The Daily Magic Formula Stock for 02/20/2008 is LoJack Corp. According to the Magic Formula Investing Web Site, the ebit yield is 20% and the EBIT ROIC is 75-100 %.
Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.
Dailystocks.com makes NO RECOMMENDATIONS whatsoever, and provides this for informational purpose only.
THE LOJACK AND BOOMERANG SYSTEMS
The LoJack System
The LoJack System is based on radio frequency, or RF, technology. In the United States, the LoJack System is comprised of a Registration System, which we maintain and operate; a Sector Activation System, or SAS, and Vehicle Tracking Units, collectively the Law Enforcement Components, each operated by law enforcement officials; and a LoJack Unit. The LoJack System is designed to be integrated with existing law enforcement computer systems and telecommunication systems and procedures. 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 throughout the coverage areas (for detail see Global Presence section below) is used to lead law enforcement officers to the stolen vehicle using sophisticated direction-finding technology to locate the source of the tracking signal emitted from the LoJack Unit in the stolen vehicle.
Under agreements with state and local governmental agencies, we furnish the Law Enforcement Components to state, county and municipal law enforcement agencies at no or nominal cost to the agencies. The installation, testing and maintenance of the Law Enforcement Components are primarily our responsibility. The local law enforcement agency operates the Law Enforcement Components as required during the term of each state, county or municipalityâ€™s agreement with us. The agreements with the applicable law enforcement agencies generally are for initial terms of up to five years. To date, substantially all such agreements that would have expired have been renewed or are in the process of renewal. Renewal or extension of any such agreement may be subject to competitive bidding. We have no legal obligation to customers to provide ongoing systems support and maintenance or to refund any of the purchase price if these agreements expire and are not renewed, or are terminated either by us or by the local law enforcement agencies.
We believe that the benefits to consumers from the LoJack System include the following:
Better than a 90% recovery rate in the United States;
Covert installation which decreases the chance of a system disablement;
RF based technology that penetrates buildings and containers to facilitate tracking and recovery of vehicles that are hidden from view;
Direct integration with law enforcement in the United States and in some foreign jurisdictions, which results in (i) the automatic activation of the LoJack Unit upon a report of theft to police, and (ii) tracking and recovery by police; and
Insurance premium discounts are mandated or offered in some foreign markets and some states within the United States.
The Boomerang System
The Boomerang System is based on RF and cellular technology and uses its internally developed tracking devices and the wireless networks of major regional telecommunications companies for locating and tracking stolen assets. The cellular coverage area for Boomerangâ€™s tracking of stolen assets includes most of North America; however its service area is primarily in Canada. The Boomerang network consists of the Boomerang Tracking System that is installed in a purchaserâ€™s vehicle, the cellular network, the Boomerang Security Center and Boomerang Vehicle Tracking Units. If a car equipped with a Boomerang Unit is stolen, the vehicle owner is instructed to report the theft to the local police department and the Boomerang Security Center. When the Boomerang Security Center is advised of a theft after a police report has been filed, it 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. After the Boomerang Unit has begun to transmit a tracking signal, a Boomerang Tracking Vehicle is dispatched to the approximate location of the Boomerang Unit. In the provinces of Ontario and British Columbia we use third parties to perform tracking. The Vehicle Tracking Units use sophisticated direction-finding technology to locate the source of the tracking signal emitted by the Boomerang Unit which, with the integration and/or assistance of local law enforcement personnel, leads to the recovery of the stolen vehicle. Boomerang is in the process of transitioning from analog to digital cellular service.
THE LOJACK ADVANTAGE OVER GPS FOR STOLEN VEHICLE RECOVERY
Unlike systems based on Global Positioning System, or GPS, including technology such as OnStar Â® , our technologies can penetrate buildings and containers for the effective tracking and recovery of stolen mobile assets hidden from view. We differ from such GPS products in that our products are covert without any visible antennas or markings on the vehicle indicating presence of the system. Additionally, the direct integration of the LoJack System with law enforcement in the United States results in the automatic activation of the LoJack Unit upon the vehicle ownerâ€™s report of the theft to police; no third party intermediaries are involved in the activation or tracking process.
PRODUCTS AND TECHNOLOGY
The LoJack Unit is the component of the LoJack System that is installed in a purchaserâ€™s vehicle. The LoJack Unit consists of a very high frequency, or VHF, transponder with antenna, microprocessor and power supply and contains a set of codes unique to the unit. The LoJack Unitâ€™s transmitter is activated upon receipt of its unique activation code from the SAS. The routine entry of a stolen vehicle report into domestic law enforcement information systems in jurisdictions where the LoJack System is operational causes the SAS to broadcast the unique activation code to the LoJack Unit in the stolen vehicle, in turn causing the LoJack Unit to transmit a signal. An activated LoJack Unit will continue to broadcast until it receives a properly coded message to stop. The deactivation command is automatically sent to the LoJack Unit upon entry of theft or recovery information in the law enforcement information system in jurisdictions where the LoJack System is operational. All transmissions are made on a nationwide radio frequency allocated by the Federal Communications Commission, or FCC, as a law enforcement radio service.
LoJack Early Warning â„˘ , sold as an optional component of the LoJack System, provides early notification to a vehicle owner in the event an unauthorized user operates the vehicle. LoJack Early Warning consists of a uniquely coded key pass and a motion sensor that works with the LoJack Unit to monitor vehicle movement and detect the presence of the registered ownerâ€™s key pass. Should the vehicle move without the presence of the registered ownerâ€™s key pass, a communication from the LoJack Unit in the vehicle is transmitted to the LoJack Control Center, a company-maintained database that provides automatic notification via e-mail, pager, and/or home, work or cell phone call to the vehicle owner.
LoJack for Construction Equipment is designed specifically for installation on heavy equipment. It functions similarly to the traditional LoJack Unit, but has been modified to meet the Society of Automotive Engineers design standards for use on heavy-duty vehicles.
LoJack for Motorcycles, a product that was launched in 2005, is designed specifically for installation in â€śon roadâ€ť motorcycles. It functions similarly to the traditional LoJack Unit, but has been modified and reduced in size so that it can be covertly installed in the limited space of a motorcycle.
We also offer warranty products that may be purchased to supplement the original purchaserâ€™s warranty. These warranty products include: LoJack Extended Limited Recovery Warranty, LoJack Guarantee Plus 5000 (all states but New York) and LoJack Protection Plus 5000 (New York only). For more information on our warranty products see Product Warranty section below.
We license Absolute Software to market computer theft recovery products under the brand name â€śLoJack for Laptops.â€ť When a computer in which the â€śLoJack for Laptopsâ€ť product is installed is reported stolen and subsequently connects to the Internet, the computer sends a signal to Absoluteâ€™s monitoring center to identify its location and provide certain other information. Absolute then works with local law enforcement and internet service providers to recover the computer.
The Boomerang Unit is the component of the Boomerang Tracking System that is installed in a purchaserâ€™s vehicle. The Boomerang Unit consists of a cellular band RF transponder with antenna, microprocessor and power supply.
If a car equipped with a Boomerang Unit is stolen, the vehicle owner reports the theft to the local police department and the Boomerang Security Center. When the Security Center is advised of a theft and after a police report has been filed, the Security Center locates the approximate location of the Boomerang Unit via a secure connection with the cellular carrier network and then sends a unique code causing the Boomerang Unit to transmit a tracking signal. A tracking vehicle is dispatched in the general area reported by the Boomerang Unit. The Vehicle Tracking Units, installed in Boomerang tracking vehicles use sophisticated direction-finding technology to locate the source of the tracking signal emitted from the Boomerang Unit. Upon location of the stolen vehicle, Boomerang Vehicle Tracking personnel notify local law enforcement, who recover the vehicle. In 2005, Boomerang introduced the BoomerangXpress unit. Although the BoomerangXpress is similar in design and functionality to the Boomerang Unit, the Boomerang Unit is installed in high end luxury vehicles, the BoomerangXpress Unit is targeted to the mid-price vehicle market.
In 2006, Boomerang introduced next generation products called Boomerang Espion and Espion Alert. Utilizing multiple wireless sensors, these products are expected to increase the effectiveness of the recovery system. In the event that one of the sensors is compromised, the remaining sensors will continue to operate and transmit tracking data to Boomerangâ€™s Security Center or tracking vehicle.
The Boomerang2 and Boomerang Espion Alert Units are products that build upon the Boomerang Unit by integrating two-way communication and diagnostics to provide automatic theft notification by sending a tracking signal upon any unauthorized vehicle movements. A key fob, used in connection with both Units, contains a uniquely coded key pass and a motion sensor, which monitors vehicle movement and detects the presence of the registered ownerâ€™s key pass. The Boomerang 2 and Boomerang Espion Alert Units also monitor any tampering with the car battery. Should the motion sensor detect that the vehicle is moving without the presence of the registered ownerâ€™s key pass, an automatic call is made by the Unit to the Boomerang Security Center indicating an alarm on the customer car. The Security Center then contacts the client to verify the status of the vehicle. If it is determined the vehicle has been stolen, the Security Center proceeds with the same tracking and recovery steps as noted for the traditional Boomerang Unit.
The Water Resistant Boomerang Unit is designed specifically for installation on construction equipment and marine craft. It functions similarly to the traditional Boomerang Unit, but is enclosed in a water resistant housing.
The Portable Boomerang Unit is designed for installation in special applications such as cargo. It functions similarly to the traditional Boomerang Unit, but is equipped with a longer lasting battery, enabling its operation without a connection to an independent power source.
The LoJack System presently operates in all or a portion of 26 states and the District of Columbia in the United States. We have available statewide coverage, defined as coverage of at least 80% of the state population, in Arizona, California, Connecticut, the District of Columbia, Maryland, Massachusetts, Michigan, New Jersey and Rhode Island. We have coverage available in major metropolitan areas, cities and high crime areas in Colorado, Delaware, Florida, Georgia, Illinois, Louisiana, Nevada, New Hampshire, New York, North Carolina, Ohio, Oregon, Pennsylvania, Tennessee, Texas, South Carolina, Virginia and Washington. We identify and define coverage areas based on a qualitative analysis of population density, new car sales, geography and distribution of LoJack Units.
Internationally, our licensed and owned and operated stolen vehicle recovery technology is operational in 28 countries and territories around the world. We have a licensed presence in countries located in Latin and South America, Europe and Africa, and the Asia Pacific Rim. We also operate Canadaâ€™s leading stolen vehicle recovery provider, Boomerang, with sales concentrated in the provinces of Quebec and Ontario. In 2006, we began commercial activities in Italy through a wholly-owned subsidiary, and expanded from Rome into Milan. In 2005, the central government of the Peopleâ€™s Republic of China approved use of a designated frequency for operation of a LoJack stolen vehicle recovery system initially within the Beijing, Tianjin and Hebei Province areas. In 2006, we entered into a license agreement for the Peopleâ€™s Republic of China, and our licensee is in the process of establishing a radio network, organizational infrastructure and commercial operations in the regions covered by the radio frequency license.
Our revenues in the United States are derived primarily from the sale of LoJack Units, LoJack Early Warning Units, related products and extended product and non-recovery warranties directly to consumers and through automobile dealers. Revenues from the domestic segment comprised 69%, 68% and 76% of our consolidated revenues for the years ended December 31, 2006, 2005 and 2004, respectively. Approximately 83% of domestic revenues originate through a distribution network of automobile dealers. Expansion into additional markets beyond the automotive market through the introduction of products, such as LoJack for Construction Equipment and LoJack for Motorcycles, leverages our existing network and requires no additional infrastructure. We derived approximately 6% and 3% of revenues from the sale of units of LoJack for Construction Equipment and Motorcycles, respectively during the year ended December 31, 2006.
In 2002, we initiated a program to expand our installation capability by contracting with, and certifying, select dealers and other third parties to install our products. In 2006, 41% of our LoJack Unit sales relating to our domestic dealer business were installed by third parties, compared to 38% and 27% for the years ended December 31, 2005 and 2004, respectively. We monitor the quality of these alternative installations through the use of an expanded quality control process. For all installations, whether performed by us or by a third party we maintain this service. We maintain full warranty service, both for the convenience of our automobile dealers through which the LoJack products are marketed and in order to maintain a high degree of quality control and security over our technology.
LoJack has a brand awareness of over 90% in the United States based on an awareness study conducted in 2004. We feel this brand awareness is beneficial to all existing sales channels, including automotive, commercial, motorcycle and laptops which will prove beneficial to any new channels we may decide to enter.
We began international operations in 1993 and LoJack technology is now operational in 27 countries and territories. We have developed our technology such that the LoJack System can be used either by local law enforcement, by the licenseeâ€™s own security organization, or by a combination of both. Revenues from the international segment comprised 22%, 22% and 21% of our consolidated revenues for the years ended December 31, 2006, 2005 and 2004, respectively. International revenues are derived from the sale of LoJack Units, system infrastructure components, royalties, licensing fees and subscription and installation services provided by our Italian subsidiary. Licensing agreements with international parties have thus far been primarily denominated in U.S. dollars and are structured with up-front licensing fees, which may be substantial and are non-recurring. The agreements provide that we will supply components and products at prices to be determined from time to time and/or receive royalties based upon licenseesâ€™ revenues. In 2006, approximately 86% of international revenues were from the sale of LoJack Units.
Our business model focuses primarily on the top 30 global markets. Markets are ranked based on high per capita thefts, high annual recurring sales of new vehicles and large numbers of vehicles operating in the area. Our expansion strategy in the international segment may include investments in new or existing international licensees and markets and/or the formation of new international subsidiaries.
We also have made direct investments in selected international licensees that we believe offer significant market opportunity for LoJack Unit sales. At December 31, 2006, we held a 7.74% equity investment, with a carrying value of $2,454,000, in our French licensee and a 12.5% equity investment, with a carrying value of $1,541,000, in our Mexican licensee.
We have commercial operations in Italy through our wholly-owned subsidiary, LoJack Italia, SRL. We estimate this ownership will require an investment of approximately $6.0 to $7.0 million over the next two to three years. This includes a capital investment of approximately $1.0 million to implement the LoJack network and recognition of $5.0 to $6.0 million of LoJack Italia losses in LoJackâ€™s operating results. Based on our experience with current international licensees, we believe that both the long-term profitability generated by LoJack Italia after the investment period and the value that will be created will prove to be compelling. This investment is part of our strategy to own a controlling interest in select international markets that present a significant opportunity.
Boomerang revenues are derived primarily from the sale and installation of Boomerang, Boomerang2 and BoomerangXpress Units, related products, and service contracts. Revenues from the Boomerang segment comprised 9%, 10% and 3% (which includes Boomerangâ€™s results for the last two months of 2004) for the years ended December 31, 2006, 2005 and 2004, respectively. Approximately 20% of segment revenues are derived from the sale of Boomerang, Boomerang2, BoomerangXpress and Boomerang Espion Units through auto accessory retailers and automobile dealers and approximately 80% of segment revenues are derived from service contracts. More than 45 insurance companies based in Quebec and Ontario offer rebates to customers who install a Boomerang Unit in their high priced or high risk of theft vehicles, and in many instances require installation of a Boomerang Unit in such vehicles.
Purchasers of Boomerang Units are required to purchase a service contract with Boomerang. The terms of service contracts offered range from 12 to 60 months and are payable in full upon activation of the related unit or renewal of a previous service contract. Customers are also offered a monthly payment option. As of December 31, 2006, there was approximately $11,316,000 of deferred revenue resulting from approximately 125,000 active service contracts.
VEHICLE AND ASSET THEFT
According to the Federal Bureau of Investigation Uniform Crime Report, 1.2 million vehicles were stolen in 2005, with an estimated value of $7.6 billion. Most auto theft is carried out by sophisticated professional thieves, rather than amateur thieves. Thieves typically steal vehicles because of the profit potential of the vehicleâ€™s components on the black market. The National Insurance Crime Bureau also reported that motorcycle theft totalled 70,000 stolen motorcycles in the United States and Canada in 2005, reflecting an increase of 135% over the past five years.
Interpol, which provides services for the law enforcement community to optimize the international effort to combat crime, indicated in a recent communication that more than 3 million vehicles are stolen globally each year with an estimated value of approximately $21.0 billion.
According to the Insurance Bureau of Canada website, more than 170,000 cars are stolen in Canada every year. This crime costs auto insurers and their policyholders more than $600 million a year in claims pay-outs, or about $43 per policy. In addition, auto theft costs taxpayers more than $400 million in other costs, such as court, policing and health care expenses. Collectively, the annual cost of auto theft is more than $1.0 billion. In addition, about 40 Canadians die every year as a result of auto theft and 65 are seriously injured.
SALES AND MARKETING
Our sales and marketing approach in the domestic segment focuses on the United States automotive channel, through which automobile dealerships offer the LoJack Unit as an option for both their new and used car sales. We also market LoJack Early Warning, conventional vehicle security devices, insurance products and extended warranties through automobile dealers. We market primarily through a national sales force that routinely visits new and used car dealers to educate and train dealership personnel on the benefits of the LoJack System and related products. In addition, to supplement distribution efforts, we have entered into cooperative arrangements with third parties specializing in after-market sales and installation of vehicle accessories to increase penetration in existing markets in a cost effective manner. The LoJack Unit and related products can ordinarily be financed as a part of the purchase price of the vehicle. In addition, we use direct advertising to generate product awareness among consumers. To augment our dealer channel sales efforts we produce media and advertising campaigns targeted towards the consumer to increase brand awareness and drive sales.
We also market our products directly to owners of commercial vehicles and to consumers using (i) a national sales force that calls on construction equipment owners and manufacturers, (ii) telemarketing representatives and (iii) direct mail.
We market our LoJack for Motorcycles product through the motorcycle dealer channel in much the same way we market traditional LoJack Systems through automobile dealerships.
We license the LoJack brand name to Absolute Software and SCI whose products are offered to customers who purchase laptop computers and cargo tracking units, respectively.
Sales and marketing efforts in territories where our licensees operate the business are typically controlled and funded by our international licensees and their respective management teams.
In Italy, our sales and marketing approach focuses on the Italian automotive channel, through which automotive dealerships offer the LoJack Unit, LoJack Early Warning, and extended warranties as options for new and used vehicle sales. We use a direct sales force in both Rome and Milan to visit car dealers to educate and train dealership personnel on the benefits of the LoJack System and related products. During 2006, we used public relations campaigns and cooperative advertising initiatives with certain car dealers to promote consumer awareness of our product in Italy. In the future, we intend to expand our use of the media and advertising campaigns in Italy to increase our brand awareness and to drive sales.
Our Boomerang segmentâ€™s sales and marketing efforts are concentrated in Quebec and Ontario. In Quebec, we work with insurance companies that mandate a stolen vehicle recovery system as a condition for insurance coverage on high priced or high risk of theft vehicles. We maintain a direct sales force in Quebec, which works with automotive accessory retailers and automobile dealers who sell and install Boomerang products to vehicle owners. We also sell products directly to consumers through two company-owned distribution centers. Unit sales in Quebec account for most of our unit sales in Canada.
In Ontario, we sell through the automotive channel in a similar fashion as in the United States using automobile dealers and automotive accessory retailers. We utilize a direct sales force to service dealers and retailers. We also sell to commercial markets, primarily to construction equipment owners. The commercial business is supported by a direct sales force as well as an infrastructure of dealers who are available to sell and install Boomerang Units.
Our overall goal is to strengthen our leadership position in the vehicle and mobile asset tracking and recovery market through technology leadership, financial strength, market expansion, partnerships with new and established distributors and the global development of the LoJack brand. In addition, if appropriate, we may make acquisitions as a means to add channels of distribution for the LoJack brand or as a way for us to acquire new technology which could be sold through our existing channels of distribution.
Our domestic strategy is to use internal resources and partnerships with third parties to increase unit sales and profitability in the automotive, motorcycle and commercial channels, while developing and introducing new products that leverage our brand recognition and reputation for vehicle recovery to enter new sales channels such as laptop computers and cargo.
We plan to focus on high volume dealers who maintain a large market share in their geographic areas and dealers that are part of large dealer groups, to drive more aggressive business growth through our automotive channel in the United States. We will continue to expand our varied distribution and installation programs to sell and install LoJack Systems more cost effectively.
In 2005, we introduced LoJack for Motorcycles and entered the motorcycle distribution channel. The motorcycle product leverages our existing network for tracking and recovery.
We also began shipping and installing the next generation LoJack Unit in 2005. The new unit, which offers the same stolen vehicle recovery features as the predecessor LoJack Unit, is smaller in size and has resulted in decreased manufacturing costs. (For more information on the next generation LoJack Unit, see â€śProduct Developmentâ€ť section below.)
The LoJack System now operates in 26 states and the District of Columbia, representing about two-thirds of the U.S. population. We will expand into additional markets as they become economically feasible. In 2006, we expanded into South Carolina.
Our international strategy is to drive more aggressive unit sales growth in countries where the LoJack System presently operates, including leveraging strategic relationships with insurance companies and automobile manufacturers. In addition, we expect to expand into new geographic markets. We intend to drive unit sales growth through existing licensees by helping them to develop their business models and expanding system infrastructure. From time to time, we may make direct strategic investments in international licensees, some of which may be substantial, in order to enable them to gain market share. Our investment strategy has focused on those markets which either represent the best opportunities for significant generation of revenue or where we can positively impact market penetration or revenue growth.
Our growth strategy is to target international markets in which the combination of new vehicle sales, population density and incidence of vehicle theft is high. Market expansion may be in the form of (i) continuing to license the use of the LoJack System technology, (ii) securing agreements with governments to obtain rights to own and operate a controlling interest in the system, such as in Italy, and/or (iii) making strategic investments and/or acquisitions.
With the introduction of the next generation LoJack Unit, we have a common global platform which utilizes the same basic unit to operate on the varying global radio frequencies used for stolen vehicle recovery. This new unit has contributed to international business growth, due in large part to product cost reductions achieved through manufacturing efficiencies.
In Italy, our growth strategy is to use our internal sales and marketing resources to penetrate the stolen vehicle recovery market through the automotive dealership channel. We are leveraging the extensive knowledge and experience of our domestic sales team to lay the foundation for a strong automotive dealer sales channel in Italy.
Effective January 1, 2006 we established LoJack Equipment Ireland Limited to serve as our international segment headquarters. Located in Dublin, Ireland, this operation will support business development, administrative and distribution activities for our international segment as well as provide nearby support to our European operations which we feel has a high potential for expansion of our LoJack vehicle tracking and recovery network in the coming years.
In 2006, we entered into a license agreement for the Peopleâ€™s Republic of China. Our licensee is in the process of obtaining funding and establishing a radio network, organizational infrastructure and commercial operations in the regions covered by the radio frequency license.
Our Boomerang segment growth strategy focuses on sales and marketing efforts in Quebec, Ontario and British Columbia in 2007. In Quebec, we intend to continue to work with insurance companies to maintain and extend mandates for the Boomerang System as a condition for consumers to obtain insurance coverage and to train insurance companies and insurance brokers about our services. We plan to maintain a direct sales force in Quebec, which works with the automotive accessory retailers and automobile dealers who sell and install Boomerang products. We intend to continue to utilize our two distribution centers, which sell and install Boomerang Units.
In Ontario and British Columbia, we intend to continue to sell through the automotive channel using automobile dealers and automotive accessory retailers. We intend to continue to leverage our direct sales force and segment experience in marketing directly to the automobile dealers. We believe that the automotive market in these two markets represents a substantial growth opportunity. We will focus on increasing penetration in the commercial channel using our direct sales force to call on equipment dealers and equipment owners.
We concentrate research and development activities on enhancing our proprietary stolen vehicle recovery network and creating new products that meet market needs for the tracking and recovery of valuable mobile assets. Our product development efforts utilize knowledge of law enforcement processes and systems to provide products that integrate into law enforcement operations and facilitate the tracking and recovery process. Our engineering staff develops products internally or in conjunction with third parties.
In 2005, we received the first units of the next generation LoJack Unit. We worked with a third party, Plextek Limited, or Plextek, to develop the product and secure manufacturing. The unit is scalable and flexible, with connectivity features that may allow us to develop new products combining GPS and/or cellular based communications with our existing RF based stolen vehicle recovery technology. The unit provides a common platform for both domestic and international operations by utilizing the same basic unit to operate on the varying radio frequencies used in the countries where our technology is utilized for stolen vehicle recovery. Effective the fourth quarter of 2006, prior generation LoJack units were fully phased out and Clarion Malaysia, (a subsidiary of Hitachi Limited), or Clarion, became the sole product manufacturer of LoJack Units.
We expect that we will coordinate our Boomerang, SCI and domestic segment research and development efforts to offer new products that meet market needs for the tracking and recovering of stolen mobile assets.
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. Total product development expenses totaled $5,805,000, $4,831,000 and $4,661,000 for the years ended December 31, 2006, 2005 and 2004, respectively. A portion of our product development efforts has been outsourced to third parties. The contracts with third parties require payments based upon completion of defined milestones. Expenses related to milestone achievements, included in the above-mentioned expenses, which are expensed to operations as the milestones are achieved, amounted to $355,000, $332,000 and $1,260,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
GOVERNMENT REGULATION AND APPROVAL
The FCC-allocated frequency 173.075 MHz, used by the LoJack System in the United States, is set aside for nationwide use by state and local law enforcement agencies for stolen vehicle recovery systems. Law enforcement agencies in jurisdictions where we operate have been granted authority by the FCC to use this frequency.
In connection with our domestic operations, we must obtain the approval of law enforcement agencies for implementation of the LoJack System before sales of LoJack Units may commence in a given jurisdiction. The approval process may be time consuming and costly and is subject to considerations generally affecting the process of governmental decision-making. In some jurisdictions, governmental approval may be terminable at the convenience of the executive or legislative body. Any such termination could have a material adverse effect on future sales in such jurisdictions.
If we were to seek to charge more than nominal prices for the Law Enforcement Components, governmental appropriation of funds would be required. Most government agencies have established, by policy, statute or regulation, a process requiring competitive bidding for all acquisitions of products and equipment. This process may cause us additional delay and expense. To date, we have not sought to charge law enforcement agencies more than nominal prices for the Law Enforcement Components and do not expect to do so in the near future.
Our international licensees and our owned and managed operation in Italy are subject to risks similar to those in our domestic segment with respect to government regulation and approval.
The Boomerang tracking beacon operates on an unlicensed frequency and does not require specific government approval. Tracking of stolen Boomerang-equipped vehicles is performed by our personnel or by private parties under contract with us.
Although specific governmental licensing and approval are not required, once a Boomerang-equipped stolen vehicle is located by our tracking team, we rely on police and other law enforcement agencies for the actual recovery. Establishing and maintaining a good relationship with law enforcement agencies is important to our business.
LoJack Parts & Labor Warranty. We warrant to original purchasers that the LoJack Unit and LoJack Early Warning will be free from defects in material or workmanship for a period of two years from the date of installation. If the product proves to be defective in material or workmanship, we will, at our option, either replace or repair the product.
LoJack Extended Limited Recovery Warranty . We also warrant to original purchasers of LoJack Units that if their LoJack equipped vehicle is stolen and reported 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 paid for the LoJack Unit up to a maximum of $695 (up to $995 if the consumer also purchased LoJack Early Warning). For an additional charge, the original purchaser of the LoJack Unit can elect to extend the warranty period from two years to a period equal to the time they own their LoJack equipped vehicle.
LoJack Guarantee Plus 5000 (Sold in all states in which we do business other than New York) . Consumers may purchase an additional five year warranty in which we, or in most jurisdictions an independent third party insurer, warrant to original purchasers of LoJack Units that, if the vehicle becomes a total loss due to theft, or is not recovered within 30 days from the time the theft is reported to the police, the consumer may receive up to $2,500 to cover theft-related expenses plus up to an additional $2,500 towards the purchase or lease of a replacement vehicle if the consumer returns to the original dealer. We have insured the risk relating to these warranty claims.
LoJack Protection Plus 5000 (Sold in New York State only). Consumers may purchase an additional five year certificate in which an independent third party insurer, guarantees to original purchasers of LoJack Units that, if the vehicle becomes a total loss due to theft, or is not recovered within 30 days from the time the theft is reported to the police, the consumer may receive up to $2,500 to cover theft-related expenses such as insurance deductible, substitute vehicle rental, airfare if the vehicle is stolen more than 100 miles away from home, or nightly accommodations and meals. In addition, the consumer may be eligible to receive $2,500 towards the purchase or lease of a replacement vehicle if the consumer returns to the original dealer.
Boomerang Parts & Labor Warranty . We warrant to original purchasers of Boomerang and Boomerang Espion Units that the units will be free from defects in material or workmanship for a period of five years from the date of purchase. A one-year limited warranty on parts and labor applies to BoomerangXpress Units. If the product proves to be defective in material or workmanship we will, at our option, replace or repair the product or reimburse the purchase price paid.
Boomerang Limited Recovery Warranty . We warrant to purchasers of Boomerang and Boomerang Espion Units that if a Boomerang equipped vehicle is stolen and not recovered, we will pay the consumer an amount equal to the full purchase price of the unit and service fees, up to a maximum of CAD$1,000 for the Boomerang and Boomerang Espion Units and CAD$2,000 for the Boomerang2 and Boomerang Espion Alert Units. For the BoomerangXpress Units we will offer the consumer a new unit, including installation.
PATENTS AND TRADEMARKS
We hold a patent portfolio that covers vehicle tracking, security and recovery. The portfolio includes United States Patent Nos. 5,917,423 and 6,229,988BI which expire in 2015 and 2018, respectively, covering portions of the LoJack System. Each of these patents adds to the predecessor patents by adding additional functionality that we believe yields a competitive advantage. Additional patent applications are pending. In addition, we hold proprietary information that is not patented, but is integral to the operation of the LoJack System. We believe that protection of the unpatented intellectual property will continue beyond the expiration of the stated patents.
We also hold United States Patent No. 6,522,698 covering LoJack Early Warning which expires in 2017.
Although management believes the patents have value, there can be no assurance such patents will effectively deter others from manufacturing and marketing a competitive stolen vehicle recovery system.
The LoJack name and logo are registered trademarks in the United States and many other countries. We believe that the LoJack trademark and other trademarks have sufficient recognition to give us a competitive advantage.
Our domestic segment intellectual property strategy is to apply for trademarks and for patents for our inventions whenever appropriate.
We hold patents similar to our domestic segment patents in various countries where we either currently do business or intend to do business.
Boomerang holds a patent portfolio that covers location, tracking and recovery using an existing network, vehicle location using a kinetic network, our two-way tracking beacon and anti-jamming technology. The portfolio includes United States Patent No. 5,895,436 which expires in 2016 (corresponding to Canadian Patent No. 2,203,302 which expires in 2017) United States patent No. 7,091,835B2 which expires in 2023 and Canadian Patent No. 2,395,843 (corresponding to United States Patent 6,498,565B2) which expires in 2021.
We also hold patents similar to our Boomerang segment patents in various countries where we either currently do business or intend to do business.
Although management believes the patents have value, there can be no assurance such patents will effectively deter others from manufacturing and marketing a stolen vehicle recovery system.
We have registered or filed for the registration of our trademarks Boomerang, Boomerang2, Boomerang & Design (logo), BoomerangXpress, Boomerang Espion and Boomerang Espion Alert in all of our major actual or potential markets. We believe these trademarks have sufficient recognition to give us competitive advantage in the Boomerang segment.
Our Boomerang segment intellectual property strategy is to apply for trademarks and for patents for our inventions whenever appropriate.
Our Boomerang segment is actively involved in protecting its intellectual property and has undertaken administrative and legal measures against companies, which, in our opinion, have infringed on our rights.
Mr. Murray has served as a director of the Company since 1992 and as Lead Director since May 2003. He was Chairman of the Board of New England Business Service, Inc., or NEBS, from December 1995 until June 2004. Mr. Murray also served as Chief Executive Officer of NEBS from December 1995 to December 2003. From January 1991 to December 1995, Mr. Murray was Executive Vice President, North Atlantic Group, of The Gillette Company. Prior to January 1991, Mr. Murray served as Chairman of the Board of Management of Braun AG, a subsidiary of The Gillette Company headquartered in Germany. He held a variety of other management positions at The Gillette Company since 1961. Mr. Murray also serves on the Boards of Directors of The Hanover Insurance Group (formerly Allmerica Financial Corporation), Tupperware Brands, Inc., IDEXX Laboratories, Inc. and Delhaize Group, an international Belgian food retailer.
Mr. Rosenthal has served as a director of the Company since 1997 and Chairperson of the Compensation Committee since 2002. Mr. Rosenthal held the offices of President and Chief Operating Officer and was a member of the Board of Directors of Melville Corporation (now known as CVS Corporation) from 1994 to 1996. From 1984 to 1994, Mr. Rosenthal was the President and Chief Executive Officer of the CVS Division of Melville Corporation. Mr. Rosenthal also serves on the Boards of Trustees of EQ Advisors Trust, an investment company registered under the Investment Company Act of 1940, and the Dana-Farber Cancer Institute.
Mr. MacKinnon has served as a director of the Company since 2000 and has been Chairperson of the Audit Committee since 2000. Mr. MacKinnon joined PricewaterhouseCoopers LLP in 1968 and was a partner from 1978 until his retirement in 1999. Mr. MacKinnon also serves on the Boards of Directors of BioSphere Medical, Inc. and National Datacomputer, Inc., each of which is a public company. Mr. MacKinnon is a Certified Public Accountant and is active in community affairs, including serving on the Boards of Trustees of Emmanuel College, Blessed John XXIII National Seminary and Laboure College.
Mr. Rewey has served as a director of the Company since 2002 and has been Chairperson of the Nominating/Corporate Governance Committee since 2002. Prior to joining the Board, Mr. Rewey spent 38 years with Ford Motor Company, serving as Group Vice President of North American Operations & Global Consumer Services from 2000 to 2001 and of Global Sales, Marketing & Service from 1998 to 2000, Vice President of Sales, Marketing & Customer Service for North America from 1988 to 1998, President of Ford Division and Vice President of Ford Motor Company from 1985 to 1988, President of Lincoln-Mercury and Vice President of Ford Motor Company from 1984 to 1985, National Sales & Marketing Manager of Lincoln-Mercury from 1977 to 1984 and in other sales and service capacities from 1963 to 1977. Mr. Rewey also serves on the Boards of Directors of Sonic Automotive, Inc. and Speedway Motors, Inc., each of which is a public company, and is active in business and community affairs.
Mr. Riley has served as Chairman and Chief Executive Officer since November 2006 and has been a director of the Company since February 2005. He served as our President and Chief Operating Officer from February 2005 until November 2006. Prior to joining the Company, Mr. Riley served as an officer and director of NEBS, then a public company listed on the New York Stock Exchange. He served as President and Chief Operating Officer of NEBS from 2002 to 2003 and as President, Chief Executive Officer and Chief Operating Officer from 2003 to 2004. Prior to that, he served as a Senior Vice President of NEBS from 1998 to 2002, as President, NEBS Direct Marketing from 2001 to 2002, as President, Integrated Marketing Services from 2000 to 2001 and as President of Rapidforms (acquired by NEBS in 1997) from 1992 to 2000. Mr. Riley served as a director of NEBS from 2002 to 2004. Mr. Riley is a Certified Public Accountant. He serves as a member of the Board of Directors of VistaPrint USA Incorporated, a publicly held company in the printing and graphic arts business, and Micro-Coax, Inc., a manufacturer of microwave and cable products, a privately held company.
Ms. Sharpe has served as a director of the Company since May 2006. She currently serves as Senior Vice President, Human Resources and Secretary of UST Inc. and is responsible for overseeing USTâ€™s Human Resources and corporate secretarial functions. She joined UST Inc. in May 2004 as Vice President, Human Resources and in January 2005, she was appointed Assistant Corporate Secretary of UST. Prior to joining UST, from May 1994 to July 2003, Ms. Sharpe held several senior human resources and legal positions at PepsiCo, Inc., including Chief Human Resources Attorney, Vice President of Worldwide Compensation, and most recently, Vice President of Worldwide Benefits. Previously, she held positions as senior tax attorney and tax consultant for Exxon Mobil Corporation and PricewaterhouseCoopers LLP. Ms. Sharpe received a BS degree in accounting, cum laude from Syracuse University and a JD degree from Boston University, where she was a Justice Edward F. Hennessey Scholar. She is also admitted to the practice of law in New York, New Jersey and Texas.
Mr. Waters has served as President and Chief Operating Officer and has been a director of the Company since February 2007. Prior to joining the Company, he served as Chief Operating Officer for the Wm. Wrigley Jr. Company from December 2003 through May 2006. Mr. Waters joined the Wm. Wrigley Jr. Company in 1999 as Chief Financial Officer and served as Chief Financial Officer until his elevation to Chief Operating Officer in 2003. Prior to joining the Wm. Wrigley Company, Mr. Waters held several senior executive positions of increasing responsibility with The Gillette Company from 1993 to 1999. Before joining the Gillette Company, Mr. Waters was a Partner and Practice Leader with KPMG International. Mr. Waters is a director of HNI Corporation, a public company that is a manufacturer of office furniture and hearth products. He is a Certified Public Accountant.
Mr. Cowan has served as a director of the Company since February 2007. He is Chief Executive Officer and Chairman of the Board of Lionbridge Technologies, Inc., which he founded in 1996. Prior to founding Lionbridge, Mr. Cowan was Executive Vice President and member of the Management Committee for R.R. Donnelly & Sons. He was also Chief Executive Officer of Stream International, Inc., a division of R.R. Donnelley & Sons. Mr. Cowan is a director of Dynabazaar, Inc., a public company that markets video and imaging products to the security market.
The LoJack executive compensation program includes salary, bonus, non-qualified stock options, time-vesting restricted stock and performance-based incentive restricted stock grants, matching contributions to a defined contribution (401(k)) retirement plan and a deferred compensation plan, health insurance benefits, executive physical examinations, contributions toward life and disability insurance premiums, financial and tax planning, charitable contribution matching up to $5,000 in the aggregate per year and a gross-up for the tax impact of certain benefits. Effective as of February 2007, the Company eliminated the tax gross-up paid to executive officers and in lieu thereof increased each executive officerâ€™s annual salary by $2,000. Executive officers may participate in the Companyâ€™s Employee Stock Purchase Plan on the same basis as all other employees, based on salary withholding up to a maximum of $25,000 per year.
Salary is intended to compensate executive officers at a level which is appropriate for an executive in his or her position, consistent with experience and capabilities and in an amount which is competitive with the level of compensation paid by companies of similar size, complexity, revenues and growth potential. The Compensation Committee reviews the salary information of a broader survey group of similar sized companies in the industry and a peer group of companies as compiled by an independent compensation consultant and uses such information as a guideline in establishing the salary for each executive officer. We believe that offering competitive salaries gives us the opportunity to attract and retain talented managerial employees.
The Compensation Committee believes that the relative portion of an executive officerâ€™s compensation that is variable rather than fixed should increase as the scope and level of the individualâ€™s business responsibilities increase. This allows the Company to more closely match total compensation with actual performance of the Company. Accordingly, the calculation of annual incentive bonus payments under its senior management incentive plan for executive officers is determined based on the Companyâ€™s (and/or an applicable business unit, division, or functionâ€™s) actual performance measured against objective performance criteria approved by the Compensation Committee as described below.
Revenue and operating income targets are established on an annual basis in connection with the Companyâ€™s budgeting process. These measures are believed to best reflect the short-term performance of the Company, as they are directly influenced by managementâ€™s actions and exclude investment income and other non-operating factors that affect net profit. For 2006 and 2007, achievement of the target bonus will require performance at a level which is significantly higher than the levels achieved in the prior year. The Compensation Committee believes the goals set are challenging, but achievable. When appropriate, the Compensation Committee will subsequently consider adjusting the targets to take into account developments which occur after the budget process has concluded. There is a formulaic adjustment to the target bonus based on the relative percentage of goal achievement. No bonus will be paid if the achievement of the goals falls below 80%, even if the prior yearâ€™s results are surpassed. Achievement at the level of 80% of goals will result in payment of 50% of the target bonus, with increases in payout for each incremental percent of achievement. Thus, at 100% achievement of the goals, the full target bonus will be paid. Achievement of 115% or more of goals will result in payment of 145% of target bonuses, which represents the cap. Bonuses which are based on achieving pre-determined targets range from 40% of base pay to 60% of base pay for the most senior executives.
Over the past four years, the Company has achieved performance in excess of the financial targets twice, and has achieved the maximum payout level only once. The payout percentage over the past four years has been between approximately 78% and 129% of the participantâ€™s target opportunity. Generally, the Compensation Committee sets the targets such that the relative difficulty of achieving the target level is consistent from year to year.
Bonuses are based on achievement of revenue and operating income goals and are intended to motivate short-term financial performance of the Company. It is intended that high levels of achievement will provide executives with above average levels of current compensation based on comparability studies, and that lower levels of achievement will provide executives with below average levels of current compensation.
Incentive Stock Compensation
Executive officers also receive performance-based incentive restricted stock awards on an annual basis that vest only if the Companyâ€™s performance meets pre-approved, objective performance goals within a specified performance period. Thus, a significant amount of executive officer compensation is tied to the Companyâ€™s actual performance. Performance-based incentive stock is forfeited, in whole or in part, unless the Company achieves specified increases in cumulative operating income over a prospective two year period.
Service-based, or time-vesting, stock options and restricted stock are also granted to executive officers, effectively tying a significant amount of additional variable compensation to the individualâ€™s continued employment (subject to the vesting and forfeiture provisions of the applicable plan) and the performance of the Companyâ€™s common stock over the vesting period. Restrictions on the restricted stock grants lapse on the third anniversary date of the date of grant. The Compensation Committee believes that three year cliff vesting promotes a longer term perspective and enhances retention of key management. The senior management stock options are seven year options which vest in equal annual increments over the first four years from the date of grant. The Compensation Committee considers these stock option grants reflective of the performance of executive officers during the fiscal year, as measured by corporate and individual performance standards and consistent with the intent and purposes of the Companyâ€™s compensation philosophy.
Employee Benefit Programs
The Companyâ€™s 401(k) plan, disability insurance, deferred compensation plan and charitable contribution matching program are all based on employee contributions and partial Company matching. The Company currently pays 100% of the premiums for health insurance for certain executive officers, and 70% for all other employees. The Employee Stock Purchase Plan allows employees to accumulate funds from payroll deductions over a six month period and purchase shares at a 15% discount from the lower of the market price at the beginning or the end of the six month period.
The benefits detailed above were chosen by the Compensation Committee because they are commonly made available to executives. The Compensation Committee believes that the contribution levels of these programs, individually and in the aggregate, are typical and necessary to recruit and retain qualified executives. The executive physical examination program is intended more to motivate executives to have regular examinations than as an element of compensation.
Deferred Compensation Plan
Designated executive officers and certain employees may participate in the Companyâ€™s Nonqualified Deferred Compensation Plan. Participants may defer payment of a portion of their salary and annual bonus as part of their personal retirement or financial planning. The Company matches contributions up to 6% of the total cash compensation, including equity gains considered as income, for executives with five years or more of service, and matches 3% of such amounts for executives with less than five years of service to the Company. Deferred amounts are deposited in a â€śRabbiâ€ť trust and invested by the participant among a number of mutual funds. Earnings or losses are allocated to the participantâ€™s individual account. Company contributions are fully vested after three years from the date of contribution. Contributions and earnings on those contributions and total account balances as of the end of the fiscal year are shown for the named executive officers in the Nonqualified Deferred Compensation Table on page 22 of this proxy statement.
The time and the level of expertise required for adequate tax, retirement and financial planning by executives has significantly increased in recent years as the variety of compensation plans and the complexity of the regulatory environment have increased. Since 2004, the Company has offered financial and tax planning as a benefit intended to allow management employees to focus on the needs of the Company with fewer distractions.
Except as specifically noted above, the Companyâ€™s practice is not to provide special perquisites and benefits to executive officers. Executive officers are compensated through salary and incentive compensation and not through personal benefits and perquisites. With the limited exceptions described above and in the Summary Compensation Table on page 18, health and welfare benefits are provided to executive officers on the same terms as other employees.
In 2007, the Company agreed to reimburse Mr. Waters for certain actual and reasonable out of pocket costs related to his relocation to Massachusetts, including travel, temporary housing, closing costs and moving expenses. The Company provided an automobile for Mr. Abely during his term as Chief Executive Officer, however, with this exception, the Company does not provide cars, private air travel, family travel reimbursement or other special travel benefits to executive officers. Except for the 401(k) plan and deferred compensation plan described above, the Company has no pension or retirement plan. The Company does not maintain lodging for the benefit of executive officers or reimburse executive officers for lodging expenses except in connection with business travel, including Company requested relocations. Except for the financial and tax planning services described above, tax gross ups and certain additional insurance premiums, the Company does not provide personal services to executive officers or reimburse executive officers for any such services. Although the Company reimbursed Mr. Abely for certain club and membership dues in 2006, going forward the Company does not intend to provide club memberships or other personal social or entertainment benefits to executive officers, nor does it reimburse executive officers for any such costs. The Company does not make loans or provide guarantees to executive officers.
MANAGEMENT DISCUSSION FROM LATEST 10K
We are a leading global provider of technology products and services for the tracking and recovery of valuable mobile assets. Our proprietary technology, wireless network and unique integration with law enforcement agencies provide an effective means for tracking and recovery of stolen vehicles and construction equipment. In October 2004, we acquired Boomerang, the dominant marketer and provider of stolen vehicle recovery technology in Canada. In 2005, we expanded the use of our technology to motorcycles.
We have three separately managed and reported business segments: domestic, international and Boomerang.
We develop and market the LoJack System, a unique, patented system designed to assist law enforcement personnel in locating, tracking and recovering stolen vehicles. We also offer LoJack Early Warning as an option to the LoJack System which provides early notification to a vehicle owner in the event an unauthorized user is operating the vehicle.
Our revenues in the United States are derived primarily from the sale of LoJack Units, LoJack Early Warning, warranty and extended products to consumers. Approximately 83% of domestic sales are made through a distribution network consisting of dealers of new and used automobiles. We have strong consumer brand awareness in the United States and in many areas around the world.
We continue to expand our installation capacity and increase efficiencies by adopting alternative installation methods through contracting with certified dealers and other third parties to perform the installation of the LoJack Unit. We monitor the quality of these alternative installations through the use of an expanded quality control process. We maintain full warranty service of LoJack Units, both for the convenience of dealers through which the LoJack Units are marketed and to maintain a high degree of quality control and security over our technology.
We also offer an extended warranty at the point of sale to new customers and through direct sales efforts to existing customers.
We record additions to deferred revenue for our LoJack Early Warning product and certain warranty products for which we have been deemed to be the primary obligor of the underlying contract. We receive full payment typically within 60 days of the transaction, but recognition of the deferred revenue is spread over the estimated life of the product or service. These payments are a significant component of our cash flow from operations. Additions of these components of deferred revenue were $16,165,000 for the year ended December 31, 2006, compared to additions of $15,616,000 for the same period in 2005.
Internationally, our licensed stolen vehicle recovery technology is operational in 27 countries and territories around the world. We have a licensed presence in Latin and South America, Europe and Africa, and the Asia Pacific Rim. These revenues consist of product sales, royalties and license fees. Revenues from the international segment comprised approximately 22% of consolidated revenues for the year ended December 31, 2006, compared to 22% in 2005 and 21% in 2004, 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 revenues are recognized when earned.
Purchasers of LoJack Units in Italy are required to purchase a service contract with LoJack Italia. The terms of service contracts offered range from 12 to 36 months and are payable in full upon activation of the related unit or renewal of a previous service contract.
Revenues from our Boomerang segment are derived primarily from the sale of Boomerang, Boomerang2 and BoomerangXpress, Boomerang Espion and Boomerang Espion Alert Units, related products, and service contracts. Revenues from the Boomerang segment comprised approximately 10% of consolidated revenues for the year ended December 31, 2006. Approximately 20% of revenues are derived from the sale of Boomerang, Boomerang2 and BoomerangXpress Units through auto accessory retailers and automobile dealers. Approximately 80% of revenues are derived from service contracts. More than 45 insurance companies based in Quebec and Ontario offer rebates to customers who install a Boomerang Unit in their high priced or high risk of theft vehicles, and in many instances, require installation of a Boomerang Unit in such vehicles.
Purchasers of Boomerang Units are required to also purchase a service contract. The terms of service contracts offered range from 12 to 60 months and are payable in full upon activation of the related unit or renewal of a previous service contract. As of December 31, 2006, there was approximately $11,316,000 of deferred revenue resulting from approximately 125,000 active service contracts. Customers are also offered a monthly payment option.
Recent Developments and Trends
Many companies in the vehicle security market have stated that they offer stolen vehicle recovery solutions and many automobile manufacturers are installing GPS products at the factory. These factors have not had a material adverse impact on our revenues, unit sales or penetration rates to date. While the long-term impact of these trends is hard to predict, we are evaluating the effectiveness of additional complementary technology combining GPS and/or cellular based communications with our time-tested RF based stolen vehicle recovery technology.
The percentage of domestic units installed by third parties rose to 41% of total domestic installations for the year ended December 31, 2006 compared to 38% and 27 % for the years ended December 31, 2005 and 2004, respectively, decreasing average direct installation labor cost per unit due to productivity improvements and the shift of expenses from fixed to variable.
Our bulk installation program which was introduced in 2005 represented 24% of domestic installations for the year ended December 31, 2006 compared to 15% for the year ended December 31, 2005. The bulk installation program provides a significantly higher penetration of new car sales, improved cost efficiencies and a deeper relationship with our dealer customers. While we experienced significant growth in ramping up this initiative in 2006, we expect the program to stabilize to around 30% of total domestic installations in 2007.
Key Factors of our Business
Key factors and areas of focus by our senior management include: (1) focusing on increasing penetration rates through our existing automobile dealer channel and markets; (2) sharing best practices among our international licensees and analyzing those practices which have been successful, including the effectiveness of strategic relationships with distributors, insurance companies and original equipment manufacturers, and the success of different pricing models such as those that include recurring payments; (3) continuing to reduce domestic and international manufactured product costs; (4) continuing to develop improved technology and products, including collaborating with SCI in creating new cargo and tracking recovery products; (5) increasing the sales of our commercial offerings and motorcycle product; (6) continuing to develop relationships with insurance companies to help drive demand, where applicable; and (7) successfully completing our initiative to own and operate a LoJack stolen vehicle recovery network in Italy We evaluate our financial condition and operating performance based on the progress in achieving the key factors listed above.
Critical Accounting Policies and Estimates
The consolidated financial statements include LoJack, our wholly-owned subsidiaries on a consolidated basis and SCI for which we use the equity method of accounting. Intercompany transactions and balances are 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 thereto. 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 â€ścritical accounting policyâ€ť is one that is both important to the portrayal of our financial condition and results of operations and requires managementâ€™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 revenues primarily from the domestic sale and installation of LoJack Units and LoJack Early Warning, the sale of products and components to international licensees, the receipt of international license fees and royalties, the sale of extended and enhanced warranty programs, the sale of our Boomerang products and service contracts.
We generally recognize revenue on domestic and Canadian sales of LoJack Units and Boomerang Units and related products upon installation, or upon shipment to our installation partners and distributors when all revenue recognition criteria have been met.
Revenues relating to the sale of LoJack Early Warning are recognized over the period of the estimated life of vehicle ownership, which management estimates is approximately five years. If the estimated life of 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, there have not been any changes to our five-year estimate.
Revenues relating to the sale of service contracts by our Boomerang segment are recognized over the life of the contract. The term of service contracts offered ranges from 12 to 60 months and are payable in full upon activation of the related unit or renewal of a previous service contract.
We sell several types of extended warranties. For those warranties to which a third party, and not us, is the primary obligor, we recognize payments for these insurance contracts, net of related costs, in revenues at the time of sale. If the laws of jurisdictions change so that we are determined to be the primary obligor, revenues may have to be deferred under such circumstances. Effective January 2007, we changed insurance underwriters and negotiated more favorable rates for our extended warranty products for automobiles. The new underwriter is an authorized provider of insurance services in all states in which we currently operate and thus as primary obligor grants us the ability to recognize revenue, net of related costs at the time of sale.
For those warranty agreements entered into before January 1, 2007 for which we are the primary obligor, revenues are deferred and recognized over the estimated term of the warranties, determined to be equivalent to the estimated life of vehicle ownership, which is five years. If the estimated life of 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 revenues are 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.
Accounts Receivable . Domestic accounts receivable are due principally from automobile dealers that are geographically dispersed. If the creditworthiness or the financial strength of the dealers were to decline, there could be an adverse effect on our operating results and cash flows.
The terms under which we generally sell products and components of the LoJack System to international licensees include cash prepayments, purchased private trade credit insurance or, most commonly, established payment terms. Should geopolitical situations change in the countries where our international licensees operate, there could be additional credit risks.
Accounts receivable related to our Boomerang segment consist of payments due from our automotive dealers and accessory retailers.
In the normal course of business, we monitor the financial condition of our customers. Our management does not believe that we have significant exposure to any individual customer. 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.
Valuation of Investments. Periodically, we have made equity investments in our international licensees and other entities. As of December 31, 2006, investments in international licensees, totaling $3,995,000, included a 12.5% equity interest, with a carrying value of $1,541,000, in our Mexican licensee and a 7.74% equity interest, with a carrying value of $2,454,000, in our French licensee. We do not exercise significant control over these licensees, and as such we account for these investments 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 and additional investments made. The carrying values of these investments are periodically reviewed. Based upon projections of anticipated future cash flows, market conditions, legal factors, market potential, operational performance, and in some cases, independent appraisals, we have concluded that there are no impairments to the fair value of these investments that should be viewed as other-than-temporary. We may be required to record an impairment charge in a future period under conditions such as: (1) a licensee requires additional capital and is unable to raise sufficient capital to continue operations, (2) a 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. We have not recorded any gains or losses on these investments through December 31, 2006. While we believe that our estimates are reasonable, different assumptions regarding items such as future cash flows and the volatility inherent in operating in these international markets could materially affect our evaluations and result in impairment charges against the carrying value of these investments. See also note 7 to the consolidated financial statements included herein at Item 8.
In October 2006, we entered into a stock purchase agreement with SCI, a Bothell, Washington based company with revenues under $5.0 million providing solutions for cargo stock theft prevention, investigation, tracking and recovery. Under the agreement, we invested $3.0 million of cash to be used for investment in the cargo and tracking recovery business. In return, we received a 40% minority ownership in SCI and representation on its Board of Directors. SCI will leverage its existing experienced sales force to sell the recently branded â€śLoJack inTransitâ€ť service. In addition, we received warrants to purchase 3,600,000 shares of SCI Class A common stock over an eight year period with exercise prices of between $1.00 and $1.92 per share. We have allocated $109,000 of our investment in SCI to these warrants. Because of explicit net settlement provisions, the warrants must be accounted for as a derivative at fair value.
We have applied the provisions of Financial Accounting Standards Board Interpretation, or FIN, No. 46(R), Consolidation of Variable Interest Entities , or FIN 46(R), in evaluating our investment in SCI. The Company has concluded that it is not deemed to be the primary beneficiary of the variable interest entity and has applied the provisions of Accounting Research Bulletin No. 51, Consolidated Financial Statements and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock , in accounting for our investment in SCI. We will account for our investment in SCI using the equity method and will recognize our pro rata share of SCIâ€™s operating results in our consolidated statement of income. For the year ended December 31, 2006, we recognized in other income (expense) $187,000 of SCIâ€™s losses since the date of our investment. The carrying values of the investment and warrants will be periodically reviewed for indications of impairment. Based upon projections of anticipated future cash flows, market conditions, legal factors, market potential and operational performance, we will make a determination whether there is any impairment to the fair value of this investment that should be viewed as other-than-temporary.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Results of Operations for the three months ended September 30, 2007 versus the three months ended September 30, 2006
Revenue for the three months ended September 30, 2007 increased by $237,000, or 0%, as compared to the same period a year ago.
For the three months ended September 30, 2007, revenue relating to our domestic segment decreased by $150,000 to $37,645,000 as compared to the same period a year ago, primarily due to:
A decrease of $1,419,000, or 4%, in revenue resulting from a 6% decline in the number of LoJack Units sold during the period. The unit and revenue decline in the quarter was a result of the economic climate in our California market, a decline in our bulk installation program and a decline in our commercial sector. Although unit volume for the quarter was reduced, the economic impact was partially offset by an increase in the average revenue per unit in the dealer; offset by
An increase of $294,000, or 21%, in revenue recognized from the sale of our Early Warning product;
An increase of $267,000, or 12%, in revenue recognized from the sale of warranty products;
An increase of $57,000 in revenue recognized from the sale of LoJack for Motorcycles units; and
An increase of $746,000, or 265%, in other revenue, primarily related to royalty income arising from the increase in the fair value of unvested stock warrants issued by Absolute Software, Inc.
For the three months ended September 30, 2007, revenue related to our international segment increased by $20,000, or 0%, to $12,034,000, as compared to the same period a year ago. Although the international segment revenue increase was modest, the segment experienced a 26% increase in unit growth when compared to the same period one year ago. Revenue was negatively impacted by new pricing agreements entered into with certain of our international licensees for 2007 and the impact of certain licensees exceeding annual volume targets resulting in a cumulative per unit price reduction. The negative revenue impact of these two items was offset by a $330,000, or 26%, increase in royalty revenue due to an increase in our licensees installed customer base.
For the three months ended September 30, 2007, revenue related to our Boomerang segment increased by $367,000, or 7%, to $5,424,000 when compared to the $5,057,000 recognized in the comparable period one year ago. This was primarily due to the strengthening of the Canadian Dollar versus the United States Dollar during the quarter ended September 30, 2007 when compared to the same quarter one year ago. Although Boomerangâ€™s net unit volume (excluding analog to digital upgrades) increased 52% for the quarter ended September 30, 2007 compared to the same period one year ago, the segmentâ€™s service revenue was negatively impacted by a decrease in its existing subscriber renewal rates.
Cost of Goods Sold
Cost of goods sold for the quarter ended September 30, 2007 was 43% of revenue as compared to 46% of revenue for the comparable period one year ago.
Cost of goods sold relating to our domestic segment for the quarter ended September 30, 2007 decreased to 40% of revenue as compared to 45% of revenue for the same period a year ago. This improvement is primarily due to the completion of the shift from the old generation LoJack Unit to the next generation unit. The next generation LoJack Unit not only represents improved technology but can be manufactured at a much lower per unit cost than its predecessor. During the quarter, we also saw a significant rationalization of our installation staff relative to current market conditions and use of third party installation partners, as several dealers continued to adjust to installation models that fit their business needs. We continue to expect that as the business needs of our dealers change, our installation methods may cause our margins to fluctuate. In addition, the domestic cost of goods sold percentage was favorably impacted by the increase in royalty income associated with the increase in the fair value of our Absolute Software warrants which have no corresponding impact on cost of goods sold.
Cost of goods sold relating to our international segment decreased to 46% of revenue for the quarter ended September 30, 2007, as compared to 51% of revenue for the same period a year ago, largely due to (i) a shift in LoJack Unit sales to a lower manufactured unit cost and (ii) an increase in royalty revenue for which there are no directly associated cost of goods sold.
Cost of goods sold relating to our Boomerang segment for the quarter ended September 30, 2007 was 57% of revenue, as compared to 42% of revenue for the same period a year ago. This increase was mainly due to the negative impact of higher costs for our Espion and EspionAlert products, lower revenue per unit for digital upgrade units and reduced service fee revenue compared to the same period last year.
Product development expenses decreased by $433,000, or 34%, for the three months ended September 30, 2007 as compared to the same period a year earlier. The decrease was primarily due to the inclusion of $805,000 related to our litigation settlement with Clare, Inc. being applied as a recovery of prior period product development costs. This positive impact was offset by a $206,000 increase in compensation costs at our domestic segment as we have lessened our reliance on third party vendors for new product development and a $100,000 increase in product development expenses at our Boomerang segment.
Sales and Marketing
Sales and marketing expenses increased by $568,000, or 5%, for the three months ended September 30, 2007, as compared to the same period a year earlier, primarily due to:
Increased bad debt expense of $217,000;
Increased sales and marketing costs at our Boomerang segment of $215,000; and
Increased dealer incentive related costs of $168,000.
General and Administrative
General and administrative expenses increased by $508,000, or 7%, for the three months ended September 30, 2007 as compared to the same period a year earlier, primarily due to:
Increased compensation related costs necessary to support future growth of $602,000;
Increased travel, meeting and relocation costs primarily related to our international segment of $199,000;
Increased Board of Directors compensation costs of $50,000; partially offset by
Decreased consulting expenses primarily associated with our international segment of $390,000.
Depreciation and Amortization
Depreciation and amortization expense increased by $114,000, or 7%, for the three months ended September 30, 2007 as compared to the same period one year ago. The increase is primarily related to depreciation expense arising from upgrading our technological infrastructure and investing in tooling equipment to support increased manufacturing capacity at our contract manufacturerâ€™s facilities. Other Income (Expense)
Other income (expense) for the three months ended September 30, 2007 increased by $959,000, or 1262%, when compared to the same period one year ago primarily due to: (i) a $349,000 increase in interest income resulting from higher investment returns on a larger average invested fund balance; (ii) the allocation of $419,000 in statutory interest arising from the settlement of the Clare litigation; and (iii) $377,000 in gains recognized on the exercise of Absolute Software warrants and subsequent sale of 100,000 shares of Absolute Software common stock.
Provision for Income Taxes
The provision for income taxes increased by $892,000, or 43%, for the three months ended September 30, 2007, as compared to the same period a year ago due to a $1,941,000, or 27%, increase in pre-tax income and a 3.7% increase to 32% in our effective tax rate. The primary increase in the effective tax rate in the current year is that the tax provision for the prior year includes $700,000 in adjustments to our accrued federal and state income tax liabilities based on the favorable results of tax audits completed and pending as of September 30, 2006.
Net Income and Earnings Per Share
As a result of the foregoing, net income for the three months ended September 30, 2007 increased by $1,049,000, or 20%, to $6,250,000, or $0.33 per diluted share from $5,201,000, or $0.28 per diluted share, in the same period in 2006.