News Column

LOJACK CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 11, 2014

Introduction

The following information should be read in conjunction with our unaudited condensed consolidated financial statements and notes thereto in Part I, Item 1 of this Quarterly Report and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2013. Safe Harbor Regarding Forward Looking Statements The Private Securities Litigation Reform Act of 1995 and other securities laws contain certain safe harbors regarding forward-looking statements. From time to time, information provided by us or statements made by our employees may contain "forward-looking" information which involves risks and uncertainties. Any statements in this report and accompanying materials that are not statements of historical fact are forward-looking statements (including, but not limited to, statements concerning the characteristics and growth of our markets and customers, our expected capital expenditures, our strategic initiatives, objectives and plans for future operations and products, our ability to sell products to our Argentine and other licensees, and our expected liquidity, revenue, profit and capital expenditures and resources). Such forward-looking statements are based on a number of assumptions and involve a number of risks and uncertainties, and accordingly, actual results could differ materially. Factors that may cause such differences include, but are not limited to: (1) the continued and future acceptance of our products and services, including, but not limited to, our pre-install program and new telematics solution; (2) our ability to obtain financing from lenders; (3) the outcome of ongoing litigation involving the Company; (4) the rate of growth in the industries of our customers; (5) the presence of competitors with greater technical, marketing, and financial resources; (6) our customers' ability to access the credit markets, including changes in interest rates; (7) our ability to promptly and effectively respond to technological change to meet evolving customer needs; (8) our ability to successfully expand our operations, including through the introduction of new products and services; (9) changes in general economic or geopolitical conditions, including the European debt crisis; (10) conditions in the automotive retail market and our relationships with dealers, licensees, partners and agents; (11) the expected timing of purchases by our customers; (12) our ability to achieve the expected benefits from our strategic alliance with TomTom; (13) financial and reputational risks related to product quality and liability issues; (14) trade tensions and governmental regulation and restrictions on imports that may affect sales to our licensees; and (15) the timing and potential impact of regulations mandating the installation of tracking devices using GPS and mobile communications technologies. For a further discussion of these and other significant factors to consider in connection with forward-looking statements concerning us, reference is made to Item 1A "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013, as updated by Item 1A "Risk Factors" in Part II of this Quarterly Report, and in our other periodic filings with the Securities and Exchange Commission. We caution readers not to place undue reliance on any forward-looking statements, which only speak as of the date made. Except as required by law, we undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Overview We are a leading global provider of technology products and services for the tracking, recovery and management of valuable mobile assets and the rescue of people with cognitive conditions such as autism or Alzheimer's who are at risk of wandering. Our proprietary technology, wireless network and unique integration with law enforcement agencies provide an effective means for the tracking and recovery of stolen vehicles, construction equipment, motorcycles, cargo and people at risk of wandering, or people at risk. We have three separately managed and reported business segments: North America, International and All Other. Our North America segment is comprised of our domestic operations, which sells products and services that operate in 29 states and the District of Columbia in the U.S., as well as our wholly owned subsidiary, LoJack Canada, a provider of stolen vehicle recovery products in Canada. Our International segment sells products, licenses or owns and operates LoJack proprietary vehicle recovery technology in approximately 30 countries and territories throughout Europe, Africa and Latin America and through our wholly owned subsidiary in Italy, LoJack Italia, SRL, or LoJack Italia. Our All Other segment includes LoJack SafetyNet and SCI, which are providers of technology for the tracking and rescue or recovery of people at risk and of valuable cargo and business information, respectively. North America Segment Our revenue in the U.S. is derived primarily from the sale of LoJack Units, LoJack Early Warning, and extended warranty products to consumers. During the first six months of 2014, approximately 85% of our sales in the U.S. market were made through a distribution network consisting of dealers of new and used automobiles. We believe that we have strong consumer brand awareness in the U.S. 15



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The price paid by the consumer for a LoJack Unit includes installation. We maintain a workforce that performs these installations, and we supplement our installation capacity by contracting with and certifying select dealers and other third parties to install our products. We continually seek to minimize the fixed costs related to the installation of a LoJack Unit by increasing our installation capacity with certified dealers and other third parties. We monitor the quality of these installations through the use of an expanded quality control process. We offer warranty products at the point of sale to new customers and through direct sales efforts to our existing customers. We record additions to deferred revenue for the monitoring service related to our LoJack Early Warning product. We typically receive full payment within 60 days of the transaction, but recognition of the deferred revenue is prorated over the estimated life of the product. For the majority of our extended warranty contracts, we recognize revenue upon delivery as we are not the primary obligor for those contracts. A significant portion of our revenue in Canada is derived from the recognition of revenue from service contracts for Boomerang Units sold prior to the transition from Boomerang Units to LoJack Units during 2011. Customers who purchased a Boomerang Unit were required to enter into a service contract. The terms of the service contracts offered ranged from 12 to 60 months and were generally payable in full upon the activation of the related unit or renewal of a previous service contract. Customers were also offered a month-to-month option. Beginning in 2011, we introduced the LoJack technology in Canada in the province of Quebec and the business model and product offerings are now similar to those of the U.S. In January of 2012, the LoJack technology was introduced in Ontario. Purchasers of LoJack Units in Canada are not required to enter into a service contract; however, the tracking and recovery of LoJack Units in Canada is still performed internally and thus we continue to recognize service revenue for a portion of each sale. Certain insurance companies in Quebec and Ontario offer rebates to customers who install LoJack Units in their vehicles, and in some instances, insurance companies require installation of a stolen vehicle recovery product in such vehicles. In our Canadian business, we have increased our emphasis in both the commercial and dealer channels as well as on our expansion into the Ontario market. Increased competition and fewer insurance mandates have challenged our growth within the insurance market in the province of Quebec. Demand for our commercial product in the Canadian market has been strong to date, particularly in the province of Ontario. In addition, our re-entry into the automotive dealership channel in Ontario with LoJack technology has been met with favorable responses from dealers. International Segment Internationally, our stolen vehicle recovery technology is operational in approximately 30 countries and territories around the world. We have existing licensees in South America, Mexico, Central America, the Caribbean, Africa and Europe. Revenue from this segment consists of product and infrastructure sales to our licensees, royalties and license fees. We record additions to deferred revenue for international license fees and recognize the revenue over the term of the license (generally ten years). Royalty revenue is recognized when earned. Italy is the only country outside of North America where we own and operate a stolen vehicle recovery network. Consumers who purchase LoJack Units in Italy are also required to enter into a service contract with LoJack Italia. The terms of service contracts offered range from 12 to 84 months and are payable in full either upon activation of the related unit or renewal of the stolen vehicle recovery service or on a monthly basis. Service revenue from these contracts is deferred and recognized over the term of the service contract. All Other Segment SCI revenue is derived from the sale, lease or service of tracking devices as well as subscription fees for monitoring service alerts and activity reporting. Key Economic Factors and Trends and our Business Economic and market data and industry statistics and forecasts used throughout this report are based upon management's review of independent industry publications, reports by market research firms and other independent and publicly available sources. Although we believe that these third-party sources are reliable, we do not guarantee the accuracy or completeness of this information and have not independently verified this information. While global economic growth remains unsettled, the automotive markets within which we sell our products on balance have been a positive growth story. During 2013, global economic growth slowed to approximately 3% as a result of the economic issues in the Eurozone and a slowdown of economic activity in several key newly-developed and emerging markets. The impact on the light vehicle automotive market was varied. In 2013, European Union light vehicle sales declined by approximately 2%, and our licensee market in Brazil experienced an approximate decline of 2%. Argentina, South Africa and Mexico's light vehicle markets all realized positive growth 16



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of approximately 14%, 4% and 8%, respectively. The U.S. light vehicle automotive market posted growth of approximately 8% compared with the prior year. During 2014, global economic growth is expected to increase slightly, to approximately 4%, led principally by continued fiscal recovery among advanced economies, namely the U.S. Emerging economies are also expected to experience stronger growth in 2014, driven by fiscal stimulus and export growth into the recovering U.S. and European Union. The U.S. is expected to realize moderate growth of approximately 3%, while Euro area economies are expected to achieve a nominal increase of 1%. International automotive growth for 2014 is estimated to continue to be varied. Growth in the European Union is expected to be between 2% and 3% for the full year as large markets in Italy, France and Spain return to positive growth rates. Our key emerging market licensee territory of Mexico is expected to grow by approximately 3%, while Brazil, Argentina and South African markets are forecasted to decline by 4%, 31% and 5%, respectively. U.S. retail automotive growth is expected to grow in line with the U.S. economy, with analysts estimating light vehicle sales volume growth between 3% and 4% during 2014. North America Segment Revenue related to our U.S. business declined slightly during the second quarter of 2014 as compared to the same period in the prior year. Our focus on the U.S. automotive business resulted in significant performance improvement during 2014, with unit sales in the dealer channel increasing 10% as compared to second quarter of 2013. Our unit sales in the second quarter continued to exceed retail market performance by 3.5 percentage points, or 10% growth. This growth in unit volume during the second quarter was offset by a 6% decrease in average revenue per unit, as our domestic pre-install business, which has lower average revenue per unit, has continued to gain traction with stronger than expected acquisition rates. In the second quarter of last year, pre-installed units accounted for 45% of our U.S. unit sales, while in the second quarter of 2014 that percentage was up to 55% of U.S. unit sales. Industry experts are projecting that during 2014, the automotive industry will grow in line with the U.S. economy, with growth in the 3% to 4% range. Although all of the 2013 growth factors are expected to remain factors into 2014, strong comparable sales volumes against 2013, and worked-off demand from the most accessible pool of buyers has weakened growth expectations as compared to 2013. Pent-up demand for light vehicles remains strong across all socio-economic segments, but the economy has not yet improved to a point where the means to buy has returned to all of those hurt by the latest recession. Buying from low income households and small businesses is expected to continue to lag behind the rest of the market, as sluggish economic growth and high unemployment leaves these potential buyers less accessible to the market. Two key factors positively impacted demand for our product in 2013. The first factor was the strong and sustained auto demand experienced during 2013. The 2013 fiscal year was the fourth year in a row of solid U.S. automotive industry growth and 2014 is projected to remain positive. The second factor was the increasing need for profitable, value-add products within Financing and Insurance departments at automotive dealers. Decreased vehicle margins resulting from price transparency, and increased brand competition have put pressure on dealerships to increase profit contributions in other areas of the dealership. We believe that our well-known brand and long history of delivering on our consumer value proposition, coupled with a strong value proposition for the dealer, make the LoJack Stolen Vehicle Recovery system an attractive alternative to other after-market products available to the dealership. These two factors contributed to increased dealer receptivity to our pre-install programs and increased volumes within selling dealers during 2013. Slow U.S. employment and GDP growth and European economic headwinds continue to be obstacles to sustaining this industry optimism for the coming years. Experts have moderated their expectations, but continue to project growth in the auto industry worldwide. Our heavy equipment, or commercial, channel experienced a decline in revenue of 26% during the second quarter of 2014 as compared to the same period in the prior year, on a 25% unit sales decline. This is largely the result of a shift in demand to the first quarter of this year in the OEM market. In 2013, demand shifted to the second quarter of the year, making the base period of 2013 a disproportionately high volume quarter. We continue to expect that this business will track with the steady recovery in the U.S. construction market. 17



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There has been a high level of interest in our ruggedized self-powered product, which was recognized as one of Equipment Today's 2012 Contractors' Top 50 New Products. In the U.S., construction spending increased approximately 7% in 2013. Construction starts are expected to outpace economic growth in 2014 at 9%. As the rebound in the construction market continues, construction and industrial equipment rentals are forecast to grow between 6% and 9% in 2014 and accelerate thereafter, resulting in a compounded annual growth rate of almost 9% from 2013 to 2016. International Segment Shipments in our international licensee business increased 25% in the second quarter of 2014 compared to the same period last year primarily due to an increase in shipments to our licensees in Colombia and Central America. This gain was partially offset by the absence of shipments to Argentina due to government controls that are restricting imports. Revenue from our international segment increased 23% in the second quarter of 2014, compared to the same period last year. In the past, we have experienced quarterly fluctuations in purchases in the International segment, with sales in many of our international markets tending to be higher in the fourth quarter of the year as licensees seek to achieve lower pricing with higher annual unit purchases. We also are experiencing downward pricing pressure and reductions in unit volumes in a number of our markets due to a variety of factors that vary from country to country. Those factors include the relative maturity of the stolen vehicle recovery market in certain highly developed territories, re-use of our products in certain territories, declining theft rates in certain territories and increasing competitive pressures by both very high frequency, or VHF, and GPS based tracking systems. We also are faced with uncertainty regarding developing governmental policies and enforcement actions in Argentina that have affected, and may continue to affect, sales to our licensee in that country, as well as uncertainty regarding the timing and potential impact of the Brazilian regulation mandating the installation of tracking devices using GPS positioning and mobile communications technologies. In South Africa, our licensee has continued to purchase in line with our expectations despite some developing headwinds in their market. Light vehicle sales have declined in the second quarter of 2014 as compared to the prior year, with industry experts predicting a 5% decline in 2014 as compared to 2013. Additional economic pressures include a softening $ZAR and an increase in inflation past the central bank's limit of 6%, driven by increases in fuel and transport prices. In Argentina, government controls restricting the importation of goods and the exchange of Argentine Pesos for U.S. Dollars continue to make the exportation of goods from any country to Argentina more difficult. On February 1, 2012, Argentine authorities began requiring all importers to request and receive approval from the Argentine Tax and Customs Authority, or AFIP, prior to each import transaction. While the official processing time is 15 days for such requests, some requests have been put on hold for indefinite periods of time for review. In some cases, importers have been asked to match imports on a dollar-for-dollar basis with exports prior to receiving authorization from AFIP to import goods. Several states and governmental bodies, including the U.S., Japan and the European Union, have submitted complaints and formal requests for the World Trade Organization, or WTO, to establish a Panel to rule on the legality of Argentina's trade measures. The WTO's Director-General composed such a Panel on May 27, 2013. Should the WTO Panel rule in favor of these complainants, Argentina could be ordered to remove the restrictions, or possibly face punitive tariffs from its foreign trading partners. Currently, it is unclear whether these proceedings with the WTO will result in changes to Argentina's trade policies that are favorable to our business. During 2012, our Argentine license did not receive permission to import our products following adoption of the pre-approval requirement in February 2012. As a result, from February through December 2012, we did not ship any units to Argentina. Our Argentine licensee has informed us that it and its affiliates have developed several commodity export programs with the expectation that our licensee would be permitted to import a dollar amount of goods approximately equivalent to the dollar amount of exports our licensee and its affiliates generate. Subsequently, we were able to make several shipments of product to our licensee in Argentina in the second, third and fourth quarters of 2013. However, the amount of these shipments remained less than the dollar amount that our licensee has told us it has generated to date in exports. In the first half of 2014, we did not ship any units to our licensee in Argentina. Our Argentine licensee continues to indicate that there is strong market demand for our product, supported primarily by insurance company mandates requiring customers to use an SVR product. In 2014, our ability to fulfill our licensee's orders based on this demand will remain contingent upon the ability of our licensee to comply with Government trade policies regulating the importation of manufactured goods. Our licensee believes that they have complied with Government policies regulating importation of goods, and they continue to work to obtain permission to import LoJack products. If our Argentine licensee and its affiliates are unable to generate significant exports or if the government changes its trade policies, we may not be able to ship products to Argentina in volumes consistent with prior years. In Brazil, our licensee purchased units during the first three months of 2013. During the last nine months of 2013 and the first half of 2014, no units were shipped to our Brazilian licensee. Our sales in 2014 to our Brazilian licensee could be impacted by the results of our legal dispute (see Part II, Item 1, "Legal Proceedings" for detail on the Brazilian licensee litigation). 18



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Certain of our European territories are experiencing an economic downturn deepened by government wage and pension reductions, rising unemployment and tight consumer credit availability. While available economic data has indicated the start of improving economic conditions, the pace of recovery is expected to be slow. Growth in consumer spending and new vehicle sales are expected to remain muted in 2014. During the first half of 2014, certain European automobile industry trade associations have indicated that demand for new cars was almost 7% higher in the EU than in the first six months of 2013. From January to June 2014, growth (compared to the first six months of 2013) prevailed across major EU markets, reaching 2% in Germany, 3% in France, 3% in Italy, 11% in the UK and 18% in Spain. Our business in Italy continued to grow in terms of subscribers during the second quarter of 2014, and our revenues grew by 65% compared to the same period in 2013 primarily due to a larger subscriber base. We entered 2014 with approximately 33,600 subscribers in Italy, and continued growing the number of subscribers, adding approximately 6,900 net new subscribers in the first half of 2014. As of June 30, 2014, our business in Italy had a total of approximately 40,500 subscribers. While we continue to grow our subscriber base in Italy, our overall performance is slower than planned in part due to the overall weakness in the Italian economy, tightened access to credit by both our channel partners and consumers, and weak new vehicle registrations. During the first quarter of 2014, new car registrations were reported to have grown by 3% as compared to the same period in 2013. Certain auto industry analysts are projecting light vehicle registrations in Italy to grow between 3% and 4% in 2014. All Other Segment During 2013 the incidents of cargo theft continued to trend upward along with commodity product line value increases and reported loss amounts. As a result of this trend, combined with the true direct and indirect replacement costs of lost shipments and increased regulatory emphasis on shipping condition integrity, brand owners and manufacturers continue to seek the type of visibility, risk reduction, prevention, control and recovery capability that SCI provides, both in the U.S. and for the international segments of its clients' supply chains. Key Factors of our Business We embarked upon a critical evaluation of our business during 2011 and developed a strategy designed to stabilize the business financially and to control growth. During 2012, we improved our internal processes and continued to explore opportunities to expand our core businesses in the U.S. and internationally. Our focus on the U.S. automotive business resulted in strong unit growth during 2012, with unit sales in the dealer channel increasing 11% as compared to the prior year, and unit sales in the fourth quarter exceeding retail market performance by 9.5 percentage points, or 21% growth. We continued the expansion of our U.S. business in 2013, most particularly within the expansion of our pre-install program. Our unit sales in the U.S. dealer channel grew 10% in the second quarter of 2014 as compared to 2013. Pre-installed units accounted for 55% of our units sold in the domestic dealer channel during the second quarter of 2014, compared to 45% during the second quarter of the prior year. During the third quarter of 2014, we implemented a program to optimize our operating model to reduce our operating expenditures and improve our profitability. The program includes reducing headcount in areas where there is redundancy or where we can gain efficiencies (shifting headcount to the areas of the organization that will better align to our business needs and the go-forward plan). On July 15, 2014, we eliminated or realigned approximately 18 positions within the Company. As a result of this program, we expect to incur a pre-tax charge of approximately $840,000 in the third quarter of 2014, comprised of severance and other employee-related costs. Substantially all of these charges will result in cash expenditures over the next four fiscal quarters. We expect to complete the program during the third quarter of 2014. The reduction plan, combined with previous cost management actions, will enable the Company to manage through this transitional time, while enabling us to pursue our strategic direction, serve our customers and provide a stronger organization for our employees today and in the future. We were notified in 2013 by some of our international licensees that some of the batteries manufactured by our former battery manufacturer, EVE Energy Co., Ltd., or EVE, and included in self-powered LoJack Units these licensees had purchased from us exhibited degraded performance below LoJack's quality standards. These notifications led us to perform our own investigation, as to which we have made further progress as of the date of this report. While our investigation is still underway, we have confirmed that certain batteries manufactured by EVE that were included in certain self-powered LoJack Units sold in the United States and to our international licensees are exhibiting variability in performance that could impact the ability of the LoJack Unit to transmit a signal when called upon for stolen vehicle recovery. This degraded performance only potentially affects the transmit battery pack in our self-powered units, and as of the date of this report, the majority of LoJack Units in circulation are vehicle powered. We have incurred, and expect to continue to incur, significant costs and expenses related to the on-going investigation of the reported battery performance issue and the actions that we have decided to take to address this matter. In our international business we face a number of challenges and opportunities. In particular, during 2012 the Argentine government imposed significant trade restrictions on imports that have precluded our licensee in that country from purchasing product from us. The restrictions continued during 2013, and while we were successful in exporting some units to Argentina in 2013, our licensee in that country was unable to arrange for governmental approval to purchase the amount of product commensurate with the demand for stolen vehicle recovery products in Argentina and its market share. Our European business has also been 19



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impacted by ongoing recessionary pressures. We continue to explore opportunities to expand into new territories and to meet the demand for our products in our existing markets. We believe that our continued focus on executing our strategic goals for 2014 will enable us to continue our growth efforts and: Build on the momentum established in 2013 to restore our domestic business to profitable growth; Grow our existing core licensee business while identifying new international go-to-market opportunities; Continue to expand our product and service offerings through our strategic alliances, the first of which is with TomTom related to our fleet management offerings; Increase our investment in those businesses that we view as potential significant sources of future revenue and profit; Streamline and simplify our business processes to improve the overall experience for our customers and continue to aggressively manage our cost structure and discretionary spending; Successfully implement our Enterprise Resource Planning (ERP) System initiative; and Develop and maintain highly differentiated products and services in each line of our business while broadening our knowledge of the industry, current markets and potential new markets to pursue going forward. Critical Accounting Policies and Estimates We prepare our condensed consolidated financial statements in accordance with U.S. GAAP. As such, management is required to make certain estimates, judgments and assumptions that it believes are reasonable based on the information available. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods presented. The significant accounting policies and estimates that management believes are the most critical to aid in fully understanding and evaluating our reported financial results include revenue recognition and deferred revenue, accounts receivable and income taxes. See the section entitled "Critical Accounting Policies and Estimates" in our Annual Report on Form 10-K for the year ended December 31, 2013 for further discussion of our critical accounting policies and estimates. Accounting Guidance Issued But Not Yet Adopted In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, an updated standard on revenue recognition. ASU 2014-09 provides enhancements to the quality and consistency of how revenue is reported while also improving comparability in the financial statements of companies reporting using IFRS and U.S. GAAP. ASU 2014-09 is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. The new standard also will result in enhanced disclosures about revenue, provide guidance for transactions that were not previously addressed comprehensively and improve guidance for multiple-element arrangements. ASU 2014-09 will be effective for the Company in the first quarter of fiscal 2017 and may be applied using a full retrospective or modified retrospective approach. The Company is currently in the process of evaluating the impact that the implementation of this standard will have on our financial statements. Results of Operations for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 Revenue Revenue for the three months ended June 30, 2014 decreased by $731,000 as compared to the same period in 2013. The following table presents revenue by our segments (in thousands): Three Months Ended June 30, Percentage Change 2014 2013 2014 vs. 2013 North America $ 24,590$ 25,652 (4 )% International 8,804 6,985 26 % All Other 1,017 1,043 (2 )% Total revenue $ 34,411$ 33,680 2 %



Revenue related to our North America segment decreased by $1,062,000 for the three months ended June 30, 2014, as compared to the same period in 2013. In the North America segment, revenue from our U.S. dealer channel increased 1% when compared to the same period in 2013. Revenue from our U.S. commercial channel decreased 26% over the same period in 2013. Our motorcycle and direct distribution channels in the U.S. market saw revenue declines of 81% and 2%, respectively, as compared to the same period in 2013. Revenue from our Canadian business saw a decrease of 19% as compared to the same period in 2013.

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The 4% decrease in our North America segment revenue for the three months ended June 30, 2014 as compared to the same period in 2013 was primarily attributable to: A decrease of $379,000, or 19%, in Canadian unit and service revenue. The

decrease was primarily due to a decrease of $590,000, or 47%, in service revenue driven by a 42% decline in the average number of subscribers to 18,000. This decrease was partially offset by a $210,000, or 28%, increase in product revenue primarily due to a 22% increase in the number of units sold and a 6% increase in average revenue per unit;



A decrease of $267,000, or 14%, in revenue from our warranty products; and

A decrease of $258,000, or 81%, in revenue from our motorcycle product.

Revenue related to our International segment increased $1,819,000 for the three months ended June 30, 2014 as compared to the same period in 2013. The increase was primarily due to an increase of $1,327,000, or 24%, in product revenue from our licensees resulting from a 25% increase in the number of units sold in the three months ended June 30, 2014 compared to the same period in 2013 and a $592,000, or 65%, increase in revenue from our Italy business. These increases were partially offset by a $100,000, or 20%, decrease in revenue from the sale of infrastructure components, royalty, license fees, and other revenue from our licensees. Revenue related to our All Other segment decreased $26,000 for the three months ended June 30, 2014 as compared to the same period in 2013. Cost of Goods Sold The following table presents cost of goods sold by our segments (in thousands): Three Months Ended June 30, Percentage Change 2014 2013 2014 vs. 2013 North America $ 13,477$ 12,073 12 % International 3,718 3,075 21 % All Other 224 168 33 % Total cost of goods sold $ 17,419$ 15,316 14 % As a percentage of total revenue, total cost of goods sold was 51% and 45% for the three months ended June 30, 2014 and 2013, respectively. As a percentage of North America revenue, cost of goods sold relating to our North America segment was 55% and 47% for the three months ended June 30, 2014 and 2013, respectively. The increase in cost of goods sold as a percentage of revenue was primarily due to an accrual recorded during the second quarter of 2014 for the estimated costs and expenses associated with our intended quality assurance notification program in the U.S. related to the evaluation of certain batteries which have exhibited degraded performance below our quality standards as discussed in Note 10 to the unaudited condensed consolidated financial statements of this report, as well as a decrease in average revenue per unit. As a percentage of International revenue, cost of goods sold relating to our International segment was 42% and 44% for the three months ended June 30, 2014 and 2013, respectively. As a percentage of All Other revenue, our cost of goods sold relating to our All Other segment was 22% and 16% for the three months ended June 30, 2014 and 2013, respectively. The decrease in cost of goods sold as a percentage of revenue was primarily due to a decrease in volume at SCI, resulting in higher fixed cost of goods sold per unit. Operating Expenses The following table presents our operating expenses (in thousands): Three Months Ended June 30, Percentage Change 2014 2013 2014 vs. 2013 Product development $ 1,122$ 1,224 (8 )% Sales and marketing 8,743 8,054 9 % General and administrative 9,007 7,844 15 % Depreciation and amortization 994 1,028 (3 )% Total operating expenses $ 19,866$ 18,150 9 % 21



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Product Development As a percentage of total revenue, product development expenses were 3% and 4% for the three months ended June 30, 2014 and 2013, respectively. Product development expenses decreased $102,000 for the three months ended June 30, 2014 as compared to the same period in 2013, primarily due to decreases in compensation costs, partially offset by increased research and development expenses. Sales and Marketing As a percentage of total revenue, sales and marketing expenses were 25% and 24% for the three months ended June 30, 2014 and 2013, respectively. The increase of $689,000 in sales and marketing expenses for the three months ended June 30, 2014 as compared to the same period in 2013 was primarily attributable to: A $370,000 increase in compensation expense, driven by a $792,000 increase in salaries expense, a $438,000 increase in severance expense and a $121,000 increase in benefits expense, partially offset by a $997,000 decrease in commissions and bonus expense; and



A $243,000 increase in advertising expenses.

General and Administrative As a percentage of total revenue, general and administrative expenses were 26% and 23% for the three months ended June 30, 2014 and 2013, respectively. The increase in general and administrative expenses of $1,163,000 for the three months ended June 30, 2014 as compared to the same period in 2013 was primarily attributable to: An increase in sales tax expense of $705,000, relating primarily to the settlement of taxes and penalties owed in the Brazilian ICMS Tax Assessment discussed in Part II, Item 1, "Legal Proceedings"; An increase of $623,000 relating to our reduction during the second quarter of 2013 of the accrual for the settlement of certain California wage-and-hour class and collective action lawsuits; An increase of $168,000 primarily related to increased general and administrative expenses at SCI;



An increase of $378,000 in bad debt expense;

An increase of $248,000 in consulting expenses; and

An increase of $168,000 in expenses related to maintenance contracts;

partially offset by

A decrease in compensation expense of $621,000, primarily due to a

$230,000 decrease in salaries expense, a $191,000 decrease in stock based compensation expense and a $1,209,000 decrease in bonus expense, partially offset by a $401,000 increase in severance expense and a $645,000 increase in benefits expense; and



A decrease of $348,000 in outside legal expenses.

Depreciation and Amortization As a percentage of total revenue, depreciation and amortization expenses were 3% for both the three months ended June 30, 2014 and 2013. Depreciation and amortization expenses decreased by $34,000 for the three months ended June 30, 2014 as compared to the same period in 2013. The decrease is primarily related to certain assets becoming fully depreciated during 2013 and the three months ended June 30, 2014.

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Other Income (Expense) The following table presents our other income (expense) (in thousands): Three Months Ended June 30, Percentage Change 2014 2013 2014 vs. 2013 Interest income $ 3$ 28 (89 )% Interest expense (480 ) (256 ) 88 % Other, net 57 378 (85 )% Total other income (expense) $ (420 )$ 150 (380 )% Total other income (expense) changed by $570,000, from income of $150,000 for the three months ended June 30, 2013 to expense of $420,000 for the three months ended June 30, 2014. This change is primarily attributable to a $223,000 increase in interest expense and a $371,000 decrease in gains from our marketable securities. The increased interest expense was due to the settlement of interest owed in the Brazilian ICMS Tax Assessment discussed in Part II, Item 1, "Legal Proceedings," and was partially offset by decreased interest expense due to a reduction in our long-term debt. Provision (Benefit) for Income Taxes We recorded a worldwide provision for income taxes of $141,000 for the three months ended June 30, 2014, which is primarily related to our Irish subsidiary. The effective tax rate is significantly lower than the U.S. statutory rate as a result of recording a small taxable profit in Ireland and recording no tax benefit for the year-to-date losses of the remaining entities of our worldwide group. We continue to maintain a full valuation allowance against the net deferred tax assets of our U.S. and non-Irish foreign subsidiaries at June 30, 2014. We recorded a worldwide benefit for income taxes of $2,281,000 for the three months ended June 30, 2013, principally related to a discrete tax benefit of $2,450,000, which was primarily related to the release of tax reserves associated with the settlement of tax examinations during the second quarter. As previously reported, in May 2011 the Internal Revenue Service opened an audit of the Company's 2009 tax return. In 2012, the IRS's audit report was furnished to the congressional Joint Committee on Taxation for their consideration. In April 2013, the Company was notified that the audit process was complete and that there would be no further changes to our 2009 tax return. The effective tax rate was higher than the U.S. statutory rate as a result of recording a significant tax benefit associated with the release of tax reserves during the second quarter. We recorded a benefit on our year-to-date Irish loss and recorded no tax benefit for the year-to-date losses of the remaining entities of our worldwide group. We continued to maintain a full valuation allowance against the net deferred tax assets of the U.S. and our non-Irish foreign subsidiaries at June 30, 2013. Net Income (Loss) Per Share Attributable to LoJack Corporation As a result of the foregoing, the net income attributable to LoJack Corporation decreased by $6,023,000 from a net income of $2,635,000 for the three months ended June 30, 2013, to a net loss of $3,388,000 for the three months ended June 30, 2014. For the three months ended June 30, 2014, the net loss per share attributable to LoJack Corporation was $0.19 per diluted share as compared to a net income of $0.15 per diluted share in the same period in 2013. Results of Operations for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 Revenue Revenue for the six months ended June 30, 2014 decreased by $356,000 as compared to the same period in 2013. The following table presents revenue by our segments (in thousands): Six Months Ended June 30, Percentage Change 2014 2013 2014 vs. 2013 North America $ 47,202$ 49,204 (4 )% International 15,314 13,536 13 % All Other 2,027 2,159 (6 )% Total revenue $ 64,543$ 64,899 (1 )%



Revenue related to our North America segment decreased by $2,002,000 for the six months ended June 30, 2014, as compared to the same period in 2013.

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In the North America segment, revenue from our U.S. dealer channel remained unchanged compared to the same period in 2013. Revenue from our U.S. commercial channel decreased 16% from the prior period. Our motorcycle and direct distribution channels in the U.S. market saw revenue declines of 76% and 9%, respectively, as compared to the same period in 2013. Revenue from our Canadian business saw a decrease of 20% as compared to the same period in 2013. The activity that resulted in a 4% decrease in our North America segment revenue for the six months ended June 30, 2014 as compared to the same period in 2013 was primarily attributable to: A decrease of $781,000, or 20%, in Canadian unit and service revenue,

primarily due to a decrease of $1,201,000, or 46%, in service revenue driven primarily by a 39% decline in the average number of subscribers to 20,000 for the six months ended June 30, 2013, partially offset by a $419,000, or 32%, increase in product revenue as the number of base units sold during the year increased 29% and average revenue per unit increased 3%;



A decrease of $476,000 in revenue from the sale of warranty products;

A decrease of $185,000, or 1%, in U.S. unit revenue due to a 6% decrease

in average revenue per unit offset by a 5% increase in unit volume; and

A decrease of $388,000, or 76%, in revenue from the sale of motorcycle units.

Revenue related to our International segment increased $1,778,000 for the six months ended June 30, 2014 as compared to the same period in 2013. The increase was primarily due to an increase of $1,097,000, or 10%, in product revenue from our licensees due to a 10% increase in the number of units sold in the first six months of 2014 compared to the same period in 2013 and an increase of $875,000, or 50%, in revenue from our Italy business. These increases were partially offset by a decrease of $194,000, or 22%, in revenue from the sale of infrastructure components, royalty and license fees from our licensees for the six months ended June 30, 2014 compared to the same period in 2013. Revenue related to our All Other segment decreased $132,000 for the six months ended June 30, 2014 as compared to the same period in 2013. The decrease was primarily the result of a decrease of $182,000, or 9%, in the revenue from SCI for the first six months of 2014 compared to the same period in 2013, partially offset by an increase of $50,000, or 35%, in revenue from our SafetyNet business. Cost of Goods Sold The following table presents cost of goods sold by our segments (in thousands): Six Months Ended June 30, Percentage Change 2014 2013 2014 vs. 2013 North America $ 25,503$ 23,666 8 % International 6,455 5,947 9 % All Other 500 451 11 % Total cost of goods sold $ 32,458$ 30,064 8 %



As a percentage of total revenue, total cost of goods sold was 50% and 46% for the six months ended June 30, 2014 and 2013, respectively. As a percentage of North America revenue, cost of goods sold relating to our North America segment was 54% and 48% for the six months ended June 30, 2014 and 2013, respectively. The increase in cost of goods sold as a percentage of revenue was primarily due to an accrual recorded during the second quarter of 2014 for the estimated costs and expenses associated with our intended quality assurance notification program in the U.S. related to the evaluation of certain batteries which have exhibited degraded performance below our quality standards as discussed in Note 10 to the unaudited condensed consolidated financial statements of this report as well as a decrease in average revenue per unit. As a percentage of International revenue, cost of goods sold relating to our International segment was 42% and 44% for the six months ended June 30, 2014 and 2013, respectively. As a percentage of All Other revenue, our cost of goods sold associated with the All Other segment was 25% and 21% for the six months ended June 30, 2014 and 2013, respectively. The increase in cost of goods sold as a percentage of revenue was primarily due to a decrease in volume at SCI, resulting in higher fixed cost of goods sold per unit.

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Operating Expenses The following table presents our operating expenses (in thousands): Six Months Ended June 30, Percentage Change 2014 2013 2014 vs. 2013 Product development $ 2,675$ 2,666 - % Sales and marketing 17,339 16,332 6 % General and administrative 18,408 19,163 (4 )% Depreciation and amortization 1,919 2,094 (8 )% Total operating expenses $ 40,341$ 40,255 - % Product Development As a percentage of total revenue, product development expenses were 4% for both the six months ended June 30, 2014 and 2013. Product development expenses increased $9,000 for the six months ended June 30, 2014 as compared to the same period in 2013, primarily due to an increase of $130,000 in consulting expense and a $102,000 increase in research and development expenses, offset by a $252,000 decrease in compensation expenses. Sales and Marketing As a percentage of total revenue, sales and marketing expenses were 27% and 25% for the six months ended June 30, 2014 and 2013, respectively. The increase of $1,007,000 of sales and marketing expenses for the six months ended June 30, 2014 as compared to the same period in 2013 was primarily attributable to: Increased compensation expense of $728,000, primarily resulting from a $1,114,000 increase in salaries largely due to new employees having been hired during the second half of 2013 and first half of 2014, a $429,000 increase in severance expense, and a $264,000 increase in benefits expense, partially offset by a $1,083,000 decrease in commissions and bonus expense; Increased expense of $259,000 relating to lead generation services for our telematics business; and



Increased advertising expense of $215,000; partially offset by

Decreased market research expenses of $194,000.

The remaining change was due to smaller changes in various other sales and marketing accounts. General and Administrative As a percentage of total revenue, general and administrative expenses were 29% and 30% for the six months ended June 30, 2014 and 2013, respectively. The decrease in general and administrative expenses of $755,000 for the six months ended June 30, 2014 as compared to the same period in 2013 was primarily attributable to: A decrease of $2,042,000 in outside legal expenses due to decreased



litigation;

A decrease in compensation expenses of $1,086,000, primarily related to a

$1,608,000 decrease in bonus expense and a $589,000 decrease in salaries expense, partially offset by a $362,000 increase in severance expenses and an $865,000 increase in benefits expense;



A decrease in patent counsel expenses of $117,000;

A decrease in training expenses of $114,000; partially offset by

An increase of $303,000 in expenses related to maintenance contracts;

An increase of $288,000 in consulting expenses;

An increase of $323,000 primarily relating to increased general and administrative expenses at SCI;



An increase of $320,000 in bad debt expense;

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An increase of $173,000 in recruiting expenses;

An increase in sales tax expense of $674,000, relating primarily to the settlement of taxes and penalties owed in the Brazilian ICMS Tax Assessment discussed in Part II, Item 1, "Legal Proceedings"; and An increase of $623,000 relating to our reduction during the second quarter of 2013 of the accrual for the settlement of certain California wage-and-hour class and collective action lawsuits. Depreciation and Amortization As a percentage of total revenue, depreciation and amortization expenses were 3% for both the six months ended June 30, 2014 and 2013. Depreciation and amortization expenses decreased by $175,000, or 8%, for the six months ended June 30, 2014 as compared to the same period in 2013. The decrease is primarily related to the retirement of assets and certain assets becoming fully depreciated during 2013 and the six months ended June 30, 2014. Other Income (Expense) The following table presents our other income (expense) (in thousands): Six Months Ended June 30, Percentage Change 2014 2013 2014 vs. 2013 Interest income $ 4$ 49 (92 )% Interest expense (587) (454 ) 29 % Other, net 43 479 (91 )% Total other income (expense) $ (540 )$ 74 (830 )% Total other income (expense) for the six months ended June 30, 2014 changed by $614,000, from income of $74,000 for the six months ended June 30, 2013, to expense of $540,000 for the same period in 2014. This change is primarily attributable to a $132,000 increase in interest expense and a $400,000 decrease in gains from the sale of marketable securities. The increased interest expense was due to the settlement of interest owed in the Brazilian ICMS Tax Assessment discussed in Part II, Item 1, "Legal Proceedings," and was partially offset by decreased interest expense due to a reduction in our long-term debt. Provision (Benefit) for Income Taxes We recorded a $178,000 provision for income taxes for the six months ended June 30, 2014. This amount was primarily comprised of the provision for income taxes for our Irish subsidiary. The effective tax rate is significantly lower than the U.S. statutory rate as a result of recording a small taxable profit in Ireland and recording no tax benefit for the year-to-date losses of the remaining entities of our worldwide group. We continue to maintain a full valuation allowance against the net deferred tax assets of the U.S. and our non-Irish foreign subsidiaries at June 30, 2014. We recorded a $2,355,000 benefit for income taxes for the six months ended June 30, 2013. This amount was primarily comprised of a benefit for income taxes recorded on the year-to-date loss of LoJack Ireland, our Irish subsidiary, and a discrete tax benefit of $2,450,000, which was primarily related to the release of tax reserves associated with the settlement of tax examinations during the second quarter. The effective tax rate was higher than the U.S. statutory rate as a result of recording a significant tax benefit associated with the release of tax reserves during the second quarter. We recorded a benefit on our year-to-date Irish loss and recorded no tax benefit for the year-to-date losses of the remaining entities of our worldwide group. We continued to maintain a full valuation allowance against the net deferred tax assets of the U.S. and our non-Irish foreign subsidiaries at June 30, 2013. Net Loss Per Share Attributable to LoJack Corporation As a result of the foregoing, the net loss attributable to LoJack Corporation increased by $5,836,000, from $3,040,000 for the six months ended June 30, 2013 to $8,876,000 for the six months ended June 30, 2014. For the six months ended June 30, 2014, the net loss per share attributable to LoJack Corporation was $0.50 per diluted share as compared to a net loss of $0.17 per diluted share in the same period in 2013. Liquidity and Capital Resources Our liquidity is primarily contingent on continued customer demand for our products and services and continuing our existing relationships with automobile dealers, insurance companies, international licensees and certain law enforcement agencies. We 26



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believe that we will be able to keep pace with required technological changes in our products and expect that our sales and marketing initiatives will continue to drive demand. On August 10, 2010, SCI issued a one year, 11% interest Convertible Promissory Note totaling $400,000 to its shareholders. On October 14, 2011, a new 11% Convertible Promissory Note totaling $752,000 and maturing on October 1, 2014, was issued, replacing the outstanding principal and interest under the original note. The amount of the note due to noncontrolling holders of SCI is $274,000 and is classified as short-term debt on our consolidated balance sheet. On December 29, 2009, we entered into the Credit Agreement with RBS Citizens, N.A., as Lender, Administrative Agent and Lead Arranger, and TD Bank, N.A., as a Lender and Issuing Bank. The Credit Agreement provides for a multi-currency revolving credit facility in the maximum amount of $30,000,000, subject to a borrowing base calculation (or its equivalent in alternate currencies). The maturity date for the revolving credit loan was January 10, 2014. On March 29, 2013, this Credit Agreement was amended, extending the maturity date to July 31, 2015. The amendment also applied restrictions on dividends and other distributions with respect to our stock in 2013 and amended the Stock Repurchase and Funded Debt to EBITDA ratios. Minimum consolidated EBITDA in the amounts of $3,000,000, $4,000,000 and $5,000,000 for the trailing four quarters ended March 31, 2013, June 30, 2013 and September 30, 2013, respectively, was also required. We have the right to increase the aggregate amount available to be borrowed under the Credit Agreement to $50,000,000, subject to certain conditions, including consent of the lenders. As of June 30, 2014, we had total outstanding borrowings of $10,000,000 under the Credit Agreement. The interest rate on borrowings under the Credit Agreement varies depending on our choice of interest rate and currency options, plus an applicable margin. The interest rate in effect as of June 30, 2014 was 2.9%. As of June 30, 2014, we also had two outstanding irrevocable letters of credit in the aggregate amount of $715,000. These letters of credit reduce our outstanding borrowing availability under the Credit Agreement. The Credit Agreement contains limitations on capital expenditures, repurchases of common stock, certain investments, acquisitions and/or mergers and prohibits disposition of assets other than in the normal course of business. Additionally, we are required to maintain certain financial performance measures including maximum leverage ratio, minimum cash flow coverage ratio, minimum quick ratio and maximum capital expenditures. The payment of dividends under the Credit Agreement was prohibited in 2013, and currently is permitted but only to the extent such payments do not affect our ability to meet certain financial performance measures. Failure to maintain compliance with covenants could impair the availability of the loans under the facility. At June 30, 2014, we had borrowing availability of $10,844,000, which was not limited by the results of our borrowing base calculation. At June 30, 2014, we were in compliance with all of the financial and non-financial covenants in the Credit Agreement. The Credit Agreement terminates on July 31, 2015, at which point all amounts outstanding under the revolving credit facility are due. The Credit Agreement is guaranteed by our U.S. domestic subsidiaries and is secured by all domestic assets, including our intellectual property, and a pledge of 65% of the capital stock of LoJack Ireland. In recent years, we have made no attempt to raise capital from external sources nor do we have any credit rated debt outstanding. Therefore, it is difficult to predict whether any efforts to raise capital would be successful. If additional equity securities were to be issued, shareholder value would be diluted and the new equity securities may have rights, preferences or privileges senior to those of our common stock. On February 15, 2008, our Board of Directors authorized the repurchase of 1,000,000 shares of our common stock under a trading plan intended to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, or the Exchange Act, and additionally renewed the remaining management discretionary authority to repurchase an incremental 2,000,000 shares, for a total repurchase authorization of 3,000,000 shares. In November 2011, we resumed our repurchase activity under the Repurchase Plan. We did not repurchase any shares under the Repurchase Plan during the first six months of 2014. Under our existing Credit Agreement, our repurchase activity is limited to $5,000,000 for the period beginning March 29, 2013 through July 31, 2015. We expect our continuing operations and expansion of the Italian stolen vehicle recovery network and LoJack Canada's operating cash deficit, combined with our longer term international investment requirements and domestic expansion, to be funded using existing cash, cash flows from operations and, if needed, our existing credit facility. For the six months ended June 30, 2014, we had capital expenditures of $3,382,000. We expect our total capital expenditures for 2014 to be between $4,200,000 and $6,500,000. We have funded our 2014 expenditures to date out of our working capital, which was $30,655,000 as of June 30, 2014, and also expect to fund the remainder of these expenditures out of our existing working capital. Non-discretionary capital expenditures budgeted for 2014 include $2,000,000 to $2,500,000 for enhancement of our core tracking and recovery technology. Discretionary expenditures for 2014, which could be delayed to a future period, include $2,200,000 to $4,000,000 for our investments in our Enterprise Resource Planning system and additional hardware infrastructure. However, we currently have no plans to delay these projects or reduce these spending levels. We earn a significant amount of our operating income outside the U.S., which is deemed to be indefinitely reinvested in foreign jurisdictions. As a result, $13,340,000 of cash and cash equivalents are held by foreign subsidiaries at June 30, 2014. Of 27



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the $13,340,000 of cash and cash equivalents held by foreign subsidiaries, $11,136,000, or 83%, is held in USD denominated accounts, with the remaining $2,204,000 held in foreign currency denominated accounts. We currently do not intend nor foresee a need to repatriate these funds. We expect existing domestic cash, cash equivalents, short-term investments, cash flows from operations and our borrowing capacity under our Credit Agreement to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities, such as material capital expenditures, for the foreseeable future. In addition, we expect existing foreign cash, cash equivalents, short-term investments, and cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities, such as material capital expenditures, for the foreseeable future. Should we require more capital in the U.S. than is generated by our operations domestically, for example to fund significant discretionary activities, we could elect to repatriate funds from foreign jurisdictions or to borrow funds under our existing Credit Agreement discussed above. These alternatives could result in increased cash outflows due to higher effective tax rates or increased interest expense. Our cash flows from operating, investing and financing activities, as reflected in the consolidated statements of cash flows, are summarized in the following table (in thousands): Six Months Ended June 30, 2014 2013 Cash provided by (used in): Operating activities $ (11,354 )$ (3,737 ) Investing activities (3,334 ) (694 ) Financing activities 4,241 1,759 Effect of exchange rate changes on cash 116 78



Decrease in cash and cash equivalents $ (10,331 )$ (2,594 )

Cash used in operating activities increased by $7,617,000 during the six months ended June 30, 2014, compared to the same period in 2013. The increase was primarily attributable to an increase of $5,522,000 in our losses excluding non-cash items and an increase in cash used by other working capital items of $2,095,000. Investing activities used $3,334,000 of cash during the six months ended June 30, 2014, as compared to $694,000 of cash used during the same period in 2013. The $2,640,000 increase in cash used for investing activities was primarily due to a decrease of $1,488,000 in cash provided by the sale of marketable securities, an increase of $911,000 in capital expenditures and a $131,000 decrease in restricted cash activities. Financing activities provided $4,241,000 of cash during the six months ended June 30, 2014, as compared to providing $1,759,000 of cash during the same period in 2013. The $2,482,000 increase was primarily attributable to a $2,202,000 increase in proceeds, net of repayments, from our debt and short term borrowings under our existing Credit Agreement and an increase of $368,000 in cash received for the exercise of stock options. Item 3. Quantitative and Qualitative Disclosures about Market Risk We have limited exposure to market risk due to the nature of the financial instruments carried on our consolidated balance sheet. Our financial instruments as of June 30, 2014 consisted of cash and cash equivalents, marketable securities, other assets, accounts receivable, accounts payable, accrued liabilities, long-term debt and credit facilities. Our financial position is subject to market risk, including, but not limited to, changes in the value of financial instruments including those resulting from changes in interest rates, foreign currency exchange rates and market valuation. As of June 30, 2014, the fair value of these financial instruments approximated their carrying values. We are exposed to changes in interest rates primarily through amounts outstanding under our Credit Agreement. As of June 30, 2014, we analyzed the effect of interest rates on our variable-rate Credit Agreement, for which there was $10,000,000 of outstanding borrowings. Based on the outstanding borrowings under the Credit Agreement at June 30, 2014, a 1% increase in the interest rate would result in an additional $100,000 of annual interest expense. We are subject to foreign currency risk through our international operations. As of June 30, 2014, we held cash denominated in foreign currencies, primarily in the Euro, Canadian Dollar, and Brazilian Real. These assets accounted for approximately 17% of our total cash and cash equivalents held by our foreign subsidiaries at June 30, 2014. We translate accounts for subsidiaries whose functional currency is not the U.S. Dollar using exchange rates in effect at period-end for assets and liabilities, and exchange rates averaged over the period for results of operations. The related translation adjustments are reported in accumulated other comprehensive income in equity. Transaction gains and losses are reported in the consolidated statement of operations. As a result, 28



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both positive and negative currency fluctuations against the U.S. Dollar may affect our results of operations and accumulated other comprehensive income. Our exposure to foreign currency exchange risk is minimized in relation to our results of operations since a significant portion of our International segment revenue is denominated in U.S. Dollars. This situation may change in the future if there is an increase in our revenue earned or expenses incurred denominated in foreign currencies. We manage future foreign exchange risk exposures that cause both earnings and cash volatility by utilizing a hedging strategy if the exposure is material and the hedge is cost effective. As of June 30, 2014, we had no derivative contracts outstanding. We do not enter into financial instrument transactions for trading or speculative purposes. We have not established any special purpose entities and do not have any material off-balance sheet financing transactions. We will continue to monitor our foreign currency exposure and will implement a hedging strategy if we feel that we are materially at risk and that the hedge is cost effective. Our other assets include our investment in our French licensee, in the form of a publicly-traded common stock, accounted for as an available-for-sale security and valued at the quoted closing price on its market exchange as of the reporting date. Unrealized gains or losses on available-for-sale securities are included, net of tax, in accumulated other comprehensive income in equity until the disposition of the security. During the three and six months ended June 30, 2014, we recorded unrealized losses on our investment of $3,000 and gains on our investment of $72,000, respectively. During the three and six months ended June 30, 2013, we recorded unrealized gains on our investment of $9,000 and unrealized losses on our investment of $58,000, respectively. Realized gains and losses on available-for-sale securities are included in other income (expense). As of June 30, 2014, we held $21,652,000 of cash and cash equivalents. Of this balance, $2,204,000, or 10%, is denominated in foreign currencies, including the Canadian Dollar, Euro and Brazilian Real. The remaining $19,448,000, or 90%, is denominated in U.S. Dollars. At June 30, 2014, $6,495,000, or 30%, of our total cash and cash equivalents balance was held in money market accounts, with the remaining $15,157,000 held in traditional deposit accounts. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our principal executive officer and principal financial officer have concluded that as of such date, our disclosure controls and procedures were effective. Changes in Internal Control Over Financial Reporting During the six months ended June 30, 2014, there were no changes to our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting except as described below. During January of 2014, we launched the first live phase of our Enterprise Resource Planning, or ERP, System implementation at our Irish subsidiary. In subsequent periods, the remaining phases of the ERP System implementation will be launched. While the implementation automated certain manual internal controls, it did not materially affect our internal control over financial reporting. 29



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