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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 2005.
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission file number: 1-10346
EMRISE CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 77-0226211
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
9485 HAVEN AVENUE, SUITE 100, RANCHO CUCAMONGA, CALIFORNIA 91730
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (909) 987-9220
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
COMMON STOCK, $0.0033 PAR VALUE NYSE ARCA
Securities registered pursuant to Section 12(g) of the Act:
NONE
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of the voting common equity held by
nonaffiliates of the registrant, computed by reference to the $1.19 closing sale
price of such stock on June 30, 2005, was approximately $42,837,000. The
registrant has no non-voting common equity.
The number of shares of the registrant's common stock, $0.0033 par
value, outstanding as of April 4, 2006 was 38,081,750.
DOCUMENTS INCORPORATED BY REFERENCE: None.
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business............................................................1
Item 1A. Risk Factors.......................................................22
Item 1B. Unresolved Staff Comments..........................................27
Item 2. Properties.........................................................28
Item 3. Legal Proceedings..................................................28
Item 4. Submission of Matters to a Vote of Security Holders................29
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities..................30
Item 6. Selected Financial Data............................................31
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................32
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.........57
Item 8. Financial Statements and Supplementary Data........................58
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...........................................58
Item 9A. Controls and Procedures............................................59
Item 9B. Other Information..................................................60
PART III
Item 10. Directors and Executive Officers of the Registrant.................61
Item 11. Executive Compensation.............................................64
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.........................71
Item 13. Certain Relationships and Related Transactions.....................73
Item 14. Principal Accountant Fees and Services.............................74
PART IV
Item 15. Exhibits and Financial Statement Schedules.........................74
Index to Financial Statements and Financial Statement Schedule...............F-1
Signatures....................................................................81
Exhibits Attached to This Report..............................................82
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PART I
ITEM 1. BUSINESS.
CORPORATE OVERVIEW
We are a Delaware corporation that was formed July 14, 1989. We have
three wholly-owned operating subsidiaries, EMRISE Electronics Corporation, a New
Jersey corporation that was formed in 1983 ("EMRISE Electronics"), CXR Larus
Corporation, a Delaware corporation that was formed in 1984 ("CXR Larus"), and
CXR-Anderson Jacobson, a French company that was formed in 1973 ("CXR-AJ").
EMRISE Electronics and its subsidiaries design, develop, manufacture and market
electronic components for defense, aerospace and industrial markets. CXR Larus
and CXR-AJ design, develop, manufacture and market network access and
transmission products and communications test equipment. CXR Larus also
manufactures and sells satellite communication timing and synchronization
products.
In December 2004, CXR Larus changed its name from CXR Telcom
Corporation when it succeeded by merger to the assets and liabilities of Larus
Corporation, a San Jose, California-based manufacturer and seller of
telecommunications products, and Vista Labs, Incorporated, a subsidiary of Larus
Corporation that provided engineering services to Larus Corporation. As
described in more detail elsewhere in this report, we acquired Larus Corporation
and Vista Labs, Incorporated in July 2004.
In March 2005, EMRISE Electronics Ltd. ("EEL"), a United Kingdom-based
subsidiary of EMRISE Electronics, acquired Pascall Electronic (Holdings) Limited
("PEHL") and its wholly-owned subsidiary, Pascall Electronics Limited
("Pascall"). Pascall is based in the United Kingdom and manufactures a range of
custom proprietary power systems and radio frequency ("RF") components and
subsystems.
On September 1, 2005, EMRISE Electronics acquired all of the
outstanding common stock of RO Associates, Inc. ("RO"), a manufacturer of
standard power supplies located in Sunnyvale, California.
Through our operating subsidiaries, CXR Larus, CXR-AJ and EMRISE
Electronics, and through the divisions and subsidiaries of those subsidiaries,
we design, develop, manufacture, assemble, and market products and services in
the following two material business segments:
o Electronic Components
-- digital and rotary switches
-- electronic power supplies
-- radio frequency, or RF, components
-- subsystem assemblies
o Communications Equipment
-- network access and transmission products
-- satellite communication timing and synchronization products
-- communications test instruments
1
Our sales are primarily in North America, Europe and Asia. Sales to
customers in the electronic components segment, primarily to defense and
aerospace customers, defense contractors and industrial customers were
approximately 62.6%, 51.1%, and 63.4% of our total net sales during 2005, 2004
and 2003, respectively. Sales of communications equipment and related services,
primarily to private customer premises and public carrier customers, were
approximately 37.4%, 48.9% and 36.6% of our total net sales during 2005, 2004
and 2003, respectively.
Our objective in our electronic components business is to become the
supplier of choice for harsh environment, high reliability digital and rotary
switches, custom and standard power supplies and RF and microwave products and
subsystems. Our objective in our communications equipment business is to become
a leader in quality, cost effective solutions to meet the requirements of
communications equipment customers. We believe that we can achieve these
objectives through customer-oriented product development, superior product
solutions, and excellence in local market service and support.
INDUSTRY OVERVIEW
ELECTRONIC COMPONENTS
The electronic components industry comprises three basic segments,
which are active components, passive components and electromechanical
components. We compete in the active and electromechanical segments of this
industry. These segments can be further segmented by industry into
telecommunications, aerospace, defense, commercial, industrial and other
environments, each of which places constraints that define performance and
permitted use of differing grades of components.
We are active only in the industry segments that are characterized by
harsh environment, high reliability, low volume, high margin and long
lead-times, namely the aerospace, defense and industrial segments. To support
the myriad customers that rely on digital and rotary switches and electronic
power supplies, we believe that our electronic components must offer high levels
of reliability and in many cases must be tailored to the size, appearance,
functionality and pricing needs of each particular customer.
The defense market, which is a predominant market for our electronic
components, makes use of sophisticated electronic assemblies in diverse
applications that involve both original equipment and retrofit of existing
equipment.
The Digitran division of EMRISE Electronics ("Digitran"), which EMRISE
Electronics acquired from Becton Dickinson in 1985, has been manufacturing
digital switches since the 1960s. XCEL Power Systems, Ltd. ("XPS"), a
second-tier subsidiary of EMRISE Electronics, has been manufacturing electronic
power supplies since 1989. Pascall was formed in 1977.
COMMUNICATIONS EQUIPMENT
Over the past decade, telecommunications and data communications
infrastructures have undergone significant growth and have become a critical
part of the global business and economic infrastructure that has been driven by
the following:
o a surge in demand for broadband access used to conduct e-commerce
activities and transmit growing volumes of data, voice and video
information;
2
o the adoption of Internet protocol, or IP, which is a protocol
developed to enable the transmission of information as packets of
data from a source to a recipient using dynamically changing
routes, with the data being reassembled at the recipient's
location into the original information format; and
o an apparent worldwide trend toward deregulation of the
communications industry, which has enabled a large number of new
communications service providers to enter the market.
This rapid growth has been succeeded by a period of consolidation.
Private and corporate communications providers and other businesses that rely
heavily on information technology continue to devote significant resources to
the purchase of network access and transmission equipment, such as high-speed
DSL and fiber optic modems, through which data and voice information may be
transmitted. DSL, or digital subscriber line, technology transmits data up to 50
times faster than a conventional dial-up modem using existing copper telephone
wires. However, we do believe that the demand for test equipment with which to
test, deploy, manage and optimize communications networks, equipment and
services remains depressed for public carrier markets.
To support the rapidly changing needs of telecommunications companies
and information technology dependent businesses, we believe that network access
and transmission products and communications test instruments must offer high
levels of functional integration, automation and flexibility to operate across a
variety of network protocols, technologies and architectures. Because the
competition for subscribers for high-speed bandwidth access is intense, the
quality and reliability of network service has become critical to
telecommunications companies due to the expense, loss of customers and negative
publicity resulting from poor service. Quality and reliability of network
service are also important to information technology dependent businesses that
rely on broadband high-speed data links for a variety of purposes.
Technicians who use service verification test equipment in the field or
in central or branch offices assist businesses in verifying and repairing
service problems effectively and, thus, increase the quality and reliability of
their networks. We believe that as broadband services are deployed further and
as competition for telecommunications subscribers and e-commerce customers
proliferates, telecommunications companies and other information
technology-reliant businesses will increasingly depend on new and improved
integrated access transmission devices and advanced field and central or branch
office testing and monitoring solutions.
OUR SOLUTION
We have developed a range of electronic components, such as digital and
rotary switches, custom and standard electronic power supplies and RF components
and subsystems, used primarily by aerospace, defense and industrial customers.
We have developed and we manufacture and market various network access
and transmission devices used by businesses and other users to efficiently
transmit data, voice and video information to destinations within and outside of
their respective networks.
We have developed and we manufacture and market a select range of test
instruments used by operators of public and private telecommunications networks
for the installation, maintenance and optimization of advanced communications
networks.
We have also developed and we manufacture and market a range of
satellite communication timing and synchronization products used by operators of
public and private telecommunications networks to provide a consistent source of
timing alignment, or synchronization, for digital networks.
3
Our extensive knowledge and understanding of our customers' needs,
together with the broad capabilities of our network access and transmission
products, test instrumentation products and our sophisticated electronic
components, enable us to provide the following features and benefits to our
customers:
DEVELOPMENT OF NEW SWITCH TECHNOLOGY. We have complemented our
long-established range of digital switch products with a new range of
patent-pending space-saving rotary switches we refer to as VLP(TM), which are
very low profile switches. These products have been specifically designed to
target harsh environment and aerospace applications where space is at a premium,
providing a substantial advantage over larger, heavier switches offered by our
competitors.
PROVISION OF RF COMPONENTS AND SUBASSEMBLIES. We have developed and
provide a range of RF components and subassemblies that meet the requirements of
defense, aerospace and industrial applications.
DEVELOPMENT AND PROVISION OF SATELLITE COMMUNICATION TIMING AND
SYNCHRONIZATION EQUIPMENT. We have extended the existing range of satellite
communication timing and synchronization products with a new range of equipment
designed specifically to target the more extensive Regional Bell Operating
Company ("RBOC") or public carrier market in addition to private networks.
PROVISION OF MORE EFFICIENT AND COST-EFFECTIVE POWER SYSTEMS. We have
developed and we provide custom and standard high and low voltage power systems
that are highly integrated within the application hardware, which minimizes
cost, space and complexity and maximizes overall system reliability and
efficiency. We believe that our ability to partner with major international
defense contractors and to provide power systems solutions based on both
standard modules and custom designs provides us with an important competitive
advantage.
BROAD RANGE OF NETWORK ACCESS AND TRANSMISSION PRODUCTS FOR A WIDE
RANGE OF APPLICATIONS. We have developed a broad range of professional network
access and transmission products capable of connecting to a wide range of remote
monitoring devices and equipment. Many of these products are designed to operate
in extended temperatures and harsh environments and meet specific requirements
such as data speeds, data interfaces, power inputs, operating temperatures, data
formats and power consumption. In addition, our desktop and rack mount
transmission product lines allow us to serve both central site data
communications needs and remote access and transmission sites on both the
enterprise-wide and single location level.
HANDHELD DESIGN OF FIELD TEST EQUIPMENT. The compact, lightweight
design of these products enables field technicians to access problems and verify
line operation quickly.
COMPREHENSIVE CONNECTIVITY. Our network access and transmission
products and communications test instruments are the result of significant
product research and engineering and are designed to connect to a broad range of
operation configurations and to connect over a wide range of prevailing
transmission conditions. Our products incorporate a wide range of standard
international connectivity protocols as well as proprietary protocols.
CUSTOMER-DRIVEN FEATURES. Most of our digital and rotary switches and
each of our power supplies are highly tailored to our customers' needs. We
manufacture digital and rotary switches for insertion into new equipment as well
as for retrofit into existing equipment. Our engineers continually interact with
our customers during the design process to ensure that our electronic components
are the best available solution for them. For example, based on conversations
with our customers, we delivered a compact multiple output power supply to allow
BAE Systems to produce a single-heads up display suitable for fitting on a large
range of commercial and military aircraft.
4
CUSTOMER RELATIONS. Our electronic components business currently enjoys
a preferred supplier status with many key accounts, which means that we work in
close association with the customer to develop custom products specifically
addressing their needs. Our electronic components also are considered qualified
products with many key accounts, which means that our products are designed into
equipment specifications of many of our customers for the duration of their
production of their equipment.
LONG-TERM RELATIONSHIPS. Market procurement methods encourage long-term
relationships between electronic components suppliers and customers, with
customers committing to a single source of supply because of the high cost
involved in qualifying a product or its alternative for use. For example, a
large proportion of XPS' and Digitran's products are qualified products that
have been involved in many hours of flight trials.
OUR STRATEGY
Our objectives are to become the supplier of choice for harsh
environment switches, RF devices and custom and standard power supplies in the
aerospace, defense and industrial markets, in addition to becoming a leading
provider of network access and transmission products and timing systems for a
broad range of applications within the global communications industry. The
following are the key elements of our strategy to achieve these objectives:
FOCUS ON OUR ELECTRONIC COMPONENTS BUSINESS. We plan to continue to
grow our electronic components business by marketing our electronic components
products in their established market niches and identifying opportunities to
broaden our customer base.
RAMP UP OUR SATELLITE COMMUNICATION TIMING AND SYNCHRONIZATION PRODUCTS
AND CONTINUE TO FOCUS ON NETWORK ACCESS AND TRANSMISSION PRODUCTS. We plan to
build upon our existing strong base businesses in the communications equipment
market introducing additional new customer premises products, especially new
carrier class satellite communication timing and synchronization products,
utilizing our broader reach with CXR Larus to address new markets.
PURSUE STRATEGIC ACQUISITIONS. The satellite communication timing and
synchronization products market and network access and transmission market are
large and highly fragmented. We plan to extend our market position by acquiring
or investing in complementary businesses or technologies on a selected basis.
CONTINUE TO INVEST IN RESEARCH AND DEVELOPMENT TO ADDRESS HIGH GROWTH
MARKET OPPORTUNITIES. We plan to continue investing in markets and technologies
that we believe offer substantial growth prospects. We believe that the
expertise we have developed in creating our existing products will permit us to
enhance these products, develop new products and respond to emerging
technologies in a cost-effective and timely manner.
LEVERAGE EXISTING CUSTOMER BASE. We believe that many of our existing
customers will continue to purchase network access and transmission products and
test instrument products and services. We intend to aggressively market new and
enhanced products and services to our existing customers. We also believe that
our existing customer base represents an important source of references and
referrals for new customers in new markets.
PURSUE FOLLOW-ON SALES OPPORTUNITIES. We plan to continue to increase
the functionality of our communications equipment products, enabling products to
be upgraded by the downloading of software or the addition of hardware to an
existing unit, allowing customers to protect their investment in their already
deployed test equipment and generating follow-on sales opportunities as we
develop new capabilities in the future. We plan to continue to approach our
existing digital switch customers to determine whether they need our proprietary
and patent pending rotary switches that we do not currently manufacture for
them.
5
SEEK COMPETITIVE WORLD-CLASS MANUFACTURING FOR SELECTED PRODUCTS.
Toward the end of 2002, we cut costs by using Asian manufacturing sources for
selected communications equipment products and subassemblies. We intend to build
on this strategy in the U.S. and Europe to increase our competitiveness in the
marketplace by looking for Tier 2 manufacturers who can offer more attractive
pricing.
SEEK ALTERNATIVE MARKET OPPORTUNITIES. We plan to expand our focus and
efforts to identify and capture more new customers, such as private network
utilities and transit customers, for our network access and transmission and
test equipment products.
DEVELOP AND ExPAND STRATEGIC RELATIONSHIPS. We plan to continue to
develop our strategic relationships with network access and transmission
manufacturers in order to enhance our product development activities and
leverage shared technologies and marketing efforts to build recognition of our
brands. In particular, in Europe, we intend to continue to expand our
relationships with offshore vendors as a reseller of their products to enhance
our position and reputation.
PURSUE TECHNOLOGY TRANSFER AND LICENSING. We plan to continue our
established practice of purchasing or licensing core technologies where this
reduces time and cost to market, as we did with the base platform for our remote
access server products purchased from Hayes Corporation.
DEVELOP CUSTOMER-FOCUSED SOLUTIONS. We design, develop, and manufacture
many products and provide services that are tailored to the specific needs of
our customers with an emphasis on ease of use. We intend to continue to adapt
our core communications technologies to deliver focused products that improve
our customers' ability to test and manage increasingly large and complex
networks and that are easily used by field technicians and central office
personnel.
EXTEND OUR GLOBAL PRESENCE. Our customers' needs evolve through
industry expansion and consolidation as well as with the deployment of new
technologies and services. To support our customers more effectively, we intend
to further augment our sales, marketing and customer support organizations.
6
PRODUCTS AND SERVICES
Our products and services currently are divided into the following two
main business segments:
o Electronic Components
-- digital and rotary switches
-- electronic power supplies
-- RF components and subsystems
o Communications Equipment
-- network access and transmission products
-- satellite communication timing and synchronization products
-- communications test instruments
During 2005, 2004 and 2003, our total net sales were approximately
$41,046,000, $29,861,000 and $25,519,000, respectively, and the percentages of
total net sales contributed by each product group within our two main business
segments were as follows:
Year Ended December 31,
------------------------------
Segment and Product Type 2005 2004 2003
------------------------ ------- ------- -------
Electronic Components
Digital and Rotary Switches 15.9% 18.5% 20.9%
Electronic Power Supplies 34.5% 26.7% 34.3%
RF Components 7.5% -- --
Subsystem Assemblies -- 0.7% 5.9%
Other Products and Services 4.7% 5.2% 2.3%
------- ------- -------
62.6% 51.1% 63.4%
Communications Equipment
Network Access and Transmission Products 21.5% 27.6% 24.0%
Satellite Communication Timing and
Synchronization Products 6.4% 4.3% --
Communications Test Instruments 6.7% 13.6% 9.2%
Other Products and Services 2.8% 3.4% 3.4%
------- ------- -------
37.4% 48.9% 36.6%
Totals 100.0% 100.0% 100.0%
======= ======= =======
7
BACKLOG
Our business is generally not seasonal, with the exception that
purchases of our communications equipment by public telecommunications carriers
tend to be lower than average during the first quarter of each year because
capital equipment budgets typically are not approved until late in the first
quarter. At December 31, 2005, our backlog of firm, unshipped orders was
approximately $22,150,000. Our backlog was related approximately 97.4% to our
electronic components business, which tends to provide us with long lead-times
for our manufacturing processes due to the custom nature of the products, and
approximately 2.6% to our communications equipment business, the majority of
which portion relates to our network access and transmission, timing and
synchronization and test equipment products. Of these backlog orders, we
anticipate fulfilling approximately 70% of our electronic components orders and
100% of our communications equipment orders within the current fiscal year.
However, we cannot assure you that we will be successful in fulfilling these
orders in a timely manner or that we will ultimately recognize as revenue the
amounts reflected as backlog.
WARRANTIES
Generally, our electronic components, network access and transmission
products and satellite communication timing and synchronization products carry a
one-year limited parts and labor warranty and our communications test
instruments and European network access and transmission products carry a
two-year limited parts and labor warranty. Products returned under warranty
typically are tested and repaired or replaced at our option. Historically,
product returns have not had a material effect on our operations or financial
condition. However, we cannot assure you that this will continue to be the case
or that disputes over components or other materials or workmanship will not
arise in the future.
OUR ELECTRONIC COMPONENTS BUSINESS
Our electronic components segment includes digital and rotary switches,
electronic power supplies, RF components and subsystem assemblies. During the
years ended December 31, 2005, 2004 and 2003, this segment accounted for
approximately 62.6%, 51.1% and 63.4%, respectively, of our total net sales.
DIGITAL AND ROTARY SWITCHES
The Digitran division of EMRISE Electronics manufactures, assembles and
sells digital and rotary switch products serving aerospace, defense and
industrial applications. Digital and rotary switches are manually operated
electromechanical devices used for routing electronic signals. Thumbwheel, push
button, lever-actuated and rotary modules, together with assemblies comprised of
multiple modules, are manufactured in many different model families. Digitran
also offers a wide variety of custom keypads for unique applications.
Our switches may be ordered with different combinations of a variety of
features and options, including night vision compatibility, harsh environment
sealing, RF shielding, various mounting methods, various electrical interfaces,
various packaging and presentation to suit each application.
ELECTRONIC POWER SUPPLIES
XPS and Pascall, based in England, and RO based in the U.S.,
manufacture a range of high and low voltage, high specification, high
reliability custom and standard power conversion products designed for hostile
environments and supplied to an international customer base, predominantly in
the military and civil aerospace, military vehicle and telecommunications
markets.
Power conversion units supplied by XPS and Pascall range from 10VA to
1.5 KVA power ratings, low voltage (1V) to high voltage (20KV+), and convert
alternating current, or AC, to direct current, or DC, convert DC to AC and
convert DC to AC. Units can be manufactured to satisfy input requirements
determined by military, civil aerospace, telecommunications or industrial
businesses, and sophisticated built-in test equipment, or BITE, and control
circuitry often is included. Operating environments for our units are diverse
and range from fighter aircraft to roadside cabinets.
8
RF COMPONENTS
Pascall designs, develops, manufactures and markets a range of RF and
microwave amplifiers, components, subsystems and systems to 18GHz for
applications that include defense, aerospace, communications, air traffic
control and weather radar.
SUBSYSTEM ASSEMBLIES
Subsystem assemblies incorporate various input and display devices and
are manufactured for integration with various aerospace, defense, industrial and
transportation industry systems.
OUR COMMUNICATIONS EQUIPMENT BUSINESS
Our communications equipment business comprises network access and
transmission products, satellite communication timing and synchronization
products, and communications test equipment. During the years ended December 31,
2005, 2004 and 2003, the sale of communications equipment products and related
services accounted for approximately 37.4%, 48.9% and 36.6%, respectively, of
our total net sales. These products, many of which are described below, are
configured in a variety of models designed to perform analog and digital
measurements or to transmit data at speeds varying from low-speed voice grade
transmission to high-speed broadband access.
Some of the acronyms and terms used most frequently in the product
discussions on the following pages include:
o Time division multiplexing, or TDM, which is a technique for
consolidating multiple data sources into a single data stream by
allocating time slots to each data source
o Traditional telephone services, such as modems and plain old
telephone service, or POTS o Competitive local exchange carriers,
or CLECs
o Independent local exchange carriers, or ILECs
o Bit error rate test, or BERT
o Dial tone multi-frequency, or DTMF
o Transmission impairment measurement, or TIMS
o Central office and private business exchange, or CO/PBX, services,
where the central office houses the local exchange equipment that
routes calls to and from customers and to Internet service
providers and long-distance carriers
o Synchronous - in digital telephone transmission, synchronous means
that the bits from one call are carried within one transmission
frame
o Digital data services, or DDS, including the USA and worldwide
standards described below:
I. USA standards, including:
-- ISDN, which is an enhanced digital network that offers
more bandwidth and faster speed than the traditional
telephone network
-- Caller identification or caller-ID services
9
-- Digital subscriber line technology, or DSL, technology
which transmits data up to 50 times faster than a
conventional dial-up modem using existing copper
telephone wires
-- Multi-rate symmetric DSL, or MSDSL, which allows the
transmission of data over longer distances than
single-rate technologies by adjusting automatically or
manually the transmission speed
-- T-1, which is a standard for digital transmission in
North America used by large businesses for broadband
access
-- FT-1, or fractional T-1, which uses only a selected
number of channels from a T-1 -- T-3, which is the
transmission rate of 44 megabits, or millions of bits,
per second, or 44 Mbps, with 672 channels
-- Digital signal level 0, or DS0, which is 64 kilobits,
or thousands of bits, per second, or 64 kbps, with one
channel of a T-1, E-1, E-3 or T-3
-- Digital signal level 1, or DS1, which is the T-1
transmission rate of 1.54 Mbps, with 24 channels
-- Digital signal level 3, or DS3, which is the T-3
transmission rate of 44 Mbps, with 672 channels
-- Router, which is an intelligent device used to connect
local and remote networks
-- Terminal adapter, which is situated between telephones
or other devices and an ISDN line and allows multiple
voice/data to share an ISDN line
-- Transmission control protocol/Internet protocol, or
TCP/IP
-- STS/SONET, which is an acronym for synchronous
transport signal/synchronous optical networks or
fiber optic networks
-- SDH is an acronym for synchronous digital hierarchy
-- STM1 (SDH) is a standard technology for synchronous
data transmission on optical media and is the
international equivalent of synchronous optical
network; SDH uses the following synchronous transport
modules, or STMs, and rates: STM1- 155 Mbps, STM-4 -
622 Mbps, STM-16 - 2.5 gigabits per second (Gpbs), and
STM-64 - 10 Gbps
-- G703/G704 is a standard for transmitting voice over
digital carriers such as T-1 and E-1; G703 provides the
specifications for pulse code modulation at data rates
from 64 Kbps to 2.048 Mbps and is typically used for
interconnecting data communications equipment such as
bridges, routers and multiplexers
-- V11/V35/X21 are types of serial interfaces; serial
interfaces work best for short (perhaps less than 20
meters), low-speed applications
-- X.25 is a protocol that allows computers on different
public networks or a TCP/IP network to communicate
through an intermediary computer at the network layer
level
II. International standards, including:
-- E-1, which is the European standard for international
digital transmission used by large businesses for
broadband access, with 2.108 Mbps, with 30 channels
-- FE-1, or fractional E-1, which uses only a selected
number of channels from an E-1
-- E-3, which is the European standard for T-3, with
34.368 Mbps and 480 channels
NETWORK ACCESS AND TRANSMISSION PRODUCTS
CXR Larus and CXR-AJ design, develop, manufacture and market a broad
range of network access and transmission products. These products include
high-quality network access devices such as fiber optic, DSL and voice
frequency, or VF, modems, ISDN terminal adapters, ISDN concentrators,
multiplexers, terminal servers, interface converters and remote access servers,
which combine to provide users with a complete solution for voice and data
transmission.
10
Modems
------
Our modem product range includes professional grade traditional VF
modems, a range of fiber optic modems and a range of DSL modems. Our modems are
sold as standalone devices for remote sites or as rack-mountable versions for
central sites, and all are remotely manageable. Our customers use our
high-quality professional grade modems worldwide for networking and for central
office telecommunications applications such as voicemail and billing systems and
secure communications. Our modems are feature rich and we believe generally
offer more capabilities and better performance than competing products,
especially when operating over poor quality lines. This characteristic alone has
made our modems the modems of choice for voicemail applications throughout the
United States. Our modems are also available in more rugged versions for
industrial applications such as telemetry and remote monitoring in harsh
environments.
ISDN Terminal Adapters
----------------------
Together with modems, we offer a line of ISDN terminal adapters, which
are the popular digital equivalent of analog modems used primarily in Europe.
These terminal adapters are used in a broad range of applications, including
point-of-sale and videoconferencing, and are available in standalone as well as
rack-mountable versions.
Terminal Servers
----------------
Terminal servers include a range of products that enable the connection
of asynchronous applications to the Ethernet Network. These products were
designed to meet the requirements of our customers to interface equipment to the
corporate local area network, commonly called the LAN, and therefore to the
outside world, via our range of network access products.
Drop and Insert Multiplexers
----------------------------
Our broad range of drop and insert multiplexers covers E-1, T-1, FE-1,
E-3, T-3 and STM1 (SDH) over both copper wires and fiber optic networks. The
units enable users to manage the consolidation of their information from a
variety of voice or data sources (G703, G704, X21, V11 and V35) through an
easy-to-use menu-driven and Microsoft Windows-based user interface.
Modular Routers
---------------
Our commercial/industrial router product range is modular, which
provides users the flexibility to configure or have configured a unit that meets
their specific requirements. Our routers provide access to the Internet or
remote sites via ISDN, leased line, X.25, frame relay and DSL connections. The
router creates or maintains a table of available routes and their conditions and
uses this information, along with distance and cost algorithms, to determine the
best route for a given packet of data.
Interface Converters
--------------------
Our range of interface converters provides users the ability to
interface data from LAN, V11 or V35 to E-1, T-1, E-3, T-3 and STM1. A channel
service unit/data service unit, or CSU/DSU, converts a digital data frame from a
LAN into a frame appropriate to a wide area network, or WAN.
11
ISDN Concentrators
------------------
We also manufacture and offer a line of ISDN intelligent concentrators
called CB2000. These products, which were designed primarily for the European
market, allow for better use of ISDN resources.
TDMoIP Voice and Data Transmission
----------------------------------
Our IP-Jet TDMoIP products facilitate the use of TDM services and
equipment over the Packet Switched Network bringing simplicity with lower cost
without the costly need to replace existing TDM hardware for both carrier and
enterprise users. TDM over IP, or TDMoIP, takes advantage of the internet
protocol, or IP, infrastructure and changing economics of data services delivery
to deliver high revenue leased line services such as E1 and T1. TDMoIP is also
ideal for the enterprise looking to reduce network expenses without compromising
features of their existing PBX and TDM equipment allowing all TDM traffic to be
carried transparently over Ethernet and IP networks irrespective of protocols or
signaling. Typical TDMoIP applications include: transmission of E1/T1, voice,
video and TDM data and IP, centralized voice services over Ethernet or IP,
secure data transmission E1/T1, and transmission of HDLC over IP.
The following are descriptions of a few of our more prominent network
access and transmission products:
PRODUCT NAME KEY USES, FEATURES AND FUNCTIONS
------------ --------------------------------
POWER MODEMS A family of products that allow asynchronous and synchronous transmission
over dial-up or leased lines; asynchronous transmission is a very
high-speed transfer mode that allows telephone companies to mix formerly
incompatible signals, such as voice, video and data.
-- in dial-up applications, a unique line qualification mechanism
assesses the quality of the line and automatically redials before
entering the transmission mode when a poor line is detected,
which avoids having to transmit in a degraded mode and leads to
money savings in long transmission sessions
-- available in standalone units or as rack mountable cards to be
inserted into our Smart Rack
-- industrial versions designed for harsh environments are available
with features such as extra line protection, metallic enclosures,
extended temperature ranges and high humidity protection
MD 2000 RANGE A multi-rate MSDSL modem that has the ability to manually or automatically
adjust line transmission speed to provide the optimum performance for a
particular pair of copper wires.
-- operates over a single twisted pair of copper wires, which
allows telecommunications companies to take advantage of
the large installed base of copper twisted pairs that has
been deployed around the world over many years and upon private
copper wire infrastructures that exist for networking purposes in
locations such as universities, hospitals, military bases, power
plants and industrial complexes
-- allows data transmission over a single copper pair at E-1 speed
over a distance of up to 8.0 miles
-- available as both a standalone unit and as a rack-mountable card
12
PRODUCT NAME KEY USES, FEATURES AND FUNCTIONS
------------ --------------------------------
CB 2000 RANGE The primary function of this unit is to split one or two primary rate
interface links, or PRIs, into multiple basic rate interfaces, or BRIs.
-- this allows substantial cost savings by allowing more
effective use of available ISDN resources without the limitations
of conventional voice PBX
-- this allows for migration from BRI to PRI when the number of
ports needs to be increased while preserving the user's investment
in existing BRI-based terminal equipment
-- this unit can be used in a wide variety of situations where
multiple BRI and PRI access is required, such as:
- videoconferencing, where the unit can be used to aggregate
bandwidth of multiple BRI lines to provide the necessary bandwidth,
and to connect the videoconferencing system to the ISDN network
through a PRI access while still providing connectivity to
other ISDN devices, or to connect two or more videoconferencing systems
together within the same building or campus without going through the ISDN
public network
- ISDN network simulation, which can be used in places such as showrooms,
exhibition and technical training centers to eliminate the need to have
access to, and pay for access to, the ISDN public network for telephone or
data calls
- remote access servers, which usually use multiple BRIs, often need a method for
migration from multiple BRIs to a single PRI as traffic and the number of users
expands
ISDN TERMINAL ADAPTERS These devices are the ISDN equivalent of a modem.
-- these devices connect non-ISDN devices to the ISDN via a network termination
unit, or NT1, which converts the "U" interface from the telephone company into a
4-wire S/T interface
-- allow users to access the data rates of the digital network
-- available as both a standalone unit and as a rack-mountable card
TERMINAL SERVERS This range of products is used to provide the connection of asynchronous applications
to the TCP/IP Ethernet network. These can include point-of-sale terminals, industrial
machines, point-to-point RS232 connections and the visual display units/keyboards.
DROP AND INSERT These products provide users the ability to manage the consolidation of data and/or voice
MULTIPLEXERS information over a variety of TDM networks such as E-1, T-1, E-3, T-3 and STM (SDH).
-- easily configured via management software
-- remotely manageable over IP or dedicated time slot
ROUTERS A router provides connection between the primary rate ISDN and local area networks.
-- dynamically route incoming and outgoing data packets to the appropriate destination
-- available as both a standalone unit and as a rack-mountable card to supplement the
functions of our Smart Rack system
13
Smart Rack
----------
Our modem cards and our ISDN terminal adapter cards generally are
available in standalone versions or in versions that can be mounted in our Smart
Rack, our universal card cage that provides remote management through a
menu-driven user interface. Each part of the framework, or chassis, of the Smart
Rack has slots to house up to 16 cards (or up to 4 cards in a smaller
installation) plus one optional management card. Each slot can be used to insert
any member of our transmission products family, such as analog modems, ISDN
terminal adapters, ISDN digital modems and high-speed MSDSL modems. The optional
Simple Network Management Protocol/Internet Protocol, or SNMP/IP, management
card that can be inserted into each chassis can be used to configure any card in
the chassis and can provide additional features, including alarm reporting,
tracking of configurations, running of diagnostic routines and generation of
statistics. Up to eight chassis can be linked together to form a fully-managed
node with 128 slots. Our Smart Rack arrangement allows each chassis to be used
to its full capacity while reducing floor space needed to house complex systems.
SATELLITE COMMUNICATION TIMING AND SYNCHRONIZATION PRODUCTS
CXR Larus designs, develops, manufactures and markets a series of
satellite communication timing and synchronization products that provide a
consistent source of timing alignment, or synchronization, for digital
communication networks. When the principal network timing source is lost, a CXR
Larus satellite communication timing system can provide an alternative source of
reference synchronization until the principal source can be restored. This is
called operating in the "holdover" state. The various levels of accuracy in
holdover mode are referred to as "stratum levels." Stratum 1 is the most
precise, followed by Stratum 2, Stratum 3E, Stratum 3, and finally Stratum 4.
Stratum 4 has no holdover mode and is the least precise. All CXR Larus satellite
communication timing products offer Stratum 3E stability, or better, and all are
available with options that meet or exceed Stratum 1.
Some of the key satellite communication timing and synchronization
products we offer are described below:
PRODUCT NAME KEY USES, FEATURES AND FUNCTIONS
------------ --------------------------------
Star Sync(TM) 5850 Primary Reference source The Larus StarSync(TM) Model STS 5850 is an economical GPS
timing clock designed for retrofits of existing BITS clocks
and for remote sites that require timing. The StarSync(TM)
provides GPS Stratum 2 clock with Stratum 2 or 3E holdover
performance.
The STS 5850 features two accurate T1 timing references that
are synthesized from GPS for use by BITS clocks, SONET NEs,
intelligent multiplexers, and PCS systems as well as other
systems requiring synchronization. Options permit the STS 5850
to be configured for Stratum 1 Input Track and either Stratum
2 or Stratum 3E Hold. Superior performance is achieved by
Kalman filtering, patented digital frequency synthesis
technology, and use of GPS UTC information to measure a
rubidium oscillator (Stratum 2) or an ultra stable ovenized
reference oscillator (Stratum 3E).
StarClock(TM) STS 5800 Timing System The Larus StarClock(TM) STS 5800 Timing System provides
GPS Stratum 1 clock and/or network tracking with Stratum 2 or
Stratum 3E holdover performance. The Larus StarClock(TM)
represents the optimal local synchronization solution for the
new distributed network. The STS 5800 is an economical
extended temperature timing system that is designed for small
installations and remote sites requiring timing (cell sites,
PCS networks, customer premises, etc.). The output MTIE of the
STS 5800 meets the mask performance specified by GR-2830 for
Stratum 1 clocks, resulting in an improvement of ten to twenty
times over other GPS solutions.
14
PRODUCT NAME KEY USES, FEATURES AND FUNCTIONS
------------ --------------------------------
StarClock(TM) 100 T1/E1 and StarClock(TM) 200 The StarClock(TM) 100 and 200 Synchronization Timing Systems
Synchronization Timing Systems offers flexible and cost-effective solutions for Stratum 1,
Stratum 2E, and Stratum 3E timing for digital transmission and
synchronization applications. The systems provide a redundant
and jitter-free source of framed ones and composite clock and
are synchronized to an equal or higher stratum framed
reference source. The StarClock(TM) 100 and 200 systems can be
employed in either DS1 or E1 digital transmission environments
simply by selecting the appropriate modules.
The StarClock(TM) 100 and 200 systems are the next generation of
Larus' industry-performance-standard STS 5400 Synchronization
System and features backward compatibility with the STS 5400.
StarClock(TM) 100 and 200 circuit card switch settings and
operating functions are software generated, affording both
speed and flexibility for system application changes, testing,
and monitoring.
The StarClock(TM) 100 system supplies up to 100 timing outputs
for use in the synchronization of transmultiplexers, digital
cross-connect systems, and SONET equipment as well as other
equipment requiring network synchronization. Hundreds of these
systems have been deployed into major local exchange carriers,
and international central offices worldwide.
The StarClock(TM) 200, designed specifically for the RBOC and
large central office environment, offers up to 200 timing
outputs unprotected, or 100 timing outputs with 1:1
protection. Expansion shelves can be added to the StarClock(TM)
200 system that will boost the number of timing outputs into
the thousands, enough for the largest central office.
Optional modules for both systems include a GPS Stratum 1
track and Stratum 2E hold or Stratum 1 track and Stratum 3E
hold card, with integral GPS receiver, a Composite Input
Signal module, a module that uses 5 or 10 MHz inputs, and the
Model 54580 Network Time Server.
COMMUNICATIONS TEST INSTRUMENTS
CXR Larus manufactures the CXR HALCYON 700 series of products, which we
believe provide performance and value in integrated installation, maintenance
and testing of communications services. These test instruments are modular,
rugged, lightweight, hand-held products used predominantly by telephone
companies and private network operators to pre-qualify facilities for services,
verify proper operation of newly installed services and diagnose problems.
15
The unique modular nature of our CXR HALCYON 700 series test equipment
provides an easy configuration and upgrade path for testing of the specific
services offered by the various national and international service providers.
Some of the key test equipment products we offer are described below:
PRODUCT NAME KEY USES, FEATURES AND FUNCTIONS
------------ --------------------------------
HALCYON 704A-NTS1 -- 704A universal data test set with 1.5 MHz TIMS, full signaling,
caller ID and full 4-wire loop DDS test functions, as well as
DDS/DS0 test functions and T-1, DS1, DS0 and FT-1 test package
-- T-1 test package includes reference receiver for T-1 level,
frequency and slip measurements
HALCYON 704A-PKG2 -- 704A universal data test set with 1.5 MHz TIMS, full signaling,
full 4-wire loop DDS test functions, as well as DDS/DS0 test
functions for DS0-DP and OCU-DP DS0 and sub-rate testing
CUSTOMERS
ELECTRONIC COMPONENTS
We sell our components primarily to original equipment manufacturers,
or OEMs, in the electronics industry, including manufacturers of aerospace and
defense systems and industrial instruments. During 2005, our top five electronic
components customers in terms of revenues were Rockwell Collins, Inc., BAE
Systems, Raytheon Systems, Advance Navigation and Positioning Corporation and
Selex Airborne Systems. Sales to Rockwell Collins, Inc. represented
approximately 10% of our total net sales during 2005. No other customer
represented 10% or more of our total net sales for that period. Sales to BAE
Systems companies represented 15% and 13% of total net sales in 2004 and 2003,
respectively.
COMMUNICATIONS EQUIPMENT
We market our network access and transmission products, satellite
communication timing and synchronization products and communications test
instruments primarily to public, private and corporate telecommunications
service providers and end users. Typically, communications service providers use
a variety of network equipment and software to originate, transport and
terminate communications sessions. Communications service providers rely on our
products and services as elements of the communications infrastructure and to
configure test and manage network elements and the traffic that runs across
them. Also, our products help to ensure smooth operation of the network and
increase the reliability of services to customers.
The major communications service providers to whom we market our
telecommunications test instruments, network access and transmission products
and services and satellite communication timing and synchronization products
include RBOCs, inter-exchange carriers, incumbent local exchange carriers,
competitive local exchange carriers, Internet service providers, integrated
communications providers, cable service providers, international post, telephone
and telegraph companies, banks, brokerage firms, government agencies and other
service providers. During 2005, our top five communications test instruments,
network access and transmission products and satellite communication timing and
synchronization products customers in terms of our net sales were Harris
Corporation, Siemens, Thalis Avioniques, Power and Telephone and Hitron
Technology. None of our communications equipment customers represented 10% or
more of our revenues during 2005.
16
Because we currently derive some of our revenues from sales to RBOCs
and other telecommunications service providers, we have experienced and will
continue to experience for the foreseeable future an effect on our quarterly
operating results due to the budgeting cycles of the RBOCs. RBOCs generally
obtain approval for their annual budgets during the first quarter of each
calendar year. If an RBOC's annual budget is not approved early in the calendar
year or is insufficient to cover its desired purchases for the entire calendar
year, we are unable to sell products to the RBOC during the period of the delay
or shortfall.
In July 2004, we acquired Larus Corporation, a manufacturer of
satellite communication timing and synchronization products. The business
formerly conducted by Larus Corporation contributed $3,424,000 in net sales from
July through December 2004 and $5,974,000 during 2005.
SALES, MARKETING AND CUSTOMER SUPPORT
ELECTRONIC COMPONENTS
We market and sell our electronic components through Digitran, XCEL
Corporation Ltd., XPS, Pascall, and XCEL Japan, Ltd., a wholly-owned subsidiary
of EMRISE Electronics based in Japan. In some European countries and the Pacific
Rim, these products are sold through a combination of direct sales and through
third-party distributors.
We sell our electronic components primarily to OEMs in the electronics
industry, including manufacturers of aerospace and military systems and
industrial instruments. Our efforts to market our electronic components
generally are limited in scope since we rely on sales to a broad base of
historical customers with whom we have long-term business dealings.
XCEL Japan, Ltd. resells Digitran's digital and rotary switches and
keypad products and some third-party-sourced components primarily into Japan and
also into other highly industrialized Asian countries. Marketing of our
electronic components is primarily through referrals from our existing
customers, with sales either direct or via a small number of selected
independent sales representatives.
We rely on long-term orders and repeat business from our existing
customers. We also approach our existing customers and their competitors to
discuss opportunities for us to provide them with subsystem assemblies that
typically incorporate our own products. Each of our components businesses has an
extensive installed base: Digitran's history spans over 40 years in the
electronic components industry, XPS, 50 years and RO 40 years. Major OEMs have
designed many of our switches, subsystem assemblies, power supplies and RF
components into their established product specifications. These factors have
frequently resulted in customers seeking us out to manufacture for them unique
subsystem assemblies as well as special variations of our standard digital
switches.
COMMUNICATIONS EQUIPMENT
Our sales and marketing staff consist primarily of engineers and
technical professionals. Our staff undergo extensive training and ongoing
professional development and education. We believe that the skill level of our
sales and marketing staff has been instrumental in building long-standing
customer relationships. In addition, our frequent dialogue with our customers
provides us with valuable input on systems and features they desire in future
products. We believe that our consultative sales approach and our product and
market knowledge differentiate our sales forces from those of our competitors.
Our local sales forces are highly knowledgeable about their respective
markets, customer operations and strategies and regulatory environments. In
addition, the familiarity of members of our sales force with local languages and
customs enables them to build close relationships with our customers.
17
We provide repair and training services to enable our customers to
improve performance of their networks. We also offer on-line support services to
supplement our on-site application engineering support. Customers can also
access information regarding our products remotely through our domestic,
European and Japanese technical assistance centers.
We sell many of our communications equipment products to large
telecommunications service providers as well as through distributors, resellers
and value added resellers. Telecommunications service providers generally commit
significant resources to an evaluation of our and our competitors' products and
require each vendor to expend substantial time, effort and money educating them
about the value of the vendor's solutions. Consequently, sales to this type of
customer generally require an extensive sales effort throughout the prospective
customer's organization and final approval by an executive officer or other
senior level employee. The result is lengthy sales and approval cycles, which
make sales forecasting difficult. In addition, even after a large
telecommunications service provider has approved our product for purchase, their
future purchases are uncertain because while we generally enter into long-term
supply agreements with those parties, these agreements do not require specific
levels of purchases.
Delays associated with potential customers' internal approval and
contracting procedures, procurement practices, testing and acceptance processes
are common and may cause potential sales of our communications products and test
equipment to be delayed or foregone. As a result of these and related factors,
the sales cycle of new products for large customers typically ranges from six to
twelve months or more. In addition to the latter case, we also have some
distribution channels that generally are box stocking distributors with
significant independent sales forces selling our products to final customers,
integrators and other resellers on a regional and nationwide basis. We perform
product applications training for the distributor and reseller workforce and
funnel many of the leads we generate to the distribution channels for their
follow-up and closure.
COMPETITION
ELECTRONIC COMPONENTS
The market for our components is highly fragmented and composed of a
diverse group of OEMs, including Power One, Interpoint/Grenson, Martek and Celab
Ltd. for power supplies and Esterline (Janco), Greyhill, Inc., Omron
Electronics, Transico Inc. and C&K Components Inc. for digital and rotary
switches. We believe that the principal competitive factors affecting our
components business include:
o capability and quality of product offerings;
o status as qualified products; and
o compliance with government and industry standards.
We have made substantial investments in machinery and equipment in our
digital and rotary switch and power supply operations. In addition, Digitran's
long history in the electronic components industry and the fact that major OEMs
have designed many of our digital switches into their product specifications
have acted as barriers to entry for other potential competitors and aided us in
establishing and maintaining both distribution channels and customers for our
products by making us a sole source supplier for approximately 30% to 50% of the
digital switches that we sell and have caused some customers to seek us out to
manufacture for them unique as well as our standard digital and rotary switches.
18
Some of our competitors have greater sales, marketing, technological,
research and financial resources than we do. Our competitors' advantage with
regard to these resources may reduce our ability to obtain or maintain market
share for our products in cases where our competitors are better able than we
are to satisfy the above competitive factors.
COMMUNICATIONS EQUIPMENT
The markets for our communications equipment and services are
fragmented and intensely competitive, both inside and outside the United States,
and are subject to rapid technological change, evolving industry standards and
regulatory developments. We believe that the principal competitive factors
affecting our communications equipment business include:
o quality of product offerings;
o adaptability to evolving technologies and standards;
o ability to address and adapt to individual customer requirements;
o price and financing terms;
o strength of distribution channels;
o ease of installation, integration and use of products;
o system reliability and performance; and
o compliance with government and industry standards.
Our principal competitors for our communications equipment include
Symmetricom and Oscilloquartz, for satellite communication timing and
synchronization products, RAD, Paradyne, Patton Electronics Corporation, Digital
Engineering, Ltd. and GDC, for network access and transmission products, and TTC
Corporation (a subsidiary of Dynatech Corporation), Ameritech Corporation,
Fluke, Sunrise Telecom, Inc. and Electrodata, Inc., for communications test
instruments.
The design of many of our data transmission products enables us to
offer numerous product combinations to our customers and to serve both central
site data communications needs and remote access and transmission sites on both
the enterprise-wide and single location level. We believe that this design
flexibility helps us to excel at many of the above competitive factors by
enabling us to offer quality products that meet and are adaptable to evolving
customer requirements, technologies and government and industry standards.
We currently derive a significant portion of our revenues from sales to
RBOCs. We believe we derive a competitive advantage from efforts we expended to
establish many of our communications equipment products as customer-approved
products for all of the RBOCs and for other key customers in the United States
and abroad. Our products' approved status facilitates the ability of our
customers to order additional products from us as their needs arise without the
long delays that might otherwise be needed to obtain the approval of our
customers' upper management or governing body prior to each purchase.
Some of our competitors have greater sales, marketing, technological,
research and financial resources than we do. Our competitors' advantage with
regard to these resources may reduce our ability to obtain or maintain market
share for our products in cases where our competitors are better able than we
are to satisfy the above competitive factors.
19
MANUFACTURING, ASSEMBLY AND QUALITY ASSURANCE
Our network access and transmission products, satellite communication
timing and synchronization products and communications test instruments
generally are assembled from outsourced components, with final assembly,
configuration and quality testing performed in house.
Manufacturing of our electronic components, including injection
molding, fabrication, machining, printed circuit board manufacturing and
assembly, and quality testing is done in house due to the specialized nature and
small and varied batch sizes involved. Although many of our electronic
components incorporate standard designs and specifications, products are
nevertheless built to customer order. This approach, which avoids the need to
maintain a finished goods inventory, is possible because long lead-times for
delivery often are available. Typically, our electronic components segment
produces products in one- to 300-piece batches, with a ten- to thirty-week
lead-time. The lead-time is predominantly to source sub-component piece parts
such as electronic components, mechanical components and services. Typical build
time is six to eight weeks from receipt of external components.
We operate seven manufacturing and assembly facilities worldwide. All
of these facilities except the RO Associates facility, which is being submitted
for accreditation, are certified as ISO 9001- or 9002-compliant. We manufacture
our network access and transmission products at CXR-AJ's facilities in France
and at CXR Larus' facility in San Jose, California. We manufacture RF components
and subsystems and custom power supplies at Pascall's facility in Ryde, Isle of
Wight, England. We manufacture standard power supplies at RO's facility in
Sunnyvale, California. We manufacture all of our test equipment and satellite
communication timing and synchronization products at the San Jose facility. We
manufacture all of our digital and rotary switches in our Rancho Cucamonga,
California facility. We manufacture our custom electronic power supplies in
Ashford, Kent, England and Ryde, Isle of Wight, England.
The purchased components we use to build our products are generally
available from a number of suppliers. We rely on a number of limited-source
suppliers for specific components and parts. We do not have long-term supply
agreements with these vendors. In general, we make advance purchases of some
components to ensure an adequate supply, particularly for products that require
lead-times of up to nine months to manufacture. If we were required to locate
new suppliers or additional sources of supply, we could experience a disruption
in our operations or incur additional costs in procuring required materials.
We intend to increase the use of outsource manufacturing for our
communications equipment products. We believe that outsourcing will lower our
manufacturing costs, in particular our components and labor costs, provide us
with more flexibility to scale our operations to meet changing demand, and allow
us to focus our engineering resources on new product development and product
enhancements.
PRODUCT DEVELOPMENT AND ENGINEERING
We believe that our continued success depends on our ability to
anticipate and respond to changes in the electronics hardware industry and
anticipate and satisfy our customers' preferences and requirements. We
continually review and evaluate technological and regulatory changes affecting
the electronics hardware industry and seek to offer products and capabilities
that solve customers' operational challenges and improve their efficiency.
For the years ended December 31, 2005, 2004 and 2003, our engineering
and product development costs were approximately $2,621,000, $1,521,000 and
$951,000, respectively.
20
Our product development costs during the past three years were related
to development of new communications test equipment and voice, data and video
transmission equipment and development of a new line of rotary switches at our
Digitran facility. We have continued incurring engineering costs applicable to
the development of new digital and rotary switches since 2001. Current research
expenditures in the communications equipment segment are directed principally
toward enhancements to the current test instrument product line, the expansion
of our range of network access and transmission products and the development and
expansion of our range of Network Equipment Building System, or NEBS, qualified
satellite communication timing and synchronization systems. These expenditures
are intended to improve market share and gross profit margins, although we
cannot assure you that we will achieve these improvements.
We strive to take advantage of the latest computer-aided engineering
and engineering design automation workstation tools to design, simulate and test
advanced product features or product enhancements. Our use of these tools helps
us to speed product development while maintaining high standards of quality and
reliability for our products. Our use of these tools also allows us to
efficiently offer custom designs for OEM customers whose needs require the
integration of our electronic components with their own products.
INTELLECTUAL PROPERTY
We regard our software, hardware and manufacturing processes as
proprietary and rely on a combination of patent, copyright and trademark laws,
trade secrets, confidentiality procedures and contractual provisions to protect
our proprietary rights. We have filed patent applications, and intend to file
additional patent applications in the future, for various products with the
United States Patent and Trademark Office and in the European Union, Japan,
Canada and Brazil. We seek to protect our software, documentation and other
written materials under trade secret and copyright laws, which afford some
limited protection. The laws of some foreign countries do not protect our
proprietary rights to the same extent as do the laws of the United States. Our
research and development and manufacturing process typically involves the use
and development of a variety of forms of intellectual property and proprietary
technology. In addition, we incorporate technology and software that we license
from third party sources into our products. These licenses generally involve a
one-time fee and no time limit. We believe that alternative technologies for
this licensed technology are available both domestically and internationally.
We may receive in the future notices from holders of patents that raise
issues as to possible infringement by our products. As the number of test
equipment products and transmission instruments increases and the functionality
of these products further overlaps, we believe that we may become subject to
allegations of infringement given the nature of the telecommunications and
information technology industries and the high incidence of these kinds of
claims. Questions of infringement and the validity of patents in the fields of
telecommunications and information technology involve highly technical and
subjective analyses. These kinds of proceedings are time consuming and expensive
to defend or resolve, result in substantial diversion of management resources,
cause product shipment delays or could force us to enter into royalty or license
agreements rather than dispute the merits of the proceeding initiated against
us.
GOVERNMENT REGULATION AND INDUSTRY STANDARDS AND PROTOCOLS
We design our products to comply with a significant number of industry
standards and regulations, some of which are evolving as new technologies are
deployed. In the United States, our products must comply with various
regulations defined by the United States Federal Communications Commission, or
FCC, and Underwriters Laboratories as well as industry standards such as NEBS
established by Telcordia Technologies, Inc., formerly Bellcore, and those
developed by the American National Standards Institute. Internationally, our
products must comply with standards established by the European Committee for
Electrotechnical Standardization, the European Committee for Standardization,
the European Telecommunications Standards Institute and telecommunications
authorities in various countries, as well as with recommendations of the
International Telecommunications Union. The failure of our products to comply,
or delays in compliance, with the various existing and evolving standards could
negatively affect our ability to sell our products.
21
Our product lines are subject to statutes governing safety and
environmental protection. We believe that we are in substantial compliance with
these statutes and are not aware of any proposed or pending safety or
environmental rule or regulation that, if adopted, would have a material affect
on our business or financial condition.
EMPLOYEES
As of December 31, 2005, we employed approximately 329 persons in our
various divisions and subsidiaries. None of our employees are represented by
labor unions, and there have not been any work stoppages at any of our
facilities. We believe that our relationship with our employees is good.
ITEM 1A. RISK FACTORS.
RISK FACTORS
THE FOLLOWING SUMMARIZES MATERIAL RISKS THAT INVESTORS SHOULD CAREFULLY
CONSIDER BEFORE DECIDING TO BUY OR MAINTAIN AN INVESTMENT IN OUR COMMON STOCK.
ANY OF THE FOLLOWING RISKS, IF THEY ACTUALLY OCCUR, WOULD LIKELY HARM OUR
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. AS A RESULT, THE
TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND INVESTORS COULD LOSE THE
MONEY THEY PAID TO BUY OUR COMMON STOCK.
OUR LACK OF LONG-TERM PURCHASE ORDERS OR COMMITMENTS MAY ADVERSELY AFFECT
OUR BUSINESS IF DEMAND IS REDUCED.
During 2005, the sale of electronic components accounted for
approximately 62.6% of our total net sales, and the sale of communications
equipment and related services accounted for approximately 37.4% of our total
net sales. In many cases we have long-term contracts with our electronic
components and communications equipment customers that cover the general terms
and conditions of our relationships with them but that do not include long-term
purchase orders or commitments. Rather, our customers issue purchase orders
requesting the quantities of communications equipment they desire to purchase
from us, and if we are able and willing to fill those orders, then we fill them
under the terms of the contracts. Accordingly, we cannot rely on long-term
purchase orders or commitments to protect us from the negative financial effects
of reduced demand for our products that could result from a general economic
downturn, from changes in the electronic components and communications equipment
industries, including the entry of new competitors into the market, from the
introduction by others of new or improved technology, from an unanticipated
shift in the needs of our customers, or from other causes.
THE UNPREDICTABILITY OF OUR QUARTERLY OPERATING RESULTS MAY CAUSE THE
PRICE OF OUR COMMON STOCK TO FLUCTUATE OR DECLINE.
Our quarterly operating results have varied significantly in the past
and will likely continue to do so in the future due to a variety of factors,
many of which are beyond our control. Our operating results from our
communications segment tend to be less stable and predictable than our operating
results from our electronic components segment.
22
The cyclical nature of the telecommunications business due to the
budgetary cycle of RBOCs has had and will continue to have for the foreseeable
future an effect on our quarterly operating results. RBOCs generally obtain
approval for their annual budgets during the first quarter of each calendar
year. If an RBOC's annual budget is not approved early in the calendar year or
is insufficient to cover its desired purchases for the entire calendar year, we
are unable to sell products to the RBOC during the period of the delay or
shortfall.
Our electronic components sales are often made in conjunction with
military contracts. The timing of required deliveries under these contracts can
be delayed based on issues related to the overall military contract, which can
cause delays in our shipment schedules and revenue recognition.
Quarter to quarter fluctuations may also result from the uneven pace of
technological innovation, the development of products responding to these
technological innovations by us and our competitors, our customers' acceptance
of these products and innovations, the varied degree of price, product and
technological competition and our customers' and competitors' responses to these
changes.
Due to these factors and other factors, including changes in general
economic conditions, we believe that period-to-period comparisons of our
operating results will not necessarily be meaningful in predicting future
performance. If our operating results do not meet the expectations of investors,
our stock price may fluctuate or decline.
MANY OF OUR COMPETITORS HAVE GREATER RESOURCES THAN US. IN ORDER TO
COMPETE SUCCESSFULLY, WE MUST KEEP PACE WITH OUR COMPETITORS IN
ANTICIPATING AND RESPONDING TO THE RAPID CHANGES INVOLVING THE ELECTRONIC
COMPONENTS AND COMMUNICATIONS EQUIPMENT INDUSTRIES.
Our future success will depend upon our ability to enhance our current
products and services and to develop and introduce new products and services
that keep pace with technological developments, respond to the growth in the
electronic components and communications equipment markets in which we compete,
encompass evolving customer requirements, provide a broad range of products and
achieve market acceptance of our products. Many of our existing and potential
competitors have larger technical staffs, more established and larger marketing
and sales organizations and significantly greater financial resources than we
do. Our lack of resources relative to our competitors may cause us to fail to
anticipate or respond adequately to technological developments and customer
requirements or to experience significant delays in developing or introducing
new products and services. These failures or delays could reduce our
competitiveness, revenues, profit margins or market share.
WE RELY HEAVILY ON OUR MANAGEMENT, AND THE LOSS OF THEIR SERVICES COULD
ADVERSELY AFFECT OUR BUSINESS.
Our success is highly dependent upon the continued services of key
members of our management, including Carmine T. Oliva, our Chairman of the
Board, President and Chief Executive Officer, Graham Jefferies, our Executive
Vice President and Chief Operating Officer, and Randolph Foote, our Senior Vice
President, Chief Financial Officer and Secretary. Mr. Oliva co-founded EMRISE
Electronics and has developed personal contacts and other skills that we rely
upon in connection with our financing, acquisition and general business
strategies. Mr. Jefferies is a long-time employee of EMRISE who we have relied
upon in connection with our United Kingdom acquisitions and who fulfills
significant operational responsibilities in connection with our foreign and
domestic operations. We rely upon Mr. Foote's skills in financial reporting,
accounting and tax matters in addition to his skills in the analysis of
potential acquisitions and general corporate administration. Consequently, the
loss of Mr. Oliva, Mr. Jefferies, Mr. Foote or one or more other key members of
management could adversely affect us. Although we have entered into employment
agreements with each of our executive officers, those agreements are of limited
duration and are subject to early termination by the officers under some
circumstances. We maintain key-man life insurance on Mr. Oliva and Mr.
Jefferies. However, we cannot assure you that we will be able to maintain this
insurance in effect or that the coverage will be sufficient to compensate us for
the loss of the services of Mr. Oliva or Mr. Jefferies.
23
IF WE ARE UNABLE TO SUCCESSFULLY IDENTIFY OR MAKE STRATEGIC ACQUISITIONS,
OUR LONG-TERM COMPETITIVE POSITIONING MAY SUFFER.
Our business strategy includes growth through acquisitions that we
believe will improve our competitive capabilities or provide additional market
penetration or business opportunities in areas that are consistent with our
business plan. Identifying and pursuing strategic acquisitions and integrating
acquired products and businesses requires a significant amount of management
time and skill. Acquisitions may also require us to expend a substantial amount
of cash or other resources, not only as a result of the direct expenses involved
in the acquisition transaction, but also as a result of ongoing research and
development activities that may be required to maintain or enhance the long-term
competitiveness of acquired products, particularly those products marketed to
the rapidly evolving telecommunications industry. If we are unable to make
strategic acquisitions due to our inability to identify appropriate targets, or
to manage the difficulties or costs involved in the acquisitions, our long-term
competitive positioning may suffer.
IF WE ARE UNABLE TO FULFILL BACKLOG ORDERS DUE TO CIRCUMSTANCES INVOLVING
US OR ONE OR MORE OF OUR SUPPLIERS OR CUSTOMERS, OUR ANTICIPATED RESULTS
OF OPERATIONS WILL SUFFER.
As of December 31, 2005, we had $22,150,000 in backlog orders for our
products. Backlog orders represent revenue that we anticipate recognizing in the
future, as evidenced by purchase orders and other purchase commitments received
from customers, but on which work has not yet been initiated or with respect to
which work is currently in progress. Our backlog orders are due in large part to
the long lead-times associated with our electronic components products, which
products generally are custom built to order. We cannot assure you that we will
be successful in fulfilling orders and commitments in a timely manner or that we
will ultimately recognize as revenue the amounts reflected as backlog. Factors
that could affect our ability to fulfill backlog orders include difficulty we
may experience in obtaining components from suppliers, whether due to
obsolescence, production difficulties on the part of suppliers or other causes,
or customer-induced delays and product holds. Our anticipated results of
operations will suffer to the extent we are unable to fulfill backlog orders
within the timeframes we establish, particularly if delays in fulfilling backlog
orders cause our customers to reduce or cancel their orders.
IF OUR PRODUCTS FAIL TO COMPLY WITH EVOLVING GOVERNMENT AND INDUSTRY
STANDARDS AND REGULATIONS, WE MAY HAVE DIFFICULTY SELLING OUR PRODUCTS.
We design our products to comply with a significant number of industry
standards and regulations, some of which are evolving as new technologies are
deployed. In the United States, our communications equipment products must
comply with various regulations defined by the FCC and Underwriters Laboratories
as well as industry standards established by Telcordia Technologies, Inc. and
the American National Standards Institute. Internationally, our communications
equipment products must comply with standards established by the European
Committee for Electrotechnical Standardization, the European Committee for
Standardization, the European Telecommunications Standards Institute,
telecommunications authorities in various countries as well as with
recommendations of the International Telecommunications Union. The failure of
our products to comply, or delays in compliance, with the various existing and
evolving standards could negatively affect our ability to sell our products.
24
OUR BUSINESS COULD SUFFER IF WE ARE UNABLE TO OBTAIN COMPONENTS OF OUR
PRODUCTS FROM OUTSIDE SUPPLIERS.
The major components of our products include circuit boards,
microprocessors, chipsets and memory components. Most of these components are
available from multiple sources. However, we currently obtain some components
used in our products from single or limited sources. Some modem chipsets used in
our data communications equipment products have been in short supply and are
frequently on allocation by semiconductor manufacturers. We have, from time to
time, experienced difficulty in obtaining some components. We do not have
guaranteed supply arrangements with any of our suppliers, and there can be no
assurance that our suppliers will continue to meet our requirements. Further,
disruption in transportation services as a result of enhanced security measures
in response to terrorism threats or attacks may cause some increases in costs
and timing for both our receipt of components and shipment of products to our
customers. If our existing suppliers are unable to meet our requirements, we
could be required to alter product designs to use alternative components or, if
alterations are not feasible, we could be required to eliminate products from
our product line.
Shortages of components could not only limit our product line and
production capacity but also could result in higher costs due to the higher
costs of components in short supply or the need to use higher cost substitute
components. Significant increases in the prices of components could adversely
affect our results of operations because our products compete on price and,
therefore, we may not be able to adjust product pricing to reflect the increases
in component costs. Also, an extended interruption in the supply of components
or a reduction in their quality or reliability would adversely affect our
financial condition and results of operations by impairing our ability to timely
deliver quality products to our customers. Delays in deliveries due to shortages
of components or other factors may result in cancellation by our customers of
all or part of their orders. Although customers who purchase from us products,
such as many of our digital switches and all of our custom power supplies, that
are not readily available from other sources would be less likely than other
customers of ours to cancel their orders due to production delays, we cannot
assure you that cancellations would not occur.
FINANCIAL STATEMENTS OF OUR FOREIGN SUBSIDIARIES ARE PREPARED USING THE
RELEVANT FOREIGN CURRENCY THAT MUST BE CONVERTED INTO UNITED STATES
DOLLARS FOR INCLUSION IN OUR CONSOLIDATED FINANCIAL STATEMENTS. AS A
RESULT, EXCHANGE RATE FLUCTUATIONS MAY ADVERSELY AFFECT OUR REPORTED
RESULTS OF OPERATIONS.
We have established and acquired international subsidiaries that
prepare their balance sheets in the relevant foreign currency. In order to be
included in our consolidated financial statements, these balance sheets are
converted, at the then current exchange rate, into United States dollars, and
the statements of operations are converted using weighted average exchange rates
for the applicable period. Accordingly, fluctuations of the foreign currencies
relative to the United States dollar could affect our consolidated financial
statements. Our exposure to fluctuations in currency exchange rates has
increased as a result of the growth of our international subsidiaries. Sales of
our products and services to customers located outside of the United States
accounted for approximately 49.7% of our net sales for 2005. We use derivatives
to manage foreign currency rate risk. Our ultimate realized gain or loss with
respect to currency fluctuations will depend on the currency exchange rates and
other factors in effect as the contracts mature. Net foreign exchange
transaction gains included in other income and expense in our consolidated
statements of operations totaled $123,000 for 2005.
25
BECAUSE WE BELIEVE THAT PROPRIETARY RIGHTS ARE MATERIAL TO OUR SUCCESS,
MISAPPROPRIATION OF THESE RIGHTS COULD ADVERSELY AFFECT OUR FINANCIAL
CONDITION.
Our future success will be highly dependent on proprietary technology,
particularly in our communications equipment business. However, we do not hold
any patents and we currently rely on a combination of contractual rights,
copyrights, trademarks and trade secrets to protect our proprietary rights. Our
management believes that because of the rapid pace of technological change in
the industries in which we operate, the legal intellectual property protection
for our products is a less significant factor in our success than the knowledge,
abilities and experience of our employees, the frequency of our product
enhancements, the effectiveness of our marketing activities and the timeliness
and quality of our support services. Consequently, we rely to a great extent on
trade secret protection for much of our technology. However, there can be no
assurance that our means of protecting our proprietary rights will be adequate
or that our competitors or customers will not independently develop comparable
or superior technologies or obtain unauthorized access to our proprietary
technology. Our financial condition would be adversely affected if we were to
lose our competitive position due to our inability to adequately protect our
proprietary rights as our technology evolves.
OUR COMMON STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN
SUBSTANTIAL LOSSES FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK AND
IN LITIGATION AGAINST US.
The market prices of securities of technology-based companies currently
are highly volatile. The market price of our common stock has fluctuated
significantly in the past. In fact, during 2005, the high and low closing sale
prices of a share of our common stock were $2.34 and $0.91, respectively.
Between January 1, 2006 and March 23, 2006, the high and low closing sale prices
of a share of our common stock were $1.46 and $1.15, respectively. The market
price of our common stock may continue to fluctuate in response to the following
factors, many of which are beyond our control:
o changes in market valuations of similar companies and stock market
price and volume fluctuations generally;
o economic conditions specific to the electronic components or
communications equipment industries;
o announcements by us or our competitors of new or enhanced
products, technologies or services or significant contracts,
acquisitions, strategic relationships, joint ventures or capital
commitments;
o delays in our introduction of new products or technological
innovations or problems in the functioning of these new products
or innovations;
o third parties' infringement of our intellectual property rights;
o changes in our pricing policies or the pricing policies of our
competitors;
o foreign currency translations gains or losses;
o regulatory developments;
o fluctuations in our quarterly or annual operating results;
o additions or departures of key personnel; and
26
o future sales of our common stock or other securities.
The price at which you purchase shares of common stock may not be
indicative of the price of our stock that will prevail in the trading market.
You may be unable to sell your shares of common stock at or above your purchase
price, which may result in substantial losses to you. Moreover, in the past,
securities class action litigation has often been brought against a company
following periods of volatility in the market price of its securities. We may in
the future be the target of similar litigation. Securities litigation could
result in substantial costs and divert management's attention and resources.
FUTURE SALES OF SHARES OF OUR COMMON STOCK BY OUR STOCKHOLDERS COULD CAUSE
OUR STOCK PRICE TO DECLINE.
We cannot predict the effect, if any, that market sales of shares of
our common stock or the availability of shares of common stock for sale will
have on the market price prevailing from time to time. As of March 24, 2006, we
had outstanding 37,911,750 shares of common stock and options and warrants to
purchase an aggregate of 6,258,433 shares of common stock. A substantial number
of these outstanding shares of common stock and shares of common stock
underlying the options and warrants are registered for issuance or public resale
under existing registration statements. Sales of shares of our common stock in
the public market, or the perception that those sales may occur, could cause the
trading price of our common stock to decrease or to be lower than it might be in
the absence of those shares or perceptions.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable.
27
ITEM 2. PROPERTIES.
As of March 24, 2006, we leased or owned approximately 174,000 square
feet of administrative, engineering, production, storage and shipping space. All
of this space was leased other than the Abondant, France facility.
FUNCTION /
BUSINESS UNIT LOCATION LEASE EXPIRATION DATE
------------------------------------ ------------------------------ -----------------------------
EMRISE Corporation Rancho Cucamonga, California Administration;
(corporate headquarters) Expires October 2009
EMRISE Electronics Corporation/Digitran Rancho Cucamonga, California Administration, Engineering and
(electronic components) Manufacturing;
Expires November 2007
Monrovia, California Expires February 2009
Administration, Engineering and
XCEL Power Systems, Ltd. Ashford, Kent, England Manufacturing; Expires March 2013
and EEL
(electronic components)
XCEL Japan, Ltd. Higashi-Gotanda Tokyo, Japan Sales;
(electronic components) Expires December 2007
CXR-AJ Paris, France Administration;
(network access and transmission
products) Expires April 2007
CXR-AJ Abondant, France Administration, Engineering,
(network access and transmission
products) Manufacturing;
Facility is owned
CXR Larus San Jose, California Administration, Engineering,
(network access and transmission Manufacturing;
products, communications test Expires June 2011 and is renewable
instruments, satellite communication
timing and synchronization products)
RO Sunnyvale, California Administrative, Engineering,
(power supplies) Manufacturing;
Expires August 2007
Pascall Electronics Limited Ryde, Isle of Wight, England Administration, Engineering,
(RF components, subsystems and custom Manufacturing;
power supplies) Expires May 2016
We believe the listed facilities are adequate for our current business
operations.
ITEM 3. LEGAL PROCEEDINGS.
We are not a party to any material pending legal proceedings.
28
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On December 21, 2005, we held our 2005 annual meeting of stockholders.
The total number of outstanding votable shares was 37,497,750. Our stockholders
were asked to consider and vote upon the following two proposals:
(1) Re-election of Carmine T. Oliva as a Class III director to serve a
three-year term.
(2) Ratification of the selection of Grant Thornton LLP as our
independent registered public accounting firm to audit our consolidated
financial statements for 2005.
Results of the vote were as follows:
Proposal For Against Abstain Withheld Total Voted
-------- --- ------- ------- -------- -----------
(1) 29,792,773 -- -- 107,752 29,900,525
(2) 29,850,830 5,750 43,945 -- 29,900,525
As a result, Mr. Oliva was re-elected to serve as a Class III member of
our board of directors. Robert Runyon, who also served as a Class III member of
our board of directors, declined to stand for re-election and therefore left his
position on our board effective as of the meeting. Laurence P. Finnegan and Otis
W. Baskin continued to serve on our board of directors following the meeting.
The selection of our independent registered public accounting firm to audit our
consolidated financial statements for 2005 was ratified.
29
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock has traded on NYSE Arca since March 8, 2006, under the
symbol "ERI." For the period from August 10, 2005 through March 7, 2006, our
common stock traded on the Archipelago Exchange(SM) (ArcaEx(R)), a facility of
the Pacific Exchange(R), under the symbol "ERI." For the period from January 1,
2004 through August 9, 2005, our common stock traded on the OTC Bulletin Board
under the symbol "EMRI." The table below shows, for each fiscal quarter
indicated, the high and low sales prices on the Pacific Exchange and the high
and low closing bid prices on the OTC Bulletin Board, as the case may be, for
shares of our common stock. The prices shown reflect inter-dealer prices,
without retail mark-up, mark-down or commission, and may not necessarily
represent actual transactions.
High Low
---- ---
Year Ended December 31, 2004
First Quarter............................................. $1.18 $0.87
Second Quarter............................................ 1.28 0.76
Third Quarter............................................. 0.82 0.52
Fourth Quarter............................................ 1.68 0.60
Year Ended December 31, 2005
First Quarter............................................. $1.82 $1.46
Second Quarter............................................ 1.51 1.08
Third Quarter............................................. 1.98 0.91
Fourth Quarter............................................ 2.34 1.14
As of March 24, 2006, we had outstanding 37,911,750 shares of common
stock outstanding held of record by approximately 3,000 stockholders. These
holders of record include depositories that hold shares of stock for brokerage
firms which, in turn, hold shares of stock for numerous beneficial owners. On
March 23, 2006, the closing sale price of our common stock on NYSE Arca was
$1.33 per share.
We have not declared or paid any cash dividends on our capital stock in
the past, and we do not anticipate declaring or paying cash dividends on our
common stock in the foreseeable future. In addition, our credit facility with
Wells Fargo Bank, N.A., described in "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources," restricts the payment of dividends without the bank's consent.
We will pay dividends on our common stock only if and when declared by
our board of directors. Our board of directors' ability to declare a dividend is
subject to restrictions imposed by Delaware law. In determining whether to
declare dividends, the board of directors will consider these restrictions as
well as our financial condition, results of operations, working capital
requirements, future prospects and other factors it considers relevant.
In August 2005, we issued 35,000 shares of common stock to our former
investor relations consultant upon exercise of a warrant at a per share exercise
price of $0.39.
In August 2005, we issued 78,042 shares of common stock to a former
employee upon net exercise of a warrant to purchase up to 120,000 shares of
common stock at a per share exercise price of $0.50.
30
In November 2005, we issued 50,000 shares of common stock to a former
financial advisor upon exercise of a warrant at a per share exercise price of
$0.75 and 2,500 shares upon the exercise of employee stock options at a per
share exercise price of $1.00.
Exemption from the registration provisions of the Securities Act of
1933 for the transactions described above is claimed under Section 4(2) of the
Securities Act of 1933, among others, on the basis that such transactions did
not involve any public offering and the purchasers were accredited or
sophisticated with access to the kind of information registration would provide.
In each case, appropriate investment representations were obtained, stock
certificates were issued with restricted stock legends, and stop transfer orders
were placed with our transfer agent.
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial data presented below for each of
the five years in the period ended December 31, 2005 have been derived from
audited financial statements which for the most recent three years appear
elsewhere herein. The data presented below should be read in conjunction with
such financial statements, including the related notes thereto and the other
information included herein. The historical results are not necessarily
indicative of results to be expected for any future periods.
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS AND 2005 2004 2003 2002 2001
COMPREHENSIVE INCOME DATA: ---------- ---------- ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net sales...................................... $ 41,046 $ 29,861 $ 25,519 $ 22,664 $ 27,423
Cost of sales.................................. 23,656 16,146 14,835 14,147 15,456
---------- ---------- ----------- ----------- ---------
Gross profit................................... 17,390 13,715 10,684 8,517 11,967
Selling, general and administrative expenses... 13,694 10,226 7,812 7,731 10,129
Engineering and product development expenses.. 2,621 1,521 951 1,015 1,076
---------- ---------- ----------- ----------- ---------
Income (loss) from operations.................. 1,075 1,968 1,921 (229) 762
Total other expense............................ (54) (439) (474) (361) (414)
---------- ---------- ----------- ----------- ---------
Income (loss) from continuing operations
before income taxes......................... 1,021 1,529 1,447 (590) 348
Income tax (benefit) expense................... (267) 49 286 (20) 77
---------- ---------- ----------- ----------- ---------
Income (loss) from continuing operations....... 1,288 1,480 1,161 (570) 271
Discontinued operations:
Gain from operations of
discontinued segment...................... -- -- -- -- 56
---------- ---------- ----------- ----------- ---------
Net income (loss).............................. 1,288 1,480 1,161 (570) 327
Foreign currency translation adjustment........ (1,357) 379 705 446 (312)
---------- ---------- ----------- ----------- ---------
Total comprehensive income (loss).............. $ (69) $ 1,859 $ 1,866 $ (124) $ 15
========== ========== ========== =========== =========
Basic and diluted earnings (loss) per share
from continuing operations.................. $ 0.03 $ 0.06 $ 0.05 $ (0.03) $ 0.01
========== ========== ========== =========== =========
Basic and diluted earnings per share from
discontinued operations..................... $ -- $ -- $ -- $ -- $ 0.01
========== ========== ========== =========== =========
Basic earnings (loss) per share................ $ 0.03 $ 0.06 $ 0.05 $ (0.03) $ 0.02
========== ========== ========== =========== =========
Diluted earnings (loss) per share.............. $ 0.03 $ 0.06 $ 0.05 $ (0.03) $ 0.01
========== ========== ========== =========== =========
Weighted average shares outstanding, basic..... 37,253 24,063 22,567 21,208 20,594
Weighted average shares outstanding, diluted... 38,386 24,839 23,811 21,208 23,782
31
YEARS ENDED DECEMBER 31,
2005 2004 2003 2002 2001
---------- ---------- ----------- ----------- ---------
BALANCE SHEET DATA: (IN THOUSANDS)
Cash and cash equivalents...................... $ 4,371 $ 1,057 $ 1,174 $ 254 $ 604
Working capital................................ 12,958 5,540 5,696 3,961 3,686
Total assets................................... 44,461 25,086 17,169 16,786 17,688
Long-term debt, net of current portion......... 2,492 3,235 819 927 763
Stockholders' equity........................... 27,013 10,909 7,916 5,732 5,862
Convertible redeemable preferred stock......... -- -- -- 282 270
No cash dividends on our common stock were declared during any of the
periods presented above. Various factors materially affect the comparability of
the information presented in the above table. These factors relate primarily to
the acquisition of Larus Corporation in July 2004, the acquisition of Pascall in
March 2005 and changes in foreign currency conversion rates that may affect the
consistency of the generally accepted accounting principles that we use. The
year ended December 31, 2004 includes five months of Larus Corporation activity.
The year ended December 31, 2005 includes nine and one-half months of Pascall
activity and five months of RO Associates activity. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Overview."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES AND THE OTHER FINANCIAL
INFORMATION INCLUDED ELSEWHERE IN THIS REPORT. THIS REPORT AND THE FOLLOWING
DISCUSSION CONTAIN FORWARD-LOOKING STATEMENTS REGARDING THE ELECTRONIC
COMPONENTS AND COMMUNICATIONS EQUIPMENT INDUSTRIES AND OUR EXPECTATIONS
REGARDING OUR FUTURE PERFORMANCE, LIQUIDITY AND CAPITAL RESOURCES. OUR ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE EXPRESSED IN THESE FORWARD-LOOKING
STATEMENTS AS A RESULT OF ANY NUMBER OF FACTORS, INCLUDING THOSE SET FORTH UNDER
"RISK FACTORS" AND UNDER OTHER CAPTIONS CONTAINED ELSEWHERE IN THIS REPORT.
OVERVIEW
GENERAL
Through our three wholly-owned operating subsidiaries, EMRISE
Electronics, CXR Larus and CXR-AJ, and through the divisions and subsidiaries of
those subsidiaries, we design, develop, manufacture, assemble, and market
products and services in the following two material business segments:
o Electronic Components
-- digital and rotary switches
-- electronic power supplies
-- RF components
-- subsystem assemblies
32
o Communications Equipment
-- network access and transmission products
-- satellite communication timing and synchronization products
-- communications test instruments
Sales to customers in the electronic components segment, primarily to
aerospace customers, defense contractors and industrial customers, were
approximately 62.6%, 51.1% and 63.4% of our total net sales during 2005, 2004
and 2003, respectively. Sales of communications equipment and related services,
primarily to private customer premises and public carrier customers, were
approximately 37.4%, 48.9% and 36.6% of our total net sales during 2005, 2004
and 2003, respectively.
Sales of our electronic components segment increased $10,425,000
(68.3%) for 2005. Without the addition of the sales of $11,157,000 and
$1,925,000, respectively, by our new subsidiaries, Pascall, which we acquired
March 18, 2005 and RO, which we acquired on September 1, 2005, our electronic
components segment sales would have declined $2,657,000 (17.4%) for 2005 as
compared to 2004, primarily due to the lower shipments of our power supplies due
to delays in the shipping schedule for the Eurofighter Typhoon program that is
now scheduled to resume shipments in the second quarter of 2006.
We achieved a $760,000 (5.2%) sales increase in our communications
equipment segment for 2005. We acquired the Larus division of CXR Larus in July
2004. Without the addition of the $2,947,000 of sales made by the Larus division
during the first half of 2005, our communications equipment segment sales would
have declined $2,187,000 (15.0%) for 2005 as compared to 2004. This was
primarily due to a low demand for our test equipment by the major United States
telecommunications companies, a delay in continued shipments on a long-term
United States government infrastructure program due to customer technical
issues, and delays in French military program orders that had been expected in
early 2005.
We continue to reduce costs at CXR Larus by reducing its work force and
increasing our sourcing of test equipment components from offshore manufacturers
that produce components for lower prices than we previously paid to our former
suppliers. Outsourcing of manufacturing to Asia was a primary reason we were
able to increase our gross margin from approximately 34% in 2002 to
approximately 62% in 2005 in our CXR Larus test equipment business, which
resulted in an annual cost reductions of approximately $1,372,000 during 2004.
During 2005, we began working toward establishing a similar arrangement for the
manufacture of our satellite communication timing and synchronization products
by Hitachi OMD, which we anticipate will result in further improvements in our
gross margin. We also reduced costs elsewhere in our communications equipment
segment and lowered the breakeven point both in our United States and France
operations through various cost-cutting methods, such as using offshore contract
manufacturers, reducing facility rent expense by approximately $327,000 on an
annual basis and downsizing our administrative office in Paris, France.
LARUS CORPORATION ACQUISITION
In July 2004, we acquired Larus Corporation. Larus Corporation was a
San Jose, California-based manufacturer and seller of telecommunications
products that had one wholly-owned subsidiary, Vista Labs, Incorporated, or
Vista, which provided engineering services to Larus Corporation. The basic
purchase terms of the acquisition are described below. We consolidated the
results of operations of Larus Corporation beginning from the date of
acquisition, July 13, 2004. CXR Larus' United States-based sales and marketing
staff, have secured relationships with two new major United States-based
33
distributors, Power and Tel and Graybar, during 2005. We consolidated our CXR
Larus subsidiary's operations into Larus Corporation's facility, which resulted
in annual savings in rent and facilities expense of approximately $250,000
beginning in the third quarter of 2004. Subsequent to March 31, 2005, we
implemented further administrative, engineering and sales cost savings through
staffing reductions of approximately $700,000 on an annual basis as compared to
our costs in the three months ended March 31, 2005. These staffing reductions
related to eliminating redundancies in our electronic components segment
personnel (including nine sales, marketing and administrative positions, one
engineering director and the former CXR president) that occurred as a result of
our acquisition of Larus Corporation.
We paid $6,539,500 to acquire the outstanding common stock of Larus
Corporation. As a result, we acquired assets that included intellectual
property, cash, accounts receivable and inventories owned by each of Larus
Corporation and Vista. The purchase price for the acquisition consisted of
$1,000,000 in cash, the issuance of 1,213,592 shares of our common stock with a
fair value of $1,000,000, $887,500 in the form of two short-term, zero interest
promissory notes that were repaid in 2004, $3,000,000 in the form of two
subordinated secured promissory notes, warrants to purchase up to an aggregate
of 150,000 shares of our common stock at $1.30 per share and approximately
$580,000 of acquisition costs. The number of shares of our common stock issued
as part of the purchase price was calculated based on the $0.824 per share
average closing price of our common stock for the five trading days preceding
the transaction. The warrants to purchase 150,000 shares of common stock were
valued at $72,526 using a Black-Scholes formula that included a volatility of
107.19%, an interest rate of 3.25%, a life of three years and no assumed
dividend.
In addition, we assumed $245,000 in accounts payable and accrued
expenses and entered into an above-market real property lease with the sellers.
This lease represents an obligation that exceeds the fair market value by
approximately $756,000 and is part of the acquisition accounting. The cash
portion of the acquisition purchase price was funded with proceeds from our
credit facility with Wells Fargo Bank, N.A. and cash on-hand.
In determining the purchase price for Larus Corporation, we took into
account the historical and expected earnings and cash flow of Larus Corporation,
as well as the value of companies of a size and in an industry similar to Larus
Corporation, comparable transactions and the market for such companies
generally. The purchase price represented a significant premium over the
$1,800,000 recorded net worth of Larus Corporation's assets. In determining this
premium, we considered our potential ability to refine various Larus Corporation
products and to use our marketing resources and status as a qualified supplier
to qualify and market those products for sale to large telecommunications
companies. We believe that large telecommunications companies desired to have an
additional choice of suppliers for those products and would be willing to
purchase Larus Corporation's products following some refinements. We also
believe that if Larus Corporation had remained independent, it was unlikely that
it would have been able to qualify to sell its products to the large
telecommunications companies due to its small size and lack of history selling
to such companies. Therefore, Larus Corporation had a range of value separate
from the net worth it had recorded on its books.
PASCALL ACQUISITION
On March 18, 2005, our EMRISE Electronics Ltd. ("EEL") subsidiary
purchased all of the outstanding capital stock of PEHL, the parent holding
company of Pascall, using funds loaned to EEL by EMRISE. The purchase price for
the acquisition totaled $9,669,000, subject to adjustments as described below,
and included a $9,054,000 cash payment to PEHL's former parent and approximately
$615,000 in acquisition costs. In connection with the purchase, EEL loaned
$3,082,000 to PEHL and Pascall, as described below.
34
The initial portion of the purchase price was 3,100,000 British pounds
sterling (approximately U.S. $5,972,000 based on the exchange rate in effect on
March 18, 2005). The initial portion of the purchase price was paid in cash and
was subject to adjustment on a pound for pound basis to the extent that the
value of the net assets of Pascall as of the closing date was greater or less
than 2,520,000 British pounds sterling. On May 6, 2005, we submitted to Intelek
Properties Limited (which is a subsidiary of Intelek PLC, a London Stock
Exchange public limited company, and is the former parent of PEHL), our
calculation of the value of the net assets of Pascall as of the closing date,
which we believed slightly exceeded 2,520,000 British pounds sterling.
Ultimately, the parties determined that the value of the net assets of Pascall
at the closing date was 2,650,000 British pounds sterling. As a result, we paid
to Intelek Properties Limited 130,000 British pounds sterling (approximately
U.S. $236,000 based on the exchange rate then in effect) on August 1, 2005 to
satisfy this obligation. The purchase price is also subject to downward
adjustments for any payments that may be made to EEL under indemnity, tax or
warranty provisions of the purchase agreement.
EEL loaned to Pascall and PEHL at the closing 1,600,000 British pounds
sterling (approximately U.S. $3,082,000 based on the exchange rate in effect on
March 18, 2005). The loaned funds were used to immediately repay outstanding
intercompany debt owed by Pascall and PEHL to Intelek Properties Limited.
We and Intelek plc have agreed to guarantee payment when due of all
amounts payable by EEL and Intelek Properties Limited, respectively, under the
PEHL purchase agreement. EMRISE and EEL have agreed to underwrite the guarantee
that Intelek Properties Limited has given to Pascall's landlord with a guaranty
from us, and EEL has agreed to indemnify Intelek Properties Limited and its
affiliates for damages they suffer as a result of any failure to obtain the
release of the guarantee of the 17-year lease that commenced in May 1999. The
leased property is a 30,000 square-foot administration, engineering and
manufacturing facility located off the south coast of England.
Intelek Properties Limited has agreed to various restrictive covenants
that apply for various periods following the closing. The covenants include
non-competition with Pascall's business, non-interference with Pascall's
customers and suppliers, and non-solicitation of Pascall's employees. In
conjunction with the closing, Intelek Properties Limited, EEL, Intelek plc and
we entered into a Supplemental Agreement dated March 18, 2005. The Supplemental
Agreement provides, among other things, that an interest-free bridge loan of
200,000 British pounds sterling (approximately U.S. $385,400 based on the
exchange rate in effect on March 17, 2005) that was made by Intelek Properties
Limited to Pascall on March 17, 2005 would be repaid by Pascall by March 31,
2005. EEL agreed to ensure that Pascall has sufficient funds to repay the bridge
loan. The bridge loan was repaid in full by Pascall to the seller on the March
31, 2005 due date.
We have consolidated the results of operations of Pascall beginning
from the date of acquisition, March 18, 2005. Based on recent history and sales
projections, we expect Pascall to provide a positive contribution to our
earnings per share. We expect to increase Pascall's sales to its existing
customers in the United States and to sell Pascall's products to EMRISE's
existing customers as a result of our local presence and enhanced support from
our United States-based sales and marketing staff. We have consolidated a number
of administrative functions of our two United Kingdom-based subsidiary's
operations and anticipate that we will be able to generate further future
savings as we continue to integrate the businesses.
35
The following table summarizes the unaudited assets acquired and
liabilities assumed in connection with this acquisition, including $615,000 in
acquisition costs:
Dollars
in Thousands
----------------
Current assets............................... $ 6,196
Property, plant and equipment................ 1,367
Intangibles, including goodwill.............. 5,534
----------------
Total assets acquired........................ 13,097
Current liabilities.......................... (2,863)
Other liabilities............................ (80)
----------------
Total liabilities assumed.................... (2,943)
----------------
Net assets acquired.......................... $ 10,154
================
The purchase price represented a significant premium over the recorded
net worth of Pascall's assets. In determining to pay this premium, we considered
various factors, including the opportunities that Pascall presented for us to
add RF components and RF subsystem assemblies to our product offerings, the
marketing resources of Pascall in the United States power supplies market, and
expected synergies between Pascall's business and our existing power supplies
business.
RO ASSOCIATES ACQUISITION
On September 2, 2005, our EMRISE Electronics subsidiary acquired all of
the issued and outstanding shares of common stock of RO, a California
corporation, under the terms of a stock purchase agreement dated effective as of
August 31, 2005 and amended as of September 28, 2005. Prior to the acquisition,
all of the common stock of RO was owned by Robert H. Okada as Trustee of the
Robert H. Okada Trust Agreement dated February 11, 1992, and Sharon Vavro, an
individual.
RO is based in Sunnyvale, California and designs and manufactures
standard power conversion products for telecom, industrial, commercial, and
military applications. The purchase price consisted of $2,400,000 in cash paid
at closing and an additional $600,000 in cash payable in two equal installments
on October 6, 2005 and March 31, 2006. The acquisition purchase price was funded
with cash on-hand. The purchase price is subject to adjustment based on the
value of the stockholders' equity, accounts receivable, accounts payable, cash
on hand and net inventory of RO, as determined by the consolidated, unaudited
balance sheet as of August 31, 2005, prepared in accordance with accounting
principles generally accepted in the United States of America. In addition,
concurrently with the closing of the acquisition of RO, EMRISE Electronics paid
in full all then existing credit facilities of RO in the aggregate amount of
$1,602,000.
In determining the purchase price for RO, EMRISE Electronics considered
the historical and expected earnings and cash flow of RO, as well as the value
of companies of a size and in an industry similar to RO, comparable transactions
and the market for such companies generally. The purchase price represented a
premium of approximately $2,275,000 over the $2,340,000 recorded net worth of
the assets of RO. In determining this premium, EMRISE Electronics considered the
synergistic and strategic advantages provided by having a United States-based
power conversion manufacturer and the value of the goodwill, customer
relationships and technology of RO. Goodwill associated with the RO acquisition
totaled approximately $1,376,000. EMRISE has commissioned a valuation firm to
determine what portion of the purchase price should be allocated to identifiable
intangible asset. We expect the valuation to be completed by May 2006. EMRISE
has estimated that RO's technology is valued at approximately $484,000, its
trademarks are valued at $300,000 and its customer relationships are valued at
$200,000. The valuation of the identified intangible assets is expected to be
completed by May 2006 and could result in changes to the value of these
identified intangible assets and corresponding changes to the value of goodwill.
However, EMRISE does not believe these changes will be material to EMRISE's
consolidated financial position or results of operations.
36
In connection with the execution of the stock purchase agreement,
EMRISE Electronics executed a lease agreement with Caspian Associates for the
lease of 25,700 square feet of a 30,700 square feet building located at 246
Caspian Drive, Sunnyvale, California. The lease provides for a two-year term
commencing on September 1, 2005 and ending on August 31, 2007, at a base rent of
$9,210 per month. Additionally, the lease provides for an extension of the lease
term for an additional three years, to August 31, 2010, if RO achieves net sales
of at least $14,500,000 and cumulative gross profit of at least $3,987,500. If
RO achieves the net sales and cumulative gross profit targets, the monthly base
rent for the facility will be increased to the fair market value as of the first
day of the next calendar month. Otherwise, the rent will remain unchanged unless
and until the targets are met. The facility will continue to be used for the
design, manufacture and sale of power conversion products.
In connection with the stock purchase agreement, EMRISE Electronics
also executed an employment agreement with Richard Okada, effective as of
September 1, 2005, to serve as president of RO. Mr. Okada is a general partner
of Caspian Associates. Mr. Okada will receive an annual base salary of $115,000
for the two-year tern of the employment agreement. In addition, Mr. Okada is
entitled to receive an incentive bonus based upon performance criteria to be
determined in the future. In connection with Mr. Okada's employment agreement,
EMRISE granted Mr. Okada an incentive stock option under EMRISE's 2000 Stock
Option Plan to purchase up to 50,000 shares of EMRISE's common stock at an
exercise price of $1.35 per share. This option vests 50% on September 1, 2006
and 50% on September 1, 2007. The option expires on August 31, 2015.
The following table summarizes the unaudited assets and liabilities
assumed in connection with the RO acquisition, including $65,000 in acquisition
costs:
Dollars
in Thousands
--------------
Current assets $ 3,213
Property, plant and equipment 329
Intangibles, including goodwill 2,360
Other assets 66
--------------
Total assets acquired 5,968
Current liabilities (943)
Other liabilities (393)
--------------
Total liabilities assumed (1,336)
--------------
Net assets acquired $ 4,632
=============
37
PRO FORMA RESULTS OF OPERATIONS
The following table summarizes, on an unaudited pro forma basis, the
combined results of operations of EMRISE, Larus Corporation, Pascall and RO, as
though the Larus Corporation, Pascall and RO acquisitions occurred as of January
1, 2004. The pro forma amounts give effect to appropriate adjustments for
interest expense and income taxes. The pro forma amounts presented are not
necessarily indicative of future operating results (in thousands, except per
share amounts).
Year Ended December 31,
------------------------------
2005 2004
------------ -------------
Revenues $ 47,709 $ 52,991
Net income $ 1,171 $ 2,225
Basic and diluted earnings per share of
common stock $ 0.03 $ 0.06
============ =============
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of those financial statements requires us to make
estimates and judgments that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amount of net sales and expenses for
each period. The following represents a summary of our critical accounting
policies, defined as those policies that we believe are the most important to
the portrayal of our financial condition and results of operations and that
require management's most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effects of matters that are
inherently uncertain.
REVENUE RECOGNITION
We derive revenues from sales of electronic components and
communications equipment products and services. Our sales are based upon written
agreements or purchase orders that identify the type and quantity of the item
being purchased and the purchase price. We recognize revenues when shipment of
products has occurred or services have been rendered, no significant obligations
remain on our part, and collectibility is reasonably assured based on our credit
and collections practices and policies.
We recognize revenues from domestic sales of our electronic components
and communications equipment at the point of shipment of those products. Product
returns are infrequent and require prior authorization because our sales are
final and we quality test our products prior to shipment to ensure they meet the
specifications of the binding purchase orders under which they are shipped.
Normally, when a customer requests and receives authorization to return a
product, the request is accompanied by a purchase order for a replacement
product.
Revenue recognition for products and services provided by our United
Kingdom subsidiaries depends upon the type of contract involved.
Engineering/design services contracts generally entail design and production of
a prototype over a term of up to several years, with all revenue deferred until
all services under the contracts have been completed. Production contracts
provide for a specific quantity of products to be produced over a specific
period of time. Customers issue binding purchase orders for each suborder to be
produced. At the time each suborder is shipped to the customer, we recognize
revenue relating to the products included in that suborder. Returns are
infrequent and permitted only with prior authorization because these products
are custom made to order based on binding purchase orders and are quality tested
prior to shipment. Generally, these products carry a one-year limited parts and
labor warranty. We do not offer customer discounts, rebates or price protection
on these products.
38
We recognize revenues for products sold by our French subsidiary at the
point of shipment. Customer discounts are included in the product price list
provided to the customer. Returns are infrequent and permitted only with prior
authorization because these products are shipped based on binding purchase
orders and are quality tested prior to shipment. Generally, these products carry
a two-year limited parts and labor warranty.
Generally, our electronic components, network access and transmission
products and satellite communication timing and synchronization products carry a
one-year limited parts and labor warranty and our communications test
instruments and European network access and transmission products carry a
two-year limited parts and labor warranty. Products returned under warranty are
tested and repaired or replaced at our option. Historically, warranty repairs
have not been material. We do not offer customer discounts, rebates or price
protection on these products.
Revenues from services such as repairs and modifications are recognized
when the service has been completed and invoiced. For repairs that involve
shipment of a repaired product, we recognize repair revenues when the product is
shipped back to the customer. Service revenues represented approximately 2.6%,
5.7% and 3.1% of net sales during 2005, 2004 and 2003, respectively.
INVENTORY VALUATION
Our finished goods electronic components inventories generally are
built to order. Our communications equipment inventories generally are built to
forecast, which requires us to produce a larger amount of finished goods in our
communications equipment business so that our customers can promptly be served.
Our products consist of numerous electronic and other parts, which necessitates
that we exercise detailed inventory management. We value our inventory at the
lower of the actual cost to purchase or manufacture the inventory (first-in,
first-out) or the current estimated market value of the inventory (net
realizable value). We perform physical inventories at least once a year. We
regularly review inventory quantities on hand and record a provision for excess
and obsolete inventory based primarily on our estimated forecast of product
demand and production requirements for the next twelve months. Additionally, to
determine inventory write-down provisions, we review product line inventory
levels and individual items as necessary and periodically review assumptions
about forecasted demand and market conditions. Any parts or finished goods that
we determine are obsolete, either in connection with the physical count or at
other times of observation, are reserved for and subsequently discarded and
written-off.
In addition, the communications equipment industry is characterized by
rapid technological change, frequent new product development, and rapid product
obsolescence that could result in an increase in the amount of obsolete
inventory quantities on hand. Also, our estimates of future product demand may
prove to be inaccurate, in which case we may have understated or overstated the
provision required for excess and obsolete inventory. Although we make every
effort to ensure the accuracy of our forecasts of future product demand, any
significant unanticipated changes in demand or technological developments could
have a significant impact on the value of our inventory and our reported
operating results.
FOREIGN CURRENCY TRANSLATION
We have foreign subsidiaries that together accounted for approximately
61.7% of our net revenues, 47.3% of our assets and 53.1% of our total
liabilities as of and for the year ended December 31, 2005. In preparing our
consolidated financial statements, we are required to translate the financial
statements of our foreign subsidiaries from the currencies in which they keep
their accounting records into United States dollars. This process results in
exchange gains and losses which, under relevant accounting guidance, are
included either within our statement of operations or as a separate part of our
net equity under the caption "accumulated other comprehensive income (loss)."
39
Under relevant accounting guidance, the treatment of these translation
gains or losses depends upon our management's determination of the functional
currency of each subsidiary. This determination involves consideration of
relevant economic facts and circumstances affecting the subsidiary. Generally,
the currency in which the subsidiary transacts a majority of its transactions,
including billings, financing, payroll and other expenditures, would be
considered the functional currency. However, management must also consider any
dependency of the subsidiary upon the parent and the nature of the subsidiary's
operations.
If management deems any subsidiary's functional currency to be its
local currency, then any gain or loss associated with the translation of that
subsidiary's financial statements is included as a separate component of
stockholders' equity in accumulated other comprehensive income (loss). However,
if management deems the functional currency to be United States dollars, then
any gain or loss associated with the translation of these financial statements
would be included within our statement of operations.
If we dispose of any of our subsidiaries, any cumulative translation
gains or losses would be realized into our statement of operations. If we
determine that there has been a change in the functional currency of a
subsidiary to United States dollars, then any translation gains or losses
arising after the date of the change would be included within our statement of
operations.
Based on our assessment of the factors discussed above, we consider the
functional currency of each of our international subsidiaries as each
subsidiary's local currency. Accordingly, we had cumulative translation losses
of $870,000 and gains of $487,000 that were included as part of accumulated
other comprehensive income within our balance sheets at December 31, 2005 and
2004, respectively. During the years ended December 31, 2005 and 2004, we
included translation adjustments of losses of approximately $1,357,000 and gains
of $379,000, respectively, under accumulated other comprehensive income (loss).
If we had determined that the functional currency of our subsidiaries
was United States dollars, these gains or losses would have decreased or
increased our gain or loss for 2005 and 2004. The magnitude of these gains or
losses depends upon movements in the exchange rates of the foreign currencies in
which we transact business as compared to the value of the United States dollar.
These currencies include the euro, the British pound sterling and the Japanese
yen. Any future translation gains or losses could be significantly higher or
lower than those we recorded for these periods.
A $6,296,000 loan payable from EEL to EMRISE was outstanding as of
December 31, 2005. This loan is not expected to be outstanding indefinitely.
Therefore, exchange rate losses and gains on this loan are recorded in
cumulative translation gains or losses in the equity section of the balance
sheet.
INTANGIBLES, INCLUDING GOODWILL
We periodically evaluate our intangibles, including goodwill, for
potential impairment. Our judgments regarding the existence of impairment are
based on legal factors, market conditions and operational performance of our
acquired businesses.
In assessing potential impairment of goodwill, we consider these
factors as well as forecasted financial performance of the acquired businesses.
If forecasts are not met, we may have to record additional impairment charges
not previously recognized. In assessing the recoverability of our goodwill and
other intangibles, we must make assumptions regarding estimated future cash
flows and other factors to determine the fair value of those respective assets.
If these estimates or their related assumptions change in the future, we may be
required to record impairment charges for these assets that were not previously
recorded. If that were the case, we would have to record an expense in order to
reduce the carrying value of our goodwill. On January 1, 2002, we adopted
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets," and were required to analyze our goodwill for
impairment issues by June 30, 2002, and then at least annually after that date
or more frequently if an event occurs or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying
amount. At December 31, 2005, the reported goodwill totaled $12,066,000. During
2005, we did not record any impairment losses related to goodwill and other
intangible assets.
40
In conjunction with our July 2004 acquisition of Larus Corporation, we
commissioned a valuation firm to determine what portion of the purchase price
should be allocated to identifiable intangible assets. The study is complete and
the intangible values are as follows: Larus trade name and trademark are valued
at $750,000 compared to our initial estimate of $2,800,000, and the technology
and customer relationships are valued at $1,350,000 as compared to our initial
estimate of $800,000. Goodwill associated with the Larus Corporation acquisition
totaled $4,043,000. The Larus trade name and trademark were determined to have
indefinite lives and therefore are not being amortized but rather are being
periodically tested for impairment. The technology and customer relationships
were both estimated to have ten-year lives and, as a result, $162,000 of
amortization expense was recorded and charged to administrative expense in 2005.
In conjunction with our March 2005 acquisition of Pascall, we selected
a valuation firm to determine what portion of the purchase price should be
allocated to identifiable intangible assets. We considered whether the
acquisition included various types of identifiable intangible assets, including
trade names, trademarks, covenants not to compete, patents, customers,
workforce, technology and software. The Pascall trade name and trademark are
valued at $500,000 and are not amortized. The covenants not to compete that were
obtained from Pascall's former affiliates are valued at $200,000 amortizable
over three years in light of public statements made by those affiliates
indicating that they were strategically exiting the power supply business, which
we believe results in a low probability that they would return to the power
supply business absent the covenants not to compete. The backlog was valued at
$200,000 amortizable over two years. Total amortization expense of $310,000 was
charged to administrative expense in 2005. We believe that no other identifiable
intangible assets of significant value were acquired. No patents were acquired.
We did not ascribe any value to Pascall's customer base because EEL already was
selling to Pascall's key customers prior to the acquisition. Pascall's workforce
does not hold any special skills that are not readily available from other
sources. We did not identify any valuable completed technology that was
acquired, because Pascall utilizes non-proprietary technology to produce custom
power supplies pursuant to customer specifications. Pascall does not develop or
design software and does not own software of any material value.
Accordingly, we estimated that the goodwill associated with the Pascall
acquisition totaled $4,634,000. The Pascall trade name and trademark were
determined to have indefinite lives and therefore are not being amortized but
rather are being periodically tested for impairment. The covenants not to
compete and backlog are being amortized over their respective three-year and
two-year durations.
In conjunction with our acquisition of RO, we commissioned a valuation
firm to determine what portion of the purchase price should be allocated to
identifiable intangible assets. Although the valuation analysis is still in
progress, we have estimated that the RO trade name and trademark are valued at
$300,000, that the technology is valued at $484,000, and customer relationships
are valued at $200,000. Goodwill associated with the RO acquisition totaled
$1,376,000. The RO trade name and trademark were determined to have indefinite
lives and therefore are not being amortized but rather are being periodically
tested for impairment. The technology and customer relationships were both
estimated to have ten-year lives and, as a result, $23,000 of amortization
expense was recorded and charged to administrative expense in 2005. The
valuation of the identified intangible assets is expected to be completed by May
2006 and could result in changes to the value of these identified intangible
assets and corresponding changes to the value of goodwill. However, we do not
believe these changes will be material to our financial position or results of
operations.
41
RESULTS OF OPERATIONS
The tables presented below, which compare our results of operations
from one period to another, present the results for each period, the change in
those results from one period to another in both dollars and percentage change,
and the results for each period as a percentage of net sales. The columns
present the following:
o The first two data columns in each table show the absolute results
for each period presented.
o The columns entitled "Dollar Variance" and "Percentage Variance"
show the change in results, both in dollars and percentages. These
two columns show favorable changes as a positive and unfavorable
changes as negative. For example, when our net sales increase from
one period to the next, that change is shown as a positive number
in both columns. Conversely, when expenses increase from one
period to the next, that change is shown as a negative in both
columns.
o The last two columns in each table show the results for each
period as a percentage of net sales.
42
YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004
RESULTS AS A PERCENTAGE
OF NET SALES FOR THE
YEAR ENDED DOLLAR PERCENTAGE YEAR ENDED
DECEMBER 31 VARIANCE VARIANCE DECEMBER 31
---------------------------- FAVORABLE FAVORABLE ---------------------------
2005 2004 (UNFAVORABLE) (UNFAVORABLE) 2005 2004
------------ ------------ ------------ ------------ ------------ ------------
Net sales
Electronic components ............. $ 25,687 $ 15,262 $ 10,425 68.3% 62.6% 51.1%
Communications equipment .......... 15,359 14,599 760 5.2% 37.4% 48.9%
------------ ------------ ------------ ------------ ------------ ------------
Total net sales ...................... $ 41,046 $ 29,861 $ 11,185 37.5% 100.0% 100.0%
------------ ------------ ------------ ------------ ------------ ------------
Cost of sales
Electronic components ............. $ 15,527 $ 9,024 $ (6,503) (72.1)% 37.8% 30.2%
Communications equipment .......... 8,129 7,122 (1,007) (14.1)% 19.8% 23.9%
------------ ------------ ------------ ------------ ------------ ------------
Total cost of sales ............... $ 23,656 $ 16,146 $ (7,510) (46.5)% 57.6% 54.1%
------------ ------------ ------------ ------------ ------------ ------------
Gross profit
Electronic components ............. $ 10,160 $ 6,238 $ 3,922 62.9% 24.8% 20.9%
Communications equipment .......... 7,230 7,477 (247) (3.3)% 17.6% 25.0%
------------ ------------ ------------ ------------ ------------ ------------
Total gross profit ................ $ 17,390 $ 13,715 $ 3,675 26.8% 42.4% 45.9%
Selling, general and administrative
expenses .......................... $ 13,694 $ 10,226 $ (3,468) (33.9)% 33.4% 34.2%
Engineering and product development .. 2,621 1,521 (1,100) (72.3)% 6.4% 5.1%
------------ ------------ ------------ ------------ ------------ ------------
Operating income ..................... 1,075 1,968 (893) (45.4)% 2.6% 6.6%
Interest expense ..................... (455) (433) (22) (5.1)% (1.1)% (1.5)%
Interest income ...................... 153 -- 153 -- 0.4% --
Other income (expense), net .......... 248 (6) 254 (4,233.3)% 0.6% --
------------ ------------ ------------ ------------ ------------ ------------
Income before income tax expense ..... 1,021 1,529 (508) (33.2)% 2.5% 5.1%
Income tax expense ................... (267) 49 316 644.9% (0.7)% 0.2%
------------ ------------ ------------ ------------ ------------ ------------
Net income ........................... $ 1,288 $ 1,480 $ (192) (13.0)% 3.1% 5.0%
============ ============ ============ ============ ============ ============
NET SALES. The $11,185,000 (37.5%) increase in total net sales for 2005
as compared to 2004 resulted from the combination of a $10,425,000 (68.3%)
increase in net sales of our electronic components and a $760,000 (5.2%)
increase in net sales of our communications equipment products and services.
Electronic Components. The increase in net sales of our electronic
components segment resulted primarily from the inclusion in our 2005 results of
Pascall's $11,157,000 sales of power supplies and RF components and RO's
$1,925,000 sales of power conversion products and licensing. This increase
occurred despite a $2,939,000 (32.0%) decrease in sales at XPS primarily related
to reduced sales of power supplies due to the delay of deliveries for the
Eurofighter Typhoon aircraft. Sales of switches manufactured by Digitran
increased $1,021,000 (18.5%) to $6,545,000 for 2005 from $5,524,000 for the
prior year period due to sales of new rotary switches and other new programs for
our digital switches.
We first reported sales of RF components during the three months ended
March 31, 2005 due to the Pascall acquisition. We acquired RO on August 31,
2005. If we excluded sales by Pascall from March 18, 2005 through December 31,
2005 and sales by RO for September through December 31, 2005, our electronic
components segment sales would have declined by $2,657,000 or (17.4%) for 2005.
We currently anticipate that our sales of electronic components will increase in
2006, based upon informal indications we have received from various customers
and based upon recent increases in our backlog, especially including orders
relating to the Eurofighter Typhoon aircraft.
43
Communications Equipment. The $760,000 increase in net sales of our
communications equipment segment resulted primarily from the inclusion in our
2005 results of the full year of $5,974,000 of net sales of satellite
communication timing and synchronization products attributable to our
acquisition of Larus Corporation that occurred on July 13, 2004 as compared to
sales of $3,424,000 for the period from July 13, 2004 to December 31, 2004. This
increase occurred despite a $1,278,000 (31.7%) decline in net sales of test
instruments primarily due to delays and non-receipt of expected orders from
large carriers. Sales of network access equipment produced by CXR-AJ in France
decreased by $380,000 (6.2%) to $5,759,000 in 2005 as compared to $6,139,000 in
2004 due to lower sales volume in military markets. We anticipate that sales of
our communications test equipment will improve in 2006. We also anticipate that
sales of our network access products both in France and more importantly in the
United States will grow as new sales channels and our stronger marketing
presence becomes effective and we work to utilize our two new United
States-based distributors we established relationships with during 2005. We also
anticipate that sales of our satellite communication timing and synchronization
products will show further growth as we build our business with
telecommunications carrier companies.
GROSS PROFIT. Gross profit as a percentage of total net sales decreased
to 42.4% from 45.9% for the prior year period. In dollar terms, gross profit
increased by $3,675,000 (26.8%) to $17,390,000 for 2005 as compared to
$13,715,000 for 2004.
ELECTRONIC COMPONENTS. The $3,922,000 (62.9%) increase in gross profit
for our electronic components segment was primarily due to the inclusion in our
results for 2005 of $3,484,000 of gross profit from Pascall and $788,000 of
gross profit from RO. Partially offsetting these increases was a $244,000
reduction in gross profit from switches primarily due to product mix and a
$399,000 decrease in gross profit on power supplies produced by XPS as a direct
result of reduced sales volume due to contract delivery delays for the
Eurofighter Typhoon aircraft. We expect overall sales of power supplies in 2006
to exceed overall sales of power supplies in 2005 based upon informal
indications we have received from various customers and increased backlog. XCEL
Japan Ltd. increased its gross profit by $346,000 (62.0%) to $904,000 from
$558,000 in the prior year due to increased sales of higher margin military
switches.
COMMUNICATIONS EQUIPMENT. This segment had a slight $247,000 decrease
in gross profits. CXR Larus contributed $2,755,000 of gross profit for 2005
relating to net sales of network access and satellite communication timing and
synchronization products as compared to $1,782,000 for the period from July 13,
2004 to December 31, 2004. Gross profit for test instruments decreased
$1,137,000 (40.4%) to $1,679,000 in 2005 as compared to $2,816,000 in 2004 due
to lower volume. Due to reduced overhead costs, CXR-AJ recorded a relatively low
$84,000 decrease in gross profit despite a $359,000 decline in sales, resulting
in a gross margin for CXR-AJ of 42.0% in 2005 as compared to a gross margin for
CXR-AJ of 41.0% in 2004. We plan to have our timing and other network access
products built for us under a signed contract with Hitachi OMD and thereby
expect to increase gross margins over our in-house manufacturing.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Our selling, general and
administrative expenses increased in dollar terms but decreased as a percentage
of net sales to 33.4% in 2005 from 34.2% in 2004. The $3,468,000 (33.9%)
increase in selling, general and administrative expenses for 2005 as compared to
2004 resulted from:
o a $332,000 (49.7%) increase in sales commissions due to the
increase or inclusion of $85,000, $243,000 and $73,000 of sales
commission expenses of CXR Larus, Pascall and RO, respectively,
partially offset by reductions in commission expenses of $50,000
for test instruments and $22,000 for our French-produced network
access products;
44
o a $1,505,000 (48.5%) increase in other selling and marketing
expenses primarily due to an increase of $694,000 and the
inclusion of $924,000 and $71,000 of selling expenses of our Larus
division, Pascall and RO, respectively, attendance at tradeshows
and increased advertising and marketing of our electronic
components. These increases were partially offset by decreases in
these expenses of $71,000 for test instruments and $118,000 at
CXR-AJ;
o a $1,622,000 (25.1%) increase in administrative expenses primarily
due to the increase or inclusion of $337,000 and $775,000 of
administrative costs for our Larus division and Pascall,
respectively;
o $74,000 in severance costs we recorded to administrative expense
to reflect a consolidation of CXR Larus' operations;
o a $55,000 expense we recorded for a repair provision for the
building in Wales that we vacated to combine our coil winding
business with XPS's operations in Ashford, England; and
o an increase of $144,000 in United States corporate legal expenses
and a $282,000 increase in our domestic accounting and auditing
expenses plus an increase of $227,000 in consulting fees relating
to internal control documentation in response to the
Sarbanes-Oxley Act of 2002.
We anticipate that selling, general and administrative expenses for
2006 will exceed those expenses for 2005 due to costs associated with
integrating Pascall and RO, increased sales and marketing expenses for our new
low profile rotary and digital switches, increased activity in searching for and
analyzing potential acquisitions, expansion of our investor relations program
and increased corporate governance activities in response to the Sarbanes-Oxley
Act of 2002 and rules and regulations of the Securities and Exchange Commission
("Commission"). However we continue to seek efficiencies and cost savings at all
operations.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of new product development engineering
activities. The $1,100,000 (72.3%) increase in these expenses resulted primarily
from the increase of $443,000 of expenses attributable to our Larus division and
a $513,000 increase in engineering expenses attributable to Pascall. Also,
expenses related to development of our new low profile rotary switches increased
$58,000 (12.0%) to $540,000 for 2005 as compared to $482,000 for 2004. We expect
this higher level of expense to continue through 2006 as we continue to develop
our new family of rotary switches and pursue long term opportunities in the
timing and synchronization market. During 2005, we eliminated one of our two
engineering directors at CXR Larus, which is helping to offset approximately
$75,000 of our increased engineering expenses on an annual basis.
INTEREST EXPENSE AND OTHER INCOME. Interest expense increased by
$22,000 (5.1%) to $455,000 for 2005 as compared to $433,000 for 2004. In
addition, we recorded $153,000 of interest income in 2005, which we earned on
the proceeds of the January 5, 2005 private placement. We did not have interest
income during 2004. Other income of $248,000 for 2005 primarily resulted from a
$100,000 gain due to the sale of our T-Com product line and $123,000 of a net
currency exchange gain. The T-Com technology and tangible assets had no carrying
value.
INCOME TAX EXPENSE. Income tax benefit for 2005 was $267,000, compared
to an expense of $49,000 for 2004 primarily because we reduced our tax asset
valuation allowance by $555,000 and recorded a federal tax benefit of $150,000
that was offset by our foreign tax provision of $408,000 and a state tax
provision of $30,000.
45
NET INCOME. Net income for 2005 decreased by $192,000 to $1,288,000 as
compared to $1,480,000 for 2004. The decrease was primarily due to the impact of
planned increased sales and marketing expenses to launch new products and
improve the marketing and sales efforts in promoting our existing products and
the addition of similar expenses of CXR Larus designed to increase future
revenue and net income, together with the substantial increase in product
development engineering associated primarily with our satellite communication
timing and synchronization products. We continue to closely monitor costs
throughout our operations and have reduced costs through staffing reductions in
our communications equipment operations in the United States and France as
indicated above.
YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003
RESULTS AS A PERCENTAGE
OF NET SALES FOR THE
YEAR ENDED DOLLAR PERCENTAGE YEAR ENDED
DECEMBER 31 VARIANCE VARIANCE DECEMBER 31
---------------------------- FAVORABLE FAVORABLE ---------------------------
2004 2003 (UNFAVORABLE) (UNFAVORABLE) 2004 2003
------------ ------------ ------------ ------------ ------------ ------------
Net sales
Electronic components................. $ 15,262 $ 16,168 $ (906) (5.6)% 51.1% 63.4%
Communications equipment.............. 14,599 9,351 5,248 56.1% 48.9% 36.6%
------------ ------------ ------------ ------------ ------------ ------------
Total net sales................... $ 29,861 $ 25,519 $ 4,342 17.0% 100.0% 100.0%
------------ ------------ ------------ ------------ ------------ ------------
Cost of sales
Electronic components................. $ 9,024 $ 9,530 $ 506 5.3% 30.2% 37.3%
Communications equipment.............. 7,122 5,305 (1,817) (34.3)% 23.9% 20.8%
------------ ------------ ------------ ------------ ------------ ------------
Total cost of sales................... $ 16,146 $ 14,835 $ (1,311) (8.8)% 54.1% 58.1%
------------ ------------ ------------ ------------ ------------ ------------
Gross profit
Electronic components................. $ 6,238 $ 6,638 $ (400) (6.0)% 20.9% 26.0%
Communications equipment.............. 7,477 4,046 3,431 84.8% 25.0% 15.9%
------------ ------------ ------------ ------------ ------------ ------------
Total gross profit.................... $ 13,715 $ 10,684 $ 3,031 28.4% 45.9% 41.9%
Selling, general and administrative
expenses........................... $ 10,226 $ 7,812 $ (2,414) (30.9)% 34.2% 30.6%
Engineering and product development
expenses........................... 1,521 951 (570) (59.9)% 5.1% 3.7%
------------ ------------ ------------ ------------ ------------ ------------
Operating income...................... 1,968 1,921 47 2.4% 6.6% 7.5%
Interest expense...................... (433) (416) (17) (4.1)% (1.5)% (1.6)%
Other expense......................... (6) (58) 52 89.7% -- 0.2%
------------ ------------ ------------ ------------ ------------ ------------
Income before income tax expense...... 1,529 1,447 82 5.5% 5.1% 5.7%
Income tax expense.................... 49 286 237 82.9% 0.2% 1.1%
------------ ------------ ------------ ------------ ------------ ------------
Net income............................ $ 1,480 $ 1,161 $ 319 27.5% 5.0% 4.5%
============ ============ ============ ============ ============ ============
NET SALES. The $4,342,000 (17.0%) increase in total net sales for 2004
as compared to 2003 resulted from the combination of a $906,000 (5.6%) decrease
in net sales of our electronic components and a $5,248,000 (56.1%) increase in
net sales of our communications equipment products and services.
ELECTRONIC COMPONENTS. The decrease in net sales of our electronic
components segment resulted from:
o a $2,012,000 (20.1%) decrease in net sales of power supplies and
subassemblies by XPS that we believe was primarily due to deferral
of orders; and
46
o a $67,000 (23.1%) decrease in sales of electronic subsystem
assemblies produced by Digitran, which we believe was primarily
due to a delay in the United States government's transfer of a
contract from one prime contractor to another.
These decreases were only partially offset by the following:
o a $217,000 (4.1%) increase in net sales of switches manufactured
by Digitran, which was primarily a result of an increase in the
volume of orders for spare parts that we believe was mainly due to
increased military activities;
o an increase from $1,000 in 2003 to $28,000 in 2004 in net sales of
a new standard rotary switch and patent pending VLP(TM) rotary
switches that were introduced by Digitran in 2004; and
o a $956,000 (164.3%) increase in net revenue from service and
miscellaneous other electronic component products primarily due to
increased service business volume at XPS.
COMMUNICATIONS EQUIPMENT. The increase in net sales of our
communications equipment products and services resulted from:
o a $2,112,000 (34.4%) increase in net sales of network access and
transmission equipment, which primarily consisted of $1,952,000 in
sales made by CXR Larus as a direct result of our acquisition of
Larus Corporation in July 2004;
o $1,298,000 of net sales of satellite communication timing and
synchronization products by CXR Larus from July through December
2004, prior to which time we did not have a similar product line;
and
o a $1,677,000 (71.3%) increase in net sales of our CXR HALCYON 704
series field test equipment, which was primarily due to a
$1,800,000 order we received and delivered in the fourth quarter
of 2004 for a project that had been under development since 2002.
These increases were partially offset by the curtailment during 2004 of orders
for CXR Larus test equipment by another large customer who shifted its focus to
fiber and HDSL services.
GROSS PROFIT. The four percentage point increase in gross profit as a
percentage of total net sales and the $3,031,000 (28.4%) increase in total gross
profit in 2004 as compared to 2003 resulted from gross profit decreases in our
electronic components segment that were more than offset by gross profit
increases in our communications equipment segment.
ELECTRONIC COMPONENTS. The $400,000 (6.0%) decrease in gross profit for
our electronic components segment was primarily due to the large reduction in
sales of power supplies described above.
COMMUNICATIONS EQUIPMENT. The $3,431,000 (84.8%) increase in gross
profit for our communications equipment segment and the 7.9 percentage point
increase in this segment's gross profit as a percentage of total net sales were
primarily the result of the addition of Larus Corporation's $1,782,000 gross
profit resulting from net sales of satellite communication timing and
synchronization products for July through December 2004 and a $1,587,000
increase in gross profit at CXR Larus as a result of a large increase in high
gross margin sales of CXR Halcyon communications test equipment. Excluding the
addition of Larus Corporation sales, gross profit for network access equipment
increased approximately $60,000 (2.1%).
47
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The $2,414,000 (30.9%)
increase in selling, general and administrative expenses in 2004 as compared to
2003 resulted primarily from:
o $994,000 in selling, general and administrative expenses generated
by Larus Corporation following its acquisition in July 2004;
o a $73,000 (12.0%) increase in sales expense at CXR Larus mostly
related to the large orders they obtained during 2004;
o a $110,000 (53.9%) increase in selling expense at Digitran related
to our new line of rotary switches;
o a $56,000 (19.6%) increase in selling expense at XPS to improve
marketing of power supplies;
o a $99,000 (110.0%) increase in corporate legal fees and $67,000
(35.9%) increase in auditing fees partially due to requirements of
the Sarbanes-Oxley Act of 2002;
o a $126,000 (91.3%) increase in deferred compensation;
o a $68,000 (42.5%) increase in stockholder relations and investor
relations expenses; and
o a $180,000 (18.3%) increase in corporate salaries, bonus and
expenses partially due to foreign currency exchange rate
fluctuation.
Some of the reasons for higher administrative expenses were increased
acquisition activities, costs of changing our name to EMRISE Corporation and
complying with the requirements of the Sarbanes-Oxley Act of 2002 and related
rules, and increased investor relations activities.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities. The $570,000 (59.9%) increase in these expenses resulted from:
o the inclusion of $200,000 of these expenses from Larus
Corporation;
o an $80,000 (65.6%) increase in these expenses at CXR Larus
relating to test instruments;
o a $53,000 (91.1%) increase in these expenses at CXR-AJ for network
access equipment; and
o a $237,000 (96.7%) increase in expenses at Digitran for the new
line of rotary switches.
INTEREST EXPENSE. Although our bank interest expense declined $58,000
(13.9%) due to our new credit line with Wells Fargo Bank, N.A., this benefit was
more than offset by the $75,000 interest we paid on the notes we issued to
acquire Larus Corporation.
INCOME TAX EXPENSE. Income tax expense for 2004 was $49,000 as compared
to $286,000 in 2003. The 2004 tax provision was composed of $177,000 net foreign
income taxes and $76,000 current federal and state taxes. These amounts were
offset with a $160,000 reduction of the valuation allowance applied against the
deferred tax asset. The release of the allowance was based on our recent and
expected U.S. based earnings and the probability that a portion of our tax net
operating loss carryforwards may be utilized.
48
NET INCOME. Net income increased by $319,000 (27.5%) to $1,480,000 in
2004 from $1,161,000 in 2003. Our 2004 net income was helped by the contribution
of $628,000 of operating earnings from Larus Corporation, a $1,414,000 increase
in operating earnings by CXR Larus due to improved test instrument sales and an
improvement of $319,000 in operating earnings at CXR-AJ due to increased network
access sales. These improvements were partially offset by lower operating
earnings at our electronics components segment due to higher operating expenses
at Digitran and lower gross margin at XPS due to a lower sales volume of power
supplies. These changes resulted in our net income before taxes in 2004 of
$1,529,000, $82,000 over 2003 net income before tax of $1,447,000. Our income
tax provision in 2004 was $49,000 as compared to $286,000 in 2003.
LIQUIDITY AND CAPITAL RESOURCES
During 2005, we funded our operations primarily through revenue
generated from our operations and through our existing and previous lines of
credit with Wells Fargo Bank, N.A. and various foreign banks. During 2005, we
continued to rely on our foreign credit facilities. In addition, we raised
approximately $16,060,000 in net proceeds through a private placement of equity
securities in January 2005 as described below to support our acquisition
program. As of December 31, 2005, we had working capital of $12,958,000, which
represented a $7,418,000 (133.9%) increase from working capital of $5,540,000 at
December 31, 2004, primarily due to the proceeds from the private placement and
the addition of the working capital of Pascall and RO. At December 31, 2005 and
2004, we had accumulated deficits of $15,118,000 and $16,406,000, respectively,
and cash and cash equivalents of $4,371,000 and $1,057,000, respectively.
Accounts receivable increased $3,617,000 (62.4%) during 2005 from
$5,796,000 as of December 31, 2004 to $9,413,000 as of December 31, 2005. Sales
attributable to the Pascall and RO acquisitions contributed $11,157,000 and
$1,925,000, respectively, to accounts receivable at December 31, 2005. Without
the acquisitions of Pascall and RO, our receivables would have increased by
$590,000 (10.2%) during 2005, primarily due to increased receivables for
switches and test instruments. Days sales outstanding, which is a measure of our
average accounts receivable collection period, increased from 61 days for 2004
to 67 days for 2005. Our customers include many Fortune 100 companies in the
United States and similarly large companies in Europe and Asia. Because of the
financial strength of our customer base, we incur few bad debts.
Inventory balances increased $3,786,000 (58.3%) during 2005, from
$6,491,000 at December 31, 2004 to $10,277,000 at December 31, 2005. Inventory
represented 23.1% and 25.9% of our total assets as of December 31, 2005 and
December 31, 2004, respectively. Included in the December 31, 2005 amount is
$1,591,000 and $2,325,000 of inventory attributable to Pascall and RO,
respectively. Excluding the effect of this inclusion, inventory would have
decreased by $130,000 (2.0%) and would have represented 22.6% of total assets
(excluding the $10,410,000 and $5,872,000 of total assets related to Pascall and
RO, respectively) at December 31, 2005. Inventory turnover, which is a ratio
that indicates how many times our inventory is sold and replaced over a
specified period, increased to 2.8 times for 2005 as compared to 2.6 times for
2004.
We took various actions to reduce costs in 2005 and 2004. These actions
were intended to reduce the cash outlays of our communications equipment segment
to match its revenue rate, which was negatively impacted by the
telecommunications downturn of 2002 and 2003. We also have contracted with
offshore manufacturers for production of test equipment at lower prices than our
previous cost for in-house manufacturing. We have also contracted with Hitachi
to outsource the manufacture of our satellite communication timing devices
beginning approximately in the second quarter of 2006. We merged Larus
Corporation with and into CXR Telcom Corporation at the end of 2004 and
integrated their operations.
49
Cash provided by our operating activities totaled $1,135,000 for 2005
as compared to cash provided by operating activities of $3,884,000 for 2004.
This $2,749,000 decrease in operating cash flows primarily resulted from
payments made as planned reductions of accounts payable and accrued expenses.
Cash used in our investing activities totaled $15,044,000 for 2005 as
compared to $2,208,000 for 2004. Included in the results for 2005 are net cash
of $10,154,000 and $4,623,000 used to acquire Pascall and RO, respectively. Also
we acquired $287,000 of property, plant and equipment purchases for production
equipment and computer equipment.
Cash provided by our financing activities totaled $18,055,000 for 2005
as compared to $2,164,000 of cash used in our financing activities for 2004. The
change is primarily due to the net proceeds of $16,060,000 from the issuance of
common stock in the January 2005 private placement.
Outstanding borrowings under our revolving lines of credit were as
follows:
December 31,
2005 2004
------------ ------------
Line of credit with a U.S. commercial lender $ -- $ 118,000
Lines of credit with foreign banks 3,283,000 760,000
------------ ------------
$ 3,283,000 $ 878,000
============ ============
On August 25, 2005, we and two of our subsidiaries, CXR Laurus and
EMRISE Electronics, acting as guarantors, obtained a credit facility from Wells
Fargo Bank, N.A. for the our domestic operations. As guarantors, each of CXR
Larus and EMRISE Electronics is jointly and severally liable with EMRISE for up
to $9,000,000. This facility is effective through September 1, 2006. The credit
facility has no prepayment penalty and is subject to an unused commitment fee
equal to 0.25% per annum, payable quarterly based on the average daily unused
amount of the line of credit described in the following paragraph.
The credit facility provides a $9,000,000 revolving line of credit
secured by accounts receivable, other rights to payment and general intangibles,
inventories and equipment. Borrowings do not need to be supported by specific
receivables or inventory balances unless aggregate borrowings under the line of
credit exceed $2,000,000 at any time (a "conversion event"). The bank has
informally notified us that it intends to raise the limit to $3,000,000. If a
conversion event occurs, the line of credit will covert into a formula-based
line of credit until the borrowings are equal to or less than $2,000,000. The
formula generally provides that the outstanding borrowings under the line of
credit may not exceed an aggregate of 80% of eligible accounts receivable plus
30% of the value of eligible finished goods inventory. Interest is payable
monthly. The interest rate is variable and is adjusted monthly based on the
prime rate. The prime rate at December 31, 2005 was 7.25%.
The credit facility is subject to various financial covenants on a
consolidated basis, which were updated on November 17, 2005 as follows. The
minimum debt service coverage ratio must be greater than 1.25:1.00 on a trailing
four-quarter basis. "Debt service coverage ratio" is defined as net profit after
taxes, plus depreciation, plus amortization, plus or minus net distributions,
divided by the sum of the current portion of long-term debt plus capitalized
lease payments. The current ratio must be not less than 1.50:1.00, determined as
of each fiscal quarter end. "Current ratio" is defined as total current assets
divided by total current liabilities. Annual net profit after taxes must be
greater than $500,000, determined as of each fiscal quarter end on a rolling
four-quarter basis; provided that EMRISE may not sustain net loss after tax in
any two consecutive fiscal quarters and no fiscal quarter's losses may exceed
$300,000. Our total liabilities divided by tangible net worth must not at any
time be greater than 1.75:1.00, determined as of each fiscal quarter end. Our
tangible net worth must not at any time be less than $12,000,000 measured at the
end of each quarter. "Total liabilities" is defined as current liabilities plus
non-current liabilities, minus subordinated debt. "Tangible net worth" is
defined as stockholders' equity plus subordinated debt, minus intangible assets.
50
As of December 31, 2005, we had no outstanding balance owing under the
revolving credit line, and had $2,000,000 of availability on the non-formula
based portion of the credit line. As of December 31, 2005, we were in compliance
with each of the covenants of the credit facility.
In the event of a default and continuation of a default, Wells Fargo
may accelerate the payment of the principal balance requiring us to pay the
entire indebtedness outstanding on that date. From and after the maturity date
of the note, or any earlier date that all principal owing under the note becomes
due and payable by acceleration or otherwise, the outstanding principal balance
will bear interest until paid in full at an increased rate per annum equal to 4%
above the rate of interest in effect from time to time under the note.
The credit facility also provides for a term loan of $150,000 secured
by equipment, amortizable over 36 months at a variable rate equal to the prime
rate plus 1.5%. The term loan portion of the facility had a balance of $75,000
at December 31, 2005.
Wells Fargo also provided us with credit for the purchase of new
capital equipment when needed, of which a balance of $123,000 was outstanding at
December 31, 2005. The interest rate is equal to the 90-day London InterBank
Offered Rate ("LIBOR") rate (4.54% at December 31, 2005) plus 3.75% per annum.
Amounts borrowed under this arrangement are amortized over 60 months from the
respective dates of borrowing and are secured by the purchased equipment.
As of December 31, 2005, our foreign subsidiaries had credit
facilities, including lines of credit and term loans, with Lloyds TSB Bank PLC
("Lloyds TSB") and Lloyds TSB Commercial Finance Limited ("Lloyds") in England,
IFN Finance, a subsidiary of ABN AMRO Holdings, N.V., Banc National de Paris,
Societe Generale in France, and Sogelease and Johnan Shinkin Bank in Japan. At
December 31, 2005, the balances outstanding under our United Kingdom, France and
Japan credit facilities were $3,006,000, $1,090,000 and $32,000, respectively.
On July 8, 2005, XPS and Pascall obtained a 24-month credit facility
with Lloyds, which facility expires July 31, 2007. At the same time, the credit
facility of Venture Finance PLC, a subsidiary of ABN AMRO Holdings, N.V., was
terminated and paid off. The Lloyds facility provides a revolving loan secured
by receivables, with a maximum availability of 2,100,000 British pounds sterling
(approximately U.S. $3,613,000 based on the exchange rate in effect on December
31, 2005). The annual interest rate on the revolving loan is 1.5% above the
Lloyds TSB base rate. The Lloyds TSB base rate was 4.5% at December 31, 2005.
The financial covenants include a 50% cap on combined export gross sales of XPS
and Pascall and days sales outstanding of less than 65 days, and the funding
balance is capped at 125% of XPS and Pascall combined gross sales.
On August 26, 2005, XPS entered into an agreement with Lloyds for an
unsecured cashflow loan of 300,000 British pounds sterling (approximately U.S.
$516,000 based on the exchange rate in effect on December 31, 2005 payable over
12 months). The loan is structured as an overadvance on the previously
negotiated 2,100,000 British pounds sterling revolving loan with Lloyds,
bringing the maximum aggregate commitment on the revolving loan to 2,400,000
British pounds sterling (approximately U.S. $4,129,000 based on the exchange
rate in effect on December 31, 2005).
The unsecured cashflow loan of 300,000 British pounds sterling is
payable at a rate of 25,000 British pounds sterling per month, the first payment
falling due one month after initial drawdown on the revolving loan. The interest
rate is variable and is adjusted monthly based on the base rate of Lloyds TSB
plus 1.9%. The Lloyds TSB base rate at December 31, 2005 was 4.5%. Lloyds TSB
has sole discretion to switch the details on this overadvance account if Lloyds
determines that the Company will have difficulty in meeting the specific
reductions in the overadvance account.
51
Lloyds TSB also issued a loan to XPS for 500,000 British pounds
sterling (approximately U.S. $860,000 at the exchange rate in effect on December
31, 2005). The loan is payable over 36 months with monthly payments of 15,820
British pounds sterling. The interest rate is the Lloyds TSB rate, which was
4.5% at December 31, 2005, plus 2.5%. This loan has a covenant requiring that
consolidated profit before tax and interest paid and payable of our U.K.
companies be not less than 500% of consolidated interest paid or payable for the
period covered by the account. The Company failed to comply with this covenant
and received a wavier. The Company and the bank are reviewing the covenants for
possible amendment.
On August 26, 2005, EEL entered into an agreement with Lloyds TSB for
an unsecured term loan for 500,000 British pounds sterling (approximately U.S.
$860,000 based on the exchange rate in effect on December 31, 2005). This loan
is repayable in 36 consecutive monthly installments of principal and interest.
The interest rate is variable and is adjusted daily based on the Lloyds TSB base
rate plus 2.5%. The Lloyds TSB base rate at December 31, 2005 was 4.5%. The loan
also includes financial covenants. EEL must maintain consolidated profit before
taxation and interest paid and payable of no less than 500% of the consolidated
interest paid and payable. Additionally, EEL must maintain consolidated profit
before taxation, depreciation, amortization of goodwill and other intangibles
and interest paid and payable of no less than 300% of the consolidated principal
repayments and the consolidated interest paid and payable.
In the event of a default, Lloyds TSB may make the loan, including any
outstanding principal and interest which has accrued, repayable on demand. If
any amount payable is not paid when due, EEL shall pay an increased interest
rate per annum equal to 3% above the rate of interest in effect from time to
time under the note.
In April 2003, CXR-AJ obtained a credit facility from IFN Finance, a
subsidiary of ABN AMRO N.V. This credit facility is for a maximum of $1,421,000
based on the exchange rate in effect at December 31, 2005 for the conversion of
euros into United States dollars. CXR-AJ also had $34,000 of term loans with two
French banks outstanding as of December 31, 2005. The IFN Finance facility is
secured by accounts receivable and carries an annual interest rate of 1.6% above
the French "T4M" rate. At December 31, 2005, the French T4M rate was 2.26%, and
this facility had a balance of $1,056,000. This facility has no financial
performance covenants.
XCEL Japan Ltd ("XJL"), obtained a term loan on November 29, 2002 from
Johnan Shinkin Bank. The loan is amortizable over five years, carries an annual
fixed interest rate of 3.25% and is secured by the assets of XJL. The balance of
the loan as of December 31, 2005 was $32,000 using the exchange rate in effect
at that date for conversion of Japanese yen into United States dollars. There
are no financial performance covenants applicable to this loan.
Our backlog was $22,150,000 as of December 31, 2005 as compared to
$7,720,000 as of December 31, 2004. The increase in backlog was primarily due to
the addition of $7,183,000 of backlog for Pascall and $695,000 for RO. Without
Pascall and RO, our backlog as of December 31, 2005 would have been $14,272,000,
representing a $5,975,000 (77.4%) increase. Our backlog as of December 31, 2005
was 97.4% related to our electronic components business, which business tends to
provide us with long lead-times for our manufacturing processes due to the
custom nature of the products, and 2.6% related to our communications equipment
business, which business tends to deliver standard products from stock as orders
are received. The amount of backlog orders represents revenue that we anticipate
recognizing in the future, as evidenced by purchase orders and other purchase
commitments received from customers, but on which work has not yet been
initiated or with respect to which work is currently in progress. However, there
can be no assurance that we will be successful in fulfilling such orders and
commitments in a timely manner or that we will ultimately recognize as revenue
the amounts reflected as backlog.
52
As described above under the heading "Overview," we acquired Larus
Corporation and Vista in July 2004. The $6,539,500 purchase price consisted of
$1,000,000 in cash, the issuance of 1,213,592 shares of our common stock with a
fair value of $1,000,000, $887,500 in the form of two short-term, zero interest
promissory notes that were repaid in 2004, $3,000,000 in the form of two
subordinated secured promissory notes, warrants to purchase up to an aggregate
of 150,000 shares of our common stock at $1.30 per share, and approximately
$580,000 of acquisition costs. In addition, we assumed $245,000 worth of
accounts payable and accrued expenses and entered into an above-market
seven-year real property lease with the sellers. This lease represents an
obligation that exceeds the fair market value by approximately $756,000 and is
part of the acquisition accounting. We funded the cash portion of the purchase
price using proceeds from our credit facility with Wells Fargo and our cash
on-hand.
On January 5, 2005, we issued to 17 accredited record holders in a
private offering an aggregate of 12,503,500 shares of common stock at a purchase
price of $1.44 per share and five-year investor warrants to purchase up to an
additional 3,125,875 shares of our common stock at an exercise price of $1.73
per share, for a total purchase price of $18,005,000. We paid cash placement
agent fees and expenses of approximately $961,000, and issued five-year
placement warrants to purchase up to an aggregate of 650,310 shares of common
stock at an exercise price of $1.73 per share in connection with the offering.
Additional costs related to the financing include registration rights-related
liquidated damages of $480,000 and legal, accounting and consulting fees that
totaled approximately $984,000 through December 31, 2005.
We agreed to register for resale the shares of common stock issued to
investors and the shares of common stock issuable upon exercise of the investor
warrants and placement warrants. The registration obligations require, among
other things, that a registration statement be declared effective no later than
June 4, 2005. We were unable to meet this obligation and therefore paid to each
investor liquidated damages equal to 1% of the amount paid by the investor to us
in the offering, which damage payments totaled an aggregate of approximately
$180,000. We also paid to the investors liquidated damages totaling $300,000 for
the period from June 5, 2005 through June 30, 2005, the date the registration
statement was declared effective. We also will be required to pay to each
investor liquidated damages for any future periods in which we are unable to
maintain the effectiveness of the registration in accordance with the
requirements contained in the registration rights agreement we entered into with
the investors. These liquidated damages would be, and the liquidated damages
paid for the period from June 5, 2005 through June 30, 2005 were, equal to 2% of
the amount paid by each investor for the common shares still owned by the
investor on each monthly anniversary of the date of the default that occurs
prior to the cure of the default, pro rated on a daily basis for periods of
default shorter than one month. The maximum aggregate liquidated damages payable
to any investor will be equal to 10% of the aggregate amount paid by the
investor for the shares of our common stock. Accordingly, the maximum aggregate
penalty that we would be required to pay under this provision is 10% of the
$18,005,000 initial purchase price of the common stock, which would be
$1,801,000. Although we anticipate that we will be able to meet our future
registration obligations, we also anticipate that we will have sufficient cash
available to pay the maximum penalties if required.
We used a portion of the proceeds from the January 2005 private
placement to fund the acquisition of Pascall described above under the heading
"Overview." In connection with the Pascall acquisition, we loaned to EMRISE
Electronics approximately $10,100,000 in cash that was used to acquire Pascall
and to repay Pascall's existing intercompany debt. As described above, the
Pascall purchase price is subject to upward or downward adjustment, and
accordingly we paid $237,000 to Intelek on August 1, 2005 to compensate for an
upward adjustment of Pascall's net worth. We have guaranteed obligations of
EMRISE Electronics in connection with the Pascall acquisition and have agreed to
indemnify Pascall's former parent in connection with obligations under Pascall's
facilities lease.
53
We used another portion of the proceeds from the January 2005 private
placement to partially fund the acquisition of RO described above under the
heading "Overview." We used $4,002,000 of cash to acquire RO, including paying
down RO's bank debt of $1,602,000. In addition, we agreed to make two deferred
payments of $300,000 each, the first of which we paid in October 2005, and the
second of which is due on March 31, 2006. Offsetting these amounts was $35,000
received from the former RO shareholders to compensate for balance sheet
adjustments.
The following table outlines payments due from us or our subsidiaries
under our lines of credit and other significant contractual obligations over the
next five years, exclusive of interest. All dollars are in thousands. The symbol
"P" represents the prime rate, the symbol "B" represents the lender's base rate
and the symbol "L" represents the 30-day LIBOR.
PAYMENTS DUE BY PERIOD
CONTRACTUAL (IN THOUSANDS)
OBLIGATIONS AT
DECEMBER 31, 2005 2006 2007 2008 2009 2010 THEREAFTER TOTAL
------------------------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Line of Credit (Domestic) $ -- $ -- $ -- $ -- $ -- $ -- $ --
Average Interest Rate P+0.5%
Line of Credit (U.K.) $ 2,227 $ -- $ -- $ -- $ -- $ -- $ 2,227
Average Interest Rate B+2%
Overdraft (France) $ 1,056 $ -- $ -- $ -- $ -- $ -- $ 1,056
Average Interest Rate %
Term Loan From
Stockholders (Domestic) $ 500 $ 500 $ 500 $ 500 $ 250 $ -- $ 2,250
P+1.5%,
Average Interest Rate L+5.0%
Capital Equipment Loan
(U.S.) $ 26 $ 26 $ 26 $ 26 $ 19 $ -- $ 123
Average Interest Rate L+4%
Term Loans (U.S.) $ 50 $ 25 $ -- $ -- $ -- $ -- $ 75
Average Interest Rate P+1.5%
Term Loan (U.K.) $ 292 $ 292 $ 195 $ -- $ -- $ -- $ 779
Average Interest Rate B+2%
Term Loans (France) $ 10 $ 10 $ 10 $ 5 $ -- $ -- $ 35
Average Interest Rate 1.2%-5.6%
Term Loan (Japan) $ 17 $ 15 $ -- $ -- $ -- $ -- $ 32
Average Interest Rate 3.25%
Capitalized Lease
Obligations $ 116 $ 56 $ 25 $ 6 $ -- $ -- $ 203
Operating Leases $ 1,202 $ 1,140 $ 745 $ 551 $ 430 $ 162 $ 4,230
------------------------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
$ 5,496 $ 2,064 $ 1,501 $ 1,088 $ 699 $ 162 $ 11,010
We intend to grow our business through both internal growth and further
acquisitions that we identify as being potentially both synergistic and
accretive of our earnings. Any additional acquisitions would likely be funded
through the use of cash and/or a combination of cash and our stock.
54
We believe that current and future available capital resources,
revenues generated from operations, and other existing sources of liquidity,
including the credit facilities we have, will be adequate to meet our
anticipated working capital and capital expenditure requirements for at least
the next twelve months. If, however, our capital requirements or cash flow vary
materially from our current projections, if unforeseen circumstances occur, or
if we require a significant amount of cash to fund future acquisitions, we may
require additional financing. Our failure to raise capital, if needed, could
restrict our growth, limit our development of new products or hinder our ability
to compete.
EFFECTS OF INFLATION
The impact of inflation and changing prices has not been significant on
the financial condition or results of operations of either our company or our
operating subsidiaries.
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4,"
SFAS No. 151 clarifies that abnormal inventory costs such as costs of idle
facilities, excess freight and handling costs, and wasted materials (spoilage)
are required to be recognized as current period costs. The provisions of SFAS
No. 151 are effective for our fiscal 2006. We are currently evaluating the
provisions of SFAS No. 151 and do not expect that adoption will have a material
effect on our financial position, results of operations or cash flows.
On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment," which is a revision of SFAS No. 123. SFAS No. 123(R)
supersedes APB Opinion No. 25, and amends SFAS No. 95, "Statement of Cash
Flows." Generally, the approach in SFAS No. 123(R) is similar to the approach
described in SFAS 123. However, SFAS 123(R) generally requires share-based
payments to employees, including grants of employee stock options and purchases
under employee stock purchase plans, to be recognized in the statement of
operations based on their fair values. Pro forma disclosure of fair value
recognition will no longer be an alternative. SFAS No. 123(R) permits public
companies to adopt its requirements using one of two methods:
o Modified prospective method: Compensation cost is recognized
beginning with the effective date of adoption (a) based on the
requirements of SFAS No. 123(R) for all share-based payments
granted after the effective date of adoption and (b) based on the
requirements of SFAS No. 123 for all awards granted to employees
prior to the effective date of adoption that remain unvested on
the date of adoption.
o Modified retrospective method: Includes the requirements of the
modified prospective method described above, but also permits
restatement using amounts previously disclosed under the pro forma
provisions of SFAS No. 123 either for (a) all prior periods
presented or (b) prior interim periods of the year of adoption.
On April 14, 2005, the Commission announced that the SFAS No. 123(R)
effective transition date will be extended to annual periods beginning after
June 15, 2005. We adopted this new standard on January 1, 2006 using the
modified prospective method.
SFAS No. 123(R) also requires the benefits of tax deductions in excess
of recognized compensation expense to be reported as a financing cash flow,
rather than as an operating cash flow as prescribed under current accounting
rules. This requirement will reduce net operating cash flows and increase net
financing cash flows in periods after adoption. Total cash flow will remain
unchanged from what would have been reported under prior accounting rules.
However, we estimate that we will record expenses relating to currently
outstanding stock option of $103,000 in 2006 and $30,000 in 2007.
55
As permitted by SFAS No. 123, we currently account for share-based
payments to employees using APB Opinion No. 25's intrinsic value method. As a
consequence, we generally recognize no compensation cost for employee stock
options under our employee stock option plans. Although the adoption of SFAS No.
123(R)'s fair value method will have no adverse effect on our balance sheet or
total cash flows, it will affect our net income and diluted earnings per share.
The actual effects of adopting SFAS No. 123(R) will depend on numerous factors,
including the amounts of share-based payments granted in the future, the
valuation model we use to value future share-based payments to employees and
estimated forfeiture rates. See Note 1 to our condensed consolidated financial
statements for the effect on reported net income and earnings per share that
would have occurred if we had accounted for our employee stock options using the
fair value recognition provisions of SFAS No. 123.
On December 16, 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets, an Amendment of APB Opinion No. 29, Accounting for
Nonmonetary Transactions." SFAS No. 153 addresses the measurement of exchanges
of nonmonetary assets and redefines the scope of transactions that should be
measured based on the fair value of the assets exchanged. SFAS No. 153 is
effective for nonmonetary asset exchanges beginning in our second quarter of
fiscal 2006. We do not believe our adoption of SFAS No. 153 will have a material
effect on our consolidated financial position, results of operations or cash
flows.
On June 7, 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections," a replacement of APB Opinion No. 20, "Accounting Changes,"
and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements."
SFAS No. 154 changes the requirements for the accounting for and reporting of a
change in accounting principle. Previously, most voluntary changes in accounting
principles required recognition of a cumulative effect adjustment within net
income of the period of the change. SFAS No. 154 requires retrospective
application to prior periods' financial statements, unless it is impracticable
to determine either the period-specific effects or the cumulative effect of the
change. SFAS No. 154 is effective for accounting changes made in fiscal years
beginning after December 15, 2005. However, SFAS No. 154 does not change the
transition provisions of any existing accounting pronouncements. We do not
believe our adoption of SFAS No. 154 will have a material effect on our
consolidated financial position, results of operations or cash flows.
On June 29, 2005, the FASB ratified Emerging Issues Task Force Issue
No. 05-06, "Determining the Amortization Period for Leasehold Improvements."
Issue No. 05-06 provides that the amortization period used for leasehold
improvements acquired in a business combination or purchased after the inception
of a lease shall be the shorter of (a) the useful life of the assets or (b) a
term that includes required lease periods and renewals that are reasonably
assured upon the acquisition or the purchase. The provisions of Issue No. 05-06
are effective on a prospective basis for leasehold improvements purchased or
acquired beginning in our second quarter of fiscal 2006. We do not believe the
adoption of Issue No. 05-06 will have a material effect on our consolidated
financial position, results of operations or cash flows.
56
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Exchange Rate Sensitivity
-------------------------
We have established and acquired international subsidiaries that
prepare their balance sheets in the relevant foreign currency. In order to be
included in our consolidated financial statements, these balance sheets are
converted, at the then current exchange rate, into United States dollars, and
the statements of operations are converted using weighted average exchange rates
for the applicable period. Accordingly, fluctuations of the foreign currencies
relative to the United States dollar affect our consolidated financial
statements. Our exposure to fluctuations in currency exchange rates has
increased as a result of the growth or acquisition of our international
subsidiaries. However, because historically the majority of our currency
exposure has related to financial statement translation rather than to
particular transactions, prior to 2005 we had not entered into forward currency
contracts or hedging arrangements in an effort to mitigate our currency
exposure. For further information regarding our exchange rate sensitivity, see
Item 7 of this report under the heading "Critical Accounting Policies - Foreign
Currency Translation."
Interest Rate Sensitivity
-------------------------
A substantial portion of our notes payable and long-term debt have
variable interest rates based on the prime interest rate and/or the lender's
base rate, which exposes us to risk of earnings loss due to changes in such
interest rates.
We have established and acquired international subsidiaries that
prepare their balance sheets in the relevant foreign currency. In order to be
included in our consolidated financial statements, these balance sheets are
converted, at the then current exchange rate, into United States dollars, and
the statements of operations are converted using weighted average exchange rates
for the applicable period. Accordingly, fluctuations of the foreign currencies
relative to the United States dollar could have an effect on our consolidated
financial statements. Our exposure to fluctuations in currency exchange rates
has increased as a result of the acquisition of Pascall located in England.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended, establishes accounting and reporting standards
requiring that every derivative instrument be recorded in the balance sheet as
either an asset or a liability measured at its fair value. SFAS No. 133 also
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met, and that a company
must formally document, designate and assess the effectiveness of transactions
that receive hedge accounting. We currently use derivatives to manage foreign
currency rate risk.
One of our United Kingdom subsidiaries conducts business in British
pounds sterling and has a program that utilizes forward currency contracts
denominated in United States dollars to offset the risk associated with the
effects of currency exposure for sales in United States dollars. Under this
program, increases or decreases in the subsidiary's foreign currency exposure
are offset by gains or losses on the forward contracts, to mitigate the
possibility of foreign currency transaction gains or losses. These forward
contracts generally have terms of 90 days or less. We do not use these forward
contracts for trading purposes. All outstanding foreign currency forward
contracts used in this program are marked to market at the end of the period
with unrealized gains and losses included in other income and expense.
EMRISE Corporation also utilized a forward currency contract
denominated in British pounds sterling to offset the risk of intercompany loans
to an English subsidiary. Under this program, increases or decreases in the
current portion of intercompany debt due from EEL are offset by gains or losses
on the forward contract, to mitigate the possibility of foreign currency
transaction gains or losses. The forward contract expired in September 2005. We
do not use this forward contract for trading purposes. The forward contract used
in this program was marked to market at the end of the period with unrealized
gains and losses included in other income and expense.
57
Our ultimate realized gain or loss with respect to currency
fluctuations will depend on the currency exchange rates and other factors in
effect as the contracts mature. Net foreign exchange transaction gains included
in other income and expense in the accompanying consolidated statements of
operations totaled $40,000 for 2005. There was no hedging in the year ended
December 31, 2004.
A substantial portion of our notes payable and long-term debt have
variable interest rates based on the prime interest rate and/or the lender's
base rate, which exposes us to risk of earnings loss due to changes in such
interest rates. Our annual report on Form 10-K for the year ended December 31,
2004 contains information about our debt obligations that are sensitive to
changes in interest rates under "Item 7A. Quantitative and Qualitative
Disclosures About Market Risk." There were no material changes in those market
risks during the nine months ended September 30, 2005.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Reference is made to the financial statements included in this report,
which begin at page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
58
ITEM 9A. CONTROLS AND PROCEDURES.
On March 28, 2006, in connection with its audit of our consolidated
financial statements for the year ended December 31, 2005, Grant Thornton LLP,
our independent registered public accounting firm ("GT"), advised our management
and audit committee of two matters that GT considered to be "material
weaknesses" as that term is defined under standards established by the Public
Company Accounting Oversight Board (United States). A material weakness is a
control deficiency or combination of control deficiencies that results in more
than a remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected.
GT indicated that in the area of accounting and financial reporting, it
believes we have insufficient accounting resources to enable us to identify and
evaluate complex accounting and reporting matters. In addition, GT recommended
that we establish procedures to ensure that our Chief Financial Officer can more
closely monitor information submitted to our corporate headquarters by our
subsidiary controllers and oversee accounting for reserves and other areas that
involving significant judgment at all company locations. GT also recommended
that we establish procedures to ensure that personnel familiar with accounting
principles generally accepted in the United States and with Commission
disclosure requirements thoroughly evaluate activities and transactions at all
company locations in order to determine that we are timely making all required
disclosures.
To remediate this material weakness in the area of accounting and
financial reporting, we intend to seek additional guidance from our financial
consultants, who are certified public accountants with the requisite background
and experience to assist us in identifying and evaluating complex accounting and
reporting matters. In addition, we intend to increase the frequency at which our
Chief Financial Officer and our Director of Financial Controls for Europe visit
and hold conference calls with accounting personnel and managers at each of our
company locations. Also, we intend to define internal processes for identifying
and disclosing non-routine and other transactions as required by Commission
disclosure requirements and for researching and determining proper accounting
treatment for those transactions. We plan to assign individuals with appropriate
knowledge and skills to perform these processes and plan to provide those
individuals with adequate technical resources to help ensure timely disclosure
of the transactions and proper application of accounting principles generally
accepted in the United States. We plan to develop procedures to document all
non-routine transactions each quarter, including support for the final
accounting treatment, and require the assigned individuals to review the
documentation with our Chief Financial Officer and/or Director of Financial
Controls for Europe prior to finalizing our quarterly and annual financial
statements.
GT also indicated that we need to improve our controls over inventory
reserves. GT noted that some items that were in our inventory reserve earlier in
2005 were not present in the year-end reserve, although those items remained in
inventory at year end. Current accounting guidance would have required us to
include in our year-end reserve all items that were included in the inventory
reserve earlier in 2005, despite the fact that we no longer viewed those items
as slow moving. Our failure to continue to include those items in the inventory
reserve resulted in a material audit adjustment. In addition, GT determined that
inventory reserves in our CXR-AJ location were understated at year-end,
resulting in an additional audit adjustment. To remediate this material weakness
with regard to our controls over inventory reserves, we will adjust the
procedures we use to compute inventory reserves to ensure that items that are
included in inventory reserves are not removed from inventory reserves until a
sale or disposal of those items occurs.
59
Our Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) have concluded,
based on their evaluation as of December 31, 2005, that the design and operation
of our "disclosure controls and procedures" (as defined in Rule 13a-15(e) under
the Securities Exchange Act of 1934, as amended ("Exchange Act")) were not
effective as of December 31, 2005 with respect to the material weaknesses
identified in the areas of accounting and financial reporting and inventory
reserves to ensure that information required to be disclosed by us in the
reports filed or submitted by us under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Commission's
rules and forms, including to ensure that information required to be disclosed
by us in the reports we file or submit under the Exchange Act is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding whether or
not disclosure is required. However, in light of the material weaknesses
described above, we performed additional analysis and other post-closing
procedures to ensure that our consolidated financial statements included in this
report fairly present, in all material respects, our financial condition,
results of operations and cash flows as of and for the periods presented.
During the quarter ended December 31, 2005, there were no changes in
our "internal controls over financial reporting" (as defined in Rule 13a-15(f)
under the Exchange Act) that materially affected, or are reasonably likely to
materially affect, our internal controls over financial reporting.
ITEM 9B. OTHER INFORMATION.
None.
60
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS AND EXECUTIVE OFFICERS
The names, ages and positions held by our directors and executive
officers as of March 24, 2006 are as follows:
NAME AGE POSITIONS HELD
---- --- --------------
Carmine T. Oliva....................... 63 Chairman of the Board, President, Chief Executive
Officer and Director
Graham Jefferies....................... 48 Executive Vice President, Chief Operating Officer and
Managing Director of various subsidiaries
Randolph D. Foote...................... 57 Senior Vice President, Chief Financial Officer and Secretary
Laurence P. Finnegan, Jr. (1)(2)(3).... 68 Director
Otis W. Baskin (1)(2)(3)............... 60 Director
Richard E. Mahmarian (3)............... 69 Director
-----------
(1) Member of the compensation committee.
(2) Member of the nominating committee.
(3) Member of the audit committee.
CARMINE T. OLIVA has been Chairman of the Board, President and Chief
Executive Officer and a Class III director of EMRISE since March 26, 1997 and of
our subsidiary, EMRISE Electronics, since he founded EMRISE Electronics in 1983.
Mr. Oliva has been Chairman of the Board of XCEL Corporation, Ltd. since 1985,
and Chairman and Chief Executive Officer of CXR Larus since March 1997. In 2002,
Mr. Oliva obtained a French government working permit and assumed responsibility
as President of our CXR-AJ subsidiary. From January 1999 to January 2000, Mr.
Oliva served as a director of Digital Transmission Systems Inc. (DTSX), a
publicly held company based in Norcross, Georgia. From 1980 to 1983, Mr. Oliva
was Senior Vice President and General Manager, ITT Asia Pacific Inc. Prior to
holding that position, Mr. Oliva held a number of executive positions with ITT
Corporation and its subsidiaries over an eleven-year period. Mr. Oliva attained
the rank of Captain in the United States Army and is a veteran of the Vietnam
War. Mr. Oliva earned a B.A. degree in Social Studies/Business from Seton Hall
University and an M.B.A. degree in Business from The Ohio State University.
GRAHAM JEFFERIES was appointed as Executive Vice President on October
21, 1999. Mr. Jefferies was also appointed as our Chief Operating Officer on
January 3, 2005, after having served as Chief Operating Officer of our
Telecommunications Group since October 21, 1999. Mr. Jefferies served as
Executive Vice President of EMRISE from April 1999 through October 1999. Mr.
Jefferies has served CXR-AJ as a director since March 1997 and as General
Manager since July 2002, has served as Managing Director of Belix Power
Conversions Ltd., Belix Wound Components Ltd. and Belix Company Ltd. since our
acquisition of those companies in April 2000, as Managing Director of XCEL Power
Systems, Ltd. since September 1996 and as Managing Director of XCEL Corporation,
Ltd. since March 1992. Prior to joining us in 1992, he was Sales and Marketing
Director of Jasmin Electronics PLC, a major United Kingdom software and systems
provider, from 1987 to 1992. Mr. Jefferies held a variety of project management
positions at GEC Marconi from 1978 to 1987. Mr. Jefferies earned a B.S. degree
in Engineering from Leicester University, and has experience in mergers and
acquisitions. Mr. Jefferies is a citizen and resident of the United Kingdom.
61
RANDOLPH D. FOOTE was appointed as our Senior Vice President and Chief
Financial Officer on October 4, 1999 and as our Assistant Secretary on February
12, 2001. Mr. Foote has been our Secretary since September 2004 and the Vice
President and Chief Financial Officer of CXR Larus and EMRISE Electronics since
March 2000. Mr. Foote was the Corporate Controller of Unit Instruments, Inc., a
publicly traded semiconductor equipment manufacturer, from October 1995 to May
1999. From March 1985 to October 1995, Mr. Foote was the Director of Tax and
Financial Reporting at Optical Radiation Corporation, a publicly traded company
that designed and manufactured products using advanced optical technology. Prior
to 1985, Mr. Foote held positions with Western Gear Corporation and Bucyrus Erie
Company, which were both publicly traded companies. Mr. Foote earned a B.S.
degree in Business Management from California State Polytechnic University,
Pomona and an M.B.A. degree in Tax/Business from Golden Gate University.
LAURENCE P. FINNEGAN, JR. has served as a Class II director since March
26, 1997. In addition to being a director of EMRISE Electronics from 1985 to
March 1997, Mr. Finnegan was EMRISE Electronics' Chief Financial Officer from
1994 to 1997. Mr. Finnegan has held positions with ITT (1970-1974) as controller
of several divisions, Narco Scientific (1974-1983) as Vice President Finance,
Chief Financial Officer, Executive Vice President and Chief Operating Officer,
and Fischer & Porter (1986-1994) as Senior Vice President, Chief Financial
Officer and Treasurer. Since August 1995, he has been a principal of GwynnAllen
Partners, Bethlehem, Pennsylvania, an executive management consulting firm.
Since December 1996, Mr. Finnegan has been a director and the President of GA
Pipe, Inc., a manufacturing company based in Langhorne, Pennsylvania. From
September 1997 to January 2001, Mr. Finnegan served as Vice President Finance
and Chief Financial Officer of QuestOne Decision Sciences, an efficiency
consulting firm based in Pennsylvania. Since August 2001, Mr. Finnegan has
served as a director and the Vice President and Chief Financial Officer of
VerdaSee Solutions, Inc., a consulting and software company based in
Pennsylvania. Mr. Finnegan earned a B.S. degree in Accounting from St. Joseph's
University.
OTIS W. BASKIN has served as a Class I director since February 6, 2004.
He has been a Professor of Management at The George L. Graziadio School of
Business and Management at Pepperdine University in Malibu, California since
June 1995 and also served as dean from 1995 to 2001. He has been a member of the
full-time faculty of the University of Houston - Clear Lake (1975-87) where he
served as Coordinator of the Management Faculty and Director of the Center for
Advanced Management Programs. He has also been Professor of Management at
Arizona State University, West Campus (1987-91) and The University of Memphis
(1991-95), in addition to serving as dean at both universities. Dr. Baskin
worked with AACSB International (Association for the Advancement of Collegiate
Schools of Business) as Special Advisor to the President and as Chief Executive
Officer from July 2002 to June 2004. He is an Associate with the Family Business
Consulting Group, where he advises family owned and closely held businesses. He
has served as an advisor to Exxon/Mobile Research and Engineering Corporation,
NASA and the United States Air Force. He earned a Ph.D. in Management, Public
Relations and Communication Theory from The University of Texas at Austin, an
M.A. degree in Speech Communication by the University of Houston, and a B.A.
degree in Religion from Oklahoma Christian University.
RICHARD E. MAHMARIAN was appointed as a Class III director on March 1,
2006. He has served as a principal and Chairman, President and Chief Executive
Officer of Control Solutions, Inc., a company that specializes in providing
business systems including hardware, software, consumable products and services
to major U.S. corporations, since December 2003. Mr. Mahmarian also has served
as managing member and Chairman and Chief Executive Officer of REM Associates,
LLC, a private investment and consulting company, since 1997. Mr. Mahmarian also
owns R&R Palos Verdes Enterprises, Inc., a home construction company in the
south bay area of Los Angeles, California, which was started in 1997. From 1998
until 2001, Mr. Mahmarian was the owner of Alpha Microsystems, LLC, a company
that manufactured and sold mini-computer systems, personal computers and
servers, provided network services and support, and information technology
hardware and software services throughout North America through 50 field
offices. He served in the U.S. Navy and was honorably discharged. While in the
Navy, he received extensive training in advanced electronic technologies. Mr.
Mahmarian earned a B.A. degree in Accounting from Upsala College and an M.B.A.
in Marketing and Economics from Seton Hall University.
62
Our business, property and affairs are managed under the direction of
our board. Directors are kept informed of our business through discussions with
our executive officers, by reviewing materials provided to them and by
participating in meetings of our board and its committees.
Our bylaws provide that our board of directors shall consist of at
least four directors. Our board is divided into three classes of directors:
Class I, Class II and Class III. The term of office of each class of directors
is three years, with one class expiring each year at our annual meeting of
stockholders. We currently have four directors on our board, with no vacancies.
Our current board consists of one Class I director whose term expires at our
2006 annual meeting, one Class II director whose term expires at our 2007 annual
meeting, and two Class III directors whose term expires at our 2008 annual
meeting.
Our officers are appointed by and serve at the discretion of our board
of directors. There are no family relationships among our executive officers and
directors.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended
("Exchange Act"), requires our executive officers and directors, and persons who
beneficially own more than 10% of a registered class of our common stock, to
file initial reports of ownership and reports of changes in ownership with the
Commission. These officers, directors and stockholders are required by the
Commission regulations to furnish us with copies of all reports that they file.
Based solely upon a review of copies of the reports furnished to us
during the year ended December 31, 2005 and thereafter, or any written
representations received by us from directors, officers and beneficial owners of
more than 10% of our common stock ("reporting persons") that no other reports
were required, we believe that, during 2005, all Section 16(a) filing
requirements applicable to our reporting persons were met.
CODE OF ETHICS
Our board of directors has adopted an Amended and Restated Code of
Business Conduct and Ethics that applies to all of our directors, officers and
employees and an additional Code of Business Ethics that applies to our Chief
Executive Officer and senior financial officers. We filed copies of these codes
as exhibits to this annual report on Form 10-K for the year ended December 31,
2005.
We intend to satisfy the disclosure requirement under Item 5.05 of Form
8-K relating to amendments to or waivers from provision of these codes that
relate to one or more of the items set forth in Item 406(b) of Regulation S-K,
by describing on our Internet website, located at http://www.emrise.com, within
four business days following the date of a waiver or a substantive amendment,
the date of the waiver or amendment, the nature of the amendment or waiver, and
the name of the person to whom the waiver was granted.
Information on our Internet website is not, and shall not be deemed to
be, a part of this report or incorporated into any other filings we make with
the Commission.
63
ITEM 11. EXECUTIVE COMPENSATION.
COMPENSATION OF EXECUTIVE OFFICERS
The following table provides information concerning the annual and
long-term compensation for the years ended December 31, 2005, 2004 and 2003
earned for services in all capacities as an employee by our Chief Executive
Officer and each of our other executive officers who received an annual salary
and bonus of more than $100,000 for services rendered to us during 2004
(collectively, the "named executive officers"):
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION AWARD
ANNUAL COMPENSATION ------------------
------------------- SECURITIES ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS UNDERLYING OPTIONS COMPENSATION
--------------------------- ---- ------ ----- ------------------ ------------
Carmine T. Oliva ........................ 2005 $ 350,000 $ -- 50,000 $ 4,821(1)
President and Chief Executive Officer 2004 $ 309,000 $ 94,000 26,000 $ 4,821(1)
2003 $ 271,510 $ 70,000 53,000 $ 4,821(1)
Graham Jefferies ........................ 2005 $ 245,769 $ -- 50,000 $ 14,037(3)
Executive Vice President and Chief 2004 $ 237,017 $ 71,000 40,000 $ 10,924(3)
Operating Officer (2) 2003 $ 210,295 $ 55,000 54,000 $ 10,320(3)
Randolph D. Foote........................ 2005 $ 170,920 $ -- 50,000 $ 2,117(4)
Senior Vice President, Chief Financial 2004 $ 173,867 $ 40,000 25,000 $ 1,965(4)
Officer and Assistant Secretary(4) 2003 $ 157,230 $ 30,000 35,000 $ 1,886(4)
---------------
(1) Represents the dollar value of insurance premiums we paid with respect to a
$1,000,000 term life insurance policy for the benefit of Mr. Oliva's
spouse.
(2) Mr. Jefferies is based in the United Kingdom and receives his remuneration
in British pounds sterling. The compensation amounts listed for Mr.
Jefferies are shown in United States dollars, converted from British pounds
sterling using the average conversion rates in effect during the time
periods of compensation. Mr. Jefferies served as Chief Operating Officer of
our Telecommunications Group until he was appointed Chief Operating Officer
of EMRISE in January 2005.
(3) Represents company contributions to Mr. Jefferies' retirement account.
(4) Represents company contributions to Mr. Foote's 401(k) retirement account.
RETIREMENT ACCOUNT MATCHING CONTRIBUTIONS
We match up to the lesser of $2,000 and 20% of Mr. Foote's
contributions to his 401(k) account. During 2005, 2004 and 2003, our matching
contributions amounted to $2,117, $1,965 and $1,886, respectively. This matching
arrangement was generally made available to all employees of EMRISE and provides
for the same method of allocation of benefits between management and
non-management participants.
Also, XPS makes matching contributions of up to 6% of Mr. Jefferies'
salary to an executives' defined contribution plan. Other employees of XPS may
receive matching contributions to a defined contribution plan of up to 4% of
their salary. Amounts contributed to the defined contribution plans are intended
to used to purchase annuities upon retirement. During 2005, 2004 and 2003, Mr.
Jefferies received matching contributions of $14,037, $10,924 and $10,320,
respectively.
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OPTION GRANTS IN LAST FISCAL YEAR
The following table provides information regarding options granted in
the year ended December 31, 2005 to the executive officers named in the summary
compensation table. We did not grant any stock appreciation rights during 2005.
This information includes hypothetical potential gains from stock options
granted in 2005. These hypothetical gains are based entirely on assumed annual
growth rates of 5% and 10% in the value of our common stock price over the
ten-year life of the stock options granted in 2005. These assumed rates of
growth were selected by the Commission for illustrative purposes only and are
not intended to predict future stock prices, which will depend upon market
conditions and our future performance and prospects.
POTENTIAL
REALIZABLE VALUE
AT ASSUMED RATES
NUMBER OF PERCENTAGE OF OF STOCK PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM(3)
GRANT OPTIONS EMPLOYEES IN PRICE EXPIRATION ---------------------
NAMED OFFICER DATE GRANTED(1) FISCAL YEAR(2) PER SHARE DATE 5% 10%
----------------------- --------- ---------- -------------- ---------- ----------- --------- ---------
Carmine T. Oliva....... 12/30/05 50,000 0.7% $2.00 12/29/15 $63,000 $159,000
Graham Jefferies....... 12/30/05 50,000 0.7% $2.00 12/29/15 $63,000 $159,000
Randolph D. Foote...... 12/30/05 50,000 0.7% $2.00 12/29/15 $63,000 $159,000
-------------------------
(1) Options vested on the date of grant.
(2) Based on options to purchase 725,000 shares granted to our employees during
2005.
(3) Calculated using the potential realizable value of each grant.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
The following table provides information regarding the value of
unexercised options held by the named executive officers as of December 31,
2005. None of the named executives officers acquired shares through the exercise
of options during 2005.
NUMBER OF
SECURITIES UNDERLYING VALUE ($) OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
DECEMBER 31, 2005 DECEMBER 31, 2005 (1)
--------------------------------- -------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
--------------------------------- ----------- ------------- ----------- -------------
Carmine T. Oliva................... 216,000 13,000 141,000 4,000
Graham Jefferies................... 214,000 20,000 135,000 7,000
Randolph D. Foote.................. 147,500 12,500 96,000 4,000
--------------
(1) Based on the last reported sale price of our common stock of $1.34 on
December 30, 2005 (the last trading day during 2005) as reported on ArcaEx,
less the exercise price of the options.
65
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
CARMINE T. OLIVA
On February 24, 2006, we executed a five-year employment agreement with
Carmine T. Oliva, our Chairman of the Board, President and Chief Executive
Officer. The agreement is effective as of January 1, 2006, and replaces his
previous employment agreement that was scheduled to automatically renew on that
date. The agreement provides for an initial base salary of $350,000 during the
first twelve months the agreement is in effect. Mr. Oliva is eligible to receive
increases and bonuses at the discretion of our compensation committee and to
participate in benefit and incentive programs we may offer.
If we terminate Mr. Oliva's employment for due cause or due to Mr.
Oliva's breach of the agreement by refusing to continue his employment, our
obligation to pay any further compensation, severance allowance, or other
amounts payable under the agreement terminates on the date of termination, other
than benefits under retirement and benefit plans and programs that are earned
and vested by the date of termination, pro rata annual salary through the date
of termination, any stock options that have vested as of the date of
termination, and accrued vacation as required by California law. "Due cause"
includes any intentional misapplication of our funds or other material assets,
or any other act of dishonesty injurious to us, or conviction of a felony or a
crime involving moral turpitude. "Due cause" also includes abuse of controlled
substances or alcohol and breach, nonperformance or nonobservance of any of the
terms of the agreement, provided that Mr. Oliva fails to satisfactorily remedy
the performance problem following 90 days' written notice.
We may terminate Mr. Oliva's employment immediately upon written notice
to him. Mr. Oliva may terminate the agreement at any time for good reason within
30 days after he learns of the event or condition constituting good reason.
"Good reason" includes: changes in Mr. Oliva's position, duties,
responsibilities, titles or status; a reduction in his base salary to an amount
less than the greater of $350,000 or 10% below the base salary in effect at the
time of the reduction; our failure to continue in effect benefits required under
the agreement, to obtain the assumption of the agreement by any successor or
assign, or to timely cure any material breach after Mr. Oliva gives us written
notice; a material reduction in support services, staff, office space and
accouterments which reduction is not generally effective for all officers; or if
we avail ourselves of or are subjected by any third party to any other
proceeding involving insolvency or the protection of or from creditors and the
proceeding is not discharged or terminated within 90 days.
If Mr. Oliva's service terminates without due cause or for good reason
prior to the expiration of the agreement on January 1, 2011, Mr. Oliva will be
entitled to his salary through the end of the month in which termination occurs
plus credit for accrued vacation, a severance payment equal to three times his
then current annual salary, net of taxes, a prorated incentive bonus, if any,
for the fiscal year during which termination occurs, and all medical and life
insurance benefits to which he was entitled immediately prior to the date of
termination (or at the election of Mr. Oliva in the event of a change in
control, immediately prior to the date of the change in control) for a period of
three years or the date or dates that Mr. Oliva's continued participation in our
medical and/or life insurance plans is not possible under the plans, whichever
is earlier. If our medical and/or life insurance plans do not allow Mr. Oliva's
continued participation, then we are required to pay to Mr. Oliva, in monthly
installments, the monthly premium or premiums that had been payable by us
covering the three-year period.
66
A "change in control" includes: a consolidation or merger in which we
are not the surviving corporation or pursuant to which all or substantially all
of our common stock would be converted into cash, securities or other property,
other than a merger in which the holders of our common stock immediately prior
to the merger have the same proportionate ownership of common stock of the
surviving corporation immediately after the merger; a sale, lease, exchange or
other transfer (in one transaction or a series of related transactions) of all,
or substantially all, of our assets; stockholder approval of any plan or
proposal for liquidation or dissolution; any person other than persons who were
stockholders on January 1, 2006, becomes the beneficial owner of 50% or more of
our outstanding common stock; during any period of two consecutive years,
individuals who at the beginning of such period constitute the entire board
cease to constitute a majority of the board unless the election, or the
nomination for election by our stockholders, of each new director was approved
by a vote of at least two-thirds of the directors then still in office who were
directors at the beginning of the period; or there is any change of control of a
nature required to be reported in response to Item 6 (e) of Schedule 14A under
the Exchange Act.
If Mr. Oliva becomes mentally or physically incapable of performing the
services required under the agreement for a period of 240 consecutive days, and
the incapacity is confirmed by the written opinion of two practicing medical
doctors, we may terminate Mr. Oliva's employment under the agreement upon 30
days' prior written notice. Upon Mr. Oliva's death, the agreement will terminate
immediately. If Mr. Oliva's employment is terminated due to his incapacity or
death, Mr. Oliva or his estate or legal representative will be entitled to
receive benefits under our retirement and benefits plans and programs that are
earned and vested at the date of termination, a prorated incentive bonus for the
fiscal year in which incapacity or death occurs, and Mr. Oliva's annual salary
then in effect for one year following the date of termination, offset, however,
by any payments received by Mr. Oliva as a result of any disability insurance
maintained by us for Mr. Oliva's benefit.
The agreement contains non-competition provisions that prohibit Mr.
Oliva from engaging or participating in a competitive business or soliciting our
customer or employees during his employment with us and for two years afterward.
The agreement also contains provisions that restrict disclosure by Mr. Oliva of
our confidential information and assign ownership to us of inventions created by
him in connection with his employment.
RANDOLPH D. FOOTE
On February 24, 2006, we entered into a two-year employment agreement
with Randolph D. Foote, our Senior Vice President, Chief Financial Officer and
Secretary. The agreement is effective as of January 1, 2006 and replaced his
existing employment agreement that was scheduled to expire in July 2006. The
agreement provides for an initial base salary of $175,000 during the first
twelve months the agreement is in effect. Mr. Foote is eligible to receive
increases and bonuses at the discretion of our compensation committee and to
participate in other benefit and incentive programs we may offer.
If Mr. Foote's employment terminates for due cause or due to Mr.
Foote's breach of the agreement by refusing to continue his employment, our
obligation to pay any further compensation, severance allowance, or other
amounts payable under the agreement terminates on the date of termination, other
than benefits under retirement and benefit plans and programs that are earned
and vested by the date of termination, pro rata annual salary through the date
of termination, any stock options that have vested as of the date of
termination, and accrued vacation as required by California law.
67
We may terminate Mr. Foote's employment immediately upon written notice
to him. Mr. Foote may terminate the agreement at any time for good reason within
30 days after Mr. Foote learns of the event or condition constituting good
reason. If Mr. Foote's service terminates without cause or for good reason prior
to the expiration of the agreement on January 1, 2008, Mr. Foote will be
entitled to his salary through the end of the month in which termination occurs
plus credit for accrued vacation, a severance payment equal to one and one-half
times his then current annual salary, net of taxes, a prorated incentive bonus,
if any, for the fiscal year during which termination occurs, and all medical and
life insurance benefits to which he was entitled immediately prior to the date
of termination (or at the election of Mr. Foote in the event of a change in
control, immediately prior to the date of the change in control) for a period of
18 months or the date or dates that Mr. Foote's continued participation in our
medical and/or life insurance plans is not possible under the plans, whichever
is earlier. If our medical and/or life insurance plans do not allow Mr. Foote's
continued participation, then we will pay to Mr. Foote, in monthly installments,
the monthly premium or premiums that had been payable by us covering the
18-month period.
If Mr. Foote becomes mentally or physically incapable of performing the
services required under the agreement for a period of 180 consecutive days, and
the incapacity is confirmed by the written opinion of two practicing medical
doctors, we may terminate Mr. Foote's employment under the agreement upon 30
days' prior written notice. Upon Mr. Foote's death, the agreement will terminate
immediately. If Mr. Foote's employment is terminated due to his incapacity or
death, Mr. Foote or his estate or legal representative will be entitled to
receive benefits under our retirement and benefits plans and programs that are
earned and vested at the date of termination, a prorated incentive bonus for the
fiscal year in which incapacity or death occurs, and Mr. Foote's annual salary
then in effect for one year following the date of termination, offset by any
payments received by Mr. Foote as a result of any disability insurance
maintained by us for Mr. Foote's benefit.
The agreement contains non-competition provisions that prohibit Mr.
Foote from engaging or participating in a competitive business or soliciting our
customer or employees during his employment with us and for two years afterward.
The agreement also contains provisions that restrict disclosure by Mr. Foote of
our confidential information and assign ownership to us of inventions created by
Mr. Foote in connection with his employment.
The terms "due cause," "good reason" and "change in control" have the
same meanings as in Mr. Oliva's employment agreement described above.
GRAHAM JEFFERIES
On February 24, 2006, we entered into a three-year employment agreement
with Graham Jefferies, our Executive Vice President and Chief Operating Officer.
The agreement is effective as of January 1, 2006, and replaces his previous
employment agreement that was scheduled to expire in July 2006. The agreement
provides for an initial base salary of 152,800 British pounds sterling per year
(approximately U.S. $263,350 as of January 1, 2006) during the first twelve
months that the agreement is in effect, which amount is to be paid by our
subsidiary, EMRISE Electronics, Ltd. Mr. Jefferies is eligible to receive
increases and bonuses at the discretion of our compensation committee and to
participate in other benefit and incentive programs we may offer.
If Mr. Jefferies' employment terminates for due cause or due to Mr.
Jefferies' breach of the agreement by refusing to continue his employment, our
obligation to pay any further compensation, severance allowance, or other
amounts payable under the agreement terminates on the date of termination, other
than benefits under retirement and benefit plans and programs that are earned
and vested by the date of termination, Mr. Jefferies' pro rata annual salary
through the date of termination, any stock options that have vested as of the
date of termination, and accrued vacation as required by applicable law.
68
We may terminate Mr. Jefferies' employment immediately upon written
notice. Mr. Jefferies may terminate the agreement at any time for good reason
within 30 days after Mr. Jefferies learns of the event or condition constituting
good reason. If termination without due cause by us or for good reason by Mr.
Jefferies occurs prior to the expiration of the agreement on January 1, 2009,
Mr. Jefferies will be entitled to his salary through the end of the month during
which the termination occurs plus credit for accrued vacation, a severance
payment in an amount equal to two times his then current annual salary, net of
applicable taxes, a prorated incentive bonus, if any, for the fiscal year during
which termination occurs, and all medical and life insurance benefits to which
Mr. Jefferies was entitled immediately prior to the date of termination (or at
the election of Mr. Jefferies in the event of a change in control, immediately
prior to the date of the change in control) for a period of two years or the
date or dates that Mr. Jefferies' continued participation in our medical and/or
life insurance plans is not possible under the plans, whichever is earlier. If
our medical and/or life insurance plans do not allow Mr. Jefferies' continued
participation, then we will be obligated to pay to Mr. Jefferies, in monthly
installments, the monthly premium or premiums that had been payable by us
covering the two-year period.
If Mr. Jefferies becomes mentally or physically incapable of performing
the services required under the agreement for a period of 180 consecutive days,
the agreement will terminate; provided, however, that Mr. Jefferies will remain
an employee of EMRISE Electronics, Ltd. and will be entitled to remuneration in
an amount equal to the amount paid under EMRISE Electronics, Ltd.'s permanent
health scheme, subject to the paragraph immediately below. Upon Mr. Jefferies'
death, the agreement will terminate immediately.
If Mr. Jefferies' employment is terminated due to his incapacity or
death, Mr. Jefferies or his estate or legal representative will be entitled to
receive benefits under retirement and benefits plans and programs that are
earned and vested at the date of termination, a prorated incentive bonus for the
fiscal year in which incapacity or death occurs, and Mr. Jefferies' annual
salary then in effect for one year following the date of termination, offset by
any payments received by Mr. Jefferies as a result of any permanent insurance
scheme maintained by us for Mr. Jefferies' benefit.
The agreement contains non-competition provisions that prohibit Mr.
Jefferies from engaging or participating in a competitive business or soliciting
our customer or employees during his employment with us and for two years
afterward. The agreement also contains provisions that restrict disclosure by
Mr. Jefferies of our confidential information and assign ownership to us of
inventions created by Mr. Jefferies in connection with his employment.
The terms "due cause," "good reason" and "change in control" have the
same meanings as in Mr. Oliva's employment agreement described above.
BOARD COMMITTEES
Our board of directors currently has an audit committee, a compensation
committee and a nominating committee.
The audit committee selects our independent auditors, reviews the
results and scope of the audit and other services provided by our independent
auditors, reviews our financial statements for each interim period and for our
year end and our internal financial and accounting controls, and recommends,
establishes and monitors our disclosure controls and procedures. From March 22,
2004 to May 24, 2005, the audit committee consisted of Messrs. Finnegan and
Baskin. From May 25, 2005 until December 21, 2005, the audit committee consisted
of Messrs. Finnegan, Baskin and Runyon. Following Mr. Runyon's departure from
our board of directors on December 21, 2005, the audit committee consisted of
Messrs. Finnegan and Baskin, with Mr. Finnegan continuing as chairman. Mr.
Mahmarian was appointed as the third member of the audit committee when he
joined our board on March 1, 2006. The audit committee held four meetings during
2005. Our board of directors has determined that Messrs. Finnegan and Mahmarian
are audit committee financial experts. The audit committee operates pursuant to
a charter approved by our board of directors and audit committee, according to
the rules and regulations of the Commission. A copy of the charter was attached
as Appendix A to our definitive proxy statement for our 2005 annual meeting of
stockholders.
69
The compensation committee is responsible for establishing and
administering our policies involving the compensation of all of our executive
officers and establishing and recommending to our board of directors the terms
and conditions of all employee and consultant compensation and benefit plans.
Our entire board of directors also may perform these functions with respect to
our employee stock option plans. From January 1, 2005 until December 21, 2005,
this committee consisted of Messrs. Runyon and Finnegan. Since December 21,
2005, the committee has consisted of Messrs. Finnegan and Mr. Baskin, with Mr.
Baskin serving as chairman. The compensation committee held two meetings and
took action by written consent on one occasion during 2005. The compensation
committee operates pursuant to a charter approved by our board of directors and
compensation committee. A copy of the charter was attached as Appendix B to the
proxy statement for our 2005 annual meeting of stockholders.
The nominating committee recommends nominees to the board of directors
and committees of the board of directors, develops and recommends to the board
of directors corporate governance principles, and oversees the evaluation of the
board of directors and management. From January 1, 2005 until December 21, 2005,
the nominating committee consisted of Mr. Runyon. Since December 21, 2005, the
nominating committee has consisted of Mr. Finnegan and Mr. Baskin, with Mr.
Finnegan serving as chairman. The nominating committee held two meetings and
took action by written consent on one occasion during 2005. The nominating
committee utilizes a variety of methods for identifying and evaluating nominees
for director, including candidates that may be referred by stockholders.
The nominating committee will consider candidates for director
recommended by any stockholder that is the beneficial owner of shares
representing more than 1.0% of the then-outstanding shares of our common stock
and that has beneficially owned those shares for at least one year. The
nominating committee will evaluate those recommendations by applying its regular
nominee criteria and considering the additional information described in the
nominating committee's below-referenced charter. Stockholders that desire to
recommend candidates for the board for evaluation may do so by contacting EMRISE
in writing, identifying the potential candidate and providing background and
other information in the manner described in the nominating committee's charter.
Candidates may also come to the attention of the nominating committee through
current board members, professional search firms and other persons. In
evaluating potential candidates, the nominating committee will take into account
a number of factors, including, among others, the following:
o independence from management;
o depth of understanding of technology, manufacturing, sales and
marketing, finance and/or other elements directly relevant to the
technology and business of our company;
o education and professional background;
o judgment, skill, integrity and reputation;
o existing commitments to other businesses as a director, executive
or owner;
o personal conflicts of interest, if any; and
o the size and composition of the board of directors
In addition, prior to nominating a sitting director for re-election at
an annual meeting of stockholders, the nominating committee considers the
director's past attendance at, and participation in, meetings of the board of
directors and its committees and the director's formal and informal
contributions to their respective activities.
70
The nominating committee operates pursuant to a charter approved by our
board of directors and nominating committee. A copy of the charter was attached
as Appendix C to the definitive proxy statement for our 2005 annual meeting of
stockholders.
Our board of directors has determined that each of Messrs. Baskin,
Finnegan and Mahmarian is independent under Rule 5.3(k) of the Pacific Exchange
because none of those directors has, or during the past three years has had, a
material relationship with us, either directly or as a partner, stockholder or
officer of an organization that has a relationship with us, and none of those
directors is disqualified from being deemed independent under any of
subparagraphs (A)-(F) of Rule 5.3(k)(1) of the Pacific Exchange. Our board of
directors has also determined that each of member of the audit committee is
independent under Rule 5.3(k)(5)(A)(i) of the Pacific Exchange and Rule
10A-3(b)(1) of the Commission.
Under the rules of the Pacific Exchange, the independent members of our
board of directors must meet at regularly scheduled executive sessions without
management, with an independent director presiding over each executive session.
A presiding director for each session is to be selected by the board members in
attendance at the session based upon the topics to be discussed at the session.
COMPENSATION OF DIRECTORS
Each non-employee director is entitled to receive $1,000 per month as
compensation for his services. In addition, each board member chairing a
standing committee is entitled to receive $500 per month as compensation for his
services. We reimburse all directors for out-of-pocket expenses incurred in
connection with attendance at board and committee meetings. We may periodically
award options or warrants to our directors under our existing option and
incentive plans. On December 30, 2005, we granted to each of Messrs. Baskin and
Finnegan a fully-vested ten-year option to purchase up to 35,000 shares of our
common stock at an exercise price of $2.00 per share.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
From January 1, 2005 until December 21, 2005, the compensation
committee consisted of Messrs. Runyon and Finnegan. Since December 21, 2005, the
committee has consisted of Messrs. Finnegan and Mr. Baskin. No member of the
board of directors has a relationship that would constitute an interlocking
relationship with executive officers and directors of another entity.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
BENEFICIAL OWNERSHIP TABLE
Except as otherwise indicated in the related footnotes, the following
table sets forth information with respect to the beneficial ownership of our
common stock as of April 4, 2006, by:
o each person known by us to beneficially own more than 5% of the
outstanding shares of our common stock;
o each of our directors;
o each of the executive officers named in the summary compensation
table contained in the "Management" section of this report; and
o all of our directors and executive officers as a group.
71
Beneficial ownership is determined in accordance with the rules of the
Commission, and includes voting or investment power with respect to the
securities. To our knowledge, except as indicated by footnote, and subject to
community property laws where applicable, the persons named in the table below
have sole voting and investment power with respect to all shares of common stock
shown as beneficially owned by them. Except as indicated in the discussion of
contractual beneficial ownership limitations below and except as indicated in
the footnotes to the principal stockholders table below, shares of common stock
underlying derivative securities, if any, that currently are exercisable or
convertible or are scheduled to become exercisable or convertible for or into
shares of common stock within 60 days after the date of the table are deemed to
be outstanding in calculating the percentage ownership of each listed person or
group but are not deemed to be outstanding as to any other person or group.
Percentage of beneficial ownership is based on 38,081,750 shares of common stock
outstanding as of the date of the table.
The warrants described in the footnotes to the table contain provisions
limiting the exercise of the warrants to the extent necessary to insure that
following the exercise, the total number of shares of common stock then
beneficially owned by the warrant holder and its affiliates and others whose
beneficial ownership would be aggregated with the holder's for purposes of
Section 13(d) of the Exchange Act does not exceed 9.999% of the total number of
then issued and outstanding shares of our common stock (including for such
purpose the shares of common stock issuable upon such exercise or call). The
9.999% beneficial ownership limitation may not be waived. However, the
beneficial ownership limitation does not preclude a holder from exercising a
warrant and selling the shares underlying the warrant in stages over time where
each stage does not cause the holder and its affiliates to beneficially own
shares in excess of the limitation amount.
The address of each of the following stockholders, unless otherwise
indicated in the footnotes to the table, is c/o EMRISE Corporation, 9485 Haven
Avenue, Suite 100, Rancho Cucamonga, California 91730. Messrs. Oliva, Finnegan,
Baskin, and Mahmarian are directors of EMRISE. Messrs. Oliva, Jefferies and
Foote are executive officers of EMRISE.
AMOUNT AND NATURE PERCENT
NAME OF BENEFICIAL OWNER OF BENEFICIAL OWNERSHIP OF CLASS
------------------------ ----------------------- --------
Carmine T. Oliva............................................... 1,383,305(1) 3.61%
Laurence P. Finnegan, Jr....................................... 260,171(2) *
Otis W. Baskin................................................. 85,000(3) *
Richard E. Mahmarian........................................... -- --
Graham T. Jefferies............................................ 237,276(4) *
Randolph D. Foote.............................................. 165,000(5) *
JLF Asset Management, LLC and Jeffrey L. Feinberg.............. 2,540,714(6) 6.55%
Jon D. Gruber.................................................. 2,387,650(7) 6.21%
All executive officers and directors as a group (6 persons).... 2,130,752(8) 5.49%
-------------------
* Less than 1.00%
(1) Includes 81,889 shares held individually by Mr. Oliva's spouse, and
229,000 shares underlying options.
(2) Includes 216,000 shares underlying options.
(3) Represents shares underlying options.
(4) Includes 234,000 shares underlying options.
(5) Includes 160,000 shares underlying options.
(6) Based on share beneficial ownership information provided to us as of
February 8, 2006 and includes an aggregate of 700,000 shares underlying
warrants held by JLF Offshore Fund, Ltd., JLF Partners I, L.P. and JLF
Partners II, L.P. Power to vote or dispose of the shares is held by
Jeffrey L. Feinberg, as managing member of JLF Asset Management, LLC,
which entity is investment manager of the three entities named in this
footnote. The address for Mr. Feinberg is c/o JLF Asset Management, LLC,
2775 Via de la Valle, Suite 204, Del Mar, CA 92014.
72
(7) Based on share beneficial ownership information contained in a Schedule
13G filed February 3, 2006, in which Mr. Gruber reported that he is a
member of a group that includes Gruber and McBaine Capital Management,
LLC, Jon D. Gruber, J. Patterson McBaine and Eric B. Swergold, each of
whom shares voting and dispositive power over 1,764,900 outstanding shares
and 337,500 shares underlying warrants. Also includes an additional
285,250 shares over which Mr. Gruber reports sole voting and dispositive
power. The address for Mr. Gruber is 50 Osgood Place, Penthouse, San
Francisco, California 94133.
(8) Includes 924,000 shares underlying options and 81,889 outstanding shares
held individually by Mr. Oliva's wife.
EQUITY COMPENSATION PLAN INFORMATION
The following table gives information about our common stock that may
be issued upon the exercise of options, warrants and rights under all of our
existing equity compensation plans as of December 31, 2005.
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE EQUITY COMPENSATION
BE ISSUED UPON EXERCISE EXERCISE PRICE OF PLANS (EXCLUDING
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, SECURITIES REFLECTED IN
Plan category WARRANTS AND RIGHTS WARRANTS AND RIGHTS COLUMN (a))
---------------------------------- ----------------------- --------------------- -----------------------
(a) (b) (c)
Equity compensation plans approved
by security holders 2,107,748(1) $1.05 368,302(2)
Equity compensation plans not
approved by security holders 4,486,685(3) $1.63 --
-------------- ------------- ----------
Total 6,594,433 368,302
-----------
(1) Represents shares of common stock underlying options that are
outstanding under our 1993 Stock Option Plan, our Employee Stock and
Stock Option Plan, our 1997 Stock Incentive Plan and our Amended and
Restated 2000 Stock Option Plan. The material features of these plans
are described in note 9 to our consolidated financial statements for
the years ended December 31, 2005, 2004 and 2003.
(2) Represents shares of common stock available for issuance under options
that may be issued under our Amended and Restated 2000 Stock Option
Plan.
(3) Represents shares of common stock underlying warrants that are
described in note 9 to our consolidated financial statements for the
years ended December 31, 2005, 2004 and 2003.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
We are or have been a party to employment and compensation arrangements
with related parties, as more particularly described above under the headings
"Compensation of Executive Officers," "Employment Contracts and Termination of
Employment and Change-in-Control Arrangements" and "Compensation of Directors."
We have entered into an indemnification agreement with each of our
directors and executive officers. The indemnification agreements and our
certificate of incorporation and bylaws require us to indemnify our directors
and officers to the fullest extent permitted by Delaware law.
73
On January 5, 2005, we issued to 17 accredited record holders in a
private offering an aggregate of 12,503,500 shares of our common stock at a
purchase price of $1.44 per share and five-year investor warrants to purchase up
to an additional 3,125,875 shares of our common stock at an exercise price of
$1.73 per share. Each of The Pinnacle Fund, L.P., JLF Offshore Fund, Ltd., JLF
Asset Management, LLC (which entity is investment manager of four of the
investors, including JLF Offshore Fund, Ltd.) and Jeffrey L. Feinberg (the
managing member of JLF Asset Management, LLC), became a beneficial owner of more
than 5% of our outstanding common stock at the closing of the offering.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The following table sets forth the aggregate fees billed to us by Grant
Thornton LLP for professional services rendered for the years ended December 31,
2005 and 2004:
Fee Category 2005 2004
------------ ------------- -------------
Audit Fees $ 642,000 $ 449,000
Audit-Related Fees 26,000 4,000
Tax Fees 114,000 106,000
All Other Fees -- --
------------- -------------
Total $ 782,000 $ 559,000
AUDIT FEES. Consists of fees billed for professional services rendered
for the audit of our consolidated financial statements and review of the interim
consolidated financial statements included in quarterly reports and services
that are normally provided by Grant Thornton LLP in connection with statutory
and regulatory filings or engagements. Audit fees increased due to the audit
work required to provide assurance on the Pascall and RO financial statements,
to expand audit work required on internal controls, and the higher value of the
British pounds sterling and the euro when those expenses are converted to United
States dollars for this report in 2005 as compared to 2004.
AUDIT-RELATED FEES. Audit-related fees during 2005 relate to due
diligence procedures in connection with the Pascall acquisition. Audit-related
fees during 2004 relate to due diligence procedures in connection with the Larus
Corporation acquisition.
TAX FEES. Consists of fees billed for professional services for tax
compliance, tax advice and tax planning. These services include assistance
regarding federal, state and international tax compliance, tax audit defense,
customs and duties, mergers and acquisitions, and international tax planning.
ALL OTHER FEES. Consists of fees for products and services other than
the services reported above. In 2005 and 2004, no such other fees were incurred.
Our audit committee pre-approves all services provided by Grant
Thornton LLP.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a)(1), (a)(2) and (c) Financial Statements and Financial Statement Schedules
------------------------------------------------------
Reference is made to the financial statements and financial statement
schedule listed on and attached following the Index to Financial Statements and
Financial Statement Schedule contained at page F-1 of this report.
(a)(3) and (b) Exhibits
--------
Reference is made to the exhibits listed on the Index to Exhibits that
follows the financial statements and financial statement schedule.
74
EMRISE CORPORATION AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Page
----
Financial Statements
--------------------
Report of Independent Registered Public Accounting Firm.................... F-2
Consolidated Balance Sheets as of December 31, 2005 and 2004............... F-3
Consolidated Statements of Operations for the Years Ended
December 31, 2005, 2004 and 2003......................................... F-4
Consolidated Statements of Comprehensive Income (Loss) for the
Years Ended December 31, 2005, 2004 and 2003............................. F-5
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 2005, 2004 and 2003................................... F-6
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2005, 2004 and 2003......................................... F-7
Notes to Consolidated Financial Statements for the Years Ended
December 31, 2005, 2004 and 2003......................................... F-9
Financial Statement Schedule
----------------------------
Consolidated Schedule II Valuation and Qualifying Accounts
for the Years Ended December 31, 2005, 2004 and 2003..................... F-49
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
and Stockholders of EMRISE Corporation
We have audited the accompanying consolidated balance sheets of EMRISE
Corporation, a Delaware corporation, as of December 31, 2005 and 2004, and the
related consolidated statements of operations, comprehensive income (loss),
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2005. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of EMRISE Corporation
as of December 31, 2005 and 2004, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2005 in
conformity with accounting principles generally accepted in the United States of
America.
Our audits were conducted for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The consolidated Schedule II
for the years ended December 31, 2005, 2004 and 2003 is presented for purposes
of complying with the Securities and Exchange Commission's rules and is not a
required part of the basic consolidated financial statements. This schedule has
been subjected to the auditing procedures applied in the audits of the basic
consolidated financial statements and, in our opinion, is fairly stated in all
material respects in relation to the basic consolidated financial statements
taken as a whole.
/S/ GRANT THORNTON LLP
Los Angeles, California
March 24, 2006
F-2
EMRISE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS (Notes 5, 6 and 7) 2005 2004
----------- -----------
Current assets:
Cash and cash equivalents $ 4,371 $ 1,057
Accounts receivable, net of allowance for doubtful
accounts of $379 and $153, respectively 9,413 5,796
Inventories (Note 2) 10,277 6,491
Deferred income taxes (Note 10) 1,386 352
Prepaid and other current assets 536 417
----------- -----------
Total current assets 25,983 14,113
Property, plant and equipment, net (Note 3) 2,073 909
Goodwill (Note 4) 12,066 5,881
Intangible assets other than goodwill, net of accumulated
amortization of $350 in 2005 and $40 in 2004 3,709 3,560
Other assets 630 623
----------- -----------
$ 44,461 $ 25,086
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Borrowings under lines of credit (Notes 5 and 6) $ 3,283 $ 878
Current portion of long-term debt (Notes 6 and 7) 504 211
Notes payable to stockholders, current portion (Note 17) 500 500
Accounts payable 4,949 3,398
Income taxes payable 218 572
Accrued expenses (Note 8) 3,571 3,014
----------- -----------
Total current liabilities 13,025 8,573
Long-term debt, less current portion (Notes 6 and 7) 742 985
Notes payable to stockholders, less current portion (Note 17) 1,750 2,250
Deferred income taxes (Note 10) 1,108 1,400
Other liabilities 823 969
----------- -----------
Total liabilities 17,448 14,177
Commitments and contingencies (Notes 12 and 17)
Stockholders' equity (Note 9):
Preferred stock, $0.01 par value. Authorized 10,000,000 shares;
zero issued and outstanding -- --
Common stock, $0.0033 par value. Authorized 150,000,000 shares;
issued and outstanding 37,550,000 shares and 24,777,000 shares
in 2005 and 2004, respectively 124 82
Additional paid-in capital 42,877 26,746
Accumulated deficit (15,118) (16,406)
Accumulated other comprehensive (loss) income (870) 487
----------- -----------
Total stockholders' equity 27,013 10,909
----------- -----------
$ 44,461 $ 25,086
=========== ===========
See accompanying notes to consolidated financial statements.
F-3
EMRISE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2005 2004 2003
-------- -------- --------
Net sales (Note 12) $ 41,046 $ 29,861 $ 25,519
Cost of sales 23,656 16,146 14,835
-------- -------- --------
Gross profit 17,390 13,715 10,684
Operating expenses:
Selling, general and administrative 13,694 10,226 7,812
Engineering and product development 2,621 1,521 951
-------- -------- --------
Income from operations 1,075 1,968 1,921
Other income (expense):
Interest expense (455) (433) (416)
Interest income 153 -- --
Other income (expense), net 248 (6) (58)
-------- -------- --------
Income before income taxes 1,021 1,529 1,447
Income tax (benefit) expense (Note 10) (267) 49 286
-------- -------- --------
Net income $ 1,288 $ 1,480 $ 1,161
======== ======== ========
Basic and diluted earnings per share $ 0.03 $ 0.06 $ 0.05
======== ======== ========
See accompanying notes to consolidated financial statements.
F-4
EMRISE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(IN THOUSANDS)
2005 2004 2003
------- ------- -------
Net income $ 1,288 $ 1,480 $ 1,161
Other comprehensive income (loss):
Foreign currency translation adjustment (1,357) 379 705
------- ------- -------
Comprehensive income (loss) $ (69) $ 1,859 $ 1,866
======= ======= =======
See accompanying notes to consolidated financial statements.
F-5
EMRISE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(IN THOUSANDS)
Accumulated
Other
Series B Convertible Additional Comprehensive
Preferred Stock Common Stock Paid-in Accumulated Income
Shares Amount Shares Amount Capital Deficit (Loss) Total
------------------------------------- -------- -------- -------- -------- -------- -------- -------- --------
Balance at January 1, 2003 64 $ 400 21,535 $ 71 $ 24,900 $(19,042) $ (597) $ 5,732
Preferred Series A conversions -- -- 1,263 4 283 -- -- 287
Preferred Series B conversions (63) (396) 635 2 395 (1) -- --
Foreign currency translation
adjustment -- -- -- -- -- -- 705 705
Accretion of redeemable
preferred stock -- -- -- -- -- (4) -- (4)
Warrants issued for services -- -- -- -- 19 -- -- 19
Exercise of warrants and options -- -- 43 -- 16 -- -- 16
Net income -- -- -- -- -- 1,161 -- 1,161
------------------------------------- -------- -------- -------- -------- -------- -------- -------- --------
Balance at December 31, 2003 1 4 23,476 77 25,613 (17,886) 108 7,916
Preferred Series B conversions (1) (3) 3 -- 3 -- -- --
Preferred Series B redemption -- (1) -- -- -- -- -- (1)
Stock options exercised -- -- 19 -- 5 -- -- 5
Foreign currency translation
adjustment -- -- -- -- -- -- 379 379
Stock issued for Larus acquisition -- -- 1,214 4 996 -- -- 1,000
Warrants exercised -- -- 65 1 19 -- -- 20
Warrants issued for services -- -- -- -- 38 -- -- 38
Value of warrants issued to
acquire Larus -- -- -- -- 72 -- -- 72
Net income -- -- -- -- -- 1,480 -- 1,480
------------------------------------- -------- -------- -------- -------- -------- -------- -------- --------
Balance at December 31, 2004 -- -- 24,777 82 26,746 (16,406) 487 10,909
Stock options exercised -- -- 106 -- 39 -- -- 39
Warrants exercised -- -- 163 -- 51 -- -- 51
Issuance of common stock and
warrants, net of issuance costs -- -- 12,504 42 16,018 -- -- 16,060
Foreign currently translation
adjustment -- -- -- -- -- -- (1,357) (1,357)
Warrants issued for services -- -- -- -- 23 -- -- 23
Net income -- -- -- -- -- 1,288 -- 1,288
------------------------------------- -------- -------- -------- -------- -------- -------- -------- --------
Balance at December 31, 2005 -- $ -- $ 37,550 $ 124 $ 42,877 $(15,118) $ (870) $ 27,013
===================================== ======== ======== ======== ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
F-6
EMRISE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(IN THOUSANDS)
2005 2004 2003
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,288 $ 1,480 $ 1,161
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation and amortization 964 287 249
Deferred income taxes (853) (206) 146
Provision for doubtful accounts 151 -- 61
Provision for inventory obsolescence 1,403 1,116 924
Stock and warrants issued for services 23 38 19
Changes in operating assets and liabilities net of
businesses acquired:
Accounts receivable 374 289 (106)
Inventories (527) (394) (113)
Prepaid and other assets (23) 23 (486)
Accounts payable (841) 1,414 (802)
Accrued expenses and other liabilities (824) (163) (14)
-------- -------- --------
Cash provided by operating activities 1,135 3,884 1,039
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of property, plant and equipment (287) (724) (63)
Cash received from sale of property, plant and equipment 20 8 13
Cash collected on notes receivable -- -- 12
Net cash paid for the acquisition of Pascall (10,154) -- --
Net cash paid for the acquisition of RO Associates (4,623) -- --
Net cash paid for acquisition of Larus, net of cash acquired -- (1,492) --
-------- -------- --------
Cash used in investing activities (15,044) (2,208) (38)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of current notes payable 2,405 (2,004) (593)
Repayments of long-term debt (1,602) (250) (110)
Proceeds from long-term debt 1,102 65 --
Cash from warrant/option exercise 90 25 16
Net proceeds from issuance of common stock 16,060 -- --
-------- -------- --------
Cash provided by (used in) financing activities 18,055 (2,164) (687)
-------- -------- --------
Effect of exchange rate changes on cash (832) 371 606
Net increase (decrease) in cash and cash equivalents 3,314 (117) 920
Cash and cash equivalents at beginning of year 1,057 1,174 254
-------- -------- --------
Cash and cash equivalents at end of year $ 4,371 $ 1,057 $ 1,174
======== ======== ========
See accompanying notes to consolidated financial statements.
F-7
EMRISE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(IN THOUSANDS)
2005 2004 2003
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: ------ ------ ------
Cash paid during the year for:
Interest $ 439 $ 367 $ 382
====== ====== ======
Income taxes $ 341 $ 428 $ 81
====== ====== ======
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
Issuance of subordinated notes for Larus acquisition $ -- $3,000 $ --
====== ====== ======
Common stock issued upon conversion of redeemable preferred stock $ -- $ 3 $ 287
====== ====== ======
Accretion of redeemable preferred stock $ -- $ -- $ 4
====== ====== ======
Common stock issued to acquire Larus $ -- $1,000 $ --
====== ====== ======
See accompanying notes to consolidated financial statements.
F-8
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
EMRISE Corporation (the "Company"), operates through three wholly-owned
subsidiaries: EMRISE Electronics Corporation ("EMRISE Electronics"), CXR Larus
Corporation ("CXR Larus"), and CXR Anderson Jacobson ("CXR-AJ"). EMRISE
Electronics and its subsidiaries design, develop, manufacture and market
electronic components for defense, aerospace and industrial markets. CXR Larus
and CXR-AJ design, develop, manufacture and market network access and
transmission products and communications test equipment. CXR Larus also engages
in the manufacture and sale of satellite communication timing and
synchronization products. The Company conducts its operations out of various
facilities in the United States, France, the United Kingdom and Japan and
organizes itself in two product line segments: electronic components and
communications equipment.
BASIS OF PRESENTATION
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
and include the accounts of the Company and each of its subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
REVENUE RECOGNITION
The Company derives revenues from sales of electronic components and
communications equipment products and services. The Company's sales are based
upon written agreements or purchase orders that identify the type and quantity
of the item being purchased and the purchase price. The Company recognizes
revenue when shipment of products has occurred or services have been rendered,
no significant obligations remain on the Company's part, and collectibility is
reasonably assured based on the Company's credit and collections practices and
policies.
The Company recognizes revenue from domestic sales of its electronic
components and communications equipment at the point of shipment of those
products. Product returns are infrequent and require prior authorization because
the Company's sales are final and the Company quality tests its products prior
to shipment to ensure they meet the specifications of the binding purchase
orders under which they are shipped. Normally, when a customer requests and
receives authorization to return a product, the request is accompanied by a
purchase order for a replacement product.
Revenue recognition for products and services provided by the Company's
United Kingdom subsidiaries, which include EMRISE Electronics Ltd. ("EEL"), XCEL
Power Systems, Ltd. ("XPS") and Pascall Electronics Ltd. ("Pascall"), depends
upon the type of contract involved. Engineering/design services contracts
generally entail design and production of a prototype over a term of up to
several years, with all revenue deferred until all services under the contracts
have been completed. Engineering/design services were not significant in 2005,
2004 and 2003. Production contracts provide for a specific quantity of products
to be produced over a specific period of time. Customers issue binding purchase
orders for each suborder to be produced. At the time each suborder is shipped to
the customer, the Company recognizes revenue relating to the products included
in that suborder. Returns are infrequent and permitted only with prior
authorization because these products are custom made to order based on binding
purchase orders and are quality tested prior to shipment. Generally, these
products carry a one-year limited parts and labor warranty. The Company's U.K.
subsidiaries do not offer customer discounts, rebates or price protection on
these products.
F-9
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
The Company recognizes revenue for products sold by its French
subsidiary at the point of shipment. Customer discounts are included in the
product price list provided to the customer. Returns are infrequent and
permitted only with prior authorization because these products are shipped based
on binding purchase orders and are quality tested prior to shipment. Generally,
these products carry a two-year limited parts and labor warranty.
Generally, the Company's electronic components, network access and
transmission products and satellite communication timing and synchronization
products carry a one-year limited parts and labor warranty. The Company's
communications test instruments and European network access and transmission
products carry a two-year limited parts and labor warranty. Products returned
under warranty are tested and repaired or replaced at the Company's option.
Historically, warranty repairs have not been material. The Company does not
offer customer discounts, rebates or price protection on these products.
Revenues from services such as repairs and modifications are recognized
when the service has been completed and invoiced. For repairs that involve
shipment of a repaired product, the Company recognizes repair revenues when the
product is shipped back to the customer. Service revenues represented 2.6%, 5.7%
and 3.1% of net sales in 2005, 2004 and 2003, respectively.
RO Associates, Inc. ("RO") generates a portion of its revenue from
royalties. Royalty income is recognized when the technology rights have
transferred to the licensee. For agreements that provide the licensees the right
to manufacture and sell our proprietary products, the Company recognizes initial
license fee revenue upon delivery of the product technology. The Company
recognizes guaranteed minimum license royalties as revenue as they become due.
Per unit royalties that exceed the guaranteed minimum are recognized as earned
when reported.
Shipping and handling fees billed to customers totaled $261,000 for the
year ended December 31, 2005 and were charged to cost of sales. Such amounts
were not significant for the year ended December 31, 2004. Shipping and handling
fees billed to international customers are included in net sales and totaled
less than 1.0% of net sales for the years ended December 31, 2005, 2004 and
2003. Depending on the operating division, shipping and handling costs are
included in cost of sales or selling, general and administrative expenses.
Freight is charged to cost of sales and the charge is reversed when the customer
is invoiced for the freight.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of all highly liquid investments with
an original maturity of three months or less when purchased. As of December 31,
2005, 2004 and 2003, cash in foreign accounts was $2,447,000, $1,035,000 and
$535,000, respectively.
F-10
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
INVENTORIES
The Company's finished goods electronic components inventories
generally are built to order. The Company's communications equipment inventories
generally are built to forecast, which requires the Company to produce a larger
amount of finished goods in its communications equipment business so that the
Company's customers can promptly be served. The Company's products consist of
numerous electronic and other parts, which necessitates that it exercise
detailed inventory management. The Company values its inventory at the lower of
the actual cost to purchase or manufacture the inventory (first-in, first-out)
or the current estimated market value of the inventory (net realizable value).
The Company performs physical inventories at least once a year. The Company
regularly reviews inventory quantities on hand and records a provision for
excess and obsolete inventory based primarily on its estimated forecast of
product demand and production requirements for the next twelve months.
Additionally, to determine inventory write-down provisions, the Company reviews
product line inventory levels and individual items as necessary and periodically
reviews assumptions about forecasted demand and market conditions. Any parts or
finished goods that are determined to be obsolete, either in connection with the
physical count or at other times of observation, are reserved for and
subsequently discarded and written-off.
In addition, the communications equipment industry is characterized by
rapid technological change, frequent new product development, and rapid product
obsolescence that could result in an increase in the amount of obsolete
inventory quantities on hand. Also, the Company's estimates of future product
demand may prove to be inaccurate, in which case the Company may have
understated or overstated the provision required for excess and obsolete
inventory. In the future, if the Company's inventory is determined to be
overvalued, the Company would be required to recognize such costs in its cost of
goods sold at the time of such determination. Likewise, if the Company's
inventory is determined to be undervalued, the Company may have over-reported
its costs of goods sold in previous periods and would be required to recognize
additional operating income at the time of sale. Therefore, although the Company
makes every effort to ensure the accuracy of its forecasts of future product
demand, any significant unanticipated changes in demand or technological
developments could have a significant impact on the value of the Company's
inventory and its reported operating results.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost, less accumulated
depreciation and amortization. Depreciation and amortization are computed
principally using the straight-line method over the useful lives of the assets
(or lease term, if shorter) as follows:
Buildings 50 years
Machinery, equipment and fixtures 3-7 years
Leasehold improvements 5 years
Maintenance and repairs are expensed as incurred, while renewals and
betterments are capitalized. Research and development costs are expensed as
incurred.
F-11
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
LONG-LIVED ASSETS
The Company reviews the carrying amount of its long-lived assets for
possible impairment whenever events or changes in circumstances indicate that
the carrying amount of the assets may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future undiscounted net cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less costs to sell.
PRODUCT WARRANTY LIABILITIES
Generally, the Company's electronic components, network access and
transmission products and satellite communication timing and synchronization
products carry a one-year limited parts and labor warranty and the Company's
communications test instruments and European network access and transmission
products carry a two-year limited parts and labor warranty. Products returned
under warranty typically are tested and repaired or replaced at the Company's
option. Historically, the Company has not experienced significant warranty costs
or returns.
The Company records in accrued expenses a liability for estimated costs
that it expects to incur under its basic limited warranties when product revenue
is recognized. Factors affecting the Company's warranty liability include the
number of units sold, historical and anticipated rates of claim, and costs per
claim. The Company periodically assesses the adequacy of its warranty liability
accrual based on changes in these factors.
The changes in the Company's product warranty liability during 2005 and
2004 were as follows:
Year Ended December 31,
2005 2004
------------ ------------
Liability, beginning of year $ 64,000 $ 79,000
Expense for new warranties issued 86,000 64,000
Warranty claims -- (79,000)
------------ ------------
Liability, end of year $ 150,000 $ 64,000
============ ============
INCOME TAXES
The Company uses the liability method of accounting for income taxes in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 109,
"Accounting for Income Taxes." Deferred income taxes are recognized based on the
differences between financial statement and income tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be realized.
The provision for income taxes represents the tax payable for the year and the
change during the year in deferred tax assets and liabilities.
F-12
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
STOCK-BASED COMPENSATION
The Company applies Accounting Principles Bulletin ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees" and related interpretations in
accounting for its employee stock-based compensation plans. Accordingly, no
compensation cost is recognized for its employee stock option plans unless the
exercise price of options granted is less than fair market value on the date of
grant. The Company has adopted the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," as amended by SFAS No. 148
"Accounting for Stock-Based Compensation - Presentation and Disclosure."
The following table sets forth the net income and basic and diluted
earnings per share for the periods presented as if the Company had elected the
fair value method of accounting for stock options:
2005 2004 2003
------------- ------------- -------------
Net income:
As reported $ 1,288,000 $ 1,480,000 $ 1,161,000
Add: Stock-based compensation expense included in
reported net income, net of related tax effect -- -- --
Deduct: Stock-based compensation expense determined
under the fair value-based method, net of related
tax effect (819,000) (127,000) (45,000)
------------- ------------- -------------
Pro forma $ 469,000 $ 1,353,000 $ 1,116,000
============= ============= =============
Basic earnings per share:
As reported $ 0.03 $ 0.06 $ 0.05
Add: Stock-based compensation expense included in
reported net income, net of related tax effect -- -- --
Deduct: Stock-based compensation expense determined
under the fair value-based method, net of related
tax effect (0.02) -- --
------------- ------------- -------------
Pro forma $ 0.01 $ 0.06 $ 0.05
============= ============= =============
Diluted earnings per share:
As reported $ 0.03 $ 0.06 $ 0.05
Add: Stock-based compensation expense included in
reported net income, net of related tax effect -- -- --
Deduct: Stock-based compensation expensed determined
under the fair value-based method, net of related
tax effect (0.02) (0.01) --
------------- ------------- -------------
Pro forma $ 0.01 $ 0.05 $ 0.05
============= ============= =============
The above calculations include the effects of all grants in the periods
presented. Because options often vest over several years and additional awards
are made each year, the results shown above may not be representative of the
effects on net income or loss in future periods. The calculations were based on
a Black-Scholes pricing model with the following assumptions: no dividend yield;
expected volatility of 88% to 107%; risk-free interest rate of 3% to 4.25%;
expected lives of 7 years.
F-13
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
EARNINGS PER SHARE
Earnings per share is calculated according to SFAS No. 128, "Earnings
Per Share." Basic earnings per share includes no dilution and is computed by
dividing net income available to common stockholders by the weighted average
number of shares outstanding during the year. Diluted earnings per share
reflects the potential dilution of securities that could share in the earnings
of the Company.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments"
requires all entities to disclose the fair value of financial instruments, both
assets and liabilities recognized and not recognized on the balance sheet, for
which it is practicable to estimate fair value. This statement defines fair
value of a financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties. As of December 31,
2005 and 2004, the fair value of all financial instruments approximated carrying
value.
The carrying amount of cash and cash equivalents, accounts receivable,
accounts payable and accrued expenses are reasonable estimates of their fair
value because of the short maturity of these items. The Company believes the
carrying amounts of its notes payable and long-term debt approximate fair value
because the interest rates on these instruments are subject to change with, or
approximate, market interest rates.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially expose the Company to
concentration of credit risk, consist primarily of cash and accounts receivable.
The Company places its cash with high quality financial institutions. At times,
cash balances may be in excess of the amounts insured by the Federal Deposit
Insurance Corporation.
The Company's accounts receivable result from sales to a broad customer
base. The Company extends credit to its customers based upon an evaluation of
the customer's financial condition and credit history and generally does not
require collateral. Accounts receivable are generally due within 30 days in the
Company's U.S., France and U.K. operations and are stated net of an allowance
for doubtful accounts. Accounts outstanding for longer than the contractual
payment terms are considered past due. Provisions for uncollectible accounts are
made based on the Company's specific assessment of the collectibility of all
past due accounts. Credit losses are provided for in the financial statements
and consistently have been within management's expectations. Sales to Rockwell
Collins, Inc. represented approximately 10% of our total net sales during 2005.
No other customer represented 10% or more of our total net sales for that
period. Sales to BAE Systems companies represented 15% and 13% of total net
sales in 2004 and 2003, respectively.
F-14
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
FOREIGN CURRENCY TRANSLATION
The accounts of foreign subsidiaries have been translated using the
local currency as the functional currency. Accordingly, foreign currency
denominated assets and liabilities have been translated to U.S. dollars at the
current rate of exchange on the balance sheet date and at the average for the
period reported for the statement of operations. The effects of translation are
recorded as a separate component of stockholders' equity in accumulated other
comprehensive income (loss). Exchange gains and losses arising from transactions
denominated in foreign currencies are translated at the exchange rates
applicable on the dates of the transactions and are included in operations.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior years' financial
statements to be consistent with the 2005 presentation.
(2) INVENTORIES
Inventories are summarized as follows as of December 31:
2005 2004
----------- -----------
Raw materials $ 4,668,000 $ 3,222,000
Work-in-process 2,716,000 1,280,000
Finished goods 2,893,000 1,989,000
----------- -----------
$10,277,000 $ 6,491,000
=========== ===========
Included in the amounts above are allowances for inventory obsolescence
of $4,053,000 and $2,251,000 at December 31, 2005 and 2004, respectively.
Allowances for inventory obsolescence are recorded as necessary to reduce
obsolete inventory to estimated net realizable value or to specifically reserve
for obsolete inventory that the Company intends to dispose of. The inventory
items identified for disposal at each year end are generally discarded during
the following year.
(3) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following as of December
31:
2005 2004
----------- -----------
Land and buildings $ 343,000 $ 390,000
Machinery, equipment and fixtures 4,002,000 3,999,000
Leasehold improvements 663,000 482,000
----------- -----------
5,008,000 4,871,000
Accumulated depreciation and amortization (2,935,000) (3,962,000)
----------- -----------
$ 2,073,000 $ 909,000
=========== ===========
F-15
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
(4) GOODWILL AMORTIZATION AND IMPAIRMENT TESTING
SFAS No. 142, "Goodwill and Other Intangible Assets," disallows the
amortization of goodwill and provides for impairment testing of goodwill
carrying values on an annual basis or more frequently if an event occurs or
circumstances change that would more likely than not reduce the fair value of a
reporting unit below its carrying amount. In applying SFAS No. 142, the Company
performed the transitional reassessment and impairment tests required as of
January 1, 2002. At the time of adoption, the Company had $1,084,000 of
accumulated amortization of goodwill. The Company performed its annual required
tests of impairment as of December 31, 2005, 2004 and 2003 for goodwill in the
electronic components segment and the communications equipment segment reporting
units. No events or changes in circumstances occurred between annual tests that
would have required an interim goodwill impairment test.
(5) LINES OF CREDIT
Outstanding borrowings under the Company's revolving lines of credit
were as follows as of December 31:
2005 2004
----------- -----------
Line of credit with a U.S. commercial lender $ -- $ 118,000
Lines of credit with foreign banks 3,283,000 760,000
----------- -----------
$ 3,283,000 $ 878,000
=========== ===========
(6) CREDIT FACILITIES
On August 25, 2005, the Company, together with two subsidiaries, CXR
Laurus and EMRISE Electronics, acting as guarantors, obtained a credit facility
from Wells Fargo Bank, N.A. for the Company's U.S. operations. As guarantors,
each of CXR Telcom Corporation and EMRISE Electronics is jointly and severally
liable with the Company for up to $9,000,000. This facility is effective through
September 1, 2006. The credit facility has no prepayment penalty and is subject
to an unused commitment fee equal to 0.25% per annum, payable quarterly based on
the average daily unused amount of the line of credit described in the following
paragraph.
The credit facility provides a $9,000,000 revolving line of credit
secured by accounts receivable, other rights to payment and general intangibles,
inventories and equipment. Borrowings do not need to be supported by specific
receivables or inventory balances unless aggregate borrowings under the line of
credit exceed $2,000,000 at any time (a "conversion event"). The bank has
informally notified the Company it intends to raise this limit to $3,000,000. If
a conversion event occurs, the line of credit will covert into a formula-based
line of credit until the borrowings are equal to or less than $2,000,000. The
formula generally provides that the outstanding borrowings under the line of
credit may not exceed an aggregate of 80% of eligible accounts receivable plus
30% of the value of eligible finished goods inventory. Interest is payable
monthly. The interest rate is variable and is adjusted monthly based on the
prime rate. The prime rate at December 31, 2005 was 7.25%.
F-16
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
The credit facility is subject to various financial covenants on a
consolidated basis, which were updated on November 17, 2005 as follows. The
minimum debt service coverage ratio must be greater than 1.25:1.00 on a trailing
four-quarter basis. "Debt service coverage ratio" is defined as net profit after
taxes, plus depreciation, plus amortization, plus or minus net distributions,
divided by the sum of the current portion of long-term debt plus capitalized
lease payments. The current ratio must be not less than 1.50:1.00, determined as
of each fiscal quarter end. "Current ratio" is defined as total current assets
divided by total current liabilities. Annual net profit after taxes must be
greater than $500,000, determined as of each fiscal quarter end on a rolling
four-quarter basis; provided that the Company may not sustain net loss after tax
in any two consecutive fiscal quarters and no fiscal quarter losses to exceed
$300,000. Total liabilities divided by tangible net worth of the Company must
not at any time be greater than 1.75:1.00, determined as of each fiscal quarter
end. Tangible net worth of the Company must not at any time be less than
$12,000,000 measured at the end of each quarter. "Total liabilities" is defined
as current liabilities plus non-current liabilities, minus subordinated debt.
"Tangible net worth" is defined as stockholders' equity plus subordinated debt,
minus intangible assets.
As of December 31, 2005, the Company had no outstanding balance owing
under the revolving credit line, and the Company had $2,000,000 of availability
on the non-formula based portion of the credit line. As of December 31, 2005,
the Company was in compliance with each of the covenants of the credit facility.
In the event of a default and continuation of a default, Wells Fargo
may accelerate the payment of the principal balance requiring the Company to pay
the entire indebtedness outstanding on that date. From and after the maturity
date of the note, or any earlier date that all principal owing under the note
becomes due and payable by acceleration or otherwise, the outstanding principal
balance will bear interest until paid in full at an increased rate per annum
equal to 4% above the rate of interest in effect from time to time under the
note.
The credit facility also provides for a term loan of $150,000 secured
by equipment, amortizable over 36 months at a variable rate equal to the prime
rate plus 1.5%. The term loan portion of the facility had a balance of $75,000
at December 31, 2005.
Wells Fargo Bank, N.A. has also provided the Company with credit for
the purchase of new capital equipment when needed of which a balance of $123,000
was outstanding at December 31, 2005. The interest rate is equal to the 90-day
London InterBank Offered Rate ("LIBOR") (4.54% at December 31, 2005) plus 3.75%
per annum. Amounts borrowed under this arrangements are amortized over 60 months
from the respective dates of borrowing and are secured by the purchased
equipment.
As of December 31, 2005, the Company's foreign subsidiaries had credit
facilities, including lines of credit and term loans, with Lloyds TSB Bank PLC
("Lloyds TSB") and Lloyds TSB Commercial Finance Limited ("Lloyds") in England,
IFN Finance, a subsidiary of ABN AMRO Holdings, N.V., Banc National de Paris,
Societe Generale in France, and Sogelease and Johnan Shinkin Bank in Japan. At
December 31, 2005, the balances outstanding under the Company's United Kingdom,
France and Japan credit facilities were $3,006,000, $1,090,000 and $32,000,
respectively.
On July 8, 2005, XPS and Pascall obtained a credit facility with
Lloyds. At the same time, the credit facility of Venture Finance PLC, a
subsidiary of ABN AMRO Holdings, N.V., was terminated, and all debt to Venture
Finance PLC was paid off. The Lloyds facility provides a revolving loan secured
by receivables, with a maximum availability of 2,100,000 British pounds sterling
(approximately U.S. $3,613,000 based on the exchange rate in effect on December
31, 2005). The annual interest rate on the revolving loan is 1.5% above the
Lloyds TSB base rate. The Lloyds TSB base rate was 4.5% at December 31, 2005.
This credit facility covers a period of 24 months, expiring on July 31, 2007.
The financial covenants include a 50% cap on combined export gross sales of XPS
and Pascall and days sales outstanding of less than 65 days, and the funding
balance is capped at 125% of XPS and Pascall combined gross sales.
F-17
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
On August 26, 2005, XPS entered into an agreement with Lloyds for an
unsecured cashflow loan of 300,000 British pounds sterling (approximately U.S.
$516,000 based on the exchange rate in effect on December 31, 2005), payable
over 12 months. The loan is structured as an overadvance on the previously
negotiated 2,100,000 British pounds sterling revolving loan with Lloyds,
bringing the maximum aggregate commitment on the revolving loan to 2,400,000
British pounds sterling (approximately U.S. $4,129,000 based on the exchange
rate in effect on December 31, 2005).
The unsecured cashflow loan of 300,000 British pounds sterling is
payable at a rate of 25,000 British pounds sterling per month, the first payment
falling due one month after initial drawdown on the revolving loan. The interest
rate is variable and is adjusted monthly based on the base rate of Lloyds TSB
plus 1.9%. The Lloyds TSB base rate at December 31, 2005 was 4.5%. Lloyds TSB
has sole discretion to switch the details on this overadvance account if Lloyds
determines that we will have difficulty in meeting the specific reductions in
the overadvance account.
Lloyds TSB also issued XPS a 500,000 British pound sterling equivalent
to U.S. $860,000 at the exchange rate of December 31, 2005. The loan is payable
over 36 months with monthly payments of 15,820 British pounds sterling. The
interest rate is the Lloyds TSB rate which was 4.5% at December 31, 2005 plus
2.5%. This loan has a covenant requiring that consolidated profit before tax and
interest paid and payable of our U.K. companies be not less than 500% of
consolidated interest paid or payable for the period covered by the account. The
Company failed to comply with this covenant and received a waiver. The Company
and the bank are reviewing the covenants for possible amendment.
On August 26, 2005, EEL, a United Kingdom-based subsidiary of the
Company, entered into an agreement with Lloyds TSB for an unsecured term loan
for 500,000 British pounds sterling (approximately U.S. $860,000 based on the
exchange rate in effect on December 31, 2005). This loan is repayable in 36
consecutive monthly installments, representing principal and interest. The
interest rate is variable and is adjusted daily based on the Lloyds TSB base
rate plus 2.5%. The Lloyds TSB base rate at December 31, 2005 was 4.5%. The loan
also includes financial covenants. EEL must maintain consolidated profit before
taxation and interest paid and payable of no less than 500% of the consolidated
interest paid and payable. Additionally, EEL must maintain consolidated profit
before taxation, depreciation, amortization of goodwill and other intangibles
and interest paid and payable of no less than 300% of the consolidated principal
repayments and the consolidated interest paid and payable.
In the event of a default, Lloyds may make the loan, including any
outstanding principal and interest which has accrued, repayable on demand. If
any amount payable is not paid when due, EEL must pay an increased interest rate
per annum equal to 3% above the rate of interest in effect from time to time
under the note.
F-18
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
In April 2003, CXR-AJ obtained a credit facility from IFN Finance, a
subsidiary of ABN AMRO N.V. This credit facility is for a maximum of $1,421,000
based on the exchange rate in effect at December 31, 2005 for the conversion of
euros into United States dollars. CXR-AJ also had $34,000 of term loans with two
French banks outstanding as of September 30,2005. The IFN Finance facility is
secured by accounts receivable and carries an annual interest rate of 1.6% above
the French "T4M" rate. At December 31, 2005, the French T4M rate was 2.26%, and
this facility had a balance of $1,056,000. This facility has no financial
performance covenants.
XCEL Japan Ltd., or XJL, obtained a term loan on November 29, 2002 from
Johnan Shinkin Bank. The loan is amortized over five years, carries an annual
fixed interest rate of 3.25% and is secured by the assets of XJL. The balances
of the loan as of December 31, 2005 and 2004 were $32,000 and $73,000,
respectively, using the exchange rates in effect at those dates for conversion
of Japanese yen into United States dollars. There are no financial performance
covenants applicable to this loan.
(7) LONG-TERM DEBT
A summary of long-term debt follows as of December 31:
2005 2004
------------ ------------
Term notes payable to U.S. commercial lender (a) $ 75,000 $ 184,000
Term notes payable to foreign banks (b) 844,000 833,000
Capitalized lease and equipment loan obligations (c) 327,000 179,000
------------ ------------
1,246,000 1,196,000
Current portion (504,000) (211,000)
------------ ------------
$ 742,000 $ 985,000
============ ============
---------------
(a) The Company's domestic credit facility with Wells Fargo Bank,
N.A. provides for a term loan of $150,000 secured by
equipment, amortizable over 36 months at a variable rate equal
to the prime rate plus 1.5%. The term loan portion of the
facility had balances of $75,000 and $126,000 at December 31,
2005 and 2004, respectively.
(b) The Company has agreements with several foreign banks that
include term borrowings that mature at various dates through
2008. Interest rates on the borrowings bear interest at rates
ranging from 3.25% to 7% and are payable in monthly
installments. The balances by country of origination at
December 31, 2005 were: United Kingdom - $778,000; France -
$34,000; and Japan - $32,000. At December 31, 2004, the
balances by country of origination were: United Kingdom -
$715,000; France - $62,000; and Japan - $56,000.
The unsecured United Kingdom term loan in the original
principal amount of $860,000 is payable over 36 months
commencing in September 2005 at $24,000 per month and interest
is the base rate plus 2.5%.
The term loans in France had aggregate balances of $34,000 and
$62,000 at December 31, 2005 and 2004, respectively, and is
payable over 60 months and secured by the assets of the local
subsidiary, bears an annual interest rate of 4% and is not
subject to financial performance covenants.
f-19
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
The term loan in Japan is a five-year amortizable loan that
commenced in November 2002 and had balances of $32,000 and
$56,000 as of December 31, 2005 and 2004, respectively,
carries an annual fixed interest rate of 3.25%, is secured by
the Japanese subsidiary's assets and is not subject to
financial performance covenants.
(c) Capitalized lease obligations are calculated using interest
rates appropriate at the inception of the lease and range from
6% to 18%. Leases are amortized over the lease term using the
effective interest method. The leases all contain bargain
purchase options and expire at various dates through December
31, 2017. Wells Fargo Bank, N.A. has provided capital
equipment loans with balances at December 31, 2005 of
$123,000. The capital equipment loans are amortized over five
years and bear interest at the bank's 30-day LIBOR plus 4%.
Principal maturities related to long-term debt, including loans from
stockholders (Note 17), as of December 31, 2005 were as follows:
Year Ending December 31, Amount
------------------------ -----------
2006 $ 1,004,000
2007 923,000
2008 756,000
2009 538,000
2010 275,000
-----------
Total $ 3,496,000
===========
(8) ACCRUED EXPENSES
Accrued expenses as of December 31 consisted of the following:
2005 2004
------------ ------------
Accrued salaries $ 675,000 $ 805,000
Accrued payroll taxes and benefits 735,000 491,000
Advance payments from customers 219,000 77,000
Other accrued expenses 1,942,000 1,641,000
------------ ------------
Total accrued expenses $ 3,571,000 $ 3,014,000
============ ============
No other individual item represented more than 5% of total current
liabilities.
F-20
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
(9) STOCKHOLDERS' EQUITY
STOCK OPTIONS AND WARRANTS
The Company has four stock option plans:
o Employee Stock and Stock Option Plan, effective July 1, 1994,
providing for non-qualified stock options as well as restricted
and non-restricted stock awards to both employees and outside
consultants. Up to 520,000 shares were authorized for issuance
under this plan. Terms of related grants under the plan are at the
discretion of the board of directors. The board of directors does
not intend to issue any additional options or make any additional
stock grants under this plan.
o 1993 Stock Option Plan, providing for the grant of up to 300,000
incentive and non-qualified stock options to purchase stock at not
less than the current market value on the date of grant. Options
granted under this plan vest ratably over three years and expire
10 years after date of grant. The board of directors does not
intend to issue any additional options under this plan.
o The 1997 Stock Incentive Plan (the "1997 Plan") provides that
options granted may be either qualified or nonqualified stock
options and are required to be granted at fair market value on the
date of grant. Subject to termination of employment, options may
expire up to ten years from the date of grant and are
nontransferable other than in the event of death, disability or
certain other transfers that the committee of the board of
directors administering the 1997 Plan may permit. Up to 1,600,000
stock options were authorized to be granted under the 1997 Plan.
All outstanding options of former optionholders under the XET 1987
Employee Stock Option Plan were converted to options under the
1997 Plan as of the date of the merger between the Company and
EMRISE Electronics at the exchange rate of 1.451478. The board of
directors does not intend to issue any additional options under
this plan.
o The 2000 Stock Option Plan was adopted by the board of directors
in November 2000 and approved by the stockholders on January 16,
2001. The board of directors adopted the Amended and Restated 2000
Stock Option Plan (the "2000 Plan") effective as of August 3,
2001. Under the 2000 Plan, options granted may be either incentive
or nonqualified options. Incentive options must have an exercise
price of not less than the fair market value of a share of common
stock on the date of grant. Nonqualified options must have an
exercise price of not less than 85% of the fair market value of a
share of common stock on the date of grant. Up to 2,000,000
options may be granted under the 2000 Plan. No option may be
exercised more than ten years after the date of grant.
The Company accounts for stock-based compensation under the "intrinsic
value" method. Under this method, no compensation expense is recorded for these
plans and arrangements for current employees whose grants provide for exercise
prices at or above the market price on the date of grant. Compensation or other
expense is recorded based on intrinsic value (excess of market price over
exercise price on date of grant) for employees, and fair value of the option
awards for others.
F-21
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
The following table shows activity in the outstanding options for the
years ended December 31, 2005, 2004 and 2003:
2005 2004 2003
---------------------- ---------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- -------- ---------- -------- ----------- -------
Outstanding at beginning of year 2,133,000 $ 0.97 1,729,000 $ 0.96 1,432,000 $1.11
Granted 725,000 $ 1.92 424,000 $ 0.96 344,000 $0.35
Exercised (106,000) $ 0.38 (19,000) $ 0.33 (28,000) $0.24
Forfeited (644,000) $ 1.88 (1,000) $ 3.44 (19,000) $2.21
-------------------------------- ----------- -------- ---------- -------- ----------- -------
Outstanding at end of year 2,108,000 $ 1.05 2,133,000 $ 0.97 1,729,000 $0.96
=========== ======== ========== ======== =========== ========
The following table summarizes information with respect to stock
options at December 31, 2005:
Options Options Exercisable
------------------------------------ --------------------------
Number Weighted Average Weighted Number Weighted
Range of Outstanding Remaining Average Exercisable Average
Exercise December 31, Contractual Life Exercise December 31, Exercise
Price 2005 (Years) Price 2005 Price
---------------- ------------ ----------------- ----------- ------------ ------------
$0.20 to $1.00 1,317,000 6.08 $ 0.54 1,217,000 $ 0.46
$1.01 to $2.00 780,000 9.38 1.87 680,000 1.93
$3.01 to $4.00 11,000 0.62 3.13 11,000 3.13
------------ ----------------- ----------- ------------ ------------
2,108,000 7.27 $ 1.05 1,908,000 $ 1.00
============ ================= =========== ============ ============
The fair value of options granted during 2005 was $738,000 at a
weighted average value of $1.02. The fair value of options granted during 2004
was $337,000, at a weighted average value of $0.79 per share. The fair value of
options granted during 2003 was $42,000, at a weighted average value of $0.12
per share.
If the Company had instead elected the fair value method of accounting
for stock-based compensation, compensation cost would be accrued at the
estimated fair value of all stock option grants over the service period,
regardless of later changes in stock prices and price volatility. The fair value
at date of grant for options granted in 2005, 2004 and 2003 has been estimated
based on a Black-Scholes pricing model with the following assumptions: no
dividend yield; expected volatility of 88% to 92% in 2005, 92% to 107% in 2004
and 92% in 2003; risk-free interest rate of 3.0% to 4.25%; and average expected
lives of seven years.
F-22
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
The board of directors has also authorized the issuance of common stock
purchase warrants to certain officers, directors, stockholders, key employees
and other parties as follows:
Exercise Price
Number ----------------------------------
of Shares Per Share Total
----------------- ---------------- -----------------
Balance outstanding at December 31, 2002 404,000 $0.25 to $2.50 $ 273,000
Warrants issued 401,000 0.75 to 1.00 325,000
Warrants expired/forfeited (138,000) 0.66 (91,000)
Warrants exercised (14,000) 0.66 (9,000)
----------------- ---------------- -----------------
Balance outstanding at December 31, 2003 653,000 $0.25 to $2.50 $ 498,000
----------------- ---------------- -----------------
Warrants issued 250,000 0.85 to 1.30 299,000
Warrants expired/forfeited (32,000) 2.50 (80,000)
Warrants exercised (65,000) 0.25 to 0.31 (17,000)
----------------- ---------------- -----------------
Balance outstanding at December 31, 2004 806,000 $0.31 to $1.30 $ 698,000
----------------- ---------------- -----------------
Warrants issued 3,886,000 1.73 to 2.00 6,741,000
Warrants exercised (205,000) 0.39 to 0.75 (111,000)
----------------- ---------------- -----------------
Balance outstanding at December 31, 2005 4,487,000 $0.75 to $2.00 $7,328,000
================= ================ =================
During 2005, the Company issued warrants to purchase up to 3,886,000
shares of common stock at exercise prices ranging from of $1.73 to $2.00
(3,776,000 in conjunction with the Company's January 2005 stock offering and
110,000 as compensation for services rendered). The estimated value of the
warrants issued during 2005 for services rendered was $23,000 and was calculated
using the Black-Scholes pricing model with the following assumptions: risk-free
interest rate of 3%, expected life of 3 years, no dividend yield, and an
expected volatility of 107.19%.
During 2004, the Company issued warrants to purchase up to 250,000
shares of common stock at exercise prices ranging from of $0.85 to $1.30 per
share in consideration for services rendered or to be rendered and in connection
with the acquisition of Larus Corporation. The estimated value of the warrants
issued during 2004 for services rendered was $38,000 and was calculated using
the Black-Scholes pricing model with the following assumptions: risk-free
interest rate of 2.5% to 3.25%, expected life of 3 years, no dividend yield, and
an expected volatility of 107%. The estimated value of the warrants issued in
connection with the acquisition of Larus Corporation was $72,526 and was
calculated using the Black-Scholes pricing model with the following assumptions:
risk-free interest rate of 3.25%, expected life of three years, no dividend
yield, and an expected volatility of 107.19%.
During 2003, the Company issued warrants to purchase up to 300,000
shares of common stock at the exercise price of $0.75 and 101,000 shares at the
exercise price of $1.00. The Company issued the warrants for services rendered
or to be rendered. The estimated value of the warrants was $19,000 and was
calculated using the Black-Scholes pricing model with the following assumptions:
risk-free interest rate of 1.6%, expected lives of 3 years, no dividend yield
and an expected volatility of 84.8%.
As of December 31, 2005, the Company was authorized to issue
150,000,000 shares of common stock. As of that date, the Company had 37,550,250
shares of common stock outstanding and 6,594,443 shares of common stock that
could become issuable pursuant to the exercise of outstanding stock options and
warrants.
F-23
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
As described in Note 18, the Company issued shares of common stock and
warrants to purchase shares of common stock in a private offering on January 5,
2005.
DIVIDENDS
No dividends on the Company's common stock have been paid to date. The
Company's line of credit with Wells Fargo Bank, N.A. prohibits the payment of
cash dividends on the Company's common stock. The Company currently intends to
retain future earnings to fund the development and growth of its business and,
therefore, does not anticipate paying cash dividends on its common stock within
the foreseeable future. Any future payment of dividends on the Company's common
stock will be determined by the Company's board of directors and will depend on
the Company's financial condition, results of operations, contractual
obligations and other factors deemed relevant by the Company's board of
directors.
(10) INCOME TAXES
The Company files a consolidated U.S. federal income tax return. This
return includes all domestic companies 80% or more owned by the Company. State
tax returns are filed on a consolidated, combined or separate basis depending on
the applicable laws relating to the Company and its domestic subsidiaries.
Income before income taxes was taxed under the following jurisdictions
for the years ended December 31:
2005 2004 2003
----------- ----------- -----------
Domestic $ (134,000) $ 884,000 $ 184,000
Foreign 1,155,000 645,000 1,263,000
----------- ----------- -----------
Total $ 1,021,000 $ 1,529,000 $ 1,447,000
=========== =========== ===========
Income tax expense (benefit) consisted of the following for the years
ended December 31:
2005 2004 2003
----------- ----------- -----------
Current
Federal $ -- $ 34,000 $ 26,000
State -- 41,000 55,000
Foreign 535,000 180,000 351,000
----------- ----------- -----------
Total current $ 535,000 $ 255,000 $ 432,000
=========== =========== ===========
Deferred
Federal $ (705,000) $ (193,000) $ (132,000)
State 30,000 (11,000) (14,000)
Foreign (127,000) (2,000) --
----------- ----------- -----------
Total deferred $ (802,000) $ (206,000) $ (146,000)
=========== =========== ===========
F-24
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
2005 2004 2003
----------- ----------- -----------
Total
Federal $ (705,000) $ (159,000) $ (106,000)
State 30,000 30,000 41,000
Foreign 408,000 178,000 351,000
----------- ----------- -----------
Total $ (267,000) $ 49,000 $ 286,000
=========== =========== ===========
Income tax expense (benefit) differed from the amount obtained by
applying the statutory federal income tax rate of 34% to income before income
taxes as follows for the years ended December 31:
2005 2004 2003
----------- ----------- -----------
Tax at U.S. federal statutory rate $ 347,000 $ 520,000 $ 492,000
State taxes, net of federal income
tax benefit 30,000 41,000 43,000
Foreign income taxes (42,000) 248,000 (63,000)
Change in valuation allowances (555,000) (179,000) (182,000)
Permanent differences (47,000) (6,000) 12,000
Utilization of net operating losses -- (575,000) --
Other -- -- (16,000)
----------- ----------- -----------
$ (267,000) $ 49,000 $ 286,000
=========== =========== ===========
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets and liabilities were as follows
as of December 31:
2005 2004
------------ ------------
Deferred tax assets:
Fixed assets depreciation $ -- $ 282,000
Allowance for doubtful accounts 44,000 12,000
Inventory reserves and uniform capitalization 770,000 393,000
Other accrued liabilities 361,000 179,000
Deferred compensation 118,000 122,000
Alternative minimum tax credit carryforwards 142,000 142,000
Capital loss carryforwards 136,000 136,000
Net operating loss carryforwards 13,122,000 11,740,000
------------ ------------
Total deferred tax assets 14,693,000 13,006,000
Valuation allowance for deferred tax assets (13,307,000) (12,654,000)
------------ ------------
Deferred tax assets (current) 1,386,000 352,000
------------ ------------
F-25
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
2005 2004
------------ ------------
Deferred tax liabilities:
Depreciation (51,000) --
Intangible assets other than goodwill (1,057,000) (1,400,000)
------------ ------------
Deferred tax liabilities (long-term) (1,108,000) (1,400,000)
------------ ------------
Net deferred tax assets (liabilities) $ 278,000 $ (1,048,000)
============ ============
As of December 31, 2005, the Company had recorded $1,386,000 of net
deferred tax assets and $1,108,000 of deferred tax liabilities. The Company had
federal and state net operating loss carryforwards of approximately $38,979,000
and $36,056,000 as of December 31, 2005 and 2004, respectively, that expire at
various dates through 2023. As of December 31, 2005 and 2004, the Company
recorded a valuation allowance on the deferred tax asset. Management believes
sufficient uncertainty exists regarding the realizability of the deferred tax
asset items and that a valuation allowance is required. Management considers
projected future taxable income and tax planning strategies in making this
assessment. For the years ended December 31, 2005 and 2004, management recorded
reduction in its valuation allowances of $555,000 and $179,000, respectively,
based on the domestic book income in 2005 and 2004 and projections for future
taxable income over periods that the deferred assets are deductible. Management
believes that it is more likely than not that the Company will realize the
benefits of its net deferred tax asset. The amount of the deferred tax assets
considered realizable, however, could materially change in the near future if
estimates of future taxable income during the carryforward period are changed.
As a result of the merger in 1997 of the privately held EMRISE
Electronics with a wholly-owned, newly formed subsidiary of the Company, with
EMRISE Electronics as the surviving subsidiary, the Company experienced a more
than 50% ownership change for federal income tax purposes. As a result, an
annual limitation will be placed upon the Company's ability to realize the
benefit of a significant portion of its federal net operating loss and credit
carryforwards. The Company currently has $9,606,000 of net operating losses
not subject to annual limitation, as these losses were generated subsequent
to the 50% change in ownership. The remaining net operating loss of $29,373,000
generated before the change in ownership is subject to the annual limitation.
Of the $29,373,000 net operating loss carryforward subject to limitation,
approximately $276,000 per year is available to offset future federal
taxable income.
F-26
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
(11) EARNINGS PER SHARE
The following table illustrates the computation of basic and diluted
earnings per share:
2005 2004 2003
------------ ------------ ------------
NUMERATOR:
Net income $ 1,288,000 $ 1,480,000 $ 1,161,000
Less: accretion of the excess of the redemption value
over the carrying value of redeemable preferred stock -- -- (4,000)
------------ ------------ ------------
Income attributable to common stockholders $ 1,288,000 $ 1,480,000 $ 1,157,000
============ ============ ============
DENOMINATOR:
Weighted average number of common shares outstanding
during the period - basic 37,253,000 24,063,000 22,567,000
Incremental shares from assumed conversions of warrants,
options and preferred stock 1,195,000 776,000 1,244,000
------------ ------------ ------------
Adjusted weighted average shares - diluted 38,448,000 24,839,000 23,811,000
============ ============ ============
Basic earnings per share $ 0.03 $ 0.06 $ 0.05
============ ============ ============
Diluted earnings per share $ 0.03 $ 0.06 $ 0.05
============ ============ ============
The following table shows the common stock equivalents that were
outstanding as of December 31, 2005 and 2004 but were not included in the
computation of diluted earnings per share because the options' or warrants'
exercise price was greater than the average market price of the common shares
and, therefore, the effect would be anti-dilutive:
Number Exercise Price
of Shares Per Share
--------- ---------------
Anti-dilutive common stock options:
As of December 31, 2005 686,000 $2.00
As of December 31, 2004 1,027,000 $1.00 to $3.44
Anti-dilutive common stock warrants:
As of December 31, 2005 3,886,000 $1.73 to $2.00
As of December 31, 2004 326,000 $1.00 to $1.30
(12) COMMITMENTS AND CONTINGENCIES
LEASES
The Company conducts most of its operations from leased facilities
under operating leases that expire at various dates through 2013. The leases
generally require the Company to pay all maintenance, insurance and property tax
costs and contain provisions for rent increases. Total rent expense, net of
sublease income, for 2005, 2004 and 2003 was approximately $885,000, $1,070,000
and $909,000, respectively.
F-27
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
The future minimum rental payments required under operating leases that
have initial or remaining noncancelable lease terms in excess of one year
(including the related party lease discussed in Note 16) are as follows:
Year Ending December 31, Amount
------------------------ ------------
2006 $ 1,202,000
2007 1,140,000
2008 745,000
2009 551,000
2010 430,000
2011 and thereafter 162,000
------------
Total $ 4,230,000
============
LITIGATION
The Company is not currently a party to any material legal proceedings.
However, the Company and its subsidiaries are, from time to time, involved in
legal proceedings, claims and litigation arising in the ordinary course of
business. While the amounts claimed may be substantial, the ultimate liability
cannot presently be determined because of considerable uncertainties that exist.
Therefore, it is possible the outcome of such legal proceedings, claims and
litigation could have a material effect on quarterly or annual operating results
or cash flows when resolved in a future period. However, based on facts
currently available, management believes such matters will not have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows.
EMPLOYEE BENEFIT PLANS
Effective October 1, 1998, the Company instituted a defined
contribution plan ("401(k) Plan") covering the majority of its U.S. domestic
employees. Participants may make voluntary pretax contributions to such plans up
to the limit as permitted by law. Company contributions to the 401(k) plan are
discretionary. The Company made contributions of $36,000, $25,000 and $20,000 to
the 401(k) Plan for the years ended December 31, 2005, 2004 and 2003,
respectively.
The Company's subsidiary in France has a defined benefit pension plan.
The plan is an unfunded plan. As of the December 31, 2005 and 2004 measurement
dates, the status of the defined benefit pension plan was as follows:
2005 2004
------------ ------------
Projected benefit obligation $ 163,000 $ 178,000
Fair value of plan assets $ -- $ 12,000
Unfunded accumulated benefit $ 155,000 $ 166,000
Accumulated benefit obligation $ 163,000 $ 122,000
Employer contributions $ -- $ 19,000
Participant contributions $ -- $ --
Benefits paid $ 18,000 $ 19,000
F-28
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
Contributions to be paid to the plan during the year ended December 31,
2006 are estimated to be none.
Weighted average assumptions used to determine pension benefit
obligations at December 31, 2005 and 2004 were as follows:
2005 2004
------------ ------------
Discount rate 4.5% 4.5%
Expected return on plan assets 4.0% --
Rate of compensation increase -- 4.5%
The components of the net periodic pension costs for the years ended
December 31, 2005 and 2004 were as follows:
2005 2004
------------ ------------
Service cost $ 11,000 $ 11,000
Interest cost 7,000 7,000
Expected return on plan assets -- --
Amortization of transition asset,
prior service cost and
actuarial loss -- --
------------ ------------
Net periodic benefit cost $ 18,000 $ 18,000
============ ============
The following table sets forth the changes in benefit obligation for
the years ended December 31, 2005 and 2004:
2005 2004
------------ ------------
Change in benefit obligations:
Benefit obligation at beginning of year $ 122,000 $ 96,000
Service cost 11,000 11,000
Interest cost 7,000 7,000
Benefits paid 18,000 (19,000)
Contributions -- 19,000
Effect of foreign currency translation 5,000 8,000
------------ ------------
Benefit obligation at end of year $ 163,000 $ 122,000
============ ============
EXECUTIVE MANAGEMENT
Effective January 1, 2001, the Company and Carmine T. Oliva, its Chief
Executive Officer, entered into an employment agreement that provided for an
annual base salary of $250,000, with annual merit increases, an initial term of
five years, two renewal periods of two years each, and severance pay of at least
three years' salary during the initial period or at least two years' salary
during a renewal period. On February 24, 2006, the Company and Mr. Oliva entered
into a new two-year employment agreement effective as of January 1, 2006. The
new employment agreement provides for an annual base salary of $350,000 and
severance of three times his annual base salary, net of taxes, under certain
circumstances.
F-29
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
Effective July 2, 2001, the Company and Randolph D. Foote, its Senior
Vice President and Chief Financial Officer, entered into an employment agreement
that provides for an initial annual salary of $130,000, an initial term of three
years, two renewal periods of one year each, and severance pay of at least one
years' salary. On February 24, 2006, the Company and Mr. Foote entered into a
new two-year employment agreement effective as of January 1, 2006. The new
employment agreement provides for an annual base salary of $175,000 and
severance of one and one-half times his annual base salary, net of taxes, under
certain circumstances.
Effective July 2, 2001, the Company and Graham Jefferies, Managing
Director of EEL and Executive Vice President and Chief Operating Officer of the
Company, entered into an employment agreement that provides for an initial
annual salary of 100,000 British pounds sterling (approximately $141,000 at the
then current exchange rates), an initial term of three years, two renewal
periods of one year each, and severance pay of at least one years' salary. On
February 24, 2006, the Company and Mr. Jefferies entered into a new three-year
employment agreement effective as of January 1, 2006. The new employment
agreement provides for an annual base salary of 152,800 British pounds sterling
per year (approximately U.S. $263,350 as of January 1, 2006) and severance of
twice his annual base salary, net of taxes, under certain circumstances.
(13) SEGMENT AND MAJOR CUSTOMER INFORMATION
The Company has two reportable segments: electronic components and
communications equipment. The electronic components segment operates in the
U.S., European and Asian markets and designs, manufactures and markets digital
switches and power supplies. The communications equipment segment operates
principally in the U.S. and European markets and designs, manufactures and
distributes voice and data transmission and networking equipment and
communications test instruments.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies. The Company evaluates
performance based upon profit or loss from operations before income taxes
exclusive of nonrecurring gains and losses. The Company accounts for
intersegment sales at prices negotiated between the individual segments.
The Company's reportable segments are comprised of operating entities
offering the same or similar products to similar customers. Each segment is
managed separately because each business has different customers and different
design and manufacturing and marketing strategies.
Each segment has business units or components as described in paragraph
30 of SFAS No. 142. Each component has discrete financial information and a
management structure. Following is a description of the Company's segment and
component structure as of December 31, 2005:
Reporting Units Within Electronic Components Segment:
-----------------------------------------------------
o EMRISE Electronics - Rancho Cucamonga, California: Digitran
Division- digital and rotary switches, and electronic subsystem
assemblies for defense and aerospace applications and keypads
F-30
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
o EMRISE Electronics - Monrovia, California: XCEL Circuits Division
- printed circuit boards mostly for intercompany sales
o RO - Sunnyvale, California manufacturer of standard power supplies
using proprietary technology.
o XCEL Japan Ltd. - Tokyo, Japan: Reseller of Digitran switches and
other third party electronic components
o EEL - Ashford, Kent, England: Power supplies and conversion for
defense and aerospace applications; this reporting unit also
includes XPS and Pascall.
Reporting Units Within Communications Equipment Segment:
-------------------------------------------------------
o CXR Telcom division of CXR Larus Corporation - San Jose,
California: Telecommunications test equipment for the field and
central office applications
o Larus division of CXR Larus Corporation - San Jose, California:
Telecommunications synchronous timing devices and network access
equipment
o CXR-Anderson Jacobson - Abondant, France: network access and modem
equipment
As described in Note 16, the Company acquired PEHL and Pascall in March
2005. These two entities are being included in EEL reporting unit of the
electronic components segment.
F-31
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
Selected financial data for each of the Company's operating segments is
shown below.
2005 2004 2003
------------ ------------ ------------
Sales to external customers
Electronic components $ 25,687,000 $ 15,262,000 $ 16,168,000
Communications equipment 15,359,000 14,599,000 9,351,000
------------ ------------ ------------
Total $ 41,046,000 $ 29,861,000 $ 25,519,000
============ ============ ============
Interest expense
Electronic components $ 181,000 $ 180,000 $ 247,000
Communications equipment 274,000 250,000 162,000
------------ ------------ ------------
Total $ 455,000 $ 430,000 $ 409,000
============ ============ ============
Depreciation and amortization
Electronic components $ 674,000 $ 91,000 $ 72,000
Communications equipment 241,000 126,000 65,000
------------ ------------ ------------
Total $ 915,000 $ 217,000 $ 137,000
============ ============ ============
Segment profits
Electronic components $ 3,191,000 $ 2,612,000 $ 3,590,000
Communications equipment 544,000 1,733,000 74,000
------------ ------------ ------------
Total $ 3,735,000 $ 4,345,000 $ 3,664,000
============ ============ ============
Segment assets
Electronic components $ 25,144,000 $ 8,435,000 $ 9,466,000
Communications equipment 16,358,000 16,313,000 6,969,000
------------ ------------ ------------
Total $ 41,502,000 $ 24,748,000 $ 16,435,000
============ ============ ============
F-32
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
GOODWILL AND OTHER INTANGIBLE ASSETS BY SEGMENT AS OF DECEMBER 31, 2005
Covenant
Trademarks Technology Customer Not to
and Acquired-- Relationships-- Compete-- Backlog-- Patents in
Goodwill -- Trade Names -- 10-Year 10-Year 3-Year 2-Year Progress--
Not Not Life Life Life Life Not
Amortizable Amortizable Amortizable Amortizable Amortizable Amortizable Amortizable
----------- ----------- ----------- ----------- ----------- ----------- -----------
Gross cost
----------
Electronic components $ 6,702,000 $ 813,000 $ 484,000 $ 200,000 $ 200,000 $ 200,000 $ 52,000
Communications equipment 6,428,000 750,000 1,150,000 200,000 -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total $13,130,000 $ 1,563,000 $ 1,634,000 $ 400,000 $ 200,000 $ 200,000 $ 52,000
=========== =========== =========== =========== =========== =========== ===========
Accumulated amortization
------------------------
Electronic components $ 192,000 $ -- $ 16,000 $ 7,000 $ 50,000 $ 75,000 $ --
Communications equipment 872,000 -- 172,000 30,000 -- -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total $ 1,064,000 $ -- $ 188,000 $ 37,000 $ 50,000 $ 75,000 $ --
=========== =========== =========== =========== =========== =========== ===========
Carrying value
--------------
Electronic components $ 6,510,000 $ 813,000 $ 468,000 $ 193,000 $ 150,000 $ 125,000 $ 52,000
Communications equipment 5,556,000 750,000 978,000 170,000 -- -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total $12,066,000 $ 1,553,000 $ 1,446,000 $ 383,000 $ 150,000 $ 125,000 $ 52,000
=========== =========== =========== =========== =========== =========== ===========
F-33
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
GOODWILL AND OTHER INTANGIBLE ASSETS BY SEGMENT AS OF DECEMBER 31, 2004
Trademarks Technology Customer
and Acquired-- Relationships--
Goodwill -- Tradenames -- 10-Year 10-Year
Not Not Life Life
Amortizable Amortizable Amortizable Amortizable
------------ ------------ ------------ ------------
Gross cost
Electronic components $ 1,297,000 $ -- $ -- $ --
Communications equipment 5,668,000 2,800,000 500,000 300,000
------------ ------------ ------------ ------------
Total $ 6,965,000 $ 2,800,000 $ 500,000 $ 300,000
============ ============ ============ ============
Accumulated amortization
------------------------
Electronic components $ 212,000 $ -- $ -- $ --
Communications equipment 872,000 -- 25,000 15,000
------------ ------------ ------------ ------------
Total $ 1,084,000 $ -- $ 25,000 $ 15,000
============ ============ ============ ============
Carrying value
--------------
Electronic components $ 1,085,000 $ -- $ -- $ --
Communications equipment 4,796,000 2,800,000 475,000 285,000
------------ ------------ ------------ ------------
Total $ 5,881,000 $ 2,800,000 $ 475,000 $ 285,000
============ ============ ============ ============
F-34
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
CHANGES IN GOODWILL BY SEGMENT
Electronic Communications
Components Equipment Total
------------ ------------ ------------
Balance at January 1, 2003 $ 914,000 $ 1,432,000 $ 2,346,000
Goodwill acquired -- -- --
Impairment -- -- --
Foreign currency translation 101,000 -- 101,000
------------ ------------ ------------
Balance December 31, 2003 $ 1,015,000 $ 1,432,000 $ 2,447,000
============ ============ ============
Balance at January 1, 2004 $ 1,015,000 $ 1,432,000 $ 2,447,000
Goodwill acquired -- 3,363,000 3,363,000
Impairment -- -- --
Foreign currency translation 70,000 1,000 71,000
------------ ------------ ------------
Balance December 31, 2004 $ 1,085,000 $ 4,796,000 $ 5,881,000
============ ============ ============
Balance at January 1, 2005 $ 1,085,000 $ 4,796,000 $ 5,881,000
Goodwill acquired or reclassed from other intangibles 5,930,000 760,000 6,690,000
Impairment -- -- --
Foreign currency translation (505,000) -- (505,000)
------------ ------------ ------------
Balance December 31, 2005 $ 6,510,000 $ 5,556,000 $ 12,066,000
============ ============ ============
F-35
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
The following is a reconciliation of the reportable segment revenues,
profit or loss and assets to the Company's consolidated totals.
2005 2004 2003
------------ ------------ ------------
Net sales
---------
Total sales for reportable segments $ 41,046,000 $ 29,861,000 $ 25,519,000
Elimination of intersegment sales -- -- --
------------ ------------ ------------
Total consolidated net sales $ 41,046,000 $ 29,861,000 $ 25,519,000
============ ============ ============
Income before income taxes
--------------------------
Total income for reportable segments $ 3,735,000 $ 4,345,000 $ 3,656,000
Unallocated amounts:
General corporate expenses (2,714,000) (2,816,000) (2,209,000)
------------ ------------ ------------
Consolidated income before income taxes $ 1,021,000 $ 1,529,000 $ 1,447,000
============ ============ ============
Assets
------
Total assets for reportable segments $ 41,502,000 $ 24,748,000 $ 16,435,000
Other assets 2,959,000 338,000 734,000
------------ ------------ ------------
Total consolidated assets $ 44,461,000 $ 25,086,000 $ 17,169,000
============ ============ ============
Interest expense
----------------
Interest expense for reportable segments $ 455,000 $ 430,000 $ 409,000
Other interest expense -- 3,000 7,000
------------ ------------ ------------
Total interest expense $ 455,000 $ 433,000 $ 416,000
============ ============ ============
Depreciation and amortization
-----------------------------
Depreciation and amortization expense
for reportable segments $ 915,000 $ 217,000 $ 185,000
Other depreciation and amortization expense 49,000 70,000 64,000
------------ ------------ ------------
Total depreciation and amortization $ 964,000 $ 287,000 $ 249,000
============ ============ ============
F-36
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
A summary of the Company's net sales and identifiable assets by
geographical area follows:
2005 2004 2003
----------- ----------- -----------
Net sales:
----------
United States $15,773,000 $12,745,000 $ 7,971,000
Japan 1,271,000 935,000 838,000
France 6,657,000 7,016,000 6,627,000
United Kingdom 17,385,000 9,165,000 10,083,000
----------- ----------- -----------
$41,046,000 $29,861,000 $25,519,000
=========== =========== ===========
Long-lived assets:
------------------
United States $ 734,000 $ 440,000 $ 117,000
Japan 7,000 11,000 16,000
France 101,000 142,000 107,000
United Kingdom 1,231,000 316,000 82,000
----------- ----------- -----------
$ 2,073,000 $ 909,000 $ 322,000
=========== =========== ===========
Sales and purchases between geographic areas have been accounted for on
the basis of prices set between the geographic areas, generally at cost plus
40%. Identifiable assets by geographic area are those assets that are used in
the Company's operations in each location. Net sales by geographic area have
been determined based upon the country from which the product was shipped.
One customer in the electronic components segment accounted for 10% or
more of net sales during 2005, 2004 and 2003.
(14) NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4,"
SFAS No. 151 clarifies that abnormal inventory costs such as costs of idle
facilities, excess freight and handling costs, and wasted materials (spoilage)
are required to be recognized as current period costs. The provisions of SFAS
No. 151 are effective for our fiscal 2006. The Company is currently evaluating
the provisions of SFAS No. 151 and does not expect that adoption will have a
material effect on its financial position, results of operations or cash flows.
On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment," which is a revision of SFAS No. 123. SFAS No. 123(R)
supersedes APB Opinion No. 25, and amends SFAS No. 95, "Statement of Cash
Flows." Generally, the approach in SFAS No. 123(R) is similar to the approach
described in SFAS 123. However, SFAS 123(R) generally requires share-based
payments to employees, including grants of employee stock options and purchases
under employee stock purchase plans, to be recognized in the statement of
operations based on their fair values. Pro forma disclosure of fair value
recognition will no longer be an alternative. SFAS No. 123(R) permits public
companies to adopt its requirements using one of two methods:
F-37
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
o Modified prospective method: Compensation cost is recognized
beginning with the effective date of adoption (a) based on the
requirements of SFAS No. 123(R) for all share-based payments
granted after the effective date of adoption and (b) based on the
requirements of SFAS No. 123 for all awards granted to employees
prior to the effective date of adoption that remain unvested on
the date of adoption.
o Modified retrospective method: Includes the requirements of the
modified prospective method described above, but also permits
restatement using amounts previously disclosed under the pro forma
provisions of SFAS No. 123 either for (a) all prior periods
presented or (b) prior interim periods of the year of adoption.
On April 14, 2005, the Commission announced that the SFAS No. 123(R)
effective transition date will be extended to annual periods beginning after
June 15, 2005. The Company is required to adopt this new standard on June 1,
2006, with early adoption permitted.
SFAS No. 123(R) also requires the benefits of tax deductions in excess
of recognized compensation expense to be reported as a financing cash flow,
rather than as an operating cash flow as prescribed under current accounting
rules. This requirement will reduce net operating cash flows and increase net
financing cash flows in periods after adoption. Total cash flow will remain
unchanged from what would have been reported under prior accounting rules. The
Company expects its expense for options outstanding as of December 31, 2005 will
be approximately $103,000 in 2006 and $29,000 in 2007 with the application of
SFAS 123(R).
As permitted by SFAS No. 123, the Company currently accounts for
share-based payments to employees using APB Opinion No. 25's intrinsic value
method. Consequently, the Company generally recognizes no compensation cost for
employee stock options under its employee stock option plans. Although the
adoption of SFAS No. 123(R)'s fair value method will have no adverse effect on
the Company's balance sheet or total cash flows, the adoption will affect the
Company's net income and diluted earnings per share. The actual effects of
adopting SFAS No. 123(R) will depend on numerous factors, including the amounts
of share-based payments granted in the future, the valuation model the Company
uses to value future share-based payments to employees and estimated forfeiture
rates. See Note 1 for the effect on reported net income and earnings per share
that would have occurred if the Company had accounted for its employee stock
options using the fair value recognition provisions of SFAS No. 123.
On December 16, 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets, an Amendment of APB Opinion No. 29, Accounting for
Nonmonetary Transactions." SFAS No. 153 addresses the measurement of exchanges
of nonmonetary assets and redefines the scope of transactions that should be
measured based on the fair value of the assets exchanged. SFAS No. 153 is
effective for nonmonetary asset exchanges beginning in our second quarter of
fiscal 2006. The Company does not believe its adoption of SPAS No. 153 will have
a material effect on its consolidated financial position, results of operations
or cash flows.
On June 7, 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections," a replacement of APB Opinion No. 20, "Accounting Changes,"
and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements."
SFAS No. 154 changes the requirements for the accounting for and reporting of a
change in accounting principle. Previously, most voluntary changes in accounting
principles required recognition of a cumulative effect adjustment within net
income of the period of the change. SFAS No. 154 requires retrospective
application to prior periods' financial statements, unless it is impracticable
to determine either the period-specific effects or the cumulative effect of the
change. SFAS No. 154 is effective for accounting changes made in fiscal years
beginning after December 15, 2005. However, SFAS No. 154 does not change the
transition provisions of any existing accounting pronouncements. The Company
does not believe our adoption of SFAS No. 154 will have a material effect on its
consolidated financial position, results of operations or cash flows.
F-38
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
On June 29, 2005, the FASB ratified Emerging Issues Task Force Issue
No. 05-06, "Determining the Amortization Period for Leasehold Improvements."
Issue No. 05-06 provides that the amortization period used for leasehold
improvements acquired in a business combination or purchased after the inception
of a lease shall be the shorter of (a) the useful life of the assets or (b) a
term that includes required lease periods and renewals that are reasonably
assured upon the acquisition or the purchase. The provisions of Issue No. 05-06
are effective on a prospective basis for leasehold improvements purchased or
acquired beginning in the Company's second quarter of fiscal 2006. The Company
does not believe the adoption of Issue No. 05-06 will have a material effect on
its consolidated financial position, results of operations or cash flows.
(15) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly operations for the years
ended December 31, 2005 and 2004 (in thousands, except for per share data).
2005
--------------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31
------- ------- ------- -------
Net sales $ 7,299 $ 9,962 $11,177 $12,608
Gross profit $ 3,112 $ 3,963 $ 4,866 $ 5,449
Net income (loss) $ (350) $ 21 $ 816 $ 801
Income available to common stockholders $ (350) $ 21 $ 816 $ 801
Earnings per share:
Basic $ (0.01) $ 0.02 $ 0.02 $ 0.02
======= ======= ======= =======
Diluted $ (0.01) $ 0.00 $ 0.02 $ 0.02
======= ======= ======= =======
2004
--------------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31
------- ------- ------- -------
Net sales $ 6,192 $ 6,432 $ 7,469 $ 9,768
Gross profit $ 2,747 $ 2,899 $ 3,230 $ 4,839
Net income $ 70 $ 369 $ 158 $ 883
Income available to common stockholders $ 70 $ 369 $ 158 $ 883
Earnings per share:
Basic $ 0.00 $ 0.02 $ 0.01 $ 0.04
======= ======= ======= =======
Diluted $ 0.00 $ 0.02 $ 0.01 $ 0.03
======= ======= ======= =======
F-39
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
(16) ACQUISITIONS
LARUS CORPORATION ACQUISITION
Pursuant to the terms of a Stock Purchase Agreement executed on July
13, 2004, the Company acquired all of the issued and outstanding common stock of
Larus Corporation. Larus Corporation was based in San Jose, California and
engaged in the manufacturing and sale of telecommunications products. Larus
Corporation had one wholly-owned subsidiary, Vista Labs, Incorporated ("Vista"),
which provided engineering services to Larus Corporation. Assets held by Larus
Corporation included intellectual property, cash, accounts receivable and
inventories owned by each of Larus Corporation and Vista.
The purchase price for the acquisition totaled $6,539,500 and consisted
of $1,000,000 in cash, the issuance of 1,213,592 shares of the Company's common
stock with a fair value of $1,000,000, $887,500 in the form of two short-term,
zero interest promissory notes that were repaid in 2004, $3,000,000 in the form
of two subordinated secured promissory notes, warrants to purchase up to an
aggregate of 150,000 shares of the Company's common stock at $1.30 per share,
and approximately $580,000 of acquisition costs. The number of shares of the
Company's common stock issued as part of the purchase price was calculated based
on the $0.824 per share average closing price of the Company's common stock for
the five trading days preceding the transaction. The warrants to purchase
150,000 shares of common stock were valued at $72,000 using a Black-Scholes
formula that included a volatility of 107.19%, an interest rate of 3.25%, a life
of three years and no assumed dividend.
In addition, the Company assumed $245,000 in accounts payable and
accrued expenses and entered into an above-market real property lease with the
sellers. This lease represents an obligation that exceeds the fair market value
by approximately $756,000 and is part of the acquisition accounting. The cash
portion of the acquisition purchase price was funded with proceeds from the
Company's credit facility with Wells Fargo Bank, N.A. and cash on-hand.
In determining the purchase price for Larus Corporation , the Company
took into account the historical and expected earnings and cash flow of Larus
Corporation, as well as the value of companies of a size and in an industry
similar to Larus Corporation, comparable transactions and the market for such
companies generally. The purchase price represented a significant premium over
the $1,800,000 recorded net worth of Larus Corporation's assets. In determining
this premium, the Company considered the Company's potential ability to refine
various Larus Corporation products and to use the Company's marketing resources
and status as a qualified supplier to qualify and market those products for sale
to large telecommunications companies. The Company believes that large
telecommunications companies desired to have an additional choice of suppliers
for those products and would be willing to purchase Larus Corporation's products
following some refinements. The Company also believes that if Larus Corporation
had remained independent, it was unlikely that it would have been able to
qualify to sell its products to the large telecommunications companies due to
its small size and lack of history selling to such companies. Therefore, Larus
Corporation had a range of value separate from the net worth it had recorded on
its books.
F-40
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
In conjunction with the Company's July 2004 acquisition of Larus
Corporation, the Company commissioned a valuation firm to determine what portion
of the purchase price should be allocated to identifiable intangible assets. The
study is complete and the intangible values are as follows: Larus trade name and
trademark are valued at $750,000 compared to the Company's initial estimate of
$2,800,000, and the technology and customer relationships are valued at
$1,350,000 as compared to the Company's initial estimate of $800,000. Goodwill
associated with the Larus Corporation acquisition totaled $4,043,000. The Larus
trade name and trademark were determined to have indefinite lives and therefore
are not being amortized but rather are being periodically tested for impairment.
The technology and customer relationships were both estimated to have ten-year
lives and, as a result, $162,000 of amortization expense was recorded and
charged to administrative expense in 2005.
The following table summarizes the unaudited assets acquired and
liabilities assumed in connection with this acquisition:
Amount
in Thousands
-------------
Current assets $ 2,460
Property, plant and equipment 90
Intangible assets other than goodwill 2,100
Goodwill 4,043
-------------
Total assets acquired 8,693
Current liabilities (450)
Deferred income taxes (815)
Unfavorable lease obligation and other
liabilities (888)
-------------
Total liabilities assumed (2,153)
-------------
Net assets acquired $ 6,540
=============
The intangible assets other than goodwill consist of non-amortizable
trade names with a carrying value of $750,000, and technology and customer
relationships with carrying values of $1,150,000 and $200,000, respectively,
that are amortizable over ten years.
Amortization for the intangibles subject to amortization as of December
31, 2005 is anticipated to be approximately $135,000 per year for each of the
next five years.
The following table summarizes, on an unaudited pro forma basis, the
combined results of operations of the Company and Larus Corporation, as though
the acquisition occurred as of January 1, 2003. The pro forma amounts give
effect to appropriate adjustments for interest expense and income taxes. The pro
forma amounts presented are not necessarily indicative of future operating
results (in thousands, except per share amounts):
Year Ended December 31,
-----------------------------
2004 2003
------------- ------------
Revenues $ 32,486 $ 31,376
Net income $ 1,720 $ 1,264
Earnings per share of common stock:
Basic $ 0.07 $ 0.06
============= ============
Diluted $ 0.07 $ 0.05
============= ============
F-41
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
PASCALL ACQUISITION
On March 1, 2005, the Company and EEL, a second-tier wholly-owned
subsidiary of the Company, entered into an agreement ("Purchase Agreement") for
EMRISE Electronics to acquire all of the issued and outstanding capital stock of
Pascall Electronic (Holdings) Limited ("PEHL"). The closing of the purchase
occurred on March 18, 2005. The Company loaned to EEL the funds that EEL used to
purchase PEHL. PEHL has one wholly-owned subsidiary, Pascall Electronics Limited
("Pascall"), which produces, designs, develops, manufactures and sells power
supplies and RF products for a broad range of applications, including in-flight
entertainment systems and military programs.
Under the Purchase Agreement, EEL purchased all of the outstanding
capital stock of PEHL, using funds loaned to EEL by the Company. The purchase
price for the acquisition initially totaled $9,669,000, subject to adjustments
as described below, and included a $5,972,000 cash payment to PEHL's former
parent, a $3,082,000 loan to PEHL and Pascall and approximately $615,000 in
acquisition costs, as described below.
The initial portion of the purchase price was 3,100,000 British pounds
sterling (approximately U.S. $5,972,000 based on the exchange rate in effect on
March 18, 2005). The initial portion of the purchase price was paid in cash at
the closing and was subject to upward or downward adjustment on a pound for
pound basis to the extent that the value of the net assets of Pascall as of the
closing date was greater or less than 2,520,000 British pounds sterling.
On May 6, 2005, the Company submitted to Intelek Properties Limited
(which is a subsidiary of Intelek PLC, a London Stock Exchange public limited
company, and is the former parent of PEHL), the Company's calculation of the
value of the net assets of Pascall as of the closing date, which the Company
believed slightly exceeded 2,520,000 British pounds sterling. Ultimately, the
parties determined that the value of the net assets of Pascall at the closing
date was 2,650,000 British pounds sterling. As a result, the Company paid to
Intelek Properties Limited 130,000 British pounds sterling (approximately U.S.
$236,000 based on the exchange rate in effect at June 30, 2005) on August 1,
2005 to satisfy this obligation. The purchase price is also subject to downward
adjustments for any payments that may be made to EEL under indemnity, tax or
warranty provisions of the Purchase Agreement. EEL loaned to PEHL and Pascall at
the closing 1,600,000 British pounds sterling (approximately U.S. $3,082,000
based on the exchange rate in effect on March 18, 2005) in accordance with the
terms of a Loan Agreement entered into by those entities at the closing. The
loaned funds were used to immediately repay outstanding intercompany debt owed
by PEHL and Pascall to the seller.
The Company and Intelek PLC have agreed to guarantee payment when due
of all amounts payable by EEL and Intelek Properties Limited, respectively,
under the Purchase Agreement. The Company and EEL agreed to underwrite the
guaranty that Intelek Properties Limited has given to Pascall's landlord with a
guaranty by the Company, and EEL has agreed to indemnify Intelek Properties
Limited and its affiliates for damages they suffer as a result of any failure to
obtain the release of the guarantee of the 17-year lease that commenced in May
1999. The leased property is a 30,000 square foot administration, engineering
and manufacturing facility located off the south coast of England.
F-42
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
Intelek Properties Limited has agreed to various restrictive covenants
that apply for various periods following the closing. The covenants include
non-competition with Pascall's business, noninterference with Pascall's
customers and suppliers, and non-solicitation of Pascall's employees. In
conjunction with the closing, Intelek Properties Limited, Intelek PLC, EEL, and
the Company entered into a Supplemental Agreement dated March 18, 2005. The
Supplemental Agreement provides, among other things, that an interest-free
bridge loan of 200,000 British pounds sterling (approximately U.S. $385,000
based on the exchange rate in effect on March 17, 2005) that was made by the
seller to Pascall on March 17, 2005 would be repaid by Pascall by March 31,
2005. EEL agreed to ensure that Pascall had sufficient funds to repay the bridge
loan. The bridge loan was repaid in full by Pascall on the March 31, 2005 due
date.
The following table summarizes the unaudited assets acquired and
liabilities assumed in connection with this acquisition, including $615,000 in
acquisition costs:
Dollars
in Thousands
------------
Current assets..................................... $ 6,196
Property, plant and equipment...................... 1,367
Intangibles, including goodwill.................... 5,534
------------
Total assets acquired.............................. 13,097
Current liabilities................................ (2,863)
Other liabilities.................................. (80)
------------
Total liabilities assumed (2,943)
------------
Net assets acquired................................ $ 10,154
============
The purchase price represented a significant premium over the recorded
not worth of Pascall's assets. In determining to pay this premium, the Company
considered various factors, including the opportunities that Pascall presented
for the Company to add RF components and RF subsystem assemblies to the
Company's product offerings, the marketing resources of Pascall in the United
States power supplies market, and expected synergies between Pascall's business
and the Company's existing power supply business.
In conjunction with the acquisition of Pascall, the Company
commissioned a valuation firm to determine what portion of the purchase price
should be allocated to identifiable intangible assets. The Company considered
whether the acquisition included various types of identifiable intangible
assets, including trade names, trademarks, patents, covenants not to compete,
customers, workforce, technology and software. The Company has recorded the
value of the trade name and trademark at $500,000, covenants not to compete that
were obtained from Pascall's former affiliates at $200,000, amortizable over
three years and backlog at $200,000 amortizable over two years. The Company
believes that no other identifiable intangible assets of value were acquired. No
patents were acquired. The Company has not ascribed any value to Pascall's
customer base because the Company's United Kingdom subsidiary, XPS already was
selling to Pascall's key customers. Pascall's workforce does not hold any
special skills that are not readily available from other sources. The Company
did not identify any valuable completed technology that was acquired, because
Pascall utilizes non-proprietary technology to produce custom power supplies
pursuant to customer specifications. Pascall does not develop or design software
and does not own software of any material value.
F-43
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
In accordance with the valuation study and taking into consideration
post-closing adjustments, the Company has recorded goodwill associated with the
Pascall acquisition of $4,634,000 compared to the initial goodwill recorded of
$4,571,000.
RO ASSOCIATES ACQUISITION
On September 2, 2005, the Company's wholly-owned subsidiary, EMRISE
Electronics, entered into a stock purchase agreement dated effective as of
August 31, 2005 to acquire RO, a California corporation. Effective September 28,
2005, EMRISE Electronics entered into an amendment to the stock purchase
agreement.
Pursuant to the terms of the stock purchase agreement, as amended,
EMRISE Electronics acquired all of the issued and outstanding shares of common
stock of RO. Prior to the acquisition, all of the common stock of RO was owned
by Robert H. Okada as Trustee of the Robert H. Okada Trust Agreement dated
February 11, 1992, and Sharon Vavro.
RO is based in Sunnyvale, California and designs and manufactures power
conversion products for telecom, industrial, commercial, and military
applications. As a result of the acquisition, EMRISE Electronics acquired all of
the assets and liabilities of RO, including the intellectual property, cash,
accounts receivable and inventories owned by RO. EMRISE Electronics intends to
use these acquired assets for the same purpose for which they were used by RO.
The purchase price consisted of $2,400,000 in cash paid at closing and
an additional $600,000 in cash payable in two equal installments on October 6,
2005 and March 31, 2006. The acquisition purchase price was funded with cash
on-hand. The purchase price is subject to adjustment based on the value of the
stockholders' equity, accounts receivable, accounts payable, cash on hand and
net inventory of RO, as determined by the consolidated, unaudited balance sheet
as of August 31, 2005, prepared in accordance with accounting principles
generally accepted in the United States of America. In addition, concurrently
with the closing of the acquisition of RO, EMRISE Electronics paid in full all
then existing credit facilities of RO in the aggregate amount of $1,602,000.
In determining the purchase price for RO, EMRISE Electronics considered
the historical and expected earnings and cash flow of RO, as well as the value
of companies of a size and in an industry similar to RO, comparable transactions
and the market for such companies generally. The purchase price represented a
premium of approximately $2,275,000 over the $2,340,000 recorded net worth of
the assets of RO. In determining this premium, EMRISE Electronics considered the
synergistic and strategic advantages provided by having a United States-based
power conversion manufacturer and the value of the goodwill, customer
relationships and technology of RO. Goodwill associated with the RO acquisition
totaled approximately $1,376,000. EMRISE intends to commission a valuation firm
to determine what portion of the purchase price should be allocated to
identifiable intangible assets. EMRISE has estimated that RO's technology is
valued at approximately $484,000, its trademarks are valued at $300,000 and its
customer relationships are valued at $200,000. The valuation of the identified
intangible assets is expected to be completed by May 2006 and could result in
changes to the value of these identified intangible assets and corresponding
changes to the value of goodwill. However, EMRISE does not believe these changes
will be material to EMRISE's consolidated financial position or results of
operations.
f-44
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
In connection with the execution of the stock purchase agreement,
EMRISE Electronics executed a lease agreement with Caspian Associates for the
lease of 25,700 square feet of a 30,700 square feet building located at 246
Caspian Drive, Sunnyvale, California. The lease provides for a two-year term
commencing on September 1, 2005 and ending on August 31, 2007, at a base rent of
$9,210 per month. Additionally, the lease provides for an extension of the lease
term for an additional three years, to August 31, 2010, if RO achieves net sales
of at least $14,500,000 and cumulative gross profit of at least $3,987,500. If
RO achieves the net sales and cumulative gross profit targets, the monthly base
rent for the facility will be increased to the fair market value as of the first
day of the next calendar month. The facility will continue to be used for the
design, manufacture and sale of power conversion products.
In connection with the stock purchase agreement, EMRISE Electronics
also executed an employment agreement with Richard Okada, effective as of
September 1, 2005, to serve as president of RO. Mr. Okada will receive an annual
base salary of $115,000 for the two-year tern of the employment agreement. In
addition, Mr. Okada is entitled to receive an incentive bonus based upon
performance criteria to be determined in the future. In connection with Mr.
Okada's employment agreement, EMRISE granted Mr. Okada an incentive stock option
under EMRISE's 2000 Stock Option Plan to purchase up to 50,000 shares of
EMRISE's common stock at an exercise price of $1.35 per share. This option vests
50% on September 1, 2006 and 50% on September 1, 2007. The option expires on
August 31, 2015.
The following table summarizes the unaudited assets and liabilities
assumed in connection with this acquisition, including $65,000 in acquisition
costs:
Dollars
in Thousands
------------
Current assets $ 3,213
Property, plant and equipment 329
Intangibles, including goodwill 2,360
Other assets 66
------------
Total assets acquired 5,968
Current liabilities (943)
Other liabilities (393)
------------
Total liabilities assumed (1,336)
------------
Net assets acquired $ 4,632
============
F-45
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
PRO FORMA RESULTS OF OPERATIONS
The following table summarizes, on an unaudited pro forma basis, the
combined results of operations of the Company, Larus Corporation, Pascall and
RO, as though the Larus Corporation, Pascall and RO acquisitions occurred as of
January 1, 2004. The pro forma amounts give effect to appropriate adjustments
for interest expense and income taxes. The pro forma amounts presented are not
necessarily indicative of future operating results (in thousands, except per
share amounts).
Year Ended
December 31,
------------------------------
2005 2004
------------ -------------
Revenues $ 47,709 $ 52,991
Net income $ 1,171 $ 2,225
Earnings per share of common stock:
Basic $ 0.03 $ 0.06
============ =============
Diluted $ 0.03 $ 0.06
============ =============
(17) RELATED PARTY TRANSACTIONS
On July 13, 2004, the Company issued two promissory notes to the former
stockholders of Larus Corporation totaling $3,000,000 in addition to paying cash
and issuing shares of common stock and two zero interest short-term notes
totaling $887,500 that were repaid in 2004, in exchange for 100% of the common
stock of Larus Corporation (see Note 16). These notes are subordinated to the
Company's bank debt and are payable in 72 equal monthly payments of principal
totaling $41,667 per month plus interest at the 30-day LIBOR plus 5% with a
maximum interest rate of 7% during the first two years of the term of the notes,
8% during the third and fourth years, and 9% thereafter. At December 31, 2005,
the 30-day LIBOR was 4.54%.
Future maturities of notes payable to stockholders are as follows:
Year Ending
December 31,
-----------
2006 $ 500,000
2007 500,000
2008 500,000
2009 500,000
2010 250,000
------------
$ 2,250,000
============
Interest paid on these notes in 2005 and 2004 was $179,000 and $75,000,
respectively.
F-46
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
The Company entered into an above-market real property lease with the
sellers. This lease represents an obligation that exceeds the fair market value
by approximately $756,000. The lease term is for 7 years and expires on June 30,
2011. It is renewable for a 5-year term priced under market conditions. The base
rent is based on a minimum rent of $.90 per square foot per month, which is
$27,000 monthly or $324,000 per year, subject to monthly adjustments of the
interest rate based on the Federal Reserve Discount Rate that match the lessor's
variable interest rate mortgage payments on the building. The maximum increase
in any year is 1.5%, with a cumulative maximum increase of 8% over the life of
the lease. The increases apply to that portion of the rent that corresponds to
the interest portion of the lessor's mortgage. Lease payments paid to the
related parties during 2005 and 2004 totaled $378,000 and $171,000,
respectively. Future minimum lease payments under the operating lease payable to
the stockholders are included in Note 12.
The Company entered into a lease for the RO building commencing
September 1, 2005 through August 31, 2007 with Caspian Associates ("Caspian"), a
California general partnership. Richard Okada, who was President of RO prior to
the Company's acquisition and is currently the President of RO, is a general
partner of Caspian. The acquisition agreement provides for an increase from the
current favorable terms of the lease agreement based on certain financial
performance of RO over the period of the lease. If the financial performance is
met, the lease automatically extends to August 31, 2010 and is adjusted to the
market value at that time, otherwise it will terminate on August 31, 2007 and
convert to a month-to-month lease. The Company paid $37,000 on this lease in
2005. Future commitments on this lease are $111,000 in 2006 and $74,000 in 2007.
There are no guarantees by officers or fees paid to officers or loans
to or from officers.
(18) STOCK ISSUANCE
On January 5, 2005, the Company issued to 17 accredited record holders
in a private offering an aggregate of 12,503,500 shares of common stock at a
purchase price of $1.44 per share and five-year investor warrants to purchase up
to an additional 3,125,875 shares of our common stock at an exercise price of
$1.73 per share, for total proceeds of approximately $18,005,000. The Company
paid cash placement agent fees and expenses of approximately $961,000, and
issued five-year placement warrants to purchase up to an aggregate of 650,310
shares of common stock at an exercise price of $1.73 per share in connection
with the offering. The total warrants issued, representing 3,776,185 shares of
the Company's common stock, have an estimated value of $4,400,000. Additional
costs related to the financing include legal, accounting and consulting fees
that totaled approximately $984,000 through December 31, 2005 including
liquidated damages of $480,000 charged directly to equity as a return of capital
against the gross proceeds of the financing. The Company used a portion of the
proceeds from this financing to fund the acquisition of Pascall described in
Note 16. The Company used the remaining proceeds from this financing for
additional acquisitions and for investments in new products and enhancements to
existing products.
F-47
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (CONTINUED)
The Company agreed to register for resale the shares of common stock
issued to investors and the shares of common stock issuable upon exercise of the
investor warrants and placement warrants. The registration obligations require,
among other things, that a registration statement be declared effective no later
than June 4, 2005. The Company was unable to timely meet this obligation and
therefore paid to each investor liquidated damages equal to 1% of the amount
paid by the investor to the Company in the offering, which damage payments
totaled an aggregate of approximately $180,000. The Company also paid to the
investors liquidated damages totaling $300,000 for the period from June 5, 2005
through June 30, 2005, the date the registration statement was declared
effective. The Company also will be required to pay to each investor liquidated
damages for any future periods in which the Company is unable to maintain the
effectiveness of the registration in accordance with the requirements contained
in the registration rights agreement the Company entered into with the
investors. The liquidated damages would be, and the liquidated damages paid for
the period from June 5, 2005 through June 30, 2005 were, equal to 2% of the
amount paid by each investor for the common shares still owned by the investor
on each monthly anniversary of the date of the default that occurs prior to the
cure of the default, prorated on a daily basis for periods of default shorter
than one month. The maximum aggregate liquidated damages payable to any investor
will be equal to 10% of the aggregate amount paid by the investor for the shares
of the Company's common stock. Accordingly, the maximum aggregate penalty that
the Company would be required to pay under this provision is 10% of the
$18,005,000 initial purchase price of the common stock, which would be
approximately $1,801,000. Although the Company anticipates that it will be able
to meet its future registration obligations, it also anticipates that it will
have sufficient cash available to pay the maximum penalties if required.
F-48
EMRISE CORPORATION AND SUBSIDIARIES
CONSOLIDATED SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Additions Reserve
Balance at Charged to Deductions Acquired
Beginning of Costs and Write-offs of with Balance at
Description Year Expenses Accounts Acquisition End of Year
----------- ----------- ----------- ----------- ----------- -----------
Allowance for doubtful accounts:
Year ended December 31, 2005 $ 153,000 $ 151,000 $ (33,000) $ 108,000 $ 379,000
Year ended December 31, 2004 $ 161,000 $ -- $ (32,000) $ 24,000 $ 153,000
Year ended December 31, 2003 $ 130,000 $ 61,000 $ (30,000) $ -- $ 161,000
Allowance for inventory obsolescence:
Year ended December 31, 2005 $ 2,251,000 $ 1,403,000 $(1,150,000) $ 1,549,000 $ 4,053,000
Year ended December 31, 2004 $ 1,692,000 $ 1,116,000 $ (557,000) $ -- $ 2,251,000
Year ended December 31, 2003 $ 1,497,000 $ 924,000 $ (729,000) $ -- $ 1,692,000
F-49
INDEX TO EXHIBITS
EXHIBIT DESCRIPTION
NUMBER -----------
------
2.1 Stock Purchase Agreement dated July 13, 2004 between MicroTel
International Inc.; Noel C. McDermott; Warren P. Yost; Noel C.
McDermott, as Trustee of the Noel C. McDermott Revocable Living
Trust dated December 19, 1995; and Warren P. Yost and Gail A. Yost,
as Co-Trustees Under Declaration of Trust dated March 9, 1988 (1)
2.2 Agreement dated March 1, 2005 among Intelek Properties Limited, XCEL
Corporation Limited, Intelek PLC and EMRISE Corporation relating to
the sale and purchase of the outstanding capital shares of Pascall
Electronic (Holdings) Limited (13)
2.3 Supplemental Agreement dated March 18, 2005 among Intelek Properties
Limited, XCEL Corporation Limited, Intelek PLC and EMRISE
Corporation (13)
2.4 Loan Agreement dated March 18, 2005 among XCEL Corporation Limited,
Pascall Electronics Limited and Pascall Electronic (Holdings)
Limited (13)
2.5 Stock Purchase Agreement dated September 2, 2005 between EMRISE
Electronics Corporation, a New Jersey corporation, Robert H. Okada,
as Trustee of the Robert H. Okada Trust Agreement dated February 11,
1992, and Sharon Vavro, an individual (16)
2.6 Amendment No. 1 dated effective as of September 28, 2005 to Stock
Purchase Agreement dated September 2, 2005 between EMRISE
Electronics Corporation, a New Jersey corporation, Robert H. Okada,
as Trustee of the Robert H. Okada Trust Agreement dated February 11,
1992, and Sharon Vavro, an individual (17)
3.1 Amended and Restated Certificate of Incorporation of EMRISE
Corporation filed with the Secretary of State of Delaware on May 9,
2005 (14)
3.2 Amended and Restated Bylaws adopted by the Board of Directors of the
Corporation on September 1, 2004 (3)
10.1 1993 Stock Option Plan (#) (5)
10.2 Employee Stock and Stock Option Plan (#) (6)
10.3 1997 Stock Incentive Plan (#) (7)
10.4 Amended and Restated 2000 Stock Option Plan (#) (9)
10.5 Form of Executive Officer and Director Indemnification Agreement
entered into between the Registrant and each of Carmine T. Oliva,
Robert B. Runyon, Laurence P. Finnegan, Jr., Otis W. Baskin, Richard
E. Mahmarian, Randolph D. Foote and Graham Jefferies (2)
10.6 Description of Retirement Account Matching Contributions (#) *
10.7 Credit Facility Letter Agreement dated June 1, 2004 between Wells
Fargo Bank, N.A., XET Corporation and CXR Telcom Corporation (10)
10.8 Revolving Line of Credit Note dated June 1, 2004 in the principal
amount of up to $3,000,000 made by XET Corporation and CXR Telcom
Corporation in favor of Wells Fargo Bank, N.A. (10)
10.9 Term Note dated June 1, 2004 in the principal amount of $150,000
made by XET Corporation and CXR Telcom Corporation in favor of Wells
Fargo Bank, N.A. (10)
10.10 Continuing Guaranty made by XET Corporation and CXR Telcom
Corporation in favor of Wells Fargo Bank, N.A. (10)
75
EXHIBIT DESCRIPTION
NUMBER -----------
------
10.11 Security Agreement Equipment made by XET Corporation in favor of
Wells Fargo Bank, N.A. (10)
10.12 Security Agreement Equipment made by CXR Telcom Corporation in favor
of Wells Fargo Bank, N.A. (10)
10.13 Continuing Security Agreement Rights to Payment and Inventory made
by XET Corporation in favor of Wells Fargo Bank, N.A. (10)
10.14 Continuing Security Agreement Rights to Payment and Inventory made
by CXR Telcom Corporation in favor of Wells Fargo Bank, N.A. (10)
10.15 Deed of Guarantee and Indemnity dated November 12, 2002 made by
MicroTel International Inc., XCEL Corporation Limited, Belix Power
Conversion Limited and Belix Wound Components Limited in favor of
Venture Finance PLC (11)
10.16 Advantage Facility dated November 12, 2002 between XCEL Power
Systems, Ltd. and Venture Finance PLC (11)
10.17 Cashflow Loan Agreement dated November 12, 2002 between XCEL Power
Systems, Ltd. and Venture Finance PLC (11)
10.18 Term Loan Agreement dated November 12, 2002 between XCEL Power
Systems, Ltd. and Venture Finance PLC (11)
10.19 Deed of Subordination dated November 12, 2002 between Venture
Finance PLC, MicroTel International Inc. and XCEL Corporation
Limited (11)
10.20 Agreement for the Purchase of Debts dated November 12, 2002 between
XCEL Power Systems, Ltd. and Venture Finance PLC (11)
10.21 Letter Agreement dated October 23, 2002 between XCEL Power Systems,
Ltd. and Venture Finance PLC regarding Amendments to Agreement for
the Purchase of Debts (11)
10.22 Credit Facility Agreement dated April 8, 2003, between IFN Finance
and CXR, S.A.S. (11)
10.23 English Summary of Credit Facility Agreement dated April 8, 2003
between IFN Finance and CXR, S.A.S. (12)
10.24 Subordinated Secured Promissory Note dated July 13, 2004 in the
principal amount of $1,681,318.68 made by MicroTel International
Inc. in favor of Noel C. McDermott Revocable Living Trust dated
December 19, 1995 (10)
10.25 Subordinated Secured Promissory Note dated July 13, 2004 in the
principal amount of $1,318,681.32 made by MicroTel International
Inc. in favor of Warren P. Yost and Gail A. Yost, as Co-Trustees
Under Declaration of Trust dated March 9, 1988 (10)
10.26 Pledge and Security Agreement dated July 13, 2004 between MicroTel
International Inc.; Noel C. McDermott, as Collateral Agent; Noel C.
McDermott, as Trustee of the Noel C. McDermott Revocable Living
Trust dated December 19, 1995; and Warren P. Yost and Gail A. Yost,
as Co-Trustees Under Declaration of Trust dated March 9, 1988 (10)
10.27 Intercreditor Agreement dated July 13, 2004 between MicroTel
International Inc.; Noel C. McDermott, as Trustee of the Noel C.
McDermott Revocable Living Trust dated December 19, 1995; and Warren
P. Yost and Gail A. Yost, as Co-Trustees Under Declaration of Trust
dated March 9, 1988 (10)
76
EXHIBIT DESCRIPTION
NUMBER -----------
------
10.28 Continuing Guarantee dated July 13, 2004 made by Larus Corporation
in favor of Noel C. McDermott, as Trustee of the Noel C. McDermott
Revocable Living Trust dated December 19, 1995, and Warren P. Yost
and Gail A. Yost, as Co-Trustees Under Declaration of Trust dated
March 9, 1988 (10)
10.29 Continuing Guarantee dated July 13, 2004 made by Vista Labs
Incorporated in favor of Noel C. McDermott, as Trustee of the Noel
C. McDermott Revocable Living Trust dated December 19, 1995, and
Warren P. Yost and Gail A. Yost, as Co-Trustees Under Declaration of
Trust dated March 9, 1988 (10)
10.30 Continuing Guarantee dated July 13, 2004 made by CXR Telcom in favor
of Noel C. McDermott, as Trustee of the Noel C. McDermott Revocable
Living Trust dated December 19, 1995, and Warren P. Yost and Gail A.
Yost, as Co-Trustees Under Declaration of Trust dated March 9, 1988
(10)
10.31 Security Agreement dated July 13, 2004 made by Larus Corporation in
favor of Noel C. McDermott, as Trustee of the Noel C. McDermott
Revocable Living Trust dated December 19, 1995, and Warren P. Yost
and Gail A. Yost, as Co-Trustees Under Declaration of Trust dated
March 9, 1988 (10)
10.32 Security Agreement dated July 13, 2004 made by Vista Labs
Incorporated in favor of Noel C. McDermott, as Trustee of the Noel
C. McDermott Revocable Living Trust dated December 19, 1995, and
Warren P. Yost and Gail A. Yost, as Co-Trustees Under Declaration of
Trust dated March 9, 1988 (10)
10.33 Security Agreement dated July 13, 2004 made by CXR Telcom in favor
of Noel C. McDermott, as Trustee of the Noel C. McDermott Revocable
Living Trust dated December 19, 1995, and Warren P. Yost and Gail A.
Yost, as Co-Trustees Under Declaration of Trust dated March 9, 1988
(10)
10.34 Lease agreement between the Registrant and Property Reserve Inc.
dated September 16, 1999 (8)
10.35 Lease agreement between XET, Inc. and Rancho Cucamonga Development
dated August 30, 1999 (8)
10.36 Commercial Lease dated July 13, 2004 between the Registrant, as
Tenant, and Noel C. McDermott and Warren P. Yost, as Landlord, for
the premises located at 894 Faulstich Court, San Jose, California
(10)
10.37 Executive Employment Agreement dated February 24, 2006 by and
between the Registrant and Carmine T. Oliva (#) (19)
10.38 Executive Employment Agreement dated February 24, 2006 by and
between the Registrant and Randolph D. Foote (#) (19)
10.39 Executive Employment Agreement dated February 24, 2006 by and
between the Company and Graham Jefferies (#) (19)
10.40 Securities Purchase Agreement dated December 29, 2004 among EMRISE
Corporation and the investors listed on an attachment thereto (4)
10.41 Registration Rights Agreement dated December 29, 2004 among EMRISE
Corporation and the investors who are parties to the Securities
Purchase Agreement dated December 29, 2004 (4)
77
EXHIBIT DESCRIPTION
NUMBER -----------
------
10.42 Form of Investor Warrant issued by EMRISE Corporation to the
investors who are parties to the Securities Purchase Agreement dated
December 29, 2004 (4)
10.43 Loan Agreement dated March 18, 2005 among XCEL Corporation Limited,
Pascall Electronics Limited and Pascall Electronic (Holdings)
Limited (13)
10.44 Form of Incentive Stock Option Agreement Under Amended and Restated
2000 Stock Option Plan (#) (15)
10.45 Form of Non-Qualified Stock Option Agreement Under Amended and
Restated 2000 Stock Option Plan (#) (15)
10.46 Credit Agreement between EMRISE Corporation and Wells Fargo Bank,
National Association dated as of August 25, 2005 (18)
10.47 Revolving Line of Credit Note between EMRISE Corporation and Wells
Fargo Bank, National Association dated as of August 25, 2005 (18)
10.48 Security Agreement between EMRISE Corporation and Wells Fargo Bank,
National Association dated as of August 25, 2005 (18)
10.49 Continuing Security Agreement between EMRISE Corporation and Wells
Fargo Bank, National Association dated as of August 25, 2005 (18)
10.50 Continuing Guaranty between CXR Telcom Corporation and Wells Fargo
Bank, National Association dated as of August 25, 2005 (18)
10.51 Continuing Guaranty between EMRISE Electronics Corporation and Wells
Fargo Bank, National Association dated as of August 25, 2005 (18)
10.52 Agreement and Acknowledgment of Security Interest by and among Wells
Fargo Bank, National Association, EMRISE Corporation and Noel C.
McDermott and Warren P. Yost dated as of August 25, 2005 (18)
10.53 Debt Purchase Agreement between Lloyds TSB Commercial Finance
Limited and Pascall Electronics Limited dated June 28, 2005 (18)
10.54 Debt Purchase Agreement between Lloyds TSB Commercial Finance
Limited and XCEL Power Systems Limited dated June 28, 2005 (18)
10.55 Loan Agreement between Lloyds TSB Commercial Finance Limited and
XCEL Power Systems Limited dated June 28, 2005 (18)
10.56 Business Loan Agreement between Lloyds TSB Bank PLC and XCEL
Corporation Limited dated June 30, 2005 (18)
10.57 Guaranty and Indemnity between XCEL Power Systems Limited, Pascall
Electronics Limited, Pascall Electronic (Holdings) Limited, Belix
Wound Components Limited and Lloyds TSB Commercial Finance Limited
dated June 21, 2005 (18)
78
EXHIBIT DESCRIPTION
NUMBER -----------
------
10.58 Deed of Guaranty and Indemnity between XCEL Corporation Limited and
Lloyds TSB Commercial Finance Limited dated June 21, 2005 (18)
10.59 Deed of Guarantee and Indemnity between Pascall Electronics Limited
and Lloyds TSB Commercial Finance Limited dated June 21, 2005 (18)
10.60 Deed of Guarantee and Indemnity between XCEL Corporation Limited and
Lloyds TSB Commercial Finance Limited dated June 21, 2005 (18)
10.61 Deed of Priorities between Lloyds TSB Commercial Finance Limited and
Lloyds TSB Bank PLC and Pascall Electronics Limited dated June 28,
2005 (18)
10.62 Deed of Priorities between Lloyds TSB Commercial Finance Limited and
Lloyds TSB Bank PLC and XCEL Power Systems Limited dated June 28,
2005 (18)
10.63 All Assets Debenture given by XCEL Power Systems Limited in favor of
Lloyds TSB Commercial Finance Limited dated June 28, 2005 (18)
10.64 First Amendment to Credit Agreement dated as of November 17, 2005 by
and between Emrise Corporation and Wells Fargo Bank, N.A.*
10.65 Description of Compensation of Directors (#) *
14.1 Amended and Restated Code of Business Conduct and Ethics *
14.2 Code of Business Ethics for CEO and Senior Financial Officers *
21 Subsidiaries of the Registrant *
23 Consent of Grant Thornton LLP, Independent Registered Public
Accounting Firm *
31.1 Certification of Principal Executive Officer required by
Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended, as adopted pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002 *
31.2 Certification of Principal Financial Officer required by
Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended, as adopted pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002 *
32 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. Section 350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 *
___________________
* Filed herewith.
(#) Management contract or compensatory plan, contract or arrangement
required to be filed as an exhibit.
(1) Filed as an exhibit to the Registrant's current report on Form 8-K for
July 13, 2004 and incorporated herein by reference.
(2) Filed as an exhibit to the Registrant's current report on Form 8-K for
December 8, 2004 and incorporated herein by reference.
(3) Filed as Appendix G to the Registrant's definitive proxy statement for
the Registrant's 2004 annual meeting of stockholders and incorporated
herein by reference.
79
(4) Filed as an exhibit to the Registrant's current report on Form 8-K for
December 29, 2004 and incorporated herein by reference.
(5) Filed as an exhibit to the Registrant's annual report on Form 10-K for
the year ended December 31, 2000 and incorporated herein by reference.
(6) Filed as an exhibit to the Registrant's definitive proxy statement for
the Registrant's annual meeting of stockholders held June 11, 1998 and
incorporated herein by reference.
(7) Filed as an exhibit to the Registrant's definitive proxy statement for
the special meeting of stockholders held January 16, 2001 and
incorporated herein by reference.
(8) Filed as an exhibit to the Registrant's interim report on Form 10-Q for
September 30, 1999 and incorporated herein by reference.
(9) Filed as an exhibit to the Registrant's quarterly report on Form 10-Q for
September 30, 2001 and incorporated herein by reference.
(10) Filed as an exhibit to the Registrant's quarterly report on Form 10-Q for
June 30, 2004 and incorporated herein by reference.
(11) Filed as an exhibit to the Registrant's quarterly report on Form 10-Q for
June 30, 2003 and incorporated herein by reference.
(12) Filed as an exhibit to amendment no. 1 to the Registrant's quarterly
report on Form 10-Q for June 30, 2003 and incorporated herein by
reference.
(13) Filed as an exhibit to the Registrant's current report on Form 8-K for
March 18, 2005 and incorporated herein by reference.
(14) Filed on May 19, 2005 as an exhibit to the Registrant's current report on
Form 8-K for May 6, 2005 and incorporated herein by reference.
(15) Filed as an exhibit to the Registrant's annual report on Form 10-K for
the year ended December 31, 2004 and incorporated herein by reference.
(16) Filed as an exhibit to the Registrant's current report on Form 8-K for
September 2, 2005 and incorporated herein by reference.
(17) Filed as an exhibit to amendment no. 1 to the Registrant's current report
on Form 8-K for September 2, 2005 and incorporated herein by reference.
(18) Filed as an exhibit to the Registrant's quarterly report on Form 10-Q for
September 30, 2005 and incorporated herein by reference.
(19) Filed as an exhibit to the Registrant's Form 8-K for February 24, 2006
and incorporated herein by reference.
80
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on this 6th day of
April, 2006.
EMRISE CORPORATION
By: /s/ Carmine T. Oliva
--------------------------------
Carmine T. Oliva
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE
--------- -------- ----
/s/ Carmine T. Oliva Chairman of the Board, President, April 6, 2006
-------------------------------- Chief Executive Officer (principal
Carmine T. Oliva executive officer) and Director
executive officer) and Director
/s/ Randolph D. Foote Chief Financial Officer (principal April 6, 2006
-------------------------------- accounting and financial officer)
Randolph D. Foote
/s/ Laurence P. Finnegan, Jr. Director April 6, 2006
--------------------------------
Laurence P. Finnegan, Jr.
/s/ Otis W. Baskin Director April 6, 2006
--------------------------------
Otis W. Baskin
/s/ Richard E. Mahmarian Director April 6, 2006
--------------------------------
Richard E. Mahmarian
81
EXHIBITS ATTACHED TO THIS REPORT
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.6 Description of Retirement Account Matching Contributions
10.64 First Amendment to Credit Agreement dated as of November 17, 2005
by and between Emrise Corporation and Wells Fargo Bank, N.A.
10.65 Description of Compensation of Directors
14.1 Amended and Restated Code of Business Conduct and Ethics
14.2 Code of Business Ethics for CEO and Senior Financial Officers
21 Subsidiaries of the Registrant
23 Consent of Grant Thornton LLP, Independent Registered Public
Accounting Firm
31.1 Certification of Principal Executive Officer required by
Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended, as adopted pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
31.2 Certification of Principal Financial Officer required by
Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended, as adopted pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief
Financial Officer Pursuant to 18 U.S.C. Section 350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002