10,000,000 under the Credit Agreement. As a result of the aforementioned commitment letter, $3,500,000 of our total outstanding borrowings have been classified as short-term as of December 31, 2014. The interest rate on borrowings under the Credit Agreement varies depending on our choice of interest rate and currency options, plus an applicable margin. The interest rate in effect as of December 31, 2014 was 2.92%. As of December 31, 2014, we also had two outstanding irrevocable letters of credit in the aggregate amount of $502,000.
The Credit Agreement terminates on July 31, 2017, at which time all amounts outstanding under the revolving credit facility are due. The Credit Agreement is guaranteed by our United States domestic subsidiaries and is secured by all domestic assets, including our intellectual property, and a pledge of 65% of the capital stock of LoJack Ireland.
In recent years, we have made no attempt to raise capital from external sources nor do we have any credit rated debt outstanding. Therefore, it is difficult to predict whether any efforts to raise capital would be successful. If additional equity securities were to be issued, shareholder value would be diluted and the new equity securities may have rights, preferences or privileges senior to those of our common stock.
On February 15, 2008, our Board of Directors authorized the repurchase of 1,000,000 shares of our common stock under the Repurchase Plan and additionally renewed the remaining management discretionary authority to repurchase an incremental 2,000,000 shares, for a total repurchase authorization of 3,000,000 shares. In November 2011, we resumed our repurchase activity under the Repurchase Plan. For the year ended December 31, 2014, we did not repurchase any shares under the Repurchase Plan. As of December 31, 2014, there were 1,205,129 shares available for repurchase under the Repurchase Plan.
We expect our continuing operations and expansion of the Italian stolen vehicle recovery network and LoJack Canada’s operating cash deficit, combined with our longer term international investment requirements and domestic expansion, to be funded using existing cash, cash flows from operations and, if needed, our existing credit facility.
We expect capital expenditures for 2015 to be between $3,400,000 and $5,000,000 which we expect to fund out of our existing working capital, which was $18,386,000 as of December 31, 2014. Non-discretionary capital expenditures planned for 2015 include $2,400,000 to $3,000,000 for enhancement of our core tracking and recovery technology. Discretionary expenditures for 2015, which could be delayed to a future period, include $500,000 to $800,000 for our investments in our Enterprise Resource Planning system and $500,000 to $1,200,000 for our expansion into the Brazilian market. However, we currently have no plans to delay these projects or reduce these spending levels. For the year ended December 31, 2014, we had capital expenditures of $8,031,000.
We earn a significant amount of our operating income outside the United States, which is deemed to be indefinitely reinvested in foreign jurisdictions. As a result, $10,039,000 of cash and cash equivalents are held by foreign subsidiaries at December 31, 2014. Of the $10,039,000 of cash and cash equivalents held by foreign subsidiaries, $8,566,000, or 85%, is held in USD denominated accounts, with the remaining $1,473,000 held in foreign currency denominated accounts. We do not provide for U.S. federal income and foreign withholding taxes on the $8,619,000 of undistributed earnings from non-U.S. operations as of December 31,
2014 because we intend to reinvest such earnings indefinitely outside of the U.S. If we were to distribute these earnings, foreign tax credits may become available under current law to reduce the resulting U.S. income tax liability. Determination of the amount of unrecognized deferred tax liability related to these earnings is not practicable. We currently do not intend to repatriate these funds. We expect existing domestic cash, cash equivalents, short-term investments, cash flows from operations and our borrowing capacity under our Credit Agreement to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities, such as material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future. In addition, we expect existing foreign cash, cash equivalents, short-term investments, and cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities, such as material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future.
In 2012, our U.S. parent company received a one-time dividend of $10,000,000 from our Irish subsidiary to assist with legal expenses and the settlement costs associated with the California wage-and-hour litigation discussed Part II, Item 1, "Legal Proceedings" of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, which were paid in 2013. No domestic tax provision was recorded due to the release of valuation allowance against attributes which could be utilized to fully offset our domestic taxable income. Although it is not currently our intention, if we do require more capital in the U.S. than is generated by our domestic operations, for example to fund significant discretionary activities, we could elect to repatriate funds from foreign jurisdictions or to borrow funds under our existing Credit Agreement discussed above. These alternatives, however, would result in increased cash outflows due to higher effective tax rates or increased interest expense.
Our cash flows from operating, investing and financing activities, as reflected in the consolidated statements of cash flows, are summarized in the following table (dollars in thousands):
Operating activities used $10,461,000 of cash during the year ended December 31, 2014, as compared to using $7,331,000 of cash during the same period in 2013. This $3,130,000 increase in cash used was due to an increase of $20,867,000 in net losses after non-cash reconciling items, partially offset by an increase of $17,737,000 in cash from working capital items.
Investing activities used $7,979,000 of cash during the year ended December 31, 2014, as compared to using $2,408,000 of cash during the same period in 2013. This $5,571,000 increase in cash used by investing activities was primarily due to a$2,468,000 decrease in cash proceeds from the sale of our shares of the common stock of Absolute Software, which was sold during the year ended December 31, 2013, and an increase in capital expenditures of $2,855,000 during the year ended December 31, 2014.
Financing activities provided $4,192,000 of cash during the year ended December 31, 2014, as compared to using $6,771,000 of cash during the same period in 2013. The $10,963,000 increase in cash provided by financing activities was due primarily to a $10,899,000 decrease in repayments, net of proceeds, of our borrowings under our existing Credit Agreement, a $225,000 increase in cash received from the exercise of stock options and a $111,000 decrease in cash used for the repurchase of our common stock, partially offset by a $272,000 increase in tax withholdings related to stock grants and lapses.
We do not enter into financial instrument transactions for trading or speculative purposes. We do not intend to establish any special purpose entities for financing purposes.
We will continue to monitor our foreign currency exposure and will implement a hedging strategy if we feel that we are materially at risk and that the hedge is cost effective.
To date, inflation has not had a material impact on our financial results.
CONTRACTUAL OBLIGATIONS
We have fixed contractual obligations under various operating lease agreements relating to our office locations, computer and office equipment, vehicles and tower infrastructure locations. Other contractual obligations include long-term debt and non-cancelable inventory purchase commitments. Contractual obligations and commercial commitments existing at December 31, 2014 were as follows (dollars in thousands):
(1)
Borrowings under the Credit Agreement bear interest at a variable rate, adjustable quarterly, at our option. Interest has been calculated assuming the interest rate prevailing as of December 31, 2014, which was 2.92%.
OFF BALANCE SHEET ARRANGEMENTS
We have no material off balance sheet arrangements as defined in Regulation S-K, Item 303(a)(4)(ii).
ITEM 7A
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have limited exposure to market risk due to the nature of the financial instruments carried on our consolidated balance sheet. Our financial instruments as of December 31, 2014 consisted of cash and cash equivalents, restricted cash, marketable securities, other assets, accounts receivable, accounts payable, accrued liabilities, long-term debt and credit facilities. Our financial position is subject to market risk, including, but not limited to, changes in the value of financial instruments including those resulting from changes in interest rates, foreign currency exchange rates and market valuation. As of December 31, 2014, the fair value of these financial instruments approximated their carrying values.
We are exposed to changes in interest rates primarily through amounts outstanding under our Credit Agreement. As of December 31, 2014, we analyzed the effect of interest rates on our variable-rate Credit Agreement, for which there was $10,000,000 of total outstanding borrowings. Based on the outstanding borrowings under the Credit Agreement at December 31, 2014, a 1% increase in the interest rate would result in an additional $100,000 of annual interest expense.
We are subject to foreign currency risk through our international operations. As of December 31, 2014, we carry cash denominated in foreign currencies, primarily in the euro, Canadian dollar, and Brazilian real. These assets accounted for approximately 8% of the total cash and cash equivalents at December 31, 2014. We translate accounts for subsidiaries whose functional currency is not the U.S. dollar using exchange rates in effect at period-end for assets and liabilities and exchange rates averaged over the period for results of operations. The related translation adjustments are reported in accumulated other comprehensive income in equity. Transaction gains and losses are reported in the consolidated statement of operations. As a result, both positive and negative currency fluctuations against the U.S. dollar may affect our results of operations and accumulated other comprehensive income. Our exposure to foreign currency exchange risk is minimized in relation to our results of operations since a significant portion of our International segment revenue is denominated in U.S. dollars. This may change in the future if revenue earned and expenses incurred denominated in foreign currencies increases.
We manage future foreign exchange risk exposures that cause both earnings and cash volatility by utilizing a hedging strategy if the exposure is material and the hedge is cost effective. As of December 31, 2014, we had no derivative contracts outstanding. We do not enter into financial instrument transactions for trading or speculative purposes. We have not established any special purpose entities and do not have any material off balance sheet financing transactions. We will continue to monitor our foreign currency exposure and will implement a hedging strategy if we feel that we are materially at risk and that the hedge is cost effective.
We are exposed to market valuation risks related to securities we hold that are carried at fair value. Our marketable securities previously consisted of 366,500 shares of Absolute common stock which was accounted for as an available-for-sale security and was valued at the quoted closing price on its market exchange as of the reporting date. Unrealized gains or losses on available-for-sale securities are included, net of tax, in accumulated other comprehensive income in equity until the disposition of the security. Prior to January 1, 2013, our investment in Absolute common stock was accounted for as a trading security and changes in fair value were recorded in the consolidated statement of operations as other income (expense). During the year ended December 31, 2013, we sold our 366,500 shares of Absolute common stock, our cost basis for which was $1,877,000. Our cost basis was
calculated using the per share value of our investment as of January 1, 2013. As a result of the sale, during the year ended December 31, 2013, gross realized gains of $591,000 were reclassified from accumulated other comprehensive income to other income (expense).
Our other assets include our investment in our French licensee, in the form of a publicly-traded common stock, accounted for as an available-for-sale security and valued at the quoted closing price on its market exchange as of the reporting date. Unrealized gains or losses on available-for-sale securities are included, net of tax, in accumulated other comprehensive income in equity until the disposition of the security. During the year ended December 31, 2014, we recorded $1,000 in unrealized losses in accumulated other comprehensive income. Realized gains and losses on available-for-sale securities are included in other income (expense). No realized gains or losses were recorded for the year ended December 31, 2014.
As of December 31, 2014, we held $17,588,000 of cash and cash equivalents. Of this balance, $1,473,000, or 8%, is denominated in foreign currencies, including the Canadian dollar, euro and Brazilian real. The remaining $16,115,000, or 92%, is denominated in U.S. dollars. At December 31, 2014, $11,287,000, or 64%, of our total cash and cash equivalents balance was held in money market accounts, with the remaining $6,301,000 held in traditional deposit accounts.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
LoJack Corporation:
We have audited the accompanying consolidated balance sheet of LoJack Corporation and subsidiaries (the “Company”) as of December 31, 2014, and the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows for the year ended December 31, 2014. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LoJack Corporation and subsidiaries as of December 31, 2014, and the results of their operations and their cash flows for the year ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2015 expressed an unqualified audit opinion.
/s/ Grant Thornton LLP
Boston, Massachusetts
March 16, 2015
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
LoJack Corporation:
We have audited the accompanying consolidated balance sheet of LoJack Corporation and subsidiaries as of December 31, 2013, and the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows for each of the years in the two-year period ended December 31, 2013. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LoJack Corporation and subsidiaries as of December 31, 2013, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Boston, Massachusetts
March 10, 2014
LOJACK CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the consolidated financial statements.
LOJACK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of the consolidated financial statements.
LOJACK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
The accompanying notes are an integral part of the consolidated financial statements.
LOJACK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012
The accompanying notes are an integral part of the consolidated financial statements.
LOJACK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of the consolidated financial statements.
LOJACK CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company - LoJack Corporation and subsidiaries, or LoJack, we, our, or the Company, is a global leader in providing after-market safety, security and protection products and services for tracking and recovering cars, trucks and other valuable mobile assets. Our proprietary technology, wireless network and integration with law enforcement agencies provide an effective means for the tracking and recovery of these assets. Our headquarters are located in Canton, Massachusetts and as of December 31, 2014 we have operations in 29 states and the District of Columbia in the United States and 30 foreign countries and territories.
The LoJack Stolen Vehicle Recovery System - The LoJack System is based on very high frequency, or VHF, technology. If a vehicle equipped with a LoJack Unit is stolen, its owner reports the theft to the local police department. If the theft is reported in a jurisdiction where the LoJack System is operational, a unique radio signal is automatically transmitted to the LoJack Unit in the stolen vehicle, activating its tracking signal. The Vehicle Tracking Unit, installed in police patrol cars and aircraft in the coverage areas, is used by law enforcement officers to lead them to the stolen vehicle using VHF direction-finding technology to locate the LoJack Unit emitting the tracking signal. In Canada and Italy, the tracking of stolen LoJack equipped vehicles is performed by our personnel or by private parties under contract with us, and once a LoJack equipped stolen vehicle is located by our tracking team, we rely on local law enforcement agencies for the actual recovery.
The Boomerang System - The legacy Boomerang Tracking System, or Boomerang System, sold in Canada prior to the transition to the LoJack system during 2011, is based on VHF and cellular technology and uses tracking devices internally developed by LoJack and the wireless network of a major Canadian telecommunications company for locating and tracking stolen assets. If a vehicle equipped with a Boomerang Unit is stolen, the vehicle owner reports the theft to the local police department and the LoJack Canada Security Center. The LoJack Canada Security Center then obtains the approximate location of the Boomerang Unit via a secure connection with the cellular carrier and then transmits a unique code causing the Boomerang Unit to transmit a tracking signal. A tracking vehicle, equipped with a Vehicle Tracking Unit, is then dispatched to the approximate location of the Boomerang Unit and local police are notified when the vehicle has been located. In the provinces of Ontario and British Columbia, we use third parties to perform tracking.
Summary of Significant Accounting Policies
Principles of Consolidation - The consolidated financial statements include the accounts of LoJack, our wholly-owned subsidiaries and our majority interest in LoJack SC-Integrity Inc., or SCI. We consolidate entities which we own or control. All intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates - Preparing financial statements in conformity with U.S. generally accepted accounting principles, or GAAP, requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent liabilities. We base our estimates on historical experience and on various other assumptions 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 amounts may differ from these estimates under different assumptions or conditions.
Revenue Recognition and Deferred Revenue - We recognize revenue principally on five types of transactions - sales of products, subscriber fees for service contracts, extended warranty sales, licensing and royalty fees. In accordance with the guidance provided by the Securities and Exchange Commission’s Staff Accounting Bulletin, SAB No. 104, Revenue Recognition, or SAB No. 104, revenue is recognized when all of the following are met: (a) persuasive evidence of an arrangement exists, (b) title and risk of loss have passed, (c) delivery has occurred or the services have been rendered, (d) the sales price is fixed or determinable and (e) collection is reasonably assured.
We generally recognize revenue on product sales with no continuing obligations upon installation. Revenue relating to sales made to our third party installation partners, who purchase our products and perform installations themselves, is recognized upon shipment, which is prior to the installation of the related products in the consumer’s vehicle. Revenue from the sales of products and components of the LoJack System to international licensees is recognized upon shipment to the licensee or when payment becomes reasonably assured, whichever is later.
In September 2009, the FASB issued Accounting Standards Update, or ASU, No. 2009-13, as codified in Accounting Standards Codification 605, Revenue Recognition, or ASC 605. ASC 605 provides greater ability to separate and allocate consideration in a multiple element revenue arrangement. In addition, ASC 605 requires the use of estimated selling price to allocate consideration in a multiple element revenue arrangement, therefore eliminating the use of the residual method of accounting.
In Canada, sales of a LoJack Unit constitute a multiple element arrangement under Accounting Standards Codification, or ASC, 605 subtopic 25, Revenue Recognition: Multiple Element Arrangements. The LoJack Unit includes LoJack Unit hardware, installation service and the tracking and recovery service, which is provided over the period of vehicle ownership.
The delivered elements of a multiple element arrangement (LoJack Unit hardware and installation service) must meet certain criteria to qualify each component of the combined LoJack Unit for separate accounting. Management performed an analysis and has determined that each of the delivered elements in the arrangement qualify for separate accounting based on the applicable guidance.
In the U.S. and Canada, sales of a combined LoJack and Early Warning Unit constitute a multiple element arrangement under ASC 605 subtopic 25. The combined LoJack and Early Warning Unit includes LoJack Unit hardware, Early Warning hardware, installation service, and an Early Warning ongoing automated notification service, which is provided over the period of vehicle ownership.
The delivered elements of a multiple element arrangement (LoJack Unit hardware and Early Warning Hardware and installation service) must meet certain criteria to qualify each component of the combined LoJack and Early Warning Unit for separate accounting. Management performed an analysis and has determined that each of the delivered elements in the arrangement qualify for separate accounting based on the applicable guidance.
The guidance establishes a selling price hierarchy for determining the selling price of a deliverable in a multiple element arrangement. The selling price for each deliverable is based on vendor-specific objective evidence, or VSOE, if available, third-party evidence, or TPE, if VSOE is not available, or management’s best estimated selling price, or BESP, if neither VSOE nor TPE are available. The residual method of allocation is no longer permitted under the relevant guidance and thus we are required to allocate consideration at the inception of the arrangement to all deliverables using the relative selling price allocation method. The relative selling price method allocates any discount in the arrangement proportionately to each deliverable on the basis of the deliverable’s estimated fair value. Management determined an estimated fair value for each element in the arrangement as follows: (i) LoJack Unit hardware selling price has been determined using VSOE; (ii) Early Warning hardware selling price has been determined based on BESP; (iii) installation service selling price has been determined using TPE; (iv) Early Warning ongoing notification service selling price has been determined based on BESP; and (v) Canadian tracking and recovery service selling price has been determined based on BESP. We analyze the selling prices used in our allocation of arrangement consideration, at a minimum, on an annual basis. Selling prices would be analyzed on a more frequent basis if a significant change in the business necessitates a more timely analysis or if we experience significant variances in our selling prices.
The LoJack and Early Warning hardware and installation service components of each sale are considered to have met delivery requirements for revenue recognition upon installation of the LoJack and Early Warning Unit; however, revenue from the ongoing notification service, as well as the tracking and recovery service in Canada, are deferred and recognized over an estimated life of new vehicle ownership.
Prior to our adoption of ASC 605 as of January 1, 2011, the Early Warning Unit and ongoing notification service was considered to be one unit of accounting, and revenue relating to the sale was deferred and recognized over an estimated life of new vehicle ownership, which we estimate is five years.
Revenue relating to the sale of service contracts is recognized over the life of the contract. The purchase of an initial service contract is a requirement at the time the consumer purchases a LoJack Unit in Italy. The service contracts, which are sold separately from the LoJack hardware, are offered in terms ranging from 12 to 60 months and are generally payable in full upon activation of the related unit or renewal of a previous service contract. Customers are also offered a month-to-month option.
We offer several types of contractual extended warranties. For those warranties for which an independent third party insurer, and not LoJack, is the primary obligor, we recognize payments for these contracts in revenue at the time of sale. For those warranty products to which we are the primary obligor, revenue is deferred and is recognized over the term of the warranties, determined to be equivalent to the estimated life of new vehicle ownership, which we estimate to be five years. In December 2011, we transferred the servicing and liability obligations for a portion of our extended warranty contracts originated in 2010 to a third party, eliminating any additional services or liability exposure as the primary obligor for those contracts. During the first quarter of 2012, we transferred the servicing and liability obligations for the majority of our extended warranty contracts originated in 2011 to the third party. Beginning in 2012, the majority of our servicing and liability obligations associated with new contracts sold are transferred to the third party upon purchase by the consumer. As such, for the majority of extended warranty contracts originated after 2011, we recognize revenue upon delivery as opposed to deferring the revenue and recognizing it over the life of the contract.
For those warranties for which a third party, and not LoJack, is the primary obligor, we record revenue on a gross basis, with related unit costs being included in cost of goods sold. We considered the factors for gross and net revenue recording and determined that despite not being the primary obligor for the majority of these arrangements, gross revenue reporting was appropriate based on the relevant accounting guidance. Specifically, we have latitude in establishing price; we can change the product offering; we have discretion in supplier selection; we are involved in the determination of product or service specifications; we bear the credit
risk; and the amount that we earn on each contract is not fixed. During the years ended December 31, 2014, 2013 and 2012, we recognized $6,272,000, $6,435,000 and $10,216,000, respectively, of revenue related to the sale of our extended warranty products for which we are not the primary obligor. We recognized related cost of goods sold of $1,139,000, $1,084,000 and $1,293,000 during the years ended December 31, 2014, 2013 and 2012, respectively.
We recognize license fees from our international licensees in revenue over the term of the license (typically ten years) and we recognize royalty revenue when earned or when payment is reasonably assured, whichever is later. (Also see Note 5 for a discussion of the license income related to Absolute Software, Inc., or Absolute.)
Revenue relating to SCI and LoJack SafetyNet Inc., or SafetyNet, consists of the sale of tracking devices and subscription fees. Sales of units are recognized upon shipment and subscription fees are recognized over the life of the contractual agreement which can range from 12 to 24 months.
Any revenue that has been deferred and is expected to be recognized beyond one year is classified as long-term deferred revenue.
Stock-Based Compensation - Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the applicable vesting period of the stock award using the straight-line method.
Advertising Expenses - Advertising costs, which include the placement of advertisements, third party media consulting firm fees, trade shows and promotional literature, are expensed as incurred and are classified under sales and marketing expense. Advertising expenses for the years ended December 31, 2014, 2013 and 2012 were $2,856,000, $2,434,000 and $2,335,000, respectively.
Warranty Costs - We provide for the estimated costs associated with fulfilling our warranty related obligations based primarily on our historical experience of the cost of fulfilling our warranty obligations. The estimated provision for accrued warranty costs is included in the consolidated balance sheet within accrued and other liabilities. Warranty coverage is provided on both our LoJack Units and Boomerang Units. We warrant to consumers that LoJack Units and Boomerang Units will be free from defects in material or workmanship for a period of two years from the date of installation. We also warrant to purchasers of the LoJack Unit that if a LoJack Unit equipped vehicle is stolen in a covered jurisdiction within two years of installation and not recovered within 24 hours from the time that the theft is reported to the police, we will pay the consumer an amount equal to the full purchase price of the LoJack Unit up to a maximum of $695 (up to $995 if the consumer has purchased LoJack Early Warning). We warrant to purchasers of the Boomerang Units that if the Boomerang equipped vehicle is stolen and not recovered within 60 days of the reported theft, we will pay the consumer an amount equal to the full purchase price of the unit and the service fees, up to a maximum of CAD $1,000 for the Boomerang Unit and CAD $2,000 for the Boomerang Unit with automatic theft notification. For the BoomerangXpress Units, we will offer the consumer a new unit, including installation, free of charge.
SCI warrants its hardware devices to be free of defects in materials or workmanship for a period of one year after date of purchase. All external batteries, cases or wiring provided by SCI as part of an assembled device are warranted for a period of 30 days from date of purchase. Any hardware item covered by SCI’s warranty and found to be defective during the warranty period will be repaired or replaced at our discretion.
We warrant to consumers that the SafetyNet transmitter will be free from defects in material, workmanship or design for a period of one year from the date of purchase. If the product proves to be defective in material, workmanship or design within that period, we will replace the transmitter. Under the SafetyNet warranty, our maximum liability may not exceed $500.
A rollforward of the activity of the warranty reserve is as follows (dollars in thousands):
Our business in Canada experienced increased recall rates related to the Boomerang products following the conversion from an analog to digital infrastructure in 2010. In 2011, we transitioned our business in Canada from Boomerang Units to LoJack Units, resulting in decreased warranty expense during the years ended December 31, 2014, 2013 and 2012.
Commitments and Contingent Liabilities - We are subject to various claims and contingencies related to lawsuits as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments, including any legal costs associated with a loss contingency, when it is probable that a liability has been incurred and the amount can be reasonably estimated. Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based only on the best information available at the time. As additional information becomes
available, we reassess the potential liability related to pending claims and litigation and may revise estimates. Given the nature of most litigation, the company is typically unable to estimate probable legal costs associated with pending litigation matters and therefore, such costs are most often expensed as incurred. (Also see Note 10.)
Cash and Cash Equivalents - We consider all highly liquid instruments with an original maturity of three months or less to be cash equivalents. We periodically maintain bank balances which exceed the federally insured limit. We routinely assess the financial strength of our depository banks and believe we had no significant exposure to credit risks as of December 31, 2014.
Marketable Securities - All marketable securities must be classified as one of the following: held-to-maturity, available-for-sale, or trading. We determine the classification at the time of purchase.
Our investment in our French licensee, in the form of a publicly-traded common stock, is accounted for as an available-for-sale security and is valued at the quoted closing price on its market exchange as of the reporting date. No realized gains or losses were recorded for the years ended December 31, 2014, 2013 or 2012. Our investment in our French licensee is reported as a long-term asset on our consolidated balance sheet. Unrealized gains or losses on available-for-sale securities are included, net of tax, in accumulated other comprehensive income in equity until the disposition of the security. We follow the specific identification method in determining the cost basis in computing realized gains and losses on the sale of available-for-sale securities. Realized gains and losses on available-for-sale securities are included in other income (expense).
The investments of the deferred compensation plan are included in other assets at fair value. See Note 11 for further discussion.
Accounts Receivable - We maintain an allowance for doubtful accounts based on an assessment of collectability of all outstanding receivables. We make this assessment by evaluating the creditworthiness of our customers, historical trends and economic circumstances. A rollforward of the activity of the allowance for doubtful accounts is as follows (dollars in thousands):
Customer and Vendor Concentration - Accounts receivable in the United States are due principally from automobile dealers that are geographically dispersed. Accounts receivable in Canada consist of payments due from our dealer channel and corporate accounts. International accounts receivable are principally due from international licensees. As of December 31, 2014, two international licensees accounted for 21% and 15% of accounts receivable. As of December 31, 2013, two international licensees accounted for 14% and 16% of accounts receivable. For the years ended December 31, 2014 and 2013, our South African licensee, Tracker South Africa, accounted for 11% of revenue. For the years ended December 31, 2012 no international licensees accounted for more than 10% of revenue. When possible, payment for our products from international licensees is supported by the purchase of private trade-credit insurance paid for by the licensee.
We have a contract manufacturing arrangement for the LoJack Unit and other LoJack System components sold in the North America and International segments with Celestica LLC. Although we currently do not use additional manufacturers, we believe that several companies have the capability to manufacture LoJack Units.
Inventories - Inventories are stated at the lower of cost or market value using the first-in, first-out method.
Property and Equipment - Property and equipment is stated at cost and depreciated using the straight-line method over the estimated useful lives of the related assets as detailed below:
Upon retirement or other disposition, the cost and the related accumulated depreciation of the assets are eliminated from the consolidated balance sheet and the related gains or losses are reflected in the consolidated statement of operations. Expenditures for maintenance and repairs are charged to expense while the costs of significant improvements that extend the life of the property and equipment are capitalized.
Internal Software Development Costs - We capitalize internal software development costs associated with software developed for internal use. In accordance with ASC 350-40, Internal-Use Software, expenses related to the design of software, coding and installation of hardware, and certain costs incurred to allow access to or conversion of old data by new systems are capitalized. Costs related to training and data migration activities are expensed as incurred. Capitalized internal software development costs are amortized over the period of economic benefit, generally between three and five years. For the years ended December 31, 2014 and 2013, capitalized software included in property and equipment totaled $1,499,000 and $1,605,000, net of accumulated amortization of $14,107,000 and $13,917,000, respectively. For the years ended December 31, 2014, 2013 and 2012, we capitalized internal software development costs of $556,000, $1,539,000 and $456,000, respectively. For the years ended December 31, 2014, 2013 and 2012, $656,000, $576,000 and $881,000, respectively, of amortization expense was recorded for these capitalized internal software costs. Additions to internal software development costs are included in investments in property and equipment in the consolidated statements of cash flows. As of December 31, 2014, we had $6,534,000 of capitalized internal software development costs which had not yet been placed into service.
Cost-Basis Investments - We have made investments in some of our international licensees. These investments to date have resulted in ownership of less than 20% of any one licensee. Unless the shares are marketable securities, these investments are accounted for using the cost method of accounting. Under the cost method of accounting, investments are carried at cost and are adjusted only for other-than-temporary declines in fair value, distributions of earnings, additional investments made and other ownership changes. We have not recorded any gains or losses on these investments in the years ended December 31, 2014, 2013 and 2012. (Also see Note 5.)
Equity Investments- We have a 64% interest in SCI, a Texas based company which provides comprehensive solutions for cargo theft monitoring prevention, investigation, tracking and recovery. Prior to August 2008, we had accounted for our interest in SCI utilizing the equity method of accounting. During the third quarter of 2008, we increased our equity investment in SCI from 40% to 60% and as a result began consolidating the results of its operations in our consolidated financial statements as well as accounting for the corresponding impact of SCI’s noncontrolling interest in a separate component of our consolidated balance sheet and statement of operations. In October 2009, we, along with the noncontrolling interest in SCI, invested an additional $800,000 into SCI in exchange for 1,188,707 shares of SCI common stock. Our portion of this investment was $508,000. As of December 31, 2014 we, along with the noncontrolling interest in SCI, have invested an additional $1,482,000, in the form of 11% convertible notes. Our portion of the notes, which was $1,004,000 as of December 31, 2014, is eliminated in consolidation. The amount of the note due to noncontrolling holders of SCI, $478,000, is classified as long-term debt on our consolidated balance sheet. (Also see Note 4.)
Goodwill and Other Intangible Assets - Goodwill is not amortized but instead is assessed for impairment at least annually and as triggering events occur. We have adopted an annual measurement date of November 30 for SCI and SafetyNet. As of each annual measurement date, we first perform a qualitative assessment to determine whether it is more likely than not that the fair value of each reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. If it is determined based on this analysis that the impairment test should be performed, the carrying value of the reporting unit is compared to its estimated fair value, and an impairment charge is measured based upon the excess of the carrying value of goodwill over the implied fair value if impairment is indicated. This analysis is performed at a reporting unit level. For the year ended December 31, 2012, we recorded a goodwill impairment charge for the entire goodwill balance of our SafetyNet business in the amount of $472,000. There was no goodwill impairment recognized for the years ended December 31, 2014 or 2013. (See Note 4 for detail.)
Other intangible assets consist of amortizing intangibles, including customer relationships, patents, trademarks, trade names and the rights to very high frequencies. Whenever events or changes in circumstances indicate that the carrying value may not be recoverable, an assessment is completed to determine whether the fair value of the asset exceeds the carrying value. When a potential impairment has been identified, forecasted undiscounted net cash flows of the operations to which the asset relates are compared to the current carrying value. If such cash flows are less than the carrying amounts, the intangible assets are written down to their respective fair values.
In making this assessment, we rely on a number of factors including operating results, business plans, economic projections, anticipated future cash flows, and transactions and marketplace data. There was no impairment charge recognized relating to other intangible assets for the years ended December 31, 2014, 2013 and 2012. (Also see Note 4.)
Impairment of Other Long-lived Assets - Other long-lived assets including property and equipment and internal software development costs are also periodically assessed for impairments. No such impairments were recorded in the periods presented.
Income Taxes - We recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been included in our financial statements or tax returns. Deferred tax assets and liabilities are determined based upon the difference between the financial statement carrying amounts and tax basis of existing assets and liabilities, using enacted tax rates anticipated to be in effect in the year(s) in which the differences are expected to reverse. Valuation allowances are provided against deferred tax assets that are not deemed to be more likely than not realizable.
Our annual effective tax rate is based on our income (loss), statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions. We provide reserves for potential payments of tax to various tax authorities related to uncertain tax positions and other issues. In accordance with ASC 740, Income Taxes, or ASC 740, tax benefits are based on a determination of whether and how much of a tax benefit taken by us in our tax filings or positions is more likely than not to be realized following resolution of any potential contingencies present related to the tax benefit, assuming that the matter in question will be raised by the tax authorities. Potential interest and penalties associated with such uncertain tax positions are recorded as a component of income tax expense. (Also see Note 9.)
Product Development - Costs for product development are expensed as incurred and include salaries, fees to consultants, and other related costs associated with the development of new products. A portion of our product development effort has been outsourced to unrelated third parties.
Income (Loss) Per Share - Basic income (loss) per common share is computed using the weighted average number of common shares and common share equivalents outstanding during each year. Diluted income (loss) per common share is computed using the weighted average number of common shares outstanding during the year, including the effect of our outstanding stock options and restricted stock (using the treasury stock method), except where such stock options or restricted stock would be antidilutive. A reconciliation of weighted average shares used for the basic and diluted computations is as follows:
Because of the net losses reported for the year ended December 31, 2014, all shares of stock issuable pursuant to stock options and unvested stock were not considered for dilution as their effect would be antidilutive. For the year ended December 31, 2014, 2,185,199 options and 571,753 shares of restricted stock were excluded from the computation of diluted net income per share as their effect would be antidilutive. For the year ended December 31, 2013, 2,335,997 options and 0 shares of restricted stock were excluded from the computation of diluted net income per share as their effect would be antidilutive. Because of the net losses reported for the year ended December 31, 2012, all shares of stock issuable pursuant to stock options and unvested stock were not considered for dilution as their effect would be antidilutive. For the year ended December 31, 2012, 2,878,860 options and 608,903 shares of restricted stock were excluded from the computation of diluted net loss per share as their effect would be antidilutive.
Comprehensive Income - Other comprehensive income, as defined, includes all changes in equity during a period from non-owner sources, such as unrealized gains and losses on available-for-sale securities and foreign currency translation. Accumulated other comprehensive income and its components were as follows (dollars in thousands):
Foreign Currency - The functional currency for each of our subsidiaries is the currency of the primary economic environment in which the subsidiary operates, generally defined as the currency in which the entity generates and expends cash. For all entities, with the exception of LoJack Equipment Ireland, Ltd., or LoJack Ireland, the functional currency is the local currency. LoJack Ireland’s functional currency is the U.S. dollar. All assets and liabilities are translated into U.S. dollar equivalents at the exchange rate in effect on the balance sheet date. Revenues and expenses are translated at the average exchange rates for the year. Translation gains or losses are recorded in equity as an element of accumulated other comprehensive income. We also incur transactional gains and losses resulting from transactions denominated in foreign currencies and the translation of intercompany balances which are not permanently invested. Such items are recorded as other income (expense) in the consolidated statement of operations. For the years ended December 31, 2014, 2013 and 2012, we recorded foreign currency losses of $214,000, $30,000 and $30,000, respectively.
Recently Adopted Accounting Guidance
In April 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. The amendments in this guidance change the requirements for reporting discontinued operations. Under the new guidance a disposal of a component of an entity or a group of components is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. The guidance was effective prospectively for disposals that occur within annual periods beginning on or after December 15, 2014. The Company has adopted this guidance as of January 1, 2015 and the adoption did not have a material impact on our consolidated financial statements.
Accounting Guidance Issued But Not Yet Adopted
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, an updated standard on revenue recognition. ASU 2014-09 provides enhancements to the quality and consistency of how revenue is reported while also improving comparability in the financial statements of companies reporting using IFRS and U.S. GAAP. ASU 2014-09 is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. The new standard also will result in enhanced disclosures about revenue, provide guidance for transactions that were not previously addressed comprehensively and improve guidance for multiple-element arrangements. ASU 2014-09 will be effective for the Company in the first quarter of fiscal 2017 and may be applied using a full retrospective or modified retrospective approach. The Company is currently in the process of evaluating the impact that the implementation of this standard will have on our financial statements.
In June 2014, the FASB issued ASU No. 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could be Achieved after the Requisite Service Period. ASU 2014-12 requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The Company does not anticipate that the adoption of this standard will have a material impact on our consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40). The new guidance addresses management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The new guidance dictates that management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued. The standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2016. Early adoption is permitted. The Company does not anticipate that the adoption of this standard will have a material impact on our consolidated financial statements.
2. INVENTORIES
Inventories are classified as follows (dollars in thousands):
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (dollars in thousands):
Depreciation expense relating to property and equipment totaled $3,703,000, $4,121,000 and $4,701,000 for the years ended December 31, 2014, 2013 and 2012, respectively.
System components and fixed assets not yet in service consist primarily of capitalized software and certain infrastructure, tooling, and other equipment that has not been placed into service.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Upon the acquisitions of SCI and Locator Systems (now known as SafetyNet), we recorded goodwill and acquired certain intangible assets with finite lives. The intangible assets acquired include customer relationships and trade names and trademarks.
Our annual measurement date for impairment testing is November 30 for SCI and SafetyNet. Tests for impairment are also performed on an interim basis if triggering events are identified. Triggering events are events or changes in circumstance that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Examples of such events or circumstances include: (a) a significant adverse change in legal factors or in the business climate; (b) an adverse action or assessment by a regulator; (c) unanticipated competition; (d) a loss of key personnel; (e) a more likely than not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of; (f) the testing for recoverability of a significant asset group within a reporting unit; or (g) recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.
At each annual measurement date, as a basis for determining whether it is necessary to perform the two-step goodwill impairment test, we perform a qualitative assessment of whether it is more likely than not that the fair value of each reporting unit is less than its carrying amount. If it is determined based on this analysis that it is not more likely than not that the fair value is less than the carrying amount, the two-step impairment test is not required.
The first step in goodwill impairment testing is to compare the estimated fair value of the reporting unit to its carrying value. We utilize the discounted cash flow, or DCF, method under the income approach to estimate a reporting unit’s fair value. Use of a DCF valuation model is common practice in impairment testing in the absence of available transactional market evidence to determine the fair value. The key assumptions used in the DCF valuation model include discount rates, growth rates, cash flow projections and terminal value rates. Discount rates, growth rates and cash flow projections are the most sensitive and susceptible to change as they require significant management judgment. Discount rates are determined by using a weighted average cost of capital, or WACC. The WACC considers market and industry data as well as Company-specific risk factors for each reporting unit in determining the appropriate discount rates to be used. Using historical and projected data, growth rates and cash flow projections are generated for each reporting unit. Terminal value rate determination follows common methodology of capturing the present value of perpetual cash flow estimates beyond the last projected period assuming a constant WACC and low long-term growth rates.
We corroborate the results of the DCF model by using the guideline company method and the comparable transaction method, both of which are market-based approaches. In the event that the estimated fair value of the reporting unit is less than its carrying amount, we would then proceed to the second step to determine if an impairment charge is necessary. The second step in the goodwill impairment testing involves comparing the implied fair value of goodwill with its carrying value. The implied fair value of goodwill is equivalent to the excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities, as if the reporting unit had been acquired in a business combination. Should the carrying value of the reporting unit’s goodwill exceed the implied fair value, an impairment loss would be recognized in the amount of the excess.
SafetyNet
At November 30, 2012, we conducted our annual review of the goodwill of the SafetyNet reporting unit for impairment. As part of this review, we noted that SafetyNet had continuously missed revenue and subscription objectives, despite the greatly reduced targets established. After assessing the totality of events and circumstances on a qualitative basis we determined that it was more likely than not that the fair value of the reporting unit was less than its carrying amount and thus the first step of the goodwill impairment test was performed.
Given the consistent financial shortfalls and past inability to accurately forecast results of the SafetyNet business, we no longer believed that SafetyNet would achieve the growth rates and returns previously anticipated. As such, the expected future growth of the business was reduced to a level that was believed to be sustainable and achievable without risking large upfront investments. Utilizing a discounted cash flow model, we determined the fair value of the SafetyNet reporting unit and compared it to the carrying value of the business, noting that the fair value was in fact less than the carrying value. As a result, we performed the second step of the goodwill impairment test, allocating the fair value to the assets and liabilities of the business, with any excess representing the implied fair value of the SafetyNet goodwill. Upon allocation of the fair value to the assets and liabilities of SafetyNet, we determined that the implied fair value of the goodwill was “de minimis.” As a result, during the year ended December 31, 2012 we recorded a goodwill impairment charge of $472,000, which eliminated the goodwill balance of the SafetyNet reporting unit going forward.
SCI
At November 30, 2014, we performed the annual qualitative assessment of the goodwill for SCI. After assessing the totality of events or circumstances affecting SCI, including macroeconomic, industry and market conditions, we determined that it was not more likely than not that the fair value of the SCI reporting unit was less than its carrying amount, and as such did not proceed with the first and second steps of the goodwill impairment testing process.
The following table summarizes the changes in goodwill by business segment (dollars in thousands):
The following table summarizes the changes in intangible assets by business segment (dollars in thousands):
Intangible assets consist of the following (dollars in thousands):
Estimated amortization expense for the next five years and thereafter for our intangible assets as of December 31, 2014 is as follows (dollars in thousands):
5. OTHER ASSETS
Other assets consist of the following (dollars in thousands):
Deferred Costs Related to Deferred Revenue Arrangements
As discussed in our revenue recognition policy in Note 1, revenue relating to the sales of LoJack Early Warning ongoing automated notification service and certain warranty products are deferred and recognized over five years. The direct and incremental cost of this revenue was comprised primarily of the cost of the Early Warning device hardware prior to the adoption of ASU 2009-13 as of January 1, 2011. The deferred cost is presented as a long-term asset.
Investment in International Licensees
As of December 31, 2014, investments in international licensees of $2,318,000 included a 12.5% equity interest in our Mexican licensee, totaling $1,541,000, a 5.5% interest in our French licensee, totaling $277,000, and a 17.5% equity interest in our Benelux licensee, totaling $500,000.
The investment in our Mexican licensee, over which we do not exercise significant influence, is accounted for using the cost method of accounting and is carried at cost and adjusted only for other-than-temporary declines in fair value, distributions of capital and additional investments made. We periodically review the carrying value of this investment, based upon projections of anticipated cash flows, market conditions, legal factors, operational performance, and valuations, when appropriate. We have concluded that there are no impairments to the fair value of this investment for all years presented. During 2014, 2013 and 2012, our Mexican licensee declared dividends of $110,000, $252,000 and $201,000, respectively, which we recorded in other income.
Our investment in our French licensee, in the form of a marketable equity security, is accounted for as an available-for-sale security and is valued at the quoted closing price of its market exchange as of the reporting date. If the quoted price of the investment in our French licensee were to drop below our recorded cost for an extended period of time we would evaluate the investment for impairment. No realized gains or losses were recorded for the year ended December 31, 2014, 2013 or 2012.
The investment in our Benelux licensee, over which we do not exercise significant influence, is accounted for using the cost method of accounting and is carried at cost and adjusted only for other-than-temporary declines in fair value, distributions of capital and additional investments made. In 2009, we obtained this investment in exchange for the licensing rights related to the Benelux region. We valued the investment based on the fair value of the licensing rights. The revenue related to the license is reflected in deferred revenue on the balance sheet at December 31, 2014 and 2013. We will begin to recognize license revenue once the licensee has completed the build-out of the VHF network. We periodically review the carrying value of this investment, based upon projections of anticipated cash flows, market conditions, legal factors, operational performance, and valuations, when appropriate.
We may be required to record an impairment charge in a future period if (1) the Benelux licensee would require additional capital and is unable to raise sufficient capital to continue operations, (2) the licensee raises sufficient capital, but at a lower stock price than currently valued and/or (3) the operations and future cash flows of the licensee vary significantly from current projections, adversely affecting the viability of the business, or other negative events were to occur.
We also hold a 5% equity interest in our licensee in Argentina, for which we have no carrying value. While our licensee has paid dividends in the past, no dividends were received for the years ended December 31, 2014, 2013 or 2012.
Below are the revenue associated with, and the receivables outstanding from, our international licensees in which we maintain some ownership (dollars in thousands):
Deferred Compensation Plan Assets
The investments of the deferred compensation plan are included in other assets at fair value. See Note 11 for further discussion.
Absolute Warrants
In June 2005, we entered into a ten year trademark license agreement with Absolute, a Vancouver, British Columbia, Canada based computer theft recovery company to brand its consumer offering LoJack for Laptops®. In addition to an annual per unit royalty, we were granted 1,000,000 (on a post-split basis) warrants to purchase Absolute’s common stock with vesting on a pro rata basis over a five year period commencing on July 1, 2006. We concluded that a measurement date is not achieved until the warrants become vested and exercisable. Prior to reaching a measurement date, the fair value of unvested warrants is calculated utilizing a Black-Scholes option pricing model and the earned and unearned revenue is adjusted to fair value. Once a measurement date has been reached, the fair value of vested warrants is measured and the revenue related to the vested warrants becomes fixed with revenue recognized over the remaining term of the licensing agreement. Subsequent to reaching a measurement date, the vested warrants are accounted for as a derivative, which requires the warrants to be recorded at fair value at each reporting date with any changes in fair value being recorded in the consolidated statement of operations. We classify the gains (losses) on investments in other income (expense). During the years ended December 31, 2014, 2013 and 2012, we recognized $547,000 in revenue related to the Absolute warrants.
At December 31, 2014, there were no unvested Absolute warrants outstanding, as the five year vesting period was completed in May 2010. Short-term deferred revenue, reflecting the value of the vested warrants at the vesting dates, totaling $274,000, will be recognized ratably over the remaining life of the license agreement. As of December 31, 2014, we no longer held any shares of the Absolute common stock acquired through the exercise of the Absolute warrants.
6. FAIR VALUE MEASUREMENTS
The FASB authoritative guidance on fair value measurements defines fair value, establishes a framework for measuring fair value and expands disclosure requirements about fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
Financial assets and liabilities recorded on the accompanying consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Level 1 - Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that the company has the ability to access at the measurement date (examples include active exchange-traded equity securities, listed derivatives and most United States Government and agency securities).
Level 2 - Financial assets and liabilities whose values are based on quoted prices in markets where trading occurs infrequently or whose values are based on quoted prices of instruments with similar attributes in active markets. Level 2 inputs include the following:
•
Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds which trade infrequently);
•
Inputs other than quoted prices that are observable for substantially the full term of the asset or liability (examples include interest rate and currency swaps); and
•
Inputs that are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability (examples include certain securities and derivatives).
Level 3 - Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.
We do not have any Level 2 or Level 3 financial assets or liabilities as of December 31, 2014 or 2013.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The fair value hierarchy requires the use of observable market data when available. In instances where the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input significant to the fair value measurement in its entirety. Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability. The following table sets forth by level within the fair value hierarchy, our financial assets and liabilities that are accounted for at fair value on a recurring basis at December 31, 2014 and 2013, according to the valuation techniques we used to determine their fair values (dollars in thousands):
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain assets are measured at fair value on a nonrecurring basis. These assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments only under certain circumstances. These include cost and equity method investments that are written down to fair value when their declines are determined to be other-than-temporary, and long-lived assets or goodwill that are written down to fair value when they are held for sale or determined to be impaired.
We use Level 3 inputs to measure the fair value of goodwill and intangible assets on their annual measurement dates or if a triggering event occurs on an interim basis. For the year ended December 31, 2012, we recognized a goodwill impairment relating
to our SafetyNet reporting unit of $472,000. (See Note 4 for detail.) No impairments were recognized for the year ended December 31, 2014 or 2013.
The following table sets forth by level within the fair value hierarchy our financial assets that are accounted for at fair value on a non-recurring basis at December 31, 2014 and 2013, according to the valuation techniques we used to determine their fair values (dollars in thousands):
As of December 31, 2014, investments in international licensees included a 12.5% equity interest in our Mexican licensee, totaling $1,541,000 and a 17.5% equity interest in our Benelux licensee, totaling $500,000. In addition, we hold a 5% equity interest in our licensee in Argentina, for which we have no carrying value in our financial statements.
Our investments in the aforementioned licensees are carried at cost and adjusted only for other-than-temporary declines in fair value, distributions of capital and additional investments made. We periodically review the carrying value of these investments using Level 3 inputs such as projections of anticipated cash flows, market conditions, legal factors, operational performance, and valuations, when appropriate. We have concluded that there are no impairments to the fair value of these investments for all periods presented. The fair value of these investments is not estimated as we have determined that it would not be practicable to do so.
Financial Instruments not Measured at Fair Value
Some of our financial instruments, including cash and cash equivalents, restricted cash, accounts receivable and accounts payable are not measured at fair value on a recurring basis but are recorded at amounts that approximate fair value due to their liquid or short-term nature.
At December 31, 2014, the carrying value of $6,500,000 of our long-term debt under our multicurrency revolving credit agreement approximated the fair value, because our agreement carries a variable rate of interest which is adjusted periodically and reflects current market conditions. (Also see Note 7 below.)
7. DEBT
Our debt consists of the following (dollars in thousands):
SCI has issued a one year, 11% interest Convertible Promissory Notes to its shareholders, totaling $1,482,000. These notes mature on August 1, 2017. The amount of the notes due to noncontrolling holders of SCI, $478,000, is classified as long-term debt on our consolidated balance sheet.
On December 29, 2009, we entered into the Credit Agreement with RBS Citizens, N.A., as Lender, Administrative Agent and Lead Arranger, and TD Bank, N.A., as a Lender and Issuing Bank. The Credit Agreement provided for a multicurrency revolving credit facility in the maximum amount of USD $30,000,000, subject to a borrowing base calculation (or its equivalent in alternate currencies). The maturity date for the revolving credit loan was July 31, 2015.
On September 19, 2014, we entered into a fifth amendment to the Credit Agreement. The amendment provided for: (i) an extension of the maturity date for revolving credit loans under the Credit Agreement to July 31, 2017; (ii) a modification to the stock repurchase covenant providing for stock repurchases of up to $5,000,000 for the period commencing on the date of the amendment through the maturity date; (iii) a modification to the Debt Service Coverage Ratio to exclude permitted stock repurchases from such calculation; (iv) deletion of the financial covenant regarding capital expenditures; and (v) modifications to certain definitions including Applicable Margin and Consolidated EBITDA. As a result of the amendment, certain one-time costs related to legal proceedings and restructuring matters were to be excluded in determining our compliance with applicable financial covenants in the Credit Agreement, and costs associated with the reported quality assurance notification program were to be recognized on a net cash flow basis for this purpose.
On March 13, 2015, we entered into a commitment letter with our lenders which provides for the granting of waivers with respect to our non-compliance with certain of the existing financial covenants in our credit facility for the fiscal year ended December 31, 2014, in connection with an amendment to our Credit Agreement to be entered into by the parties. The amendment will include, among other things: (i) a reduction in our total facility commitment amount to $12,000,000 with up to $7,000,000 in outstanding borrowings on the closing date of the amendment; (ii) a mandatory reduction in our total commitment amount of $2,000,000 on August 31, 2015 and an additional $2,000,000 on October 31, 2015; (iii) an interest rate for Eurodollar loans of LIBOR plus 3.25%; (iv) a commitment fee of 0.50% on the unused portions of the credit facility, with additional quarterly commitment fees payable by us; (v) a prohibition on all dividends, stock repurchases or other restricted payments; and (vi) adjustments to certain of the financial covenants included in the Credit Agreement. Under the revised terms, our obligations under the Credit Agreement could not, at any time, exceed the lesser of (a) the commitment amount less a reserve or (b) the results of our revised borrowing base calculation. Our borrowing base will be calculated as 80% of our domestic accounts receivable. The reserve will be set at $3,000,000 and is to be reduced to $2,000,000 on August 31, 2015 and to $1,000,000 on October 31, 2015. In addition to the aforementioned terms, we will be required to maintain a minimum cash balance in the U.S. of $2,000,000 at all times as well as maintain certain financial performance measures, including minimum quick ratio and minimum adjusted EBITDA requirements. Such commitments of the lenders are subject to certain conditions, including, but not limited to, the completion of definitive documentation and no material adverse changes in our business.
As of December 31, 2014, we had total outstanding borrowings of $10,000,000 under the Credit Agreement. As a result of the aforementioned commitment letter, $3,500,000 of our total outstanding borrowings have been classified as short-term as of December 31, 2014. The interest rate on borrowings under the Credit Agreement varies depending on our choice of interest rate and currency options, plus an applicable margin. The interest rate in effect as of December 31, 2014 was 2.92%. As of December 31, 2014, we also had two outstanding irrevocable letters of credit in the aggregate amount of $502,000.
The Credit Agreement terminates on July 31, 2017, at which point all amounts outstanding under the revolving credit facility are due. The Credit Agreement is guaranteed by our United States domestic subsidiaries and is secured by all domestic assets, including our intellectual property, and a pledge of 65% of the capital stock of LoJack Ireland.
8. EQUITY AND STOCK COMPENSATION
Preferred Stock - As of December 31, 2014, we had 10,000,000 authorized shares of $0.01 par value preferred stock.
Common Stock - As of December 31, 2014, we had 35,000,000 authorized shares of $0.01 par value common stock and had reserved 3,854,068 shares for the future issuance and exercise of stock options.
Incentive Plan - In May 2008, our shareholders approved the 2008 Stock Incentive Plan, or the Incentive Plan, which provides for the issuance of stock options and the granting of restricted stock to our directors, executive officers, officers and other key employees. A total of 2,090,000 shares of common stock were authorized for issuance under the Incentive Plan, consisting of 2,000,000 new shares and 90,000 shares allocated from our 2003 Stock Incentive Plan. Beginning in May 2008, no additional grants were to be made under the 2003 plan. On May 20, 2009 and May 17, 2012, our shareholders approved an additional 2,000,000 and 750,000 shares, respectively, of common stock for issuance under the Incentive Plan. We grant stock options at exercise prices equal to the fair market value of our common stock on the date of grant. Options issued under the Incentive Plan generally become exercisable over periods of two to five years and expire seven years from the date of the grant. At December 31, 2014, there were 1,148,359 shares available for future grant under the Incentive Plan.
The following table presents activity of all stock options for the year ended December 31, 2014:
The aggregate intrinsic values in the preceding table represent the total intrinsic values based on our closing stock price of $2.54 per share as of December 31, 2014.
The total intrinsic values of options exercised for the years ended December 31, 2014, 2013 and 2012 were $165,000, $17,000 and $0, respectively. Proceeds from the exercise of stock options were $489,000, $264,000 and $0 for the years ended December 31, 2014, 2013 and 2012, respectively. Income tax deficiencies realized from the exercise of stock options and the vesting of restricted stock for the years ended December 31, 2014, 2013 and 2012 were $0, $0 and $0, respectively. The income tax benefit in excess of, or less than, previously recognized stock compensation expense is recognized in additional paid-in-capital to the extent of previously recognized excess tax benefits as calculated.
As of December 31, 2014, there was $662,000 of unrecognized compensation cost related to our stock option plans. The cost is expected to be recognized over a weighted average period of 1.5 years.
Unvested Stock - Unvested stock represents shares of common stock that are subject to the risk of forfeiture until the fulfillment of specified conditions. Our restricted stock awards generally cliff vest either on the first, second or third anniversary date of the grant.
For grants that vest based on certain specified performance criteria, the grant date fair value of the shares is recognized as compensation expense over the requisite period of performance once achievement of criteria is deemed probable. For grants that vest through only the passage of time, the grant date fair value of the award is recognized as compensation expense on a straight line basis over the vesting period. The fair value of unvested stock awards is determined based on the number of shares granted and the market value of our shares on the grant date. For the years ended December 31, 2014, 2013 and 2012, $1,119,000, $902,000 and $1,424,000 of compensation expense, respectively, has been recorded in operating expenses for unvested stock awards. As of December 31, 2014, there was $1,246,000 of unrecognized compensation cost related to unvested stock-based compensation arrangements granted under our stock plans that is expected to be recognized as compensation expense in the amounts of $737,000, $401,000 and $108,000 for the years ended December 31, 2015, 2016, and 2017, respectively.
The following table presents activity of all unvested stock for the year ended December 31, 2014:
The following table presents the total amount of stock-based compensation expense included in our consolidated statement of operations for the years ended December 31, 2014, 2013 and 2012 (dollars in thousands):
The fair value of options at date of grant is estimated using the Black-Scholes option pricing model. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Use of an option pricing model requires us to make certain assumptions with respect to selected model inputs. Expected stock price volatility was calculated based on the historical volatility of our common stock over the expected life of the option. The average expected life was based on the contractual term of the option and expected employee exercise behavior. The risk-free interest rate is based on United States Treasury zero-coupon issues with a remaining term equal to the expected life assumed at the date of grant.
The weighted-average assumptions used in the Black-Scholes option pricing model for the years ended December 31, 2014, 2013 and 2012, were as follows:
Stock Repurchase Plans - On February 28, 2006, our Board of Directors authorized our stock repurchase plan, or the Repurchase Plan. The Repurchase Plan authorized us to purchase up to 2,000,000 shares of our outstanding common stock on or before February 25, 2008. From the date of the adoption of the Repurchase Plan through December 18, 2006, we repurchased 1,244,566 shares. On December 19, 2006, the Board of Directors increased the remaining authorization to 2,000,000 shares. On February 15, 2008, our Board of Directors approved an increase of 1,000,000 shares to be repurchased under the Repurchase Plan, pursuant to a plan intended to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and additionally renewed the remaining management discretionary authority to repurchase 2,000,000 shares, for a total repurchase authorization of 3,000,000 shares as of February 15, 2008. In November 2011, we resumed our repurchase activity under the Repurchase Plan. During the year ended December 31, 2014, we did not repurchase shares under the Repurchase Plan. At December 31, 2014, 1,205,129 shares remained available for repurchase under our Repurchase Plan.
All other share repurchases in 2014, 2013 and 2012 were shares acquired from our employees or directors in accordance with our Incentive Plan as a result of share withholdings to pay income tax related to the lapse of restrictions on restricted stock and thus did not impact the shares available for repurchase under the Repurchase Plan.
9. INCOME TAXES
The components of income (loss) before provision (benefit) for income taxes and net income (loss) attributable to the noncontrolling interest are as follows (dollars in thousands):
The (benefit) provision for income taxes consists of the following (dollars in thousands):
A reconciliation of statutory federal income tax benefit at a 35% tax rate to recorded income tax expense is as follows (dollars in thousands):
The tax effects of the items comprising our deferred tax assets and liabilities are as follows (dollars in thousands):
As of December 31, 2014, in the United States we had federal net operating loss carryforwards of $20,742,000 related to the LoJack Corporation consolidated tax group, which expire between 2030 and 2034, and $8,794,000 of net operating loss carryforwards associated with our investment in SCI, which expire between 2025 and 2032. We had state net operating loss carryforwards which could result in a net benefit of approximately $1,219,000, which will expire at various dates through 2034. We also had domestic research and development tax credit carryforwards of $1,300,000, which will expire between 2029 and 2034, and United States foreign tax credit carryforwards of $238,000, which will expire in 2021 and approximately a $43,616,000 capital loss carryforward, which expired at December 31, 2014 and has been reflected within the effective tax rate’s reconciliation as a capital loss expiration.
At December 31, 2014, we had foreign net operating loss carryforwards of approximately $44,817,000 primarily related to our operations in Italy and Canada. Our net operating loss carryforwards in Italy have indefinite lives. The net operating loss carryforwards of our remaining subsidiaries expire at various dates through 2034.
At December 31, 2014, we maintain a full valuation allowance against our worldwide deferred tax assets net of deferred tax liabilities, with the exception of Ireland, which has deferred tax assets of $0. The valuation allowance decreased by approximately $10,186,000 and increased by approximately $15,426,000 and $710,000 during the years ended December 31, 2014, 2013 and 2012, respectively. The decrease in valuation allowance is primarily due to the tax effect of approximately $15,266,000 expired capital loss carryforward, net of the additional effect of the tax benefit of losses generated by both domestic and foreign jurisdictions. The increase in valuation allowance in 2013 is primarily due to the effect of reserving the tax benefit of losses generated in foreign jurisdictions and the derecognition of a $15,304,000 capital loss that had been tracked and upheld by the 2009 IRS Audit and offset by a valuation allowance. The increase in valuation allowance in 2012 is primarily due to the effect of reserving the tax benefit of losses generated in foreign jurisdictions, partially offset by a decrease in the valuation allowance due to the utilization of certain tax attributes to offset current year domestic taxable income. If sufficient evidence of our ability to generate future taxable income in the jurisdictions in which we currently maintain a valuation allowance causes us to determine that our deferred tax assets are more likely than not realizable, we would release our valuation allowance, which would result in an income tax benefit being recorded in our consolidated statement of operations.
We recorded a $176,000 benefit for income taxes for the year ended December 31, 2014. This amount is comprised of the provision for income taxes for our Irish subsidiary and miscellaneous state tax provisions.
The effective tax rate is significantly lower than the U.S. statutory rate as a result of recording a moderate taxable profit in our Irish operations. Furthermore, we recorded a tax provision on our year-to-date Irish profits and are recording no tax benefit for the year-to-date losses of the remaining entities of our worldwide group. We continue to maintain a full valuation allowance against the net deferred tax assets of the U.S. and our non-Irish foreign subsidiaries at December 31, 2014.
In general, it is the practice and intention of the Company to indefinitely reinvest the earnings of its non-U.S. subsidiaries in those operations. As of December 31, 2014, the Company has not made a provision for U.S. or additional foreign withholding taxes on approximately $8,619,000 of the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries because such earnings are considered to be indefinitely reinvested in the business. Generally, such amounts become
subject to U.S. taxation upon the remittance of dividends and under certain other circumstances. It is not practicable to estimate the amount of deferred tax liability related to investments in these foreign subsidiaries.
Uncertain Tax Positions
Due to complexity within and diversity among the various jurisdictions in which we do business, there is a risk that a governmental agency may disagree with the manner in which we have computed our taxes. Additionally, due to the lack of uniformity among all of the foreign and domestic taxing authorities, there may be situations where the tax treatment of an item in one jurisdiction is different from the tax treatment in another jurisdiction or that a transaction causes a tax liability to arise in another jurisdiction.
As of December 31, 2014 and December 31, 2013, we had no material gross unrecognized tax benefits. However, if an uncertain tax position does arise, the Company will recognize interest and penalties related to income tax matters within income tax expense. At December 31, 2014 and December 31, 2013, we had no accrued interest and penalties.
The total amount of unrecognized tax benefits was as follows (dollars in thousands):
We are subject to U.S. federal income tax, as well as income tax in multiple state and foreign jurisdictions. We have substantially concluded all U.S. federal tax matters through 2011 and state income tax matters for years through 2006. All material foreign income tax matters through 2008 have been substantially concluded as well.
10. COMMITMENTS AND CONTINGENT LIABILITIES
Lease Commitments - We lease various facilities, equipment and vehicles under operating leases whose terms expire from 2015 to 2025. Certain facility and equipment leases contain renewal options ranging from one to five years. Certain of our facility and equipment leases contain escalation clauses. For facility leases, we record the total expense of the lease on a straight-line basis over the estimated term of lease.
Minimum annual lease payments under operating leases as of December 31, 2014 are as follows (dollars in thousands):
Rental expense under operating leases aggregated approximately $5,781,000, $5,193,000 and $5,088,000 for the years ended December 31, 2014, 2013 and 2012, respectively.
Purchase Commitments and Milestone Payments - As of December 31, 2014, we had outstanding commitments for items including certain inventory material, system components, testing services, tooling equipment and software subscription services totaling approximately $2,611,000.
Loan Guarantees - We guarantee the amortized value of LoJack Units purchased by customers via auto loans underwritten by a certain financing company. Under this agreement, we will reimburse participating dealers the remaining unamortized cost of a financed LoJack Unit upon a borrower’s default within the initial eighteen months of the auto loan. This agreement terminated effective December 31, 2014 but is automatically renewed for subsequent one year terms until either of the parties provides a notification of intent to terminate the agreement. As neither party provided a notice of intent to terminate, the agreement was automatically renewed for the year ended December 31, 2015.
Payment to the participating dealers is remitted by us under this agreement on a claim-by-claim basis. Based on the unamortized cost of units sold, our maximum potential amount of future payments under this agreement, assuming the default of all participants, is $5,127,000 as of December 31, 2014. Our expected obligation is accrued based on sales to the participating
dealers and industry default statistics. As of December 31, 2014, we had accrued $102,000 under this guarantee. Accruals for loan guarantees are recorded as a reduction of revenue in the consolidated statement of operations.
Contingencies - From time to time, we are engaged in certain legal matters arising in the ordinary course of business and in certain matters more fully described below. The results of legal proceedings cannot be predicted with certainty. Should we fail to prevail in any of these legal matters, our financial condition and results of operations could be materially adversely affected.
Brazilian Licensee Litigation
As previously reported, on September 27, 2011, LoJack Ireland, a subsidiary of LoJack Corporation, received a demand for arbitration with the International Centre for Dispute Resolution of the American Arbitration Association (“ICDR”) filed by Tracker do Brasil LTDA (“Tracker”), which licenses the LoJack technology in Brazil. The demand for arbitration was made by Tracker following the stipulation by the parties to the entry of an order in Norfolk Superior Court in Massachusetts that Tracker’s dispute be re-filed for arbitration with the ICDR. The filing alleged interference with contractual relations, fraud/intentional misrepresentation, negligent misrepresentation, breach of contract, breach of the implied covenant of good faith and fair dealing, and violation of Mass. Gen. Laws c. 93A relating to product pricing and the fulfillment of purchase orders to the licensee. The claimant sought, among other things, $55,000,000 in actual damages, treble damages, and attorneys' fees, and also declaratory and injunctive relief.
On November 22, 2011, LoJack Ireland brought a counterclaim against Tracker in the ICDR. The counterclaim asserted Tracker’s breach of contract, breach of the implied covenant of good faith and fair dealing, business defamation, negligent misrepresentation, and violation of Mass. Gen. Laws c. 93A, and sought recovery of monetary damages from past and continuing economic injury as well as damages and reasonable attorneys' fees and costs under Mass. Gen. Laws c. 93A.
On June 28, 2012, the arbitration proceedings were bifurcated into a liability and a damages phase.
On August 7, 2012, Tracker agreed to arbitrate LoJack Ireland’s counterclaims.
On April 19, 2013, LoJack Ireland submitted an amended counterclaim pursuant to a ruling by the arbitration panel, which permitted LoJack Ireland to amend its counterclaims, asserting that Tracker is selling or leasing competitive non-LoJack products. The Amended Counterclaim reasserted LoJack Ireland's prior counterclaims and alleges Tracker’s additional violations of the Lanham Act, Mass. Gen. Laws ch. 266, § 91, and the Massachusetts common law, as well as additional grounds for Tracker’s breach of contract, breach of the implied covenant of good faith and fair dealing, and violation of Mass. Gen. Laws c. 93A. In addition to monetary damages from past and continuing economic injury and reasonable attorneys' fees and costs, LoJack Ireland sought injunctive relief, disgorgement of all profits and/or pecuniary gain derived directly or indirectly from Tracker’s trademark infringement, unfair competition, and trademark dilution, and a declaratory judgment that the License Agreement with Tracker is terminated as a result of Tracker do Brasil LTDA's material breaches thereof.
On December 24, 2013, the arbitration panel issued a preliminary injunction against Tracker, enjoining Tracker and its officers, employees and agents from using, publishing, disseminating or circulating LoJack trademarks, trade names, copyrights or other intellectual property or confidential information to advertise, market, sell or lease non-LoJack products, or in any other way representing that a non-LoJack product is a LoJack product. In addition, to the extent Tracker uses the “LoJack” name or intellectual property in any advertising or marketing communications for stolen vehicle recovery products, such name or intellectual property may only be associated with, and related to, those products that are manufactured or licensed by LoJack. Further, to the extent Tracker advertises, markets or offers to sell, lease or otherwise disseminate other stolen vehicle recovery products, Tracker must clearly state and identify the manufacturer, licensor, or distributor of such non-LoJack products with at least the same prominence that is used to name and identify LoJack products and in such a manner that the non-LoJack products cannot be confused as being LoJack products.
The hearings on the liability phase and the Amended Counterclaim of the arbitration were completed in March 2013 and in November 2013, respectively.
On May 9, 2014, the arbitration panel issued a partial final award on the liability phase of the arbitration, dismissing all of Tracker’s claims against LoJack Ireland. LoJack Ireland’s counterclaims against Tracker for breach of contract and breach of the implied covenant of good faith and fair dealing were upheld in material part, as noted further below. LoJack Ireland’s counterclaim that Tracker engaged in unfair competition was also upheld.
The arbitration panel ruled that Tracker made unauthorized use of LoJack’s trademarks, copyrights, technology and other confidential information to advertise, lease, sell or market non-LoJack products, representing them to the public as LoJack products. The arbitration panel also ruled that Tracker’s conduct violated Massachusetts common law of unfair competition. In addition to Tracker’s use of LoJack’s trademarks/trade names and copyrights to sell non-LoJack products, the panel found that Tracker “passed off” non-LoJack products as LoJack products and that this conduct did deceive or likely could deceive customers into believing that they were buying a LoJack product when they were not. The arbitration panel found that such conduct constitutes unfair
competition under Massachusetts common law. LoJack Ireland’s Lanham Act, Mass. Gen. Laws ch. 266, § 91, Mass. Gen. Laws c. 93A, and defamation claims against Tracker were dismissed.
Also, because Tracker failed to meet its minimum unit purchase requirements under the parties’ License Agreement, the panel further concluded that LoJack Ireland has the right to terminate such License Agreement upon the giving of 60 days written notice to Tracker.
The arbitration panel reserved jurisdiction for the purpose of determining damages and costs in favor of LoJack Ireland at a future damages phase of the arbitration. Except for these issues, the partial final award is in full and final settlement of all claims and counterclaims submitted to the arbitration panel with respect to liability.
On July 12, 2014, the arbitration panel issued a further ruling, holding that Tracker has not adequately informed its customers that some of the stolen vehicle recovery units that Tracker is providing to them were made by a Chinese manufacturer. Tracker was ordered to send letters to both its insurance company customers and to its individual customers, informing them that Tracker has been marketing and leasing stolen vehicle recovery tracking devices that customers may have thought were LoJack products, but that some of these tracking devices actually are manufactured by another company.
On January 28, 2015, LoJack Ireland reached a legal settlement with Tracker with respect to the counterclaims included in the arbitration. Under the settlement, Tracker is required to pay LoJack Ireland $2,000,000 in cash and provide $3,000,000 of value in the form of gross margin through product sales. The cash payments are to be paid by Tracker evenly over the twelve months ending January 2016. Of the total value, $4,000,000 is expected to be received by LoJack in 2015 and the remaining $1,000,000 in the first seven months of 2016. The product sales are a combination of last time purchases by Tracker in Brazil and other purchases by Tracker affiliates with valid license agreements in other territories. The settlement also terminates all litigation between the parties, although LoJack Ireland’s damages claim may be re-instated in the event that Tracker does not comply with the terms of the settlement agreement, and also provides for the immediate termination of Tracker as LoJack’s exclusive licensee in the country of Brazil.
New York Litigation
On October 13, 2010, a suit was filed by G.L.M. Security & Sound, Inc. against LoJack Corporation in United States District Court for the Eastern District of New York, or the New York Court, alleging breach of contract, misrepresentation, and violation of the New York franchise law, violation of Mass. Gen. Laws c. 93A and the Robinson-Patman Act, among other claims. The plaintiff sought damages of $10,000,000, punitive damages, interest and attorney’s fees, and treble damages. The Company filed a motion to dismiss all counts. Thereafter, G.L.M. moved to amend its complaint and to add a claim for breach of fiduciary duty. The Company then filed an opposition to G.L.M.'s motion to amend and sought dismissal of all counts.
On September 30, 2011, the New York Court ruled on the motions referenced above and denied, as futile, the plaintiff's request to amend the complaint with respect to the misrepresentation, New York franchise law, violation of Mass. Gen. Laws c. 93A and breach of fiduciary duty claims. The New York Court granted the plaintiff permission to re-plead the tortious interference with business relations and Robinson-Patman Act claims. The breach of contract and breach of covenant of good faith and fair dealing claims also remained viable.
On October 14, 2011, the plaintiff filed a motion for reconsideration of the dismissal of the violation of Mass. Gen. Laws c. 93A and the violation of the New York franchise law claims. The Company opposed this motion.
On November 21, 2011, the plaintiff filed its First Amended Complaint, alleging breach of contract, breach of the covenant of good faith and fair dealing, tortious interference with business relations, violation of the New York Franchise Act, violation of Mass. Gen. Laws c. 93A and the Robinson-Patman Act, among other claims. On December 5, 2011, the Company moved to strike the First Amended Complaint in its entirety, including those portions of the First Amended Complaint previously dismissed or subject to the pending motion for reconsideration, and in the alternative for dismissal of some or all claims.
On September 28, 2012, the New York Court entered a Memorandum & Order deciding all of the pending motions. The Court dismissed the plaintiff's claims for tortious interference and violation of the Robinson-Patman Act. The Court denied plaintiff's motion for reconsideration of the previously dismissed claim for violation of the New York Franchise Act. The Court also struck plaintiff's request for punitive damages and attorney's fees in connection with its breach of contract and duty of good faith and fair dealing claims. The Court reconsidered its prior decision and allowed plaintiff's Mass. Gen. Laws c. 93A claim to proceed on a limited basis.
On November 12, 2013, the Company filed a motion seeking summary judgment on G.L.M.'s three remaining counts as well as its counterclaim against G.L.M. G.L.M. opposed the Company's request for summary judgment and also filed a cross-motion for summary judgment on a portion of its breach of contract claim. The United States District Court, Eastern District of New York heard oral argument on all of these pending motions on February 12, 2014. The Court took all matters under advisement.
On September 19, 2014, the Court entered summary judgment in favor of the Company on G.L.M’s three remaining claims for breach of contract, breach of the duty of good faith and fair dealing, and violation of Mass. Gen. Laws c. 93A. The Court denied G.L.M.’s attempt to amend its complaint on the basis of futility and undue delay. The Court also entered summary judgment in favor of the Company on its counterclaim for breach of contract. The Court set a deadline for the parties to provide a schedule to brief the issue of monetary damages related to the Company’s successful counterclaim for breach of contract.
The Company intends to pursue all rights and remedies available to it in connection with its counterclaim. The decision of the Court remains subject to possible appeal by G.L.M. The Company cannot predict the ultimate outcome of the case nor the amount of damages that the Company may be awarded by the Court.
Battery Evaluation
We were notified in 2013 by some of our international licensees that some of the batteries manufactured by our former battery manufacturer, EVE Energy Co., Ltd., or EVE, and included in self-powered LoJack Units these licensees had purchased from us exhibited degraded performance below LoJack’s quality standards. These notifications led us to perform our own investigation. While our investigation is still underway, we have confirmed that batteries manufactured by EVE that were included in certain self-powered LoJack Units sold in the United States and to our international licensees are exhibiting variability in performance that could impact the ability of the LoJack Unit to transmit a signal when called upon for stolen vehicle recovery. We manufacture both vehicle and self (battery) powered LoJack Units and this degraded performance only potentially affects the transmit battery pack in our self-powered units. As of the date of this report, the majority of LoJack Units in circulation are vehicle powered.
In our effort to maintain a high recovery rate of stolen vehicles with LoJack Units, we commenced a quality assurance notification program in the U. S. related to the battery evaluation for vehicle product customers with EVE batteries in self-powered LoJack Units currently under base or extended warranty. As of the date of this report, we have recorded an accrual in the amount of $8,040,000 with respect to certain costs associated with this program and other business concessions related to the EVE battery performance matter, based on our best estimates where a potential loss is considered probable. Because of the on-going nature of this matter, we cannot predict what other actions will be required or otherwise taken by LoJack, nor can we predict the outcome nor estimate the possible loss or range of loss with respect to any such actions.
The Company and its subsidiaries have incurred, and expect to continue to incur, significant costs and expenses related to the on-going investigation of the reported battery evaluation and the actions that we have decided to take to address this matter. These costs and expenses may include, among others, those related to quality assurance programs, product or battery replacements, warranty claims, extension of product warranties, legal and other professional fees, litigation, and payments or other business concessions to our B2B customers. On October 27, 2014, the Company and LoJack Ireland commenced arbitration proceedings against EVE by filing a notice of arbitration with the Hong Kong International Arbitration Centre. The filing alleges that EVE breached representations and warranties relating to the quality and performance of the batteries supplied by EVE. We have also filed a formal claim under our relevant insurance policy and, as of the date of this report, are in discussions with our insurance carrier as to whether this matter will be covered by insurance. Our relevant insurance policy provides up to $5,000,000 of coverage and includes a deductible of $100,000. There can be no assurances that we will be able to recover any amounts from EVE or our insurance company to help reduce our financial exposure.
11. EMPLOYEE BENEFIT PLANS
We have a profit sharing plan with a Section 401(k) feature to provide retirement benefits covering substantially all of our full-time domestic employees. Under the provisions of the plan, employees are eligible to contribute a portion of their compensation within certain limitations as established by the plan and the Internal Revenue Code. On March 26, 2009, our Board of Directors amended the Company’s 401(k) Plan to make the Company’s match of employee contributions discretionary on the part of the Company. Our Board of Directors elected to match 50% of employee contributions (100% of employee contributions for those individuals with more than five years of service) up to a maximum of 6% of the participants’ compensation, for the years ended December 31, 2014, 2013 and 2012, subject to certain limitations. Company contributions become fully vested after five years of continuous service. Company contributions related to the plan were approximately $1,236,000, $1,629,000 and $1,517,000 for the years ended December 31, 2014, 2013 and 2012, respectively.
We also maintain a nonqualified deferred compensation plan for the benefit of our key employees. The plan allows for eligible employees to defer a percentage of their total cash compensation. The plan also provides for the Company to make matching contributions of 50% of employee contributions (100% of employee contributions for those individuals with more than five years of service) up to a maximum of 6% of their total cash compensation, however in March 2009 the Board of Directors voted to suspend the matching contributions. Company contributions become fully vested three years after contribution. We may also make discretionary contributions to the deferred compensation plan. No company contributions were made to the nonqualified deferred compensation plan during the years ended December 31, 2014, 2013 or 2012.
Our investments associated with our nonqualified deferred compensation plan consist of mutual funds that are publicly traded and for which market prices are readily available. The investments of the deferred compensation plan are included in other assets at fair value (also refer to Note 6). Investments related to the deferred compensation plan are classified as trading securities and reported at fair value with unrealized gains and losses included in other income (expense) in the consolidated statement of operations. The other income (expense) is offset in equal amounts by adjustments to compensation expense recognized and included in general and administrative expenses. Our investments in the deferred compensation plan are reported as long-term assets on our consolidated balance sheets. Our liabilities to the participants in the deferred compensation plan, which are equal to the fair value of the assets in the plan, are reported as long-term accrued compensation on our consolidated balance sheets.
12. BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION
We have three separately managed and reported business segments: North America, International and All Other. The accounting policies of our segments are consistent with those policies described in Note 1.
Our North America segment includes our domestic operation which sells products that operate in all or a portion of 29 states and the District of Columbia, in the United States as well as LoJack Canada, a provider of stolen vehicle recovery products and services in Canada.
Our International segment sells products, licenses or owns and operates LoJack proprietary vehicle recovery technology in 30 countries and territories throughout Europe, Africa and Latin and South America and our wholly owned subsidiary in Italy, LoJack Italia, SRL, or LoJack Italia. For the years ended December 31, 2014, 2013 and 2012, LoJack Italia had revenue of $5,774,000, $3,727,000 and $3,418,000 and operating losses of $3,683,000, $3,437,000 and $3,545,000, respectively. As of December 31, 2014 and 2013, LoJack Italia had assets of $2,965,000 and $2,040,000, respectively.
In 2008, we acquired the assets of Locator Systems (now known as SafetyNet) and SCI, providers of technology for the tracking and rescue or recovery of people at risk of wandering and valuable cargo and business information, respectively. The financial statement impact of these businesses is included in the All Other segment below.
The following table presents information about our operating segments for 2014, 2013 and 2012 (dollars in thousands). Certain general overhead costs have been allocated to the North America and International segments based on methods that we consider to be reasonable.
The following table presents information about our geographic revenue, based on the location of our customers, for 2014, 2013 and 2012 (dollars in thousands):
The following table presents information about our revenue, by product and service lines, for 2014, 2013 and 2012 (dollars in thousands):
(1) Prior to our adoption of ASC 605 as of January 1, 2011, the Early Warning Unit and ongoing notification service were considered to be one unit of accounting. In 2014, 2013 and 2012, the above includes service revenue related to the delivery of the Early Warning ongoing notification service of $3,152,000, $2,222,000 and $1,341,000, respectively.
The following table presents information about our long-lived assets, by geographic location, as of December 31, 2014, 2013 and 2012 (dollars in thousands):
13. UNAUDITED QUARTERLY RESULTS
Our unaudited quarterly results are summarized below (dollars in thousands, except per share data):
14. RESTRUCTURING ACTIVITIES
During the fourth quarter of 2014, the Company announced a plan to consolidate our Canadian operations to reduce costs and more closely align the Canadian business with our U.S. operations. As a result of this plan, we incurred a pre-tax charge of approximately $2,396,000 in the fourth quarter of 2014. We expect to complete the program during the second quarter of 2015. Substantially all of these charges will result in cash expenditures over the next nine fiscal quarters.
The following table summarizes our restructuring activity during the years ended December 31, 2014 and 2013:
The following table summarizes our total restructuring charges incurred during the years ended December 31, 2014 and 2013 as well as charges incurred to date by segment:
The following table summarizes our accrued restructuring balance and associated activity from December 31, 2013 through December 31, 2014:
ITEM 9
ITEM 9 -
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A
ITEM 9A -
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively) have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
Changes in Internal Control Over Financial Reporting
There were no significant changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of financial reporting. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. Based on our evaluation under the 2013 framework, Internal Control - Integrated Framework, we concluded that our internal control over financial reporting was effective as of December 31, 2014.
Our internal control over financial reporting was audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report appearing below.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
LoJack Corporation:
We have audited the internal control over financial reporting of LoJack Corporation and subsidiaries (the “Company”) as of December 31, 2014, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Controls Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2014, and our report dated March 16, 2015 expressed an unqualified opinion on those financial statements.
/s/ Grant Thornton LLP
Boston, Massachusetts
March 16, 2015
ITEM 9B
ITEM 9B -
OTHER INFORMATION
On March 13, 2015, we entered into a commitment letter with our lenders which provides for the granting of waivers with respect to our non-compliance with certain of the existing financial covenants in our credit facility for the fiscal year ended December 31, 2014, in connection with an amendment to our Credit Agreement to be entered into by the parties. The amendment will include, among other things: (i) a reduction in our total facility commitment amount to $12,000,000 with up to $7,000,000 in outstanding borrowings on the closing date of the amendment; (ii) a mandatory reduction in our total commitment amount of $2,000,000 on August 31, 2015 and an additional $2,000,000 on October 31, 2015; (iii) an interest rate for Eurodollar loans of LIBOR plus 3.25%; (iv) a commitment fee of 0.50% on the unused portions of the credit facility, with additional quarterly commitment fees payable by us; (v) a prohibition on all dividends, stock repurchases or other restricted payments; and (vi) adjustments to certain of the financial covenants included in the Credit Agreement. Under the revised terms, our obligations under the Credit Agreement could not, at any time, exceed the lesser of (a) the commitment amount less a reserve or (b) the results of our revised borrowing base calculation. Our borrowing base will be calculated as 80% of our domestic accounts receivable. The reserve will be set at $3,000,000 and is to be reduced to $2,000,000 on August 31, 2015 and to $1,000,000 on October 31, 2015. In addition to the aforementioned terms, we will be required to maintain a minimum cash balance in the U.S. of $2,000,000 at all times as well as maintain certain financial performance measures, including minimum quick ratio and minimum adjusted EBITDA requirements. Such commitments of the lenders are subject to certain conditions, including, but not limited to, the completion of definitive documentation and no material adverse changes in our business.
PART III
ITEM 10
ITEM 10 -
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Code of Ethics
Our Amended and Restated Code of Business Conduct and Ethics, or the Code of Business Conduct and Ethics, applies to our directors, officers and employees. The Code of Business Conduct and Ethics is posted on our website, www.lojack.com, under the heading “ABOUT LOJACK”, then under the heading “Investor Relations - Corporate Governance”. Any waiver for directors or executive officers from a provision of the Code of Business Conduct and Ethics must be approved by our Board of Directors and shall be disclosed on a Form 8-K within four business days. Additionally, we intend to satisfy our disclosure requirement regarding any amendment to the Code of Business Conduct and Ethics by posting such information on our website within four business days.
Our website address is included in this Annual Report on Form 10-K as a textual reference only and the information in our website is not incorporated by reference into this Annual Report on Form 10-K.
See Item 1, Business - Executive Officers of the Registrant.
The remainder of the information required by this Item 10 is incorporated herein by reference to our definitive Proxy Statement for our 2015 Annual Meeting of Shareholders, or our definitive Proxy Statement, under the headings “Proposal No. 1 - Election of Directors,” “Corporate Governance” and “Section 16(a) Beneficial Ownership Reporting Compliance.”
The information required by this Item 11
ITEM 12 -
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item 12 is incorporated herein by reference to the information appearing in our definitive Proxy Statement under the headings “Security Ownership of Certain Beneficial Owners and Management Shareholders."
The following table provides a summary, as of December 31, 2014, of shares of our common stock reserved for issuance pursuant to all of our current equity compensation plans (the 2003 Plan and the 2008 Plan):
ITEM 13
ITEM 13 -
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item 13 is incorporated herein by reference to our definitive Proxy Statement under the headings “Policy Governing Related Person Transactions” and “Corporate Governance.”
ITEM 14
ITEM 14 -
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item 14 is incorporated herein by reference to our definitive Proxy Statement under the heading “Auditors.”
PART IV
ITEM 15
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements
The following documents are filed as part of this annual report:
The financial statements and report of the independent registered public accounting firm required by this Item are included in Part II, Item 8.
(b) Exhibits
*
Indicates an exhibit which is filed herewith.
**
Indicates an exhibit which is furnished herewith.
++
Indicates an exhibit which constitutes a management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacity and on the dates indicated.