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LIFELOC TECHNOLOGIES INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following is a discussion of our financial condition and results of operations, and should be read in conjunction with our financial statements and the related notes included elsewhere in this prospectus. Certain statements contained in this section are not historical facts, including statements about our strategies and expectations about new and existing products, market demand, acceptance of new and existing products, technologies and opportunities, market and industry segment growth, and return on investments in products and markets. These statements are forward looking statements and involve substantial risks and uncertainties that may cause actual results to differ materially from those indicated by the forward looking statements. These statements include comments regarding: · reliance on customers who may not consistently purchase our products in the future; · reliance upon the talents of our Chief Executive Officer; · need to attract employees with the scientific and technical skills; · need to comply with a high degree of regulatory oversight; · susceptibility of our business in the domestic law enforcement area to changes in state policies and DUI laws; · reliance on state contracts, governed by state contracting policies; · reliance on our sales representative group for access to the channels of distribution; · risk that third parties may infringe on our patents or claim that we have infringed on their patents; · reliance on the availability of certain key supplies and services that are available from only a few sources; · risk that our customers may claim that the products we sold them were defective; · presence of a number of large, well-financed competitors who have research and marketing capabilities that are superior to ours; · reliance on technology that may become outdated or out of favor; and · other factors discussed under "Risk Factors" in our registration on Form 10, which became effective on May 31, 2011 (our "Form 10"). All forward looking statements in this section are based on information available to us on the date of this document, and we assume no obligation to update such forward looking statements. Readers of this Form 10-Q are strongly encouraged to review the section titled "Risk Factors" in our registration statement on Form 10. Overview We have been a developer and manufacturer of advanced alcohol testing instruments since 1986. We design and produce high-quality, precise and rapid recovery alcohol testing instruments for use in workplace, clinics, schools, law enforcement, corrections, and other applications. We offer our customers accessories, service support, training and supplies. Our internet websites are www.lifeloc.com and www.lifeguardbreathtester.com. Information contained in our websites does not constitute part of this Form 10-Q unless expressly incorporated by reference. The areas in which we do business are highly competitive and include both foreign and domestic competitors. Our major competitors are larger and have substantially greater resources than we do. Furthermore, other domestic or foreign companies, some with greater financial resources than we have, may seek to produce products or services that compete with ours. We believe that competition for sales of alcohol testing products is based on product performance, service, delivery and price. We believe that our future success depends to a large degree on our ability to develop new alcohol testing products and services to enhance the performance characteristics and methods of manufacture of existing products. Accordingly, we expect to continue to invest resources in research and development, to the extent funds are available. Outlook Installed Base of Breathalyzers. We believe the installed base of our breathalyzers will increase as the inherent risks associated with drinking while driving, and of working in safety sensitive jobs, become more widely acknowledged and as our network of direct and independent sales representatives grows. We believe that increased marketing efforts, the introduction of new products and the expansion of our network of sales representatives, may provide the basis for increased sales and continuing profitable operations. However, these measures, or any others that we may adopt, may not result in either increased sales or continuing profitable operations. Possibility of Operating Losses. Over the past several years we have operated profitably; however, prior to that we incurred losses. As of June 30, 2011, we have an accumulated deficit of $1,332,510. There is no assurance that we will not incur losses in any given quarter or year in the future. Sales Growth. We expect to increase sales in the U.S. and worldwide as our network of direct and independent sales representatives grows, becomes more proficient and expands the number of new accounts. We have recently begun to sell certain ignition interlock components and breath alcohol testing kiosks. Orders for these products are on an intermittent purchase order basis and there is no assurance that they will continue at any given rate, or that orders will repeat. Sales and Marketing Expenses. We continue our efforts to expand domestic and international distribution capability, and we believe that sales and marketing expenses will need to be maintained at a healthy level in order to do so. Sales and marketing expenses are expected to increase as we increase our direct sales representatives and marketing efforts. We presently have approximately 80 active distributors and two internal business development managers. Research and Development Expenses. Research and development expenses are expected to increase to support refinements to our products, and the development of additional new products. Results of Operations For the three months ended June 30, 2011 compared to the three months ended June 30, 2010. Net sales. Our sales for the quarter ended June 30, 2011 were $2,436,360, an increase of 56% from $1,566,169 for the quarter ended June 30, 2010. This increase is primarily attributable to a new order, that may not repeat in future periods, for $650,000, shipped to an international customer. In addition, the increase is attributable to the improving economic environment, as many customers were faced with constrained budgets in the same quarter a year ago. We also benefited from a high customer retention rate and a recurring sales stream from the purchases of supplies, training, and replacement instruments to existing accounts. 9 -------------------------------------------------------------------------------- Gross profit. Gross profit for the quarter ended June 30, 2011 of $1,170,708 represented an increase of 52% from gross profit of $768,427 for the quarter ended June 30, 2010. Gross profit as a percentage of sales (gross margins) decreased from 49% to 48% as a result of a sales mix favoring slightly higher volume but lower gross margins in the quarter ended June 30, 2011. Research and development expenses. Research and development expenses were $118,197 for the quarter ended June 30, 2011, representing an increase of 22% over the $96,749 in the same quarter a year ago. This increase resulted from compensation increases as well as utilization of outside services for software development. Sales and marketing expenses. Sales and marketing expenses of $288,290 for the quarter ended June 30, 2011 represented an increase of 20% from sales and marketing expenses of $240,263 for the quarter ended June 30, 2010. This increase resulted from additional compensation as a result of sales volume increases. General and administrative expenses. General and administrative expenses were $307,862 for the quarter ended June 30, 2011, which represented an increase of 20% over the $255,604 spent in the same quarter a year earlier. This increase results primarily from a $50,000 provision for bad debt. Net income. Net income was $290,857 for the quarter ended June 30, 2011 compared to net income of $92,677 for the quarter ended June 30, 2010. This increase of 214% was the result of increased sales, offset in part by an increase in the loss on currency exchange which increased by $11,508 and offset by an increased provision for federal and state income taxes. For the six months ended June 30, 2011 compared to the six months ended June 30, 2010. Net sales. Our sales for the six months ended June 30, 2011 were $4,216,670, an increase of 46% from $2,881,899 for the six months ended June 30, 2010. This increase is attributable to the improving economic environment, as many customers were faced with constrained budgets in the same period a year ago. In addition, a new order that may not repeat in future periods for $650,000, was shipped to an international customer. We also benefited from a high customer retention rate and a recurring sales stream from the purchase of supplies, training and replacement instruments to existing accounts. All increases were the result of unit volume increases as opposed to price increases. Gross profit. Gross profit for the six months ended June 30, 2011 of $2,050,723 represented an increase of 43% from gross profit of $1,433,161 for the six months ended June 30, 2010. Gross profit as a percentage of sales (gross margins) decreased from 50% to 49% as a result of a sales mix favoring slightly lower gross margins in the six months ended June 30, 2011. Research and development expenses. Research and development expenses were $217,752 for the six months ended June 30, 2011, representing an increase of 39% over the $156,141 in the same six month period a year ago. This increase resulted from compensation increases as well as utilization of outside services for software development. Sales and marketing expenses. Sales and marketing expenses of $508,878 for the six months ended June 30, 2011 represented an increase of 17% from sales and marketing expenses of $434,435 for the six months ended June 30, 2010. This increase resulted from additional compensation as a result of additional sales volume increases. General and administrative expenses. General and administrative expenses were $541,362 for the six months ended June 30, 2011, which represented an increase of 21% over the $447,537 spent in the same six month period a year earlier. This increase results from increased compensation resulting from the bonus plan contribution which is a function of increased income, as well as a $50,000 provision for bad debt. Net income. Net income was $489,236 for the six months ended June 30, 2011 compared to net income of $222,922 for the six months ended June 30, 2010. This increase of 119% was the result of increased sales, offset in part by an increase in the loss on currency exchange which increased by $24,435 and offset by an increased provision for federal and state income taxes of $98,350. Trends and Uncertainties That May Affect Future Results Although revenues in 2011 are up compared to revenues in 2010, we received several orders from international customers that may not repeat in future periods. We expect our quarter-to-quarter revenue fluctuations to continue, due to the unpredictable timing of large orders from customers and the size of those orders in relation to total revenues. Going forward, we intend to focus our development efforts on products we believe offer the best prospects to increase our intermediate and near-term revenues. Our 2011 operating plan is focused on growing sales, increasing gross profits, increasing research and development costs as appropriate while increasing profits and positive cash flows. We cannot predict with certainty the expected sales, gross profit, net income or loss and usage of cash and cash equivalents for 2011. However, we believe that cash resources and borrowing capacity will be sufficient to fund our operations for the next twelve months under our current operating plan. If we are unable to manage the business operations in line with our budget expectations, it could have a material adverse effect on business viability, financial position, results of operations and cash flows. Further, if we are not successful in sustaining profitability and remaining at least cash flow break-even, additional capital may be required to maintain ongoing operations. 10 -------------------------------------------------------------------------------- Liquidity and Capital Resources We compete in a highly technical, very competitive and, in most cases, price driven alcohol testing marketplace, where products can take years to develop and introduce to distributors and end users. Furthermore, manufacturing, marketing and distribution activities are regulated by the FDA, the DOT, and other regulatory bodies that, while intended to enhance the ultimate quality and functionality of products produced, can contribute to the cost and time needed to maintain existing products and develop and introduce new products. We have traditionally funded working capital needs through product sales and close management of working capital components of our business. Historically, we have also received cash from private offerings of our common stock, warrants to purchase shares of our common stock, and notes, although we have not engaged in any such capital-raising transactions in the past five years. In our earlier years, we incurred quarter to quarter operating losses to develop current product applications, utilizing a number of proprietary and patent-pending technologies. Although we have been profitable during the last several years, we expect that operating losses could well occur in the future. Should that situation arise, we may not be able to obtain working capital funds necessary in the time frame needed and at satisfactory terms or at all. On May 11, 2004, we entered into a credit facility agreement with Citywide Bank, which was renewed for one year on May 11, 2011. The terms of the credit facility include a line of credit for $150,000 for one year at an interest rate calculated at prime rate plus 1%. Our borrowing under the credit facility is limited by our eligible receivables and inventory at the time of borrowing. At June 30, 2011 and 2010, we had not borrowed any amounts from the credit facility. The credit facility requires us to meet certain financial covenants. At June 30, 2011 and at June 30, 2010, we were in compliance with the financial covenants. As of June 30, 2011, cash and cash equivalents were $1,735,365, trade accounts receivable were $530,893 and current liabilities were $790,017 resulting in a net liquid asset amount of $1,476,241. We believe that the introduction of several new products during the last several years, along with new and on-going customer relationships, will continue to generate sufficient revenues, which are required in order for us to maintain profitability. If these revenues are not achieved on a timely basis, we will be required to implement cost reduction measures, as necessary. We made a loan of $62,500 to Tipping Point, Inc. ("TPI"), an early stage company, during Q2. Although the loan was paid down by $10,000 in Q3, we do not expect to realize any significant sales to TPI in the near term. We have provided a reserve against the loan of $50,000, leaving a net amount of $12,500, which is included in our balance sheet at June 30, 2011. Two of our directors also serve as directors of TPI. This note has a provision entitling us to convert it into stock of Tipping Point, Inc. If converted, we would become a 20% equity holder. We generally provide a standard one-year warranty on materials and workmanship to our customers. We provide for estimated warranty costs at the time product revenue is recognized. Warranty costs are included as a component of cost of goods sold in the accompanying statements of operations. For the quarter ended June 30, 2011 and for the quarter ended June 30, 2010, warranty costs were not deemed significant. Off-Balance Sheet Transactions We currently have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, sales returns, warranty, contingencies and litigation. 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 results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required, which would increase our expenses during the periods in which any such allowances were made. The amount recorded as a provision for bad debts in each period is based upon our assessment of the likelihood that we will be paid on our outstanding receivables, based on customer-specific as well as general considerations. To the extent that our estimates prove to be too high, and we ultimately collect a receivable previously determined to be impaired, we may record a reversal of the provision in the period of such determination. 11 -------------------------------------------------------------------------------- We provide for the estimated cost of product warranties at the time sales are recognized. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers, we have experienced some costs related to warranties. The warranty accrual is based on historical experience and is adjusted based on current experience. Should actual warranty experience differ from our estimates, revisions to the estimated warranty liability would be required. We reduce inventory for estimated obsolete or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Any write-downs of inventory would reduce our reported net income during the period in which such write-downs were applied. To the extent that our estimates prove to be too high, and we ultimately utilize or sell inventory previously determined to be impaired, we may record a reversal of the provision in the period of such determination. We recognize deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets and liabilities. Deferred tax assets are then reduced, if deemed necessary, by a valuation allowance for the amount of any tax benefits which, more likely than not based on current circumstances, are not expected to be realized. Should we maintain sufficient, sustained income in the future, we may conclude that all or some of the valuation allowance should be reversed. Property and equipment are stated at cost, with depreciation computed over the estimated useful lives of the assets, generally three to five years. We use the double declining method of depreciation for property and equipment. Leasehold improvements are depreciated over the shorter of the remaining lease term or the estimated useful life of the asset. Maintenance and repairs are expensed as incurred and major additions, replacements and improvements are capitalized. We amortize our patent costs over their estimated useful lives, which is typically the remaining statutory life. From time to time, we may be required to adjust these useful lives of our patents based on advances in technology, competitor actions, and the like. We review the recorded amounts of patents at each period end to determine if their carrying amount is still recoverable based on our expectations regarding sales of related products. Such an assessment, in the future, may result in a conclusion that the assets are impaired, with a corresponding charge against earnings. We recognize revenue from product when title has passed to the customer, provided that we have evidence of a customer arrangement and can conclude that collection is probable. We recognize revenue from sales to stocking distributors when there is no right of return, other than for normal warranty claims. |