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

August 13, 2014

ANALYSIS OF RESULTS OF OPERATIONS

Executive Summary - Second Quarter

Operating earnings for the second quarter of 2014 totaled $308,000 compared to an operating loss of $1.9 million for the same quarter last year. Key factors contributing to the $2.2 million improvement in operating results for 2014's second quarter when compared to 2013's second quarter were as follows:



Net sales increased $3.1 million, or 12.1 percent, attributable to sales

increases in both segments Gross profit increased $1.4 million and gross margin improved over 2 points to 28.3 percent Selling, general and administrative expenses decreased $725,000, or 8.5



percent, mainly due to lower legal and professional fees

Interest expense increased $256,000 mainly due to the 2014 write-off of financing fees for bank amendments and waivers. Other income increased $109,000 primarily due to higher CSV income for the current year quarter compared to the prior year's quarter.



The combined impact of the favorable change in operating results, the higher interest expense and the increase in other income generated a $2.0 million increase in pre-tax earnings for the second quarter of 2014 compared to the second quarter of 2013.

The Company's consolidated tax provision for the second quarter of 2014 totaled $10,000 compared to a $14,000 tax provision in the same quarter last year.

For the second quarter of 2014, the Company reported a net income of $87,000, or $0.01 per share, compared to a net loss of $1.9 million, or $0.29 per share, for the second quarter of 2013.



Executive Summary - Six Months

Operating loss for the first six months of 2014 totaled $1.3 million compared to an operating loss of $3.6 million for the same period last year. Key factors contributing to the $2.3 million improvement in operating results for the first half of 2014 as compared to 2013 were as follows:



Net sales increased $2.9 million, or 6.2 percent, attributable to sales

increases in both segments



Gross profit increased $992,000 and gross margin improved by nearly half a

point to 27.8 percent



Selling, general and administrative expenses decreased $1.3 million, or

7.7 percent, mainly due to lower legal and professional fees

Interest expense increased $353,000 mainly due to the 2014 write-off of the financing fees for bank amendments and waivers. Other income decreased mainly due to lower CSV income and a smaller foreign exchange loss when compared to the prior year. The combined impact of the favorable change in operating results, the higher interest expense and the decrease in other income generated a $1.9 million reduction in the pre-tax loss for the first six months of 2014 compared to the comparable prior year period.



The Company's consolidated tax benefit for the first half of 2014 totaled $12,000 compared to a $13,000 tax provision for the year ago period.

For the six months ended June 30, 2014, the Company reported a net loss of $1.6 million, or $0.24 per share, compared to a net loss of $3.5 million or $0.53 per share, for the same period in 2013.



Valuation Allowance

The U.S. operations were in a loss position for the six month period ended June 30, 2014. Based on this and other relevant information, the Company concluded it did not meet the more likely than not criteria to justify the reversal of the valuation allowance at June 30, 2014. The valuation allowance for the U.S. operations totaled $10.3 million at June 30, 2014 and December 31, 2013. The Company will continue to monitor the need for a valuation allowance throughout 2014, pursuant to the guidance of U.S. accounting principles. Should the Company demonstrate a favorable and sustainable trend for its historic and projected operating results in the U.S., a reduction in the valuation allowance and a corresponding income tax benefit may result. 20



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EBITDA

The following table shows the reconciliation of net earnings (loss) to EBITDA and EBITDA As Defined for the three and six months ended June 30, 2014 and 2013: Three Months Ended June 30 Six Months Ended June 30 2014 2013 2014 2013 (in thousands) (in thousands) Net earnings (loss) $ 87 $ (1,943 )$ (1,579 )$ (3,475 ) Depreciation/amortization 1,087 833 1,905 1,673 Interest expense, excluding waiver and loan fee amortization 138 126 357 262 Income tax provision (benefit) 10 14 (12 ) 13 EBITDA 1,322 (970 ) 671 (1,527 ) Stock option expense 41 65 102 139 CSV gain (235 ) (106 ) (339 ) (564 ) Other non-cash items (212 ) (43 ) (422 ) (287 ) EBITDA As Defined $ 916$ (1,054 ) $ 12 $ (2,239 )



Other non-cash items shown in the preceding EBITDA reconciliation include exchange gains and losses and deferred revenue.

EBITDA represents earnings before interest, taxes, depreciation and amortization. EBITDA As Defined represents EBITDA adjusted to conform with the EBITDA measurement used to measure compliance with the financial covenants under the Company's Credit Agreement. The Company believes EBITDA is a useful performance indicator and is frequently used by management, securities analysts and investors to judge operating performance between time periods and among other companies. The Company uses EBITDA As Defined to assess operating performance and ensure compliance with financial covenants. EBITDA and EBITDA As Defined are non-GAAP performance indicators that should be used in conjunction with GAAP performance measurements such as net sales, operating profit and net income to evaluate the Company's operating performance. EBITDA and EBITDA As Defined are not alternatives to net income or cash flow from operations determined in accordance with GAAP. Furthermore, EBITDA and EBITDA As Defined may not be comparable to the calculation of similarly titled measures reported by other companies. 21



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Second Quarter - 2014 vs. 2013

The following table summarizes net sales and pre-tax earnings by business segment for the three months ended June 30, 2014 and 2013:

2014 vs. 2013 2014 2013 Increase (Decrease) (In Thousands) Net Pre-tax Net Pre-tax Net Pre-tax Business Segment Sales Earnings Sales Loss Sales Earnings Cobra $ 24,672$ 17$ 22,020$ (1,877 )$ 2,652$ 1,894 PPL 4,067 80 3,610 (52 ) 457 132 Total Company $ 28,739$ 97$ 25,630$ (1,929 )$ 3,109$ 2,026 Cobra Business Segment Net sales increased $2.7 million, or 12.0 percent, in the second quarter of 2014 to $24.7 million compared to $22.0 million in the second quarter of 2013. Domestic sales were up $5.1 million and international sales were down $2.4 million. The increase in domestic sales was attributed to higher sales of Two-Way radio, Citizens Band radio, Portable Power Pack, Truck Navigation and Dash Cam products. Sales of the recently introduced Truck Navigation products (6500 PRO HD and 8500 PRO HD), the new Two-Way radio products (CXT 1095 FLT and 1035 FLT), the four new Portable Power Pack models and the three new Dash Cam models contributed to the domestic sales increase for the second quarter of 2014 compared to the prior year. The international sales decline from 2013, mainly in the Two-Way radio, Citizens Band radio and Detection products, was attributable to the economic conditions in certain of the Company's export markets and the political turmoil in parts of Eastern Europe. Gross profit increased $1.2 million, or 22.6 percent, to $6.7 million for the second quarter of 2014, and gross margin increased to 27.3 percent from 24.9 percent in the prior year's quarter. The improved gross margin for the domestic business was due to the higher margin on Two-Way radios and favorable sales mix, which included more sales of the higher margin products such as Citizens Band radios, Truck Navigation, and Portable Power Packs. International gross margins improved due to sales mix, lower product costs and a foreign exchange gain. Selling, general and administrative expense decreased $815,000, or 11.1 percent, to $6.5 million for the second quarter of 2014 compared to $7.3 million in the prior year's quarter and, as a percentage of net sales, were 26.4 percent and 33.2 percent, respectively. The $326,000 increase in variable selling expenses reflected higher merchandising program costs and sales commissions due to higher sales volume. Fixed selling and general administrative expenses decreased $1.1 million or 18.1 percent, mainly due to lower legal and professional fees, which included settlement expenses for the Fleming patent litigation in the second quarter of 2013. Interest expense for the second quarter of 2014 increased $256,000 to $406,000 from the year ago period mainly because of the 2014 write-off of the financing fees for the bank amendment that was required due to a change in the participant bank from Fifth Third Bank to First Midwest Bank and the waiver required for the non-compliance with the twelve-month trailing EBITDA As Defined covenant for the first quarter of 2014. Other income for the second quarter of 2014 increased to $200,000 from $105,000 in the second quarter of 2013 mainly due to higher CSV income in 2014 when compared to 2013. As a result of the above, the Cobra segment had pre-tax earnings of $17,000 for the current year's quarter compared to the $1.9 million pre-tax loss reported for 2013's second quarter.



Performance Products Limited ("PPL") Business Segment

Net sales for the second quarter of 2014 increased $457,000, or 12.7 percent, to $4.1 million from $3.6 million for the second quarter of 2013. The increase in net sales was mainly due to Satellite Navigation products. Foreign currency translation due to the strength of the British pound versus the U.S. dollar significantly affected the sales revenue. On a local currency basis, net sales for 2014 increased 2.9 percent from the prior year. Gross profit increased $208,000, or 17.4 percent, to $1.4 million for the second quarter of 2014, while gross margin improved 1.4 points to 34.5 percent from 33.1 percent in the prior year's quarter. The improved gross margin was mainly due to sales mix, including new products with higher margins and lower sales of the low margin Trackers. Selling, general and administrative expenses for the second quarter of 2014 totaled $1.3 million compared to $1.2 million for the second quarter of 2013 and as a percentage of net sales were 32.4 percent and 34.0 percent, respectively. Excluding the translation effect of the stronger British pound, selling, general and administrative expenses were down 1.8 percent due to lower advertising and promotion costs. 22



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Other expense for the second quarter of 2014 was $5,000 compared to $19,000 for the second quarter of 2013, principally due to a lower foreign exchange loss in 2014 as compared to 2013. As a result of the above, the PPL segment had pre-tax earnings of $80,000 for the second quarter of 2014 compared to a pre-tax loss of $52,000 for the second quarter of 2013. Six Months - 2014 vs. 2013



The following table summarizes net sales and pre-tax earnings by business segment for the six months ended June 30, 2014 and 2013:

2014 vs. 2013 2014 2013 Increase (Decrease) (In Thousands) Net Pre-tax Net Pre-tax Net Pre-tax Business Segment Sales Loss Sales Loss Sales Loss Cobra $ 42,709$ (1,428 )$ 40,435$ (3,292 )$ 2,274$ 1,864 PPL 7,411 (163 ) 6,772 (170 ) 639 7 Total Company $ 50,120$ (1,591 )$ 47,207$ (3,462 )$ 2,913$ 1,871 Cobra Business Segment Net sales increased $2.3 million, or 5.6 percent, for the six months ended June 30, 2014 to $42.7 million compared to $40.4 million in the year ago period. Domestic sales were up $4.9 million and international sales were down $2.6 million. The increase in domestic sales was attributed to higher sales of Two-Way radio, Citizens Band radio, Portable Power Pack, Truck Navigation and Dash Cam products. Sales of the new Two-Way radio products (1035 FLT and 1095 FLT), the four new Portable Power Pack models, the recently introduced Truck Navigation products (6500 PRO HD and 8500 PRO HD) and the three new Dash Cam models contributed to the domestic sales increase for the first six months of 2014 compared to 2013. The international sales decline, mainly in the Two-Way radio, Citizens Band radio and Detection products, was attributable to the weather and economic conditions in certain of the Company's export markets and the political turmoil in parts of Eastern Europe. Gross profit increased $871,000, or 8.3 percent, to $11.4 million for the first half of 2014, and gross margin increased to 26.7 percent from 26.1 percent in the prior year period. The improved gross margin for the domestic market was partially offset by lower margin for the international market. The improved gross margin for the domestic business was due to the higher margin on Two-Way radios and favorable sales mix, which included more sales of the higher margin products such as Citizens Band radios, Truck Navigation, and Portable Power Packs. The decline in the international gross margin was mainly due to pricing concessions to move older products and lower sales volume on the higher margin detection products in Eastern Europe. Selling, general and administrative expense decreased $1.5 million, or 10.6 percent, to $12.6 million for the first half of 2014 compared to $14.1 million for the year ago period and, as a percentage of net sales, were 29.5 percent and 34.8 percent, respectively. The increase in variable selling expenses of $487,000 reflected higher merchandising program costs and sales commissions due to higher sales volume. Fixed selling and general administrative expenses decreased $2.0 million, or 16.0 percent, mainly due to lower legal and professional fees, which included the litigation expenses incurred in the first six months of 2013 for the Fleming patent lawsuit. Interest expense for the first half of 2014 increased $353,000 to $663,000 from the year ago period mainly because of the 2014 write-off of the financing fees for the bank amendment that was required due to a change in the participant bank from Fifth Third Bank to First Midwest Bank and the waiver required for the non-compliance with the twelve-month trailing EBITDA As Defined covenant for the first quarter of 2014. Other income for the first six months of 2014 decreased to $412,000 from $558,000 for 2013 mainly due to lower CSV income in 2014 when compared to 2013.



As a result of the above, the Cobra segment had a pre-tax loss of $1.4 million for the current year's first half compared to the $3.3 million pre-tax loss reported for the first six months of 2013.

Performance Products Limited ("PPL") Business Segment

Net sales for the first six months of 2014 increased $639,000, or 9.4 percent, to $7.4 million from $6.8 million for the same period of 2013. The increase in net sales was mainly due to Satellite Navigation and GPS products. Foreign currency translation due to the strength of the British pound versus the U.S. dollar significantly affected the sales revenue. On a local currency basis, net sales for 2014 increased 1.2 percent from the prior year. Gross profit increased $121,000, or 5.1 percent, to $2.5 million for the first half of 2014, while gross margin decreased 1.4 points to 33.7 percent from 35.1 percent in the prior year. The decreased gross margin was mainly due to lower average selling prices for the older Satellite Navigation, AVN and golf products. 23



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Selling, general and administrative expenses for the first half of 2014 totaled $2.7 million compared to $2.4 million for the first six months of 2013 and as a percentage of net sales were 35.8 percent and 35.9 percent, respectively. Excluding the translation effect of the stronger British pound, selling, general and administrative expenses were up 1.3 percent mainly due to the costs related to the new General Manager in the Cobra Europe group.



Other expense for the first six months of 2014 was $11,000 compared to a $119,000 expense for the same period of 2013, principally due to a lower foreign exchange loss in 2014 as compared to 2013.

As a result of the above, the PPL segment had a pre-tax loss of $163,000 for six months ended June 30, 2014 compared to a pre-tax loss of $170,000 for the same period of 2013. LIQUIDITY AND CAPITAL RESOURCES The Company is party to a Credit Agreement dated July 16, 2010 (as amended, the "Credit Agreement") among the Company, BMO Harris Bank N.A., as administrative agent (the "Administrative Agent"), and the lenders party thereto from time to time (the "Lenders"). The Credit Agreement provides for a $35.0 million secured credit facility expiring on July 16, 2016. At June 30, 2014, the Company had interest bearing debt outstanding of $18.7 million and credit availability of approximately $5.4 million under the Credit Agreement. The Credit Agreement was amended on March 6, 2014 to waive the non-compliance with the fixed charge coverage ratio for the fourth quarter of 2013, to replace the interest reserve with a $1.5 million availability block which applies to the borrowing base under the Credit Agreement and to add a 2 percent pricing fee on a portion of the amount of borrowings outstanding under the Credit Agreement. On May 14, 2014, the Lenders granted the Company a waiver with respect to non-compliance with the minimum twelve-month trailing EBITDA As Defined covenant contained in the Credit Agreement of $1.5 million for the period ended March 31, 2014. The Company did not meet the minimum twelve-month trailing EBITDA As Defined covenant of $4.3 million for the period ended June 30, 2014. On August 11, 2014, the Company and the Lenders entered into a waiver and amendment agreement pursuant to which the Lenders waived the non-compliance for the second quarter of 2014, increased the availability block to $2.0 million and changed the applicable covenant to a minimum fixed charge coverage ratio of 1.50 to 1.00 for the third quarter of 2014, the fourth quarter of 2014 and thereafter. As amended, the Credit Agreement provides a minimum covenant based on a fixed charge coverage ratio of 1.50 to 1.00 for the third and fourth quarter of 2014 and thereafter. A failure to comply, absent a waiver from Lenders, with the covenants contained in the Credit Agreement could result in any outstanding indebtedness under the Credit Agreement becoming immediately due and payable and in the inability to borrow additional funds under the Credit Agreement. The Company believes that, for the foreseeable future, it will be able to continue to fund its operations and seasonal working capital requirements with cash generated from operations and borrowings under the Credit Agreement. For the six months ended June 30, 2014, net cash flows provided by operating activities totaled $4.0 million. Net cash inflows from operations and non-cash add-backs included a net loss of $1.6 million, non-cash depreciation and amortization of $1.9 million, a decrease in accounts receivable of $3.7 million, an increase in accounts payable of $1.3 million and a decrease in inventories of $179,000. Offsetting these inflows were decreases in other liabilities of $709,000 and increases in other assets of $457,000. The decrease in accounts receivable was due to normal cash collections and lower sales for the second quarter of 2014 as compared to the fourth quarter of 2013. Accounts payables increased due to the payment timing for receipts of the new product rollouts. The inventory decrease reflected the net effect of sales volume for the first half of 2014 and inventory purchases for new product rollouts for the second and third quarters of 2014. The decrease in other liabilities was attributable to a lower payroll accrual for the second quarter due to the timing of the pay cycles compared to year end and lower promotional and warranty accruals due to the lower sales volume for the second quarter of 2014 compared to the prior year's fourth quarter. The increase in other assets resulted from higher vendor receivables and additions to prepaid assets. Working capital requirements are seasonal, with demand for working capital being higher later in the year as customers begin purchasing for the holiday selling season. The Company believes that cash generated from operations and from borrowings under its Credit Agreement will be sufficient in 2014 to fund its working capital needs. Net cash used in investing activities for the first six months of 2014 totaled $1.0 million. Property, plant and equipment additions, which totaled $382,000, were primarily for tooling. Intangible asset additions, which totaled $495,000, included in-house development of software for new products, patents and trademarks. Premiums for life insurance totaled $125,000.



Net cash used in financing activities for the six months ended June 30, 2014 totaled $2.0 million and mainly resulted from repayments of bank borrowings.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES Critical accounting policies and estimates consist of those that reflect significant judgments and uncertainties and could potentially result in materially different results under different assumptions. For a description of the Company's critical accounting policies and estimates, refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2013. The application of certain of these policies requires significant judgments or a historical based estimation process that can affect the results of operations and financial position of the Company as well as the related footnote disclosures. The Company bases its estimates on historical experience and other assumptions that it believes are reasonable. If actual amounts ultimately differ from previous estimates, the revisions are included in the Company's results of operations for the period in which the actual amounts become known. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements within the meaning of that term in the Private Securities Litigation Reform Act of 1995 found at Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). Additional written or oral forward-looking statements may be made by the Company from time to time in filings with the SEC, press releases or otherwise. Statements contained in this report that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act. Forward-looking statements may include, but are not limited to, projections of revenue, income or loss and capital expenditures, statements regarding future operations, anticipated financing needs, compliance with financial covenants in loan agreements, liquidity, plans for acquisitions or sales of assets or businesses, plans relating to products or services, assessments of materiality, expansion into international markets, growth trends in the consumer electronics industry, technological and market developments in the consumer electronics industry, the availability of new consumer electronics products and predictions of future events, as well as assumptions relating to these statements. In addition, when used in this report, the words "anticipates," "believes," "should," "estimates," "expects," "intends," "plans" and variations thereof and similar expressions are intended to identify forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified based on current expectations. Consequently, future events and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements contained in this report or in other Company filings, press releases, or otherwise. Factors that could contribute to or cause such differences include, but are not limited to, unanticipated developments in any one or more of the following areas: global economic and market conditions, including continuation of or changes in the current economic environment;



ability of the Company to introduce new products to meet consumer needs,

including timely introductions as new consumer technologies are

introduced, and customer and consumer acceptance of these new product

introductions; pressure for the Company to reduce prices for older products as newer technologies are introduced; significant competition in the consumer electronics business, including

introduction of new products and changes in pricing;



factors related to foreign manufacturing, sourcing and sales (including

foreign government regulation, trade and importation, and health and safety concerns, and effects of fluctuation in exchange rates); ability of the Company to maintain adequate financing, to bear the



interest cost of such financing and to remain in compliance with financing

covenants; impairment of intangible assets due to market conditions and/or the Company's operating results;



ability of the Company to defend its intellectual property rights and the

costs associated with such defense; changes in law; and other risk factors, which may be detailed from time to time in the Company's SEC filings. Readers are cautioned not to place undue reliance on any forward-looking statements contained in this report, which speak only as of the date set forth on the signature page hereto. The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after such date or to reflect the occurrence of anticipated or unanticipated events. 25



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